What is 'Translation Exposure'

Translation exposure is the risk that a company's equities, assets, liabilities or income will change in value as a result of exchange rate changes. This occurs when a firm denominates a portion of its equities, assets, liabilities or income in a foreign currency, and it's also known as "accounting exposure.”

Accountants use various methods to insulate firms from these types of risks, such as consolidation techniques for the firm's financial statements and the use of the most effective cost accounting evaluation procedures, and in many cases, this exposure will be recorded in financial statements as an exchange rate gain (or loss).

BREAKING DOWN 'Translation Exposure'

Translation exposure is most evident in multinational organizations, since a portion of their operations, and assets, will be based in a foreign currency. It can also affect companies that produce goods or services that are sold in foreign markets even if they have no other business dealings within that country.

In order to properly report the organization's financial situation, the assets and liabilities for the whole company need to be adjusted into the home currency. Since an exchange rate can vary dramatically in a short period of time, this unknown, or risk, creates accounting exposure. This risk is present whether the change in the exchange rate cause the value of assets to go up or down.

Reporting the Value of Foreign Assets

On financial statements or balance sheets, this can lead to what appears to be a financial gain or loss that is not a result of a change in assets, but in the current value of the assets based on the exchange rate fluctuations. For example, should a company be in possession of a facility located in Germany worth €1 million and the current dollar-to-euro exchange rate is 1:1, then the property would be reported as a $1 million asset. If the exchange rate changes, and the dollar to euro ratio becomes 1:2, the asset would be reported as having a value of $500,000. This would appear as a $500,000 loss on financial statements, even though the company is in possession of the exact same asset it had before.

Hedging Translation Risk

A variety of mechanisms are in place that allow a company to using hedging to lower the risk created by translation exposure. One technique includes the purchasing of foreign currency, while others involve the use of currency futures or currency swaps.

Transaction versus Translation Exposure

There is a distinct difference between transaction and translation exposure. Transaction exposure involves the risk that when a business transaction is arranged in a foreign currency, the value of that currency may change before the transaction is complete. Should the foreign currency appreciate, it will cost more in the business’ home currency. Translation risk focuses on the change in a foreign held asset’s value based on a change in exchange rate between the home and foreign currencies.

RELATED TERMS
  1. Translation Risk

    The exchange rate risk associated with companies that deal in ...
  2. Foreign Exchange Risk

    1. The risk of an investment's value changing due to changes ...
  3. Currency Translation

    The process of quoting the amount of money denominated in one ...
  4. Economic Exposure

    A type of foreign exchange exposure caused by the effect of unexpected ...
  5. Current Rate Method

    A method of foreign currency translation where most items in ...
  6. International Currency Exchange ...

    The rate at which two currencies in the market can be exchanged. ...
Related Articles
  1. Investing

    Corporate Currency Risks Explained

    Transaction, translation and economic risks can affect a company's balance sheet.
  2. Investing

    Explaining Foreign Exchange Risk

    Foreign exchange risk is the chance that an investment’s value will decrease due to changes in currency exchange rates.
  3. Investing

    Protect Your Foreign Investments From Currency Risk

    Hedging against currency risk can add a level of safety to your offshore investments.
  4. Trading

    Exchange Rate Risk: Economic Exposure

    Investopedia explains: In the present era of increasing globalization and heightened currency volatility, changes in exchange rates have a substantial influence on companies’ operations and profitability. ...
  5. Trading

    Managing Currency Exposure In Your Portfolio

    The value of your investments is impacted by changes in global currency exchange rates. Find out how.
  6. Investing

    The 3 Biggest Risks Faced By International Investors

    Investing internationally is a great way to diversify your portfolio, but you need to know the risks.
  7. Investing

    3 Strategies to Mitigate Currency Risk (EUFX)

    Discover the often overlooked risk known as currency risk, and learn three strategies to mitigate or eliminate it in your portfolio.
  8. Trading

    The Effects Of Currency Fluctuations On The Economy

    Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies. The exchange rate of one currency versus the other is influenced by ...
  9. Trading

    Exploring Non-Dollar Currencies For Forex Trading

    Learn how investments in foreign currencies can diversify your portfolio.
  10. Trading

    6 Factors That Influence Exchange Rates

    An in depth look at out how a currency's relative value reflects a country's economic health and impacts your investment returns.
RELATED FAQS
  1. How can I invest in a foreign exchange market?

    The foreign exchange market, also called the currency market or forex (FX), is the world's largest financial market, accounting ... Read Answer >>
  2. What types of companies benefit from reporting results utilizing constant currencies ...

    Understand constant currency figures, and explore some of the reasons why a company is likely to benefit from reporting using ... Read Answer >>
  3. How are international exchange rates set?

    International currency exchange rates display how much one unit of a currency can be exchanged for another currency. Currency ... Read Answer >>
  4. What is foreign exchange?

    Foreign exchange, or Forex, is the conversion of one country's currency into that of another. In a free economy, a country's ... Read Answer >>
  5. How does the balance of payments impact currency exchange rates?

    Take a brief look at the relationship between a nation's balance of payments and the exchange rate value of its currency ... Read Answer >>
  6. What risks do organizations face when engaging in international finance activities?

    When an organization decides to engage in international financing activities, they also take on additional risk as well as ... Read Answer >>
Hot Definitions
  1. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  2. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  3. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  4. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  5. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  6. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
Trading Center