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 Faculty Working Papers 
 
 AN ASSESSMENT OF THE 
 RELEVANCE OF EXCHANGE RATES TO TRANSLATION 
 
 Dennis H. Patz 
 
 #168 
 
 College of Commerce and Business Administration 
 
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FACULTY WORKING PAPERS 
 College of Commerce and Business Administration 
 University of Illinois at Urbana-Champaign 
 March 5, 1974 
 
 AN ASSESSMENT OF THE 
 RELEVANCE OF EXCHANGE RATES TO TRANSLATION 
 
 Dennis H. Patz 
 
 #168 
 

AN ASSESSMENT OF THE 
 RELEVANCE OF EXCHANGE RATES TO TRANSLATION 
 
 by 
 
 Dennis H. Patz* 
 
 *Lecturer in Accountancy, The University of Illinois at Urbana-Champaign. 
 This paper derives from doctoral dissertation research currently in progress 
 at The University of Texas at Austin under a grant from the Ernst & Ernst 
 Foundation and under the supervision of Professors George M. Scott and Charles 
 H. Smith, all to whom the author acknowledges his indebtedness. The author 
 would also like to thank Professors Hanns-Martin Schoenfeld and Ronald D. Picur, 
 The University of Illinois, for their review and helpful comments on this paper. 
 
AN ASSESSMENT OF THE 
 RELEVANCE OF EXCHANGE RATES TO TRANSLATION 
 
 Every professionally sanctioned U.S. method of translation involves the 
 exclusive use of exchange rates to translate financial statements of foreign- 
 based subsidiaries. For that matter, nearly every other method proposed or 
 used elsewhere in the world relies on exchange rates to effect translation. 
 Yet, in general, accountants "have taken for granted that exchange rates should 
 be used to translate instead of other data but have never explained why." 1 
 It is our purpose in this paper to examine the "conventional wisdom" of using 
 exchange rates to translate foreign accounts by assessing the relevance of ex- 
 change rates to accounting measurement in a translation context. 
 
 S ources of Relevance 
 Given a set of foreign financial statements the information content of 
 the statements after translation rests considerably on the translation rates 
 applied. It follows that relevance tor exchange rates in translation must 
 lie in the information content inherent in the rates themselves and so imparted 
 by their use. As a result, levels of exchange rates and changes in exchange 
 rates could be relevant to accounting measurement in one of two ways. 
 
 Leonard Lorenson, "The Temporal Principle of Translation," Journal of 
 Accountancy , LXXXIV, No. 2 (August, 1972), p. 48. Such is not the case, how- 
 ever, in economics where exchange rates are used for strikingly similar pur- 
 poses to that for which accountants use exchange rates; that is, to express 
 real incomes or assess real income differences of various countries in terms 
 of a common unit of account. See, for example, Paul A. David, "Just How Mis- 
 leading Are Official Exchange Rate Conversions?," The Economic Journal , LXXXII, 
 No. 327 (September, 1972), p. 979. 
 
First, they may provide useful information regarding future actions in 
 the foreign exchange market, and recognition of changes in them would measure 
 changes in the firm's ability to eng ge in transactions in this market. In 
 this case, the foreign exchange market is the environment impacting on the firm 
 and exchange rates themselves the environmental variables of concern. Exchange 
 rates could be of direct relevance in the sense that as market prices they con- 
 tain information with regard to accounting valuation of foreign firm resources 
 by way of reflecting the conversion or remit table dollar value of those re- 
 sources. Correspondingly, changes in exchange rates (where recognized) would 
 directly measure the effect of the foreign exchange market environment acting 
 on the firm by reflecting alterations in the value of firm assets in terms of 
 command over remittable dollars. Conceptually this can be viewed as the use 
 of exchange rates to establish value. Establishing relevance for exchange 
 rates along these lines rests in establishing the relevance of the foreign ex- 
 change market to foreign operations in general and to foreign firm values spe- 
 cifically. 
 
 Second, the relevance of exchange rates to translation could be indirect 
 or conceptually derived in an opposite fashion; that is, the nature of economic 
 value justifies the use of exchange rates. Exchange rates may constitute 
 reasonable approximations of relative currency value. They may reflect the 
 relative values of currencies in acquiring goods and services in their respec- 
 tive economies vis a vis the dollar in the U.S. Correspondingly, their use 
 would result in logical restatement of foreign-held net assets and income in 
 terms of equivalent dollar economic magnitudes . ^ Here useful information re- 
 
 2 
 
 Restatement would be with reference to either a historical point in time, if 
 
 historical rates were used, or to the present, if current rates were used. Such 
 restatement would be logical in the sense of relating accounting measures in terms 
 of the attribute expressed by all currency units — general command over goods and 
 services — and in the sense of reflecting asset value in terms of the actual loca- 
 tion and place of use of the assets. 
 
garding future actions in local input-output markets is involved, and recog- 
 nition of charges in exchange rates would reflect changes in the firm's ability 
 to engage in transactions in these il rkets. In this c^se the environment is 
 the local economies involved, internal prices the relevant environmental varia- 
 bles and exchange rates become surrogates for direct measures of relative cur- 
 rency value. Establishing relevance of local input-output markets to foreign 
 operations, in general, is not an issue. Rather, justification for the use of 
 exchange rates revolves around the question of how good a surrogate for direct 
 measurement of relative currency value are exchange rates. 
 
