As discussed in this module, it is important to have performance measures to eva
ID: 2502293 • Letter: A
Question
As discussed in this module, it is important to have performance measures to evaluate managers as they control resources and invest in assets for the company. Describe how you could use different variances (actual to standard) to evaluate performance. Additionally, there are nonfinancial performance measures that can be used. Are there any that you think would be more or less important to a manufacturing company or a service company? Can you provide an example of a personal spending variance that you have experienced?
Explanation / Answer
The factors affecting a company's translation exposure under FASB-52 include the currency of the primary economic environment in which the company (or its affiliate) does business, the currency in which it invoices its sales, the currency in which it negotiates to buy, the currency denomination of its borrowings, the currency denomination of the securities in which it invests surplus cash, and the location of its customers. This list suggests the actions that a company can take to affect its degree of translation exposure: borrow, invest, and invoice both sales and purchases in the local currency. It also has some degree of control over which customers to serve--foreign or domestic--but this decision should be based on economic profitability rather than its impact on translation exposure. As mentioned in the text, the parent has three available methods for managing its translation exposure: (1) adjusting fund flows, (2) entering into forward contracts, and (3) exposure netting. Direct funds-adjustment methods include pricing exports in hard currencies and imports in a soft currency, investing in hard-currency securities, and replacing hard-currency borrowings with local currency loans. The indirect methods (see Chapter 20), include adjusting transfer prices on the sale of goods between affiliates; speeding up or slowing down the payment of dividends, fees, and royalties; and adjusting the leads and lags of intersubsidiary accounts. The standard techniques for responding to anticipated currency changes are summarized in Exhibit 10.1.
The translation exposure would change if the functional currency were the U.S. dollar. For example, U.S. dollar transactions with the German sub would be considered exposed if the euro were the functional currency; by contrast, U.S. dollar transactions are exposed if the euro is the functional currency. The company faces uncertainty as to what its future yen sales revenue will be. This uncertainty stems from quantity risk, the risk that those future sales will not materialize, and price risk, the uncertainty as to the yen prices it can expect to realize in Japan. If it uses forward contracts to hedge its uncertain future yen sales revenue, it faces the risk that it will overhedge, winding up with yen liabilities not offset by yen assets. The company can protect itself by using forward contracts to hedge the certain component of its expected future yen sales then hedging the remainder of its projected sales revenue with currency options.
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