13.4. ACCOUNTING EXPOSURE 515
translation exposure, even though it deals with accounting data, can have an
impact on cash flows through its effect on the tax basis.- Consolidated Financial Statements Most countries require consolidation
of the parent’s and subsidiaries’ financial statements for reporting purposes.
Consolidation here refers to the integration of the financial statements of the
firm’s subsidiaries into the parent’s asset and liabilities (A&L) and profit and
loss (P&L) statements. Of course, one needs to first translate the financial
statements of the subsidiary before they can be consolidated with those of the
parent. - Performance evaluation and budget allocation across subsidiaries
The parent firm itself may feel the need to translate the financial statements
of foreign subsidiaries. This is because one needs to compare data in order to
allocate investment budgets or to evaluate the performance of the subsidiary.
For example, even to get some idea about the importance of a foreign unit,
one needs to determine its value in terms of a common currency. Of course,
importance cannot be determined on the basis of a single figure and surely
not on the basis of just backward-looking accounting data. Still, translated
accounting data give a first impression of the relative importance of the foreign
activities. - Bonuses In order to make performance measures comparable, foreign data
need to be translated into a common currency. For example, many firms have
bonus plans that link their managers’ compensation to their performance.
Decisions to promote or fire managers are also based on performance. To
make such decisions, one needs to translate the financial statements of the
foreign subsidiaries into the currency of the parent. - Valuation To value the entire firm (as an outside investor or financial ana-
lyst), one needs far more than just accounting data. Still, valuation is often
partially based on accounting values; or, at the very least, the accounting value
serves as a benchmark. For instance, if the discounted cash flow value of the
entire firm turns out to be four times its book value, one would surely take a
closer look at both types of information. Again, the book value of the firm as
a whole cannot be computed unless assets and liabilities of foreign subsidiaries
are first translated into a common currency.
In the next section we first discuss the general objectives that any method used
to translate the accounts of the subsidiary into the currency of the parent firm
tries to accomplish, and then the details of the various methods that are used for
translation.