 Direct Relevance 
 As noted, establishing the direct relevance of exchange rates to transla- 
 tion involves establishing the relevance of the foreign exchange market to for- 
 eign operations in general and to foreign firm values specifically. An exchange 
 rate, viewed solely as a market price, when applied to a foreign-sourced account- 
 ing measurement, results in an expression of remittable dollar value. We must, 
 therefore, be able to establish the remittable dollar value attribute of net 
 assets and income as of paramount importance. For this we require evidence to 
 support a view of foreign operations, in terms of the "general case,"-* similar 
 to that of a home office with branch sales outlets. There should exist con- 
 vincing evidence to support a nationalistic view of the foreign firm as essen- 
 
 The concept of a "general case" lies at the heart of theory construction. 
 Without initial assumptions (propositions) regarding the nature of the phenome- 
 non that an accounting process is to depict, no logical derivation of princi- 
 ples to depict the phenomenon is possible. By the same token, the applicabil- 
 ity of the principles derived is indeterminant ; i.e., situations warranting 
 exception cannot be identified. Most important, however, such propositions 
 about the phenomenon at issue have empirical content and their validity is 
 empirically testable, 
 
4 
 
 tially a source of cash flow to its domestic parent or affiliate. Such a 
 viewpoint accentuates the attribute of foreign-held net assets which is domi- 
 nant and warrants measurement: dollar remittance value over a going concern 
 value in the foreign economy; historical cost as an expression of economic 
 sacrifice with reference to the U.S. economy and price structure over sacri- 
 fice with reference to the foreign country. 
 
 Unless a remittance oriented view of the nature of foreign operations can 
 be upheld, there is little sense in valuing foreign-held assets at conversion 
 prices when they are not likely to be converted in the foreseeable future or 
 in costing assets as if they were purchased with U.S. dollars and being used 
 to generate income streams in the U.S. economy when they were not and are 
 not. 5 For example, if remittance cannot be expected until the year 2000, then 
 it becomes questionable if resources held abroad possess a remittable dollar 
 value attribute in any meaningful sense or if useful information is being pro- 
 vided through measurement of this attribute and changes therein. These argu- 
 ments do not seem circumvented by the contention that a decision has been made 
 to leave the assets abroad and so a need for measurement to reflect the conse- 
 
 Such a view pervades the translation literature and is widely acknowledged 
 For example, the International Accounting Committee of the AAA isolated the 
 assumption "that the foreign branch or subsidiary exists solely to provide cash" 
 to the domestic company and considered it common to the work of most writers. 
 Committee on International Accounting, American Accounting Association, Re- 
 port of the Comm itt ee on International Accounting , supplement to the Accounting 
 Review , XLVIII, 1973, p. 151. See also Eugene L. Schotanus, "A Strategy for 
 Coping With Exchange Risks," Management Accounting, LII, No. 7 (January, 1971), 
 pp. 45-46. 
 
 5 
 Traditional theoretical premises would lack validity; e.g., "the attribute 
 
 of foreign money of most interest from the perspective of the U.S. dollar finan- 
 cial statements" is the foreign money* s command over U.S. dollars and approxima- 
 tion of U.S. dollar prices of non-monetary assets is a desirable and useful end. 
 Leonard Lorenson, project director, American Institute of Certified Public Ac- 
 countants, Accounting Research Study No. 12 , "Reporting Foreign Operations of 
 U.S. Companies in U.S." Dollars," (New York: AICPA, 1972), pp. 17-18. 
 
quences of this decision vis a vis its opposite (repatriation to the U.S.) exists. 
 This constitutes measurement of an opportunity value, one derived from considera- 
 tion of only one of many possible alternatives available where the alternative 
 chosen is generally an infeasible one and where complete measurement of that value 
 is not possible. The result is portrayal of non-reality rather than reality. 
 
 Foreign exchange is a commodity and a foreign exchange rate the price ap- 
 plicable to that commodity in a conversion market. There is no a priori basis 
 for applying a market determined price for one commodity to transactions not 
 involving that commodity or to use such a price in general accounting valua- 
 tion. It must be shown that value derives essentially from command over that 
 commodity. Hence we must be able to demonstrate, at a minimum, that foreign- 
 based subsidiaries engage in extensive remittance and other exchange transac- 
 tions requiring command over the domestic currency. Coincidentally, we would 
 need to show that the operations of the bulk of these firms consist of short- 
 lived transaction cycles with a preponderance of cash or near cash assets 
 being held awaiting remittance in order to substantiate remittable dollar or 
 conversion valuation of net assets and income. 
 
