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Accounting risk, also known as accounting exposure or translation risk, refers to the possibility of a company’s financial statements needing to be recalculated due to fluctuations in exchange rates. This can affect the paper value of assets listed in a foreign currency, but does not necessarily imply a negative effect. There are different approaches to dealing with accounting risk, including using historical or current exchange rates to value assets. The concept only applies to existing assets and not future business.
Accounting risk is the concept that a company’s financial statements may have to be recalculated due to fluctuations in exchange rates. It is also known as accounting exposure or translation risk. The phrase refers to the possibility of recalculation and does not necessarily imply that the effect will be unfavorable.
The problem of accounting risk arises when a company has assets listed in a foreign currency. In its simplest form, this could be effective. In more complicated situations, it could be all the assets of a subsidiary company based in another country. If the exchange rate changes, the paper value of the assets to the company will change, even if the assets remain unchanged.
Of course, it is perfectly possible that the change in the exchange rate makes an asset more valuable than less valuable. Accounting risk does not specifically mean the risk of losing paper value. Instead, it means risk in the broadest sense, which is the lack of certainty.
The concept of accounting risk only applies to existing assets. It does not cover the risk that exchange rate fluctuations may affect future business. For example, a traveling entertainment company may visit a foreign country and book a tour for the following year. It may turn out that the exchange rate moves unfavorably in the meantime and, even if the tour attracts the same crowd as the previous year, it would have been more profitable to have done more national dates. Since income from hypothetical future sales is generally not counted in current financial statements, accounting risk does not normally cover this situation.
There are different ways to deal with the problem of accounting risk. Preferred ones may vary depending on accounting customs and culture in a particular economy. Those allowed will depend on national accounting laws.
As a general rule, there are two main approaches to provisioning for accounting risk. One is simply to value the assets using the actual exchange rate that applied when the assets were applied, known as the historical exchange rate. The other is to value them using the exchange rate from the point at which the accounts are prepared.
Supporters of the former method argue that it shows the underlying value of the assets and that using the current exchange rate is irrelevant until the assets are converted into real local currency. Supporters of the latter method argue that it shows a more realistic image. In some cases, a company will use a hybrid approach, listing monetary assets such as cash and securities using current exchange rates, but physical assets such as stocks and machinery using the historical exchange rate.
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