13.4. ACCOUNTING EXPOSURE 523
Given the wide choice that is offered in many cases, one could wonder which
method is best. And even where one particular method is imposed, one could
consider whether it is useful to adopt a different method for internal reporting
purposes. Even more fundamentally, one could ask whether accounting exposure
matters at all. Let us briefly dwell on this before we close this chapter.
From the discussion of the various translation methods, we see that the question
of which translation method to choose is similar to the issue of whether the firm
should use the method of last-in/first-out (LIFO), or first-in/first-out (FIFO), or some
average cost, for the purpose of valuing its inventory. One could argue that the
accounting method for inventory valuation does not matter, since a shift from, say,
LIFOtoFIFO will change neither the firm’s physical inventory nor its cash flows
(except possibly through an effect on taxes). Moreover, one could argue that neither
LIFOnorFIFOnor average cost is correct; only replacement value is theoretically
sound. In the same vein, one could argue that the choice of the translation method
does not affect reality—except possibly through its effect on taxable profit—so that
the whole issue is, basically, a non-issue. Furthermore, while in the case of inventory
valuation, one could argue thatLIFO, being generally closer to replacement value,
is the least of all evils, it is not obvious which of the translation methods generally
corresponds best to economic value. The whole issue is, perhaps, best settled on the
basis of practical arguments. Accounting data are already complicated enough, so
that the Current Rate Method is probably a good choice, given its simplicity and
internal consistency.
In Table 13.6 we compare economic and accounting exposures. Perusal of the list
will reveal that economic exposure is the one to watch, not accounting exposure. But
although accounting exposure suffers from the limitations described above, often
accounting data are the only data that are readily available to a firm. Thus, it
is important that treasurers andCFO’s, when using these data to make hedging
decisions, be aware of these limitations when using accounting data.
*
Let is recapitulate the results obtained thus far in the current part. We first
argued that hedging adds value at least for some firms some of the time. We then
discussed exposure, that is, the size of the forward hedge that should be added to
minimize uncertainty. But the decision whether or not to hedge was hitherto dis-
cussed in isolation from other risks the firm incurs, many of which are not hedgeable
at all. So perhaps the question should be what the total risk of the company is,
and by how much this total risk goes down if exchange risk is being hedged. Such
a holistic, portfolio view is taken by Value at Risk (VaR), the issue of the next
chapter.