 In contrast, we do not seek evidence of a preponderance of non-monetary 
 assets (as in manufacturing abroad) . We do not seek evidence of realization 
 cycles where the time between U.S. investment, foreign income, remittance is 
 long, The latter state of affairs suggests continual recognition of reversing 
 and/or non-existant gains and losses. 6 This will obtain in that realization 
 
 "That gains and losses presently recognized are often not real in any econ- 
 omic sense is broadly recognized. See Accounting Principles Board, Proposed APB 
 Opinion , "Translating Foreign. Operations," (New York: AICPA, 1972). See also 
 Donald J. Hayes, "Translating Foreign Currencies," Harvard Business Review , L, 
 No. 1 (January-February, 1972), pp. 14 and 159. Joseph E. Connor, "Accounting for 
 the Upward Float in Foreign Currencies," Journal of Accountancy , CXXXIII, No. 6 
 (July, 1972), p. 41, "Multinational Profits," Forbes , CVIII, No. 10 (November 15, 
 1971). p. 77, "Corporate Gnomes," Fortune, LXXXIV, No. 1 (July, 1971), p. 71 and 
 Gunter Duffey, "The Outlook for the International Monetary System and Implications 
 for Subsidiary Valuation," International Journal of Accounting , VI, No* I (Fall, 
 1970), pp, 30-31. 
 
of gains and losses recognized are necessarily contingent upon the validity 
 of assumptions which must be made at the time of their measurement. In par- 
 ticular, future remittance, the relative permanence of exchange rate levels 
 and often the magnitude and timing of future foreign currency cash flows must 
 be assumed. Overall, we do not seek evidence that the population of foreign 
 firms with which translation deals contains primarily seperate, viable, perma- 
 nent going concerns. 
 
 Evaluation of Direct Relevance 
 
 If we must look to the general nature of foreign operations to establish 
 the relevance of the foreign exchange market to the firm, and so the direct 
 relevance of exchange rates, given available evidence little support can be 
 found for the use of exchange rates. Unfortunately, at present no difinitive 
 empirical study of the characteristics of the population of multinational firms 
 and their foreign affiliates appears to exist. However, based upon what evi- 
 dence does exist, the apparent nature of contemporary foreign operations in 
 terms of the general case will not uphold the dollar conversion value view 
 required. 
 
 While the meaning of the term multinational enterprise differs from writer 
 to writer, 7 we use the term here simply to identify companies with material 
 interests in foreign affiliates or subsidiaries and to differentiate these 
 
 For example, Scott sees the primary distinguishing characteristic of multi- 
 national enterprises as the attempt by management to conduct global operations in 
 an integrated fashion. Zenoff and Zwick, on the other hand, differentiate by 
 size of foreign earnings, designating a multinational as typically deriving one- 
 fourth of its earnings or better from foreign operations. George M. Scott, 
 "Global Financial Coordination in Multinational Enterprises," Working Paper 72-13 , 
 Graduate School of Business, The University of Texas at Austin, October, 1971, 
 p. 1 and David B. Zenoff and Jack Zwick, International Financial Management , 
 (Englewood Cliffs: Prentice-Hall, 1969), p. 10. 
 
firms from domestic firms that merely engage in some foreign transactions and 
 as a result may carry foreign currency denominated assets and liabilities re- 
 quiring translation. ° Thus, we are -peaking of firms where translated amounts 
 constitute a material aspect of reported results and position. With regard 
 to these firms , Mueller makes the following distinction which can be used in 
 attempting description of the multinational firm population: firms involved 
 in import-export activities, national firms with international business and 
 international firms. 9 
 
 Indeed, there appears to be a continuum of multinational firms, beginning 
 with firms whose foreign operations are categorized as import-export activities 
 through those characterized as national operations with international business 
 operations to the extreme form of the international or multinational firm in 
 the view of Mueller and Scott. There is good reason to believe, however, based 
 on the characteristics that define the place along the continuum that any 
 firm would fall, that a distribution of these firms is markedly leptokurtic 
 and positively skewed* 
 
 Figure 1 illustrates such a distribution. The continuum referred to 
 above, the horizontal axis in Figure 1, should be viewed as a weighted com- 
 bination of several individual characteristic continuums. The degree to which 
 a particular firm possesses each presumed pertinent characteristic, in combina- 
 tion with the degree possessed of each other characteristic, defines the firm's 
 
 ft 
 Parkinson utilizes a similar distinction throughout his study for the 
 
 Canadian Institute. R. MacDonald Parkinson, author, Canadian Institute of 
 
 Chartered Accountants 5 Acc ounting and Audit ing Rese arch Committee Research 
 
 Study , "Translation of Foreign Currencies," (Toronto: CICA, 1972). 
 
 -'Gerhard G Mueller, International Accounting, (New York: Macmillan, 1967). 
 
position along the classificational continuum. These characteristics 
 would at least include remittance-reinvestment behavior, the permanence 
 continuity and normalcy of the foreign operations conducted, management view 
 of the foreign element of the total system* the absolute and relative magni- 
 tudes of foreign operations conducted, direction of operational expansion and 
 emphasis, goals adopted by management, and the degree of centralization and 
 worldwide coordination. 
 
