a consistent basis and controlling for capital increases or deductions and dividends,
are generally a more accurate method of profit determination. Owing to changing
commodity, currency, and credit prices, the income statement is often just a best at-
tempt to explain what has taken place from one balance sheet to the next.
Understandably, many companies operating in high-inflation environments have
not fared well in explaining what actually transpired during the period based on re-
ported earnings numbers. Coopers & Lybrand (C&L) state the problem thusly:^4
Hard currency income statements prepared by the traditional FASB Statement No. 52
monetary/nonmonetary method tend to display a large translation gain or loss. Com-
monly, this is one of the larger items in the income statement. The gain or loss reflects
so many features... that it is remarkably difficult to analyze. Management is often
highly perplexed by this item. Some managements... have been known to persuade
their head offices... that they should be judged on net income before the “extraneous”
translation loss.In fact, the item is not all extraneous but pertains to various lines of the income
statement. A business cannot be managed intelligently unless the translation gain or
loss is reallocated to its various sources.
27.2 MANAGEMENT REPORTING FRAMEWORK. Our reporting model is premised
on the following conviction: management’s objective of maximizing the value of the
firm should be framed in terms of a currency that holds its value. Accordingly, the
best way to measure the performance of an affiliate located in a hyperinflationary en-
vironment is to do so in terms of hard currency.^5 Our model also implicitly assumes
that inflation rates, exchange rates, and interest rates are interrelated, although this
assumption is not critical to our proposal.
In accounting for foreign currency transactions, a common reporting convention
is to record revenues and expenses at exchange rates prevailing at the financial state-
ment date, although use of average rates are also common. For month-end closing,
this entails using the month-end rate. We argue that local currency transactions
should be reported (valued) at the exchange rate prevailing on payment date. This re-
porting mode provides the best measure of a transaction’s intrinsic value as this is the
date that the transaction in question is tracked in hard currency. Recording a transac-
tion at any other date muddles the measurement process by introducing gains or
losses in the purchasing power of money or implicit interest into the picture. In a per-
fectly competitive market, all local currency transactions would be made for cash.
However, under conditions of imperfect competition and inflation, it will prove ad-
vantageous for buyers to delay payment as long as possible and for sellers to accel-
erate collections. The date at which payment is effected will be determined by the
competitive strengths of the contracting parties. The recommended reporting treat-
ment produces reported numbers that are reliable, economically interpretable, and
symmetric in the sense that two economically similar transactions (for example, one
foreign, one domestic) produce the same financial statement numbers when the trans-
27.2 MANAGEMENT REPORTING FRAMEWORK 27 • 3(^4) Coopers & Lybrand, op. cit.
(^5) Interviews with financial executives of U.S.-based multinationals as well as subsidiary managers
suggest that this assumption is consistent with corporate practices at the micro level. It also appears con-
sistent with practices at the macro level. Witness the recent trend of more and more Latin American coun-
tries pegging their currencies to the U.S. dollar. Moffett and Friedland, 1995.