What does Translation Exposure Mean?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.
Firms have income statements and balance sheets. The balance sheets reflect the valuation of the assets and liabilities of the firm. Changes in those valuations can represent capital gains or losses which may have to be reported in the income statements. An exogenous factor such as a change in interest rates may change the value of assets and liabilities and generate a capital gain or loss. But this capital gain or loss is not connected with any decision about the operation of the company. Once the capital gain or loss occurs there is nothing that can be done about it. The capital gain or loss may alter expectations of future gains or losses and some action might be possibly be warranted, but typically the exogenous changes are deviations from expected conditions and these deviations are in their nature unpredictable.
These changes in the valuation of assets and liabilities are particularly a problem in international operations because fluctuations in exchange rates can generate paper gains and losses for the parent company. The valuation of assets and liabilities in foreign operations must be translated into the home country currency. The fluctuations in currency exchange rates could generate significant gains or losses and the entry of these into the income statement could produce a distorted impression of what is happening to the company.
The practice concerning these translation or accounting gains or losses is to include them nominally in the income statement but in such a way that the operating characteristics are not disguised or distorted. The difficulty in...