 Figure 1 
 
 y-Number of multinational firms, as defined in this paper as those 
 domestic firms having material interests in operations conducted 
 abroad . 
 
 x-A classificational continuum by nature of the firm from export- 
 import, through national firms with foreign operations to interna- 
 tional or "multinational" in the sense used by Mueller and Scott; 
 a conceptual ordering of the total population of multinational 
 firms based on the characteristics they exhibit. 
 
 z-The implied dichotomization, the right of which constitutes the 
 "general case." 
 
All of the above stated characteristics, of course, are not of equal sig- 
 nificance, with remittance-reinvestment behavior, permanence and continuity 
 more important than, say, degree of entralization from the standpoint of an 
 accounting concept of the firm. Nevertheless, the evidence available sug- 
 gests that a distribution such as that illustrated in Figure 1 holds, and 
 e specially with reference to those characteristics of particular accounting 
 consequence. Some observations by Mueller provide a useful starting point 
 in arraying this evidence: 
 
 International business has significantly shifted to inter- 
 national operations, including manufacturing, assembling, and 
 distributing goods from plants and facilities located in almost 
 every country of economic significance. 
 
 Summarizing contemporary business internationalism, it 
 seems fair to say that there are no longer foreign operations 
 in the traditional sense. Some few firms still fit the older 
 models of export and import activities only and therefore may 
 be said to be engaged in foreign business. For most firms, how- 
 ever, business outside their respective home countries is no 
 longer thought of as foreign. Rather it has become an integral 
 and permanent part of the overall undertaking and there is 
 nothing "foreign" about it. It is international in the fullest 
 sense of the term.-*-*-* 
 
 Mueller suggests that few firms fit the import-export mold and the shift 
 
 has been toward more permanent forms of investment. Aggregate statistics 
 
 tend to support this view. U»S. direct foreign investment reached approxi- 
 
 mately $78.1 billion by the end of 1970. Manufacturing and petroleum make 
 
 up the bulk of this investment. Manufacturing investments rose 190% from 
 
 1961 so as to account for an estimated $32.2 billion in 1970. 12 Plant and 
 
 10 Ibid* , p. 193. 
 
 11 
 
 Lorenson, ARS No. 12, p. 1. 
 
 1? 
 
 Susan B. Foster, "Impact of Direct Investment Abroad by United States 
 
 Multinational Companies on the Balance of Payments," Fed eral Reserve Bank of 
 
 New York Monthly Bullet in, LIV, No. 7 (July, 1972), p. 170. 
 
10 
 
 equipment expenditures by foreign affiliates of U.S. corporations for 1972 
 have been estimated at $15.2 billion (as compared with $9.3 billion in 1967), 
 with Canada accounting for $3.2 bill'^n, Europe for $5.7 billion and Latin 
 America $1.7 billion. Manufacturing and petroleum are estimated as making up 
 $6.8 billion and $5.1 billion of the total respectively. " Sales by foreign 
 affiliates were estimated at $132 billion in 1970, up from $50 billion in 
 1960 and were broken down as follows: $74 billion from manufacturing, $36 
 billion from petroleum, $6 billion from mining and smelting and $16 billion 
 from all other sources. ^ Production by U.S. companies abroad in 1969 was 
 estimated at $200 billion, which was approximately equal to the gross national 
 product of Japan. 5 
 
 As expected, earnings and interest remittances to the U.S. have increased 
 as well, from $2.8 billion in 1961 to $6.0 billion in 1970. 16 Interestingly, 
 however, remittances have not kept pace either with sales increases or with 
 earnings growth, the latter growing from $3.0 billion in 1958 (and approxi- 
 mately $3.8 billion in 1961), tc $10.8 billion in 1970. 17 This is not sur- 
 prising as overseas markets are growing faster than the U.S. market and the 
 non-U. S. business of multinational f:*.rms is likewise growing faster than their 
 
 *3r. David Belli, "Plant and Equipment Expenditures by Foreign Affiliates 
 of U.S. Corporations, 1971-73," Su rvey of Current Business , LII, No. 9 (Septem- 
 ber, 1972), p. 19. The figures are based on the U.S. Department of Commerce, 
 Bureau of Economic Analysis seroi-aunuai survey of 45C U.S. direct investors 
 and their 4800 affiliates. The Bureau extrapolates to universe estimates of 
 gross property and plant expenditures for all directly held affiliates where 
 the U.S. equity is 25% or more. 
 
 14 Foster, p. 254. 
 
 i5 "Special Report on Multinational Companies," Bu siness Week , No. 2155 
 (December 19, 1970), p. 61. 
 
 i6 Foster, p. 254. 
 
 ^'Lorenson, ARS No. 12, p. 1. 
 
11 
 
 U.S. business. 8 Thus, we observe a marked decline in earnirge-remittance 
 (from 74% in 1961 to 56% in 1970) , and it is not unreasonable to expect 
 greater and greater proportions of foreign earnings to be reinvested abroad, 
 either in the affiliate generating such earnings or in companies located 
 elsewhere in the world. 
 
