Accounting for foreign currency : an efficient contracting portfolio approach

Godfrey, Jayne M. (Jayne Maree) (1990). Accounting for foreign currency : an efficient contracting portfolio approach PhD Thesis, School of Business, The University of Queensland.

       
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Author Godfrey, Jayne M. (Jayne Maree)
Thesis Title Accounting for foreign currency : an efficient contracting portfolio approach
School, Centre or Institute School of Business
Institution The University of Queensland
Publication date 1990
Thesis type PhD Thesis
Total pages 215
Language eng
Subjects 1501 Accounting, Auditing and Accountability
Formatted abstract This thesis examines whether Australian companies' unregulated foreign currency accounting policies were part of contractually efficient resolutions of agency problems. It proposes that managers' unregulated foreign currency accounting technology selections were a consequence of contractual arrangements directed at maximizing firm value by reducing the incidence of asset substitution, bankruptcy costs, underinvestment and claim dilution.

Aims
The thesis tests three groups of hypotheses. First, it tests whether managers established foreign currency accounting policies for long term monetary items and for translation of overseas subsidiary accounts interdependently. It tests whether firms used portfolios of the accounting choices to create accounting hedges which are contemporaneous with foreign debt hedges of economic exchange rate risk from the firm's investments in overseas subsidiaries. Economic exchange rate risk is defined as exposure to changes in firm value due to exchange rate movements. The thesis then tests whether foreign currency long term monetary item accounting policies provided accounting hedges concurrent with foreign debt hedges of economic exchange rate risk from domestically domiciled foreign currency - earning assets. Finally, it tests whether factors outside the hypothesized efficient contracting framework influenced foreign currency long term monetary item accounting policy.

Scope
The thesis studies foreign currency accounting policy choices prior to their regulation by professional and other institutional requirements. It focuses on policies adopted in firms' 1985 financial statements. The policy choices examined relate to accounting for unrealized exchange rate gains and losses on long term monetary items and on the translation of overseas subsidiary accounts. The most frequently adopted methods of accounting for foreign currency long term monetary items are:
(1) Immediate recognition in earnings;
(2) Deferral and amortization; and
(3) Deferral until monetary item settlement.

Firms translated foreign subsidiary accounts using either the current rate method or the temporal method. The resultant translation gains and losses were taken either to earnings or to reserves.

The questions addressed in the study are:
(1) Why did managers select particular combinations of policies to account for foreign currency gains and losses on long term monetary items and translation of overseas subsidiary accounts? and
(2) In the absence of overseas subsidiaries, why did managers choose particular methods to account for exchange rate gains and losses on long term monetary items?

Conclusions
The evidence documented supports the following general conclusions:
(1) Managers adopted portfolios of foreign currency long term monetary item and overseas subsidiary translation accounting methods. These portfolios provided accounting hedges consistent with firms' foreign debt economic hedges of exchange rate risks from investments in offshore subsidiaries. In contrast with Zmijewski and Hagerman (1981), the portfolio examined concerns accounting policies for underlying economically interrelated attributes.
(2) Managers created accounting hedges reflecting their firms' economic hedges of exchange rate risk from domestically domiciled assets. Firms whose foreign currency long term monetary items did not hedge economic exchange rate risk used immediate recognition. Firms which hedged economic exchange rate risk from domestic assets in place with high specificity in relation to exchange rate movements used deferral and amortization more than other firms. Firms which hedged economic exchange rate risk from growth options inherent in Australian-based assets used deferral until settlement relatively more than other firms with foreign currency long term debt. Asset specificity and relative investments in growth options / assets in place appear to drive accounting choices of firms whose onshore assets produce foreign currency denominated earnings.

Results support an efficient contracting view of foreign currency accounting policy decision-making. Strong support for hypotheses indicates that firms used foreign currency long term monetary item accounting methods both (1) independently; and (2) in portfolio with methods of translating overseas subsidiary accounts. Moreover, the accounting policies reflected underlying economic hedges of the firms' foreign currency risk exposure. That is, managers' foreign currency accounting choices were contractually efficient. The efficient contracting variables exceed political cost, wealth transfer and alternative wealth maximizing effects in their explanatory power.

Keyword Foreign exchange -- Accounting.

 
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