International Accounting ( Part 10 )

FINANCIAL RISK MANAGEMENT

A. Main Components of Foreign Currency Risk

To minimize the exposure faced by the volatility of foreign exchange rates, commodity prices, interest rates and securities prices, the financial services industry offers a lot of financial hedging products, such as swaps, interest rate, and also an option. Most other financial instruments are treated as off-balance sheet item by a number of companies that conduct international financial reporting. As a result, the risks associated with using these tools is often covered up, and until now the world's accounting standard makers to be in discussions on the principles of measurement and reporting according to financial products. The material of this discussion is to discuss one of the problems of reporting and related internal control is essential.

There are several key components in the foreign currency risk, namely:
a) Accounting for risk (the risk of accounting)

The risk that the preferred accounting treatment of the transaction were not available.
b) Balance sheet hedging (hedging balance sheet)

Reduce foreign exchange exposure faced by differentiating the various assets and liabilities of foreign companies.
c) Counterparty (the opponent)

Individuals / organizations that are affected by a transaction.
d) Credit risk (credit risk)

The risk that the opponent has failed to pay its obligations.
e) Derivatives

Contractual agreements that give rise to certain rights or obligations to the value derived from other financial instrument or commodity.
f) Economic exposure (economic exposure)

Effect of changes in foreign exchange rates against the costs and revenues in the future.
g) Exposure to management (management of exposure)

Preparation of the company to minimize the impact of exchange rate changes on the income statement.
h) Foreign currency commitments (commitments to foreign currencies)

Commitment to the sale / purchase of the company in foreign currency.
i) Inflation differential (difference of inflation)

Differences in inflation rates between two countries or more.
j) The liquidity risk (liquidity risk)

Inability to trade financial instruments in a timely manner.
k) Market discontinuities (discontinuities market)

Market value changes suddenly and significantly.
l) Market risk (market risk)

The risk of loss due to unexpected changes in foreign exchange rates, commodity loans, and equity.
m) Net assets exposed position (net asset position of the potential risk)

Excess asset liability position (also referred to as a positive position).
n) Exposed to a net liability position (potential risk of a net liability position)

Excess liabilities position to assets (also referred to as a negative position).
o) The net investment (net investment)

A position of net assets or liabilities that occur in this company.
p) National number (national number)

The total principal amount stated in the contract to determine the settlement.
q) Operational hedging (hedging operations)

Kurs risk protection that focuses on variables that affect the cost income and companies in foreign currencies.
r) Options (option)

Right (not obligation) to buy or sell a financial contract with a specified price before or during a specific date in the future.
s) Of risk (regulatory risk)

The risk that the law would mean limiting the use of financial products.
t) Risk mapping (risk mapping)

Observe the temporal relationship with the market risk of financial reporting variables that affect the value of the company and analyze the possibility.
u) Structural Hedging (structural hedging)

The selection or relocation of operations to reduce overall exposure to foreign exchange company.
v) The tax risks (fiscal risk)

The risk that the absence of the desired tax treatment.
w) Type of exposure (translation exposure)

Measuring the effect of currency changes the parent company of foreign exchange for the assets, liabilities, revenues, and expenses in foreign currencies.
x) Transaction risk potential (the potential risks of the transaction)

Risk foreign exchange gains arising from the settlement or konvertion transaction in foreign currencies.
y) Value at Risk (the risk)

The risk of loss in trading portfolio companies that are caused by changes in market conditions.
z) The driver (trigger values)

Financial statement balance sheet and income statement of company values.

B. Tasks in Managing the Risks of Foreign Currency 

Risk management can increase shareholder value by identifying, controlling / managing the financial risks faced by the current. If the value of the company to match the present value of cash flows, active management of potential risks can be justified by the following reasons:
a. Exposure management helped in stabilizing the company's cash expectations of the flow 

Flow is more stable cash flows that can minimize earnings surprises, thus increasing the present value of expected cash flows. Stable income also reduces the possibility of default and bankruptcy risk, or risk that profits may not be able to cover the debt payments of the contract.
b. Management of exposure to Active allows the company to concentrate on the risk of major business 

For example in a manufacturing company, he can hedge interest rate risk and currency, so it can concentrate on the production and marketing.
c. Creditors, employees, and customers also benefit from the management of exposure

Lenders generally have a lower risk tolerance than the shareholders, thereby limiting the exposure of companies to balance the interests of shareholders and bondholders. Derivative Products also allow pension funds managed by the employer to get a higher return with an opportunity to invest in certain instruments without having to buy or sell the related real instrument. Due to losses caused by price and interest rate risk of certain transferred to the customer in the form of higher prices, limiting exposure to the management of risks faced by consumers. 

C. Defining and Calculating the Risk of Translation

Companies with significant overseas operations prepare consolidated financial statements that allow the readers of financial statements to gain a holistic understanding of the company's operations both domestically and abroad. The financial statements of foreign subsidiaries denominated in foreign currencies are restated in the currency of the parent company.