 The preceding statistics indicate expanded investment, manufacturing 
 emphasis, extensive commitment to long-lived assets and earnings retention. 
 They, as well as the statistically demonstrable^ proliferation of foreign 
 subsidiaries and the high relative and absolute size of commitments by in- 
 dividual U.S. firms abroad, support an argument that the terms permanency, 
 continuity and normalcy are more descriptive of the foreign operations of 
 multinational firms in general than would be their antonyms. 
 
 The existing. literature also tends to bear out a contention that the 
 population of firms having material interests in foreign subsidiaries and 
 affiliates is distributed as in Figure 1. For example, Seidler expresses the 
 need to recognize that many foreign operations are viable entities separate 
 from their parents. He later asserts? "Foreign operations or, in current 
 parlance, multinational operations, .re now quite conventional and normal. ° 
 
 18 
 
 Raymond Vernon, "Future of the Multi-national Enterprise," in Charles 
 
 P. Kindleberger, The International Corporation , p. 381 and ''Special Report on 
 
 Multinational Companies," p. 58, 
 
 "■^Raymond Vernon, "Future of the Multinational Enterprise," in Charles P. 
 Kindleberger,, The^ International Corporation, (Cambridge: The M.T.T. Press, 1970) 
 Chapter XV, Table 1, pp.~" 380-3 8T, "Special Report on Multinational Companies," 
 Business Week, No. 2155 (December 19, 1970), pp. 57-58, Gerhard G. Mueller, "Are 
 Traditional Foreign Exchange Translation Methods Obsolete?," California Manage- 
 ment Review, VII, No. 4 (Summer, 1965), p. 41, "Multinational Profits," p. 77, 
 Lorenson, ARS No. 12 , p. 1 and Hayes, p. 6. 
 
 20 
 
 ^ u Lee J. Seidler, "An Income Approach to the Translation of Foreign Cur- 
 rency Financial Statements," The CFA Jour nal, XLII, No. 1 (January, 1972), p. 31 
 and 34. 
 
12 
 
 Duepree sums up fairly well the overall contemporary view: 
 
 Companies having foreign operations today tend to be 
 multinationa l in character. Their operations are viewed by 
 many investors from a worldwide Doint of view, which recognizes 
 that there are specific differences in conditions among the 
 countries. . . In the large multinational companies, remittance 
 to the U.S. parent company is generally no longer a primary 
 objective. 
 
 There 3eems every reason to believe that the distribution in Figure 1 
 
 is a fairly accurate description of the population of firms having material 
 
 interests in foreign subsidiaries and affiliates. The importance of this 
 
 22 
 distributions in particular its peakedness and skewness, suggests that a 
 
 "general case" exists as far as multinational firms are concerned, is speci- 
 fiable in terms of specific characteristics, and these characteristics are 
 anathema to establishing direct relevance for exchange rates in the accounting 
 measurement of foreign operations and net asset values . 
 
 A disinvestment, dollar conversion view of foreign operations clashes 
 with the foregoing "general case" where normalcy, continuity, expansion, re- 
 investment > and permanency are descriptive of foreign operations conducted 
 by the vast majority of multinational firms. This conflict has not gone un- 
 noticed. The International Accounting Committee concluded that the assumption 
 
 Marvin M. Duepree, "Translating Foreign Currency Financial Statements 
 to U.S. Dollars , " Financial Execut ive , XL, No. 10 (October, 1972), p. 49. 
 
 22 
 
 In the present case, peakedness is not as important as skewness. The more 
 
 peaked the less difficulty dichotomizing firms for accounting purposes. The 
 flatter the curve the greater the chance that more than two categories of firms 
 exist which are significantly different for accounting purposes. The less skew 
 the distribution, however, the greater the number of exceptions to the "general 
 case." The researcher's own perception of the situation, expressed by the 
 extreme skewness and kurtosls in Figure 1, is that a near nominal scale applies 
 to those characteristics of the firms which have direct accounting consequences. 
 That is, firms either do or do not exhibit a particular characteristic, and 
 for those that do a higher degree possessed merely makes the arguments advanced 
 stronger. 
 

13 
 
 that subsidiaries exist to provide cash to the parent is no longer tenable 
 
 for multinational enterprises. -* Parkinson states: 
 
 Looked at from the point of view of a Canadian parent, in 
 a typical situations no part of its investment in a foreign sub- 
 sidiary can be regarded as current. (A possible exception might 
 be represented by surplus funds held by the subsidiary awaiting 
 remittance to the parent.) That is to say, for all practical 
 purposes, none of the current assets or liabilities appearing in 
 the balance sheet of the subsidiary is about to be converted to 
 Canadian currency or remitted to the parent; for this reason the 
 working capital held by a foreign subsidiary represents as much 
 a permanent investment by the parent as do the non-current bal- 
 ances held by the subsidiary. f 
 
 Given the available evidence, only one conclusion appears tenable with 
 regard to the direct relevance of exchange rates for firm valuation. Unless 
 there is substantive evidence that a firm is not described by the general case, 
 i.e., the firm clearly falls in the left-hand tail of the distribution in 
 Figure 1, they are only directly relevant to transactions involving actual 
 currency conversion or to valuation of particular assets and liabilities when 
 conversion in the short-term is reasonably assured. In other words, if objec- 
 tive evidence is present that a portion of cash will be remitted as dollar 
 dividends or that a particular liability will require a conversion of U.S« dol- 
 lars prior to settlement, exchange rates as conversion prices are directly rele- 
 vant to valuing the asset or liability. If in a reasonably short time a con- 
 version of foreign currency is to take place then it is consistent with accrual 
 accounting to apply an expected price or exchange rate to valuation of the item.. 
 
