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ACCA Applied Skills · Financial Management · The nature and types of risk and approaches to risk management

Alder Group, a euro-reporting parent, owns a subsidiary in Brazil whose net assets are denominated in reais. When consolidating, the net assets are restated into euros at the closing rate, and the group reports a foreign exchange loss in other comprehensive income because the real has weakened. Which statement about this exposure is correct?

The exposure is translation risk. Restating the Brazilian subsidiary's reais net assets into euros at consolidation changes reported values, but it does not create an actual cash flow. Transaction risk requires a foreign-currency cash settlement, and economic risk concerns long-term cash flow and competitiveness.

  1. AIt is translation risk, an accounting exposure that does not itself involve an actual cash flowCorrect
  2. BIt is transaction risk, because the loss will be settled in cash at consolidation
  3. CIt is economic risk, because the loss reduces future competitiveness directly
  4. DIt is transaction risk, because the subsidiary trades with customers in reais

Explanation

Restating foreign net assets into the reporting currency at consolidation creates translation risk. This is an accounting effect on reported values and involves no immediate cash flow. Option B is wrong because no cash settlement arises from the retranslation itself.

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