The process of re-presentation of financial information from one currency to another currency is called translation. Translation is not the same as the conversion. Conversion is the exchange of one currency to another currency physically. Translation is just a change of monetary units, for example, only the balance of the re-expressed in USD expressed in U.S. dollar equivalent value.

In addition to traditional accounting measures of risk potential translational potential of foreign exchange risk is also centered on the potential risks of the transaction. Potential risks associated with gains and losses on foreign exchange transactions arising from the settlement of transactions in foreign currencies. Transaction gains and losses have a direct impact on cash flow. Potential risks of the transaction report contains items that generally do not appear in conventional financial statements, but it raises transaction gains and losses as foreign currency forward contracts, purchase commitments and future sales and long-term lease.
Understanding Risk Management

Risk management or self-employed people working in strategic areas, each day dealing with poor road conditions. Someone could have been sure to arrive at the office on time. However, conditions on the road no one knows, for example, a tree felled by the earlier rain, or the road is closed, or other factors which may cause obstruction of the trip.

Person's ability to manage uncertainty in the streets is one form of risk management.
Similarly, the financial world. Risk is the uncertainty that will occur from each situation and the decisions we take. It's just that the consequences of that risk management is reduced or loss of our funds.

D. The risk difference of Accounting and Economic Risk 

Management accounting plays an important role in the process of risk management. They help identify market exposure, calculate the equilibrium associated with alternative risk response strategy, the company faced a potential measure of risk, noting certain hedging products and evaluate the hedging program. 

The basic framework is useful for identifying different types of potential market risk can be referred to as risk mapping. This framework begins with the observation of the relationship between the risk of triggering a variety of market value of the company and its competitors. Trigger value refers to the financial condition and operating performance of the items affecting the financial value of the company. 

Market risk including the risk of foreign exchange and interest rates, and commodity and equity price risk. Name the source of the purchase currency depreciates in value relative to the domestic currency, then this change may cause domestic competitors can sell at a lower price, referred to as the risk faced by competitive currency. Management accountant should include functions such that the probability associated with a set of output values ​​from each trigger. 

Another role played by accountants in the risk management process involves a balancing process of quantifying the risks associated with alternative management strategies. Foreign exchange risk is one of the most common form of risk and will be faced by multinational companies. 

In a world of floating exchange rate, risk management include:
a. Anticipated exchange rate movements,
b. Measurement of exchange rate risk faced by the company,
c. Design of appropriate protection strategies,
d. Preparation of internal risk management controls. 

Financial managers must have information about the possible direction, timing, and magnitude of exchange rate changes and to develop defensive measures are adequate more efficient and effective. 

E. Strategy Protection Exchange Rates And Treat Accounting Required

After identifying potential risks, the next is designing hedging strategies to reduce or even eliminate potential risks. This can be done with balance sheet hedging, operational, and contracts.
a. Balance Sheet Hedging

Protection strategy by adjusting the level and value of assets and liabilities exposed to the eye, which will reduce the possible risks facing the company. Examples of hedging methods subsidiaries located in countries that are vulnerable to devaluation is:
• Keeping the cash balance in local currency at the minimum level needed to support current operations.
• Restore income above the required amount of capital to the parent company.
• Speeding (leading ensure) the receipt of receivables in the local currency.
• The delay (slow-lagging) the payment of debt in local currency.
• Accelerate the payment of debts in foreign currencies.
• Investment of surplus cash to stock other debt in local currency which is less affected by devaluation losses.
• Investment in foreign assets with a strong currency

b. Operational Hedging

Focusing on operational hedging variables that affect the revenue and expenses in foreign currencies. Cost control is more stringent allowing a larger margin of safety against currency risk potential. Structural hedges, including the relocation of manufacturing to reduce the potential risks facing the company or changing the state is a source of raw materials and component manufacturing.
c. Hedging Contract

One form of hedging with financial instruments, whether derivative instruments and basic instruments. These products include instruments of forward contracts, futures, options, and a mixture of all three are developed. To provide greater flexibility for managers to manage the potential risks faced by foreign exchange.

F. Accounting and Control Problems Related to the Exchange Rate Risk Management Foreign Currency 

Examples of accounting and control issues related to foreign currency risk management can be seen in the following cases: 

These companies continuously create and implement new strategies to improve their cash flow to increase shareholder wealth. It does require some expansion strategy in the local market. Other strategies need to penetrate foreign markets. Foreign markets can be very different from the local market. Overseas markets create opportunities increased incidence of corporate cash flow. Number of barriers to entry into foreign markets that have been revoked or reduced, encouraging companies to expand international trade. As a result, many national companies to multinational corporations (MNCs) are defined as companies engaged in some form of international business. Control of the company's cash management performance measurement include the exchange of all the risks, hedging is used to identify, and reporting the results of the hedge. Evaluation system also includes documentation on how and to what extent a company helping other business units within the organization. 

In many organizations, foreign exchange risk management is centralized at corporate headquarters. This allows the managers of subsidiaries to concentrate on its core business. However, when comparing the actual and the expected results, the evaluation system must have a reference that the company used the success of risk protection.