 *" J Commit tee on International Accounting, p. 151. 
 
 9 A 
 
 ^Parkinson, p. 79. See also pp. 29, 70 and 98. It is also worthy of note 
 
 that the AiCPA recognized this same fact for many companies back in 193.1. Com- 
 mittee on Accounting Procedure, American Institute of Accountants, Accou nting 
 lf- s jSfi£Sil £ ^JJ^AILJjSj^^ "Foreign Operations and Foreign Exchange," 
 
 (Kew York: AIA, 1939), pp. 32-33. 
 
14 
 
 However, exchange rates as conversion prices do not appear relevant to firm 
 valuation in general. The information provided directly by exchange rates 
 relates to activity in a particular market, a market with which a multination- 
 al firm may have only limited dealings. 
 
 Indire ct Rel evance 
 
 While exchange rates as conversion prices do not appear to be environ- 
 mental variables directly relevant to translation, they might be indirectly 
 relevant in the sense of reflecting the relative economic value of currencies. 
 That is, exchange rates may constitute approximations of the relative values 
 of currencies in acquiring goods and services, and so reflect the relative cost- 
 price structures of economies. Exchange rates are then surrogates for another 
 environmental variable., relative price level, and move with inflation in the 
 foreign economy rather than the foreign exchange market. 
 
 There are several reasons to consider this possibility. First, internal 
 inflation is often cited as a major factor contributing to changes in exchange 
 rates. As a result, there is a priori basis for the hypothesis that exchange 
 rates reflect the relative values of currencies in acquiring goods and services 
 and changes therein due to inflation. Parkinson, for example, notes that "con- 
 trol, or absence of control, over inflation is a factor in establishing an 
 exchange rate." 2 -' Mueller contends: "There are many reasons why the for- 
 eign exchange rate of a given currency may fall. Foremost are internal in- 
 flationary pressures. " z ^ Similarly, Wells takes the following view: 
 
 25 Parkinson, p. 21. 
 
 2& Mueller, International Accounting, p. 173. 
 
15 
 
 Devaluation and inflation are intimately connected. Exchange 
 problems generally arise because devaluation takes place when the 
 financial authorities of a country decide that the currency is 
 overvalued , and that the country's balance of payments would bene- 
 fit from a lower value of the ci rrency internationally. A cur- 
 rency normally becomes overvalued because the supply of money has 
 been increased without a corresponding increase in the amount of 
 goods and services available for consumption — in other words, when 
 inflation exists. 
 
 A second reason exists to consider a relative value justification for the 
 use of exchange rates in translation. A great deal of the theoretical reason- 
 ing offered to support the use of particular exchange rates for certain items 
 in traditional translation methods rests upon occurrence of internal inflation 
 with material changes in exchange rates. The use of historical exchange rates 
 in translating fixed assets in particular rests upon an "exchange rate-price 
 level covariance assumption." It is presumed after devaluation of a foreign 
 currency, for example, that internal prices will rise so that while the for- 
 eign currency unit commands fewer dollars than before, the future flow of those 
 units will be greater. Thus it is reasoned no real loss occurs and so, by use 
 of historical rates, no loss is recognized. 
 
 A final reason is that if exchange rates reasonably reflect relative pur- 
 chasing power and their movements reasonably parody inflation, a seemingly sound 
 conceptual basis is provided for their use in translation. Reasonable approxi- 
 mation of relative value and reasonable adjustment for changes in value by 
 
 27 Michael T. Wells, "Devaluation and Inflation and Their Effect on Foreign 
 Operations," Accountancy, (August, 1965), as reprinted in Kenneth B. 3erg, 
 Gerhard G. Mueller and Lauren M. Walker, Readi ngs in International Accounting , 
 (Boston: Houghcon-Mif f len, 1969), p. 262. A similar view is expressed by 
 Shulman, i.e., fundamental disequilibrium occurs when high inflation affects 
 international competitiveness to the point of structural deterioration in a 
 country's balance of payments, R. B. Shulman, "Are Foreign Exchange Risks 
 Measureable," Columbia Journal of World Business, V, No. 3 (May- June, 1970), 
 p. 56, 
 
16 
 
 exchange rates is all that should be expected of exchange rates. The alterna- 
 tives are direct measurement versus surrogate measurement. An attempt at 
 direct estimation of currency value is certain to involve difficulty and costs 
 and be itself somewhat imprecise, In contrast, exchange rates are readily 
 available for use at nominal cost. 
 
