416 Planning and Forecasting
- Most hedging activity centers around efforts to protect cash f lows and
earnings from the volatility that would be produced by the combination of
unhedged currency exposure and f luctuations in exchange rates. Transla-
tion exposure, which does not pose the same threat to cash f lows and
earnings, is hedged far less frequently than transaction exposure. - Note all of the effects of changes in exchange rates are ref lected in trans-
action and translation gains and losses. The strength of the U.S. dollar in
recent years has both reduced the dollar value of foreign sales as well as
the competitiveness of U.S. products. - The emergence of the Euro has the potential to reduce both the cost and
complexity of hedging because many European currencies are replaced
by a single currency, the Euro. However, some companies express con-
cern about possible adverse competitive effects associated with the pric-
ing transparency that results from a common currency. - Substantial differences continue to exist between GAAP in the U.S. and
that in other countries. However, the International Accounting Standards
Committee (IASC) continues its efforts to create more harmony in GAAP
across the world. These GAAP differences create substantial challenges
when analyzing the financial performance of foreign firms. - The evaluation of the performance of foreign subsidiaries and their man-
agement can be affected by exchange-rate changes. A common response is
to remove the effects of exchange rate changes from key performance in-
dicators. Another approach is to evaluate performance using budgeted ex-
change rates. The extent to which the responsibility for hedging currency
exposure is delegated to management of these entities should affect deci-
sions about how to deal with the effects of exchange-rate changes. Re-
moving the effects of exchange rate changes is consistent with an absence
of responsibility for the hedging of currency risk. - Recent changes in the accounting for derivative instruments and hedging
activities call for the recording of all foreign-currency derivatives at their
fair values. In some cases, gains and losses from the revaluation of cur-
rency derivatives will initially be included in other comprehensive in-
come. However, these gains and losses will subsequently be included in
net income when the related hedged transaction is included in earnings.
The deferral of foreign-currency gains and losses on the balance sheet is
no longer permitted. - Transfer pricing policies between U.S. parents and their foreign sub-
sidiaries create challenges in terms of both performance evaluation and
worldwide tax minimization. - Modest levels of inf lation in the U.S. in recent years has meant that in-
creases in the general price level have not been a major management
issue. However, inf lation continues to present issues for global firms be-
cause of substantial inf lation in some of their foreign markets.