Effect of exchange rates on the value of assets and liabilities

Effect of exchange rates on the value of assets and liabilities

Published:   12 Dec at 9 AM

By:Admin

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Fluctuations in the exchange rates
will also have a direct impact on the value of any foreign currency
denominated assets or liabilities held by a company or organisation.

Asset Ownership

For example, let's say a company
or corporation has recently acquired a United States based asset which
would obviously be denominated in US dollars. This might be in the form
of shares in a United States subsidiary, or perhaps a United States
dollar loan it has made to another company who were looking for a financial
injection, or even just a US dollar bank account which obviously over
time would attract interest on any funds held within it. If the Great
British Pound strengthens against the US dollar, each $1 unit is worth
less in pound terms, so the value of the asset - measured in pound -
declines. The company will have made a loss.

Obviously the opposite is the case
if sterling weakens against the US dollar. The company will get fewer
dollars for each pound, or - looking at it the other way round - more
pounds for each dollar. So any US dollar denominated asset will be worth
more in sterling terms, and the company has made a gain. A US dollar
denominated liability will cost more to repay, resulting in a loss to
the company.

Liabilities

If, on the other hand, the company
has a US dollar denominated liability - for example, it has borrowed
in US dollars - it will cost it less in sterling terms to repay the
liability. The company has made a gain.

This can be seen as an overall summary
as:

£ strengthens = Foreign Currency
Liabilities Gain + Foreign Currency Assets Loss

£ weakens = foreign currency liabilities
loss + foreign currency assets gain

« Exchange Rates - What are they and how are they calculated?

Exchange Rates in Company Accounts »