Clearly, currency exposure is part of business operations, presenting an extra element in overseas operations not present in domestic operations. In order to anticipate currency changes and their impact on his companies, the analyst must develop greater understanding of the techniques of currency translation and of international economics.
The Financial Accounting Standards Board’s Statement No. 8, Accounting for the Translation of Foreign Currency Transactions and Foreign Currency Financial Statements, covers both aspects of currency translation—the balance sheet and the income statement. The translation gain or loss stemming from the balance sheet occurs at the time of a change in currency rates; no deferrals of translation gains or losses are permitted. Fixed assets are translated at the historical rate. Inventories are generally also translated at historical rates, while cash, receivables, and debt, both short and long term, are translated at current rates. Thus it is the net monetary exposure—the difference between cash and receivables on one hand and current and long-term debt on the other—that determines whether a revaluation will result in a balance sheet loss or gain.
In translating the income statement, one compares each period with the corresponding period a year earlier. Unlike sales, which decline when a foreign currency weakens, depreciation is translated at the historical rate. Inventory cost of goods sold is also translated at the historical rate; hence profit margins shrink when the foreign currency weakens. The profit and loss impact will continue for 12 months following a rate change.