 Upon investigation of exchange rates s depending upon the approach taken* 
 we would expect certain conditions to hold in general for exchange rate behav- 
 ior. Several criteria for assessing the appropriateness of using exchange rates 
 in translation under an indirect relevance criterion suggest themselves. First, 
 exchange rates should tend toward being equilibrium rates. An exchange rate 
 could be deemed an equilibrium rate if it tended toward creating a zero balance 
 of payments position; i.e., that rate which would tend to eliminate an existing 
 payments deficit or surplus. A second type of equilibrium rate would be a 
 "clearing" rate in the sense of tending toward a balancing off of international 
 dealings at points in time and one which would not tend to change an existing 
 payments position. Conceptually the two interpretations are the same in that 
 given continuous existence of the latter the former could never exist . How- 
 ever, large deficits do occur so the first type of equilibrium rate may be the 
 best (in the sense of reflection of relative currency value) we can expect. 
 
 Second, exchange rates should tend to move toward equilibrium on a timely 
 basis. Material overvaluation or undervaluation of currencies should not 
 persist for extended periods of time. This is particularly important. Timely 
 recognition in the accounts of the effects of environmental variables is clear- 
 ly desirable in order that action can be taken to avoid those which are dysfunc- 
 tional. Also, erradic recognition of changing values frustrates single period 
 and multiple period interpretation of financial statements. 
 
17 
 
 Third, since rates are derived from the international goods market, equil- 
 ibrium rates must basically express relative cost-price relationships between 
 internationally traded goods. Relative purchasing power must be what is es- 
 sentially being portrayed by exchange rates at different points in time and 
 this should not be continually obscured by other forces acting on exchange 
 rates. 
 
 Fourth, the goods traded internationally and therefore their relative 
 costs and prices must be fairly representative of the relative costs and prices 
 of the goods and services that any multinational firm may deal in or hold. If 
 this condition does not hold, then the value expressed by exchange rates is 
 not relevant at the firm level. Since our concern is with a wide range of 
 firms and therefore a wide range of assets held, there must exist some rea- 
 sonable correspondence between the behavior of exchange rates and the behav- 
 ior of local prices in general. There must be correspondence between internal 
 _g^eral purchasing power of currencies and their external purchasing power — 
 general purchasing power because, as Zenoff and Zwick state: "The impact in- 
 flation may have on an affiliate of a multinational firm depends on inflation's 
 effect on the overall, business environment."-^ 
 
 The preceding four criteria provide a useful framework for evaluating 
 exchange rates in a step by step fashion. The hypothesis that exchange rates 
 reflect relative currency value must derive from a multiple-step reasoning 
 process. Exchange rates arise from the supply and demand for currencies. The 
 supply and demand for currencies is related to a country's balance of pay- 
 ments. A country's balance of payments arises from the import and export of 
 
 28 
 
 ''Zenoff and Zwick, p. 53. 
 
18 
 
 goods and services. The level of imports and exports for a country is a. 
 function of supply and demand for internationally traded goods and services 
 (including capital) and that in turn lepends upon the cost-price structure 
 in that country vis a_ vis other countries. Thus a reasonable relationship 
 between internal prices and the prices of currencies is possible. The four 
 criteria deal with both the links in the necessary train of reasoning as 
 well as accounting considerations such as timely adjustment and relevance 
 at the firm level. 
 
 Evaluation of Indirect Relevance 
 Achievement of the first two criteria advanced, (i.e., reasonable ten- 
 dency toward equilibrium and reasonably timely movement toward equilibrium) , 
 can be assessed by way of an examination of past exchange rate behavior and 
 identification of environmental variables which enter into determining that 
 behavior. We shall conduct this examination on two levels — fluctuations of 
 rates about par or parity and changes in par or parity values. The last two 
 criteria reduce to a proposition that exchange rates parody the effect of in- 
 flation on currency values and therefore firm values. This proposition is 
 assessed in the final section of this paper. 
 
 Fluctuations About Parity 
 Given a central parity and upper and lower bounds for fluctuations around 
 parity, a basic determinant of the value of any currency at a point in time 
 (the spot rata) is the supply and demand for the currency . Supply and demand, 
 in turn, is generally related to the country's balance of payments, and move- 
 ments in exchange rates n will normally reflect changes in a country^ balance 
 of payments." 2 ' Since balance of payments is directly related to cost-price 
 
 ^Alan R. Holmes and Francis H. Schott, The New York Foreign Exchange 
 Market „ (New York: Federal Reserve Bank of New York, 1965), p. 31. 
 

