Foreign Subsidiary Consolidator Description
The Foreign Exchange Subsidiary Consolidator is a risk modeling tool that illustrates the economics and mechanics of the accounting consolidation process of foreign subsidiaries into their parent company’s financial statements. This tool shows step-by-step how foreign exchange translation risk arises, and also outlines the accounting benefits of using the elective “net investment” hedge accounting designation for hedges of net investments in foreign subsidiaries.
The resulting output shows the Income Statement, Statement of Retained Earnings, and Balance Sheet, along with the exchange rates that are used to translate foreign currency amounts into functional currency amounts. Furthermore, the balancing of the accounting equation, where assets must equal liabilities and equity, is demonstrated by calculating and reporting the Cumulative Translation Adjustment (CTA) of Other Comprehensive Income (OCI) in the Equity section of the Balance Sheet.
This highly engaging tool transforms 15 inputs into a highly informative analysis with 3 basic steps. The first step is to define the parameters of the foreign subsidiary by specifying (1) the Parent Company’s Functional Currency, (2) the Foreign Subsidiary’s Functional Currency, (3) the Net Investment Amount in the Foreign Subsidiary, (4) the Forecasted Net Income the Foreign Subsidiary is expected to generate, (5) the Start Date, (6) the End Date, (7) the Currency Quoting Convention, and (8) the Exchange Rate. Step 2 is to select a (9) Hedging Strategy for the net investment and input the related variables of (10) Hedge Ratio %, (11) Domestic Interest Rate, (12) Foreign Interest Rate, (13) Implied Volatility, and (14) the Collar Range. The third and final step is to forecast (15) the ending exchange rate to see how positive and negative changes in exchange rates impact the cash flow and financial reporting of your net investment hedging strategy.
Foreign exchange translation risk and the accounting consolidation process are both complex areas of foreign exchange risk management, and this tool provides clarity and insight into how translation risk arises and how it can be mitigated. Many organizations struggle with deciding if, when and how to hedge foreign exchange translation risk. The Foreign Exchange Subsidiary Consolidator can be used to crate a custom analysis of your company’s foreign subsidiary to help you understand the risk more precisely and mitigate the impact to the financial statements more effectively.
Question to Consider
- Are you interested in seeing a visual example of how foreign subsidiary Income Statements and Balance Sheets are consolidated into the parent company’s financial statements?
- Can you picture the financial reporting benefits of using “net investment” accounting treatment when hedging the equity stake in a foreign subsidiary?
- Would you like to know how the Cumulative Translation Adjustment (CTA) is calculated in Other Comprehensive Income (OCI) as part of the Equity section of the Balance Sheet?
- Do you know how the cash flow and accounting implications of hedging foreign subsidiaries can create conflicting risk management objectives?
- The Foreign Exchange Subsidiary Consolidator will guide you through all of these questions in an easy to understand format.