Foreign Currency: Accounting, Communication and Management of Risks

Abstract

We obtain survey responses from 168 North American CFOs and interview 16 of them to understand (i) how foreign currency exposure is measured and reported inside and outside the firm; (ii) how goal setting, performance evaluation and compensation of managers reflect exchange rate impacts, (iii) what specific currency exposures firms hedge and why? To develop expected answers to these questions, we provide a series of exhibits of hypothetical transactions at, and financial reports for, the foreign subsidiary. We benchmark these theoretical insights against the survey responses and uncover several questionable managerial choices. First, although no performance measure is insulated from a currency impact, a large majority of senior managers and board members only review translated USD data, especially cash flows, that are fraught with significant measurement error. Second, companies are more likely to communicate, both inside and outside, the currency impact on net income and revenue but not on operating costs, operating cash flows and the foreign subsidiary’s balance sheet. Hence, decision makers, especially investors, will be unable to readily isolate the portion of the firm’s performance attributable to currency changes. Third, many of the current practices used to (i) set budgeted exchange rates for planning; (ii) hold local managers accountable for currency fluctuations; and (iii) manage foreign currency risk are inconsistent both with one another and with theory. We hope our work furthers the understanding of currency exposure among students, academics and practitioners.

Keywords: foreign currency, translation, transaction, reporting, performance evaluation, hedging, compensation, free cash flow, accounting standards, SFAS 1 and 8, SFAS 52, budgeting, survey

JEL Classification: M4, M52, F23, G15, G32