19 
 
 structure through supply and demand for imports and exports , it is plausible 
 that movement in exchange rates could be reflecting, to a large extent, changes 
 in the relative value of currencies. However, at the short-term fluctuation 
 level it is highly unlikely that value will be precisely specified or remain 
 unobscured by other forces acting on the market rate as it moves around par. 
 Interrelationships 
 
 The relationship between internationally traded goods s their prices, 
 price levels in general and exchange rates is less than simple. The prices 
 of traded goods are affected by many factors other than supply and demand and 
 internal price levels. The same holds true for exchange rates. They too are 
 not just influenced by the balance of payments position of countries. For 
 example, the prices of traded goods will be affected by border taxes, tarriffs, 
 goods prohibitions, differing tax rates and various other impediments to a free 
 flow of goods, money and services. These factors and other factors such as 
 interest rates in one country versus another will likewise affect the supply 
 and demand for a particular currency. As these factors change so also will 
 exchange rates change. This raises an ancillary point. Not only is relative 
 value between currencies obscured because these factors enter into the determi- 
 nation of exchange rates, but the possibility of reasonable separation, iden- 
 tification and measurement of the effect of changing values indirectly through 
 use of market exchange rates becomes doubtful. While an account such as "ex- 
 change gain or loss 1 ' may capture part of the effects caused by the factors 
 above, other accounts such as tax expense, duties and cost of goods sold will 
 be capturing additional or offsetting effects and not necessarily in the same 
 accounting period. If a market exchange rate is responding to interest rate 
 differentials, then an offsetting effect is implicit in any interest expense 
 being recognized on foreign denominated debt. 
 
20 
 
 Exchange Control s 
 
 Exchange controls significantly interfere with supply and demand. The 
 result is that value relationships which exchange rates under the influence of 
 supply and demand for goods and therefore currencies might otherwise reflect 
 become obscured. From the point of view of a particular government, devaluation 
 or revaluation is merely one of several policy tools available for managing a 
 country's international position* If a country is experiencing balance of pay- 
 ments problems, changing the par value of its currency is one approach to solv- 
 ing the problem. Another approach is to use fiscal or monetary policies to 
 reduce aggregate demand. Interest rates, for example, may be exchanged to 
 stimulate inflows of capital or to control inflation. Exchange controls, 
 controls over currency exchange transactions by the government, constitute 
 other "discretionary policy measures that can be employed to counter the free 
 market forces affecting a country's balance of international payments." 30 
 
 Government control over exchange varies from little to complete both 
 by countries and for single countries over a period of time. Nearly all 
 countries have some remittance restrictions. For example, at December 31, 
 1971j companies in Greece were restr- cted to repatriation of invested equity 
 at 10% per year and profits on equity at 12% per year. At that same time, 
 Brazil not only restricted repatriation but also applied a penalty tax on 
 remittances in excess of 12% per year. Multiple exchange rates exist in 
 several countries providing preferential rates to exporters or importers or 
 for certain goods over others. 
 
 The point is that supply and demand for a currency and, therefore, its 
 
 30 Zanoff and Zwick, p. 41. 
 

21 
 
 market rate of exchange is artificially controlled through exchange controls. 
 Furthermore j, the impact of these controls is not stable* since they are changed 
 frequently. The result is that neither the existing rate for a currency nor 
 changes in that rate are reflections of supply and demand for the currency 
 on numerous occasions. 
 D ir ec_ t Mar ke t --M l^t erven ti on 
 
 Exchange rates might still consistently reflect supply and demand for a 
 currency, and so perhaps intrinsic value,, if supply and demand was not often 
 overshadowed by another factor in the market. Relatively long-term imbalance 
 can be perpetuated by government intervention in the foreign exchange market 
 alone. As an exchange rate moves upward or downward from parity, a country 
 may sell or buy its currency against dollars. In the case of the United States* 
 the Federal Reserve Bank of New York enters the market to slow or halt move- 
 ments within official limits. Such government intervention in the foreign ex- 
 change market "is known to have taken place regularly since the IMF was founded, 
 and particularly at times of considerable strain on those currencies which are 
 world trading currencies."^- It should be noted that: 
 
 Official activity is at least an ever present factor and at times 
 
 may be the most important single element In the market. 
 
 Implications 
 
 From the foregoing observations it must be concluded that no meaning can 
 safely be attached to any particular movement in an exchange rate about its es- 
 tablished par for accounting valuation purposes. Change in the market value 
 of a currency may have resulted from any number of factors unrelated to change 
 
 " 1 
 
 J 1 Committee on International Accounting, p. 129. 
 
 ■^Holmes and Schott, p. 14. 
 

 
22 
 
 in the nature of the currency for purposes of claim on goods and services. 
 We have discussed some of these factors. To those discussed we can add ran- 
 dom, unfulfilled and self-fulfilling speculation, seasonal peaks in import- 
 export activity s sporadic disturbances via singularly large international 
 payments and surely other obscuring factors exist. 
 
 Since fluctuations around parity cannot, in general, be associated with 
 permanent, identifiable and measurable effects on firm values use of specific 
 market rates in translation will often result in accounting recognition of tem- 
 porary and reversing movements in rates which are of no discernable consequence 
 to the firm. This can only introduce additional confusion into the interpreta- 
 tion of financial statements that include foreign operations. This conclusion 
 corresponds with that reached by Parkinson in the recent Canadian study where 
 bookkeeping rates, generally seