I got confused, I have seen when we are talking fx risks, the exposure is calculated at current asset-current liability, so only cash +AR - AP - Debt, but I asm looking at reading 20 eoc question 12, it says if the company’s reporting method is changed to current method, the exposure of balance sheet would be the net asset. which excludes the equity.
Is that because the net asset is what exposed to the current rate if the change happen, so balance sheet exposure is really whatever that is impacted by current exchange rate? instead of current asset - current liability?
Under Current rate method, the exposure of the Parent is the subsidiary’s equity (assets-liabilities). Subsidiary’s equity is exposed to foreign currency appreciation/depreciation. There is no distinction made between monetary and non-monetary items.
The gain/loss calculated is on the whole EQUITY.
Under Temporal method, the exposure is the Net Monetary assets/liability. Net monetary asset/liability is equal to monetary assets - monetary liabilities.
Under the current method, the exposure is all of the equity, except for capital and dividends (If I remember correctly), the difference is put under a gain or loss as a plug-in figure.
This different range of risk between two methods is caused because of different form of FS translation method to reporting currency. The parent is lower exposed to currency risk by applying temporal method because all BS positions except monetary positions are translated upon historical exchange rate what exactly means that assets and liabilities values (other than monetary) in another currency had been frozen at same historical exchange rate. Also in P/L accounts average FX rate applies only to revenues and expenses related to monetary BS items. At most other PL positions also historical rate have been applied. This is not such case with the CR method. Another thing to distinguish is that by temporal method exchange gains and losses appear in parent PL instead of OCI such in case of CR method. In the event of high FX oscillation the parent net income may become more volatile upon temporal method.
Thanks! But what about the unrealized earning and realized earning, was it just because current method recognize CTA in BS thus it cant ignore the unrealized part
Nothing is ignored. CTA position in parent BS increases (FX gains from business abroad) or decreases (FX losses from business abroad) parent overal equity position thus pump up or contract parent consolidated BS.
Realized FX gains/losses are expensed as ocurred in subsdiary P/L thus have been brought to parent BS via regular consolidation method as any other gain/loss.
Here we are talking about parent exposure (net asset vs net monetary asset) to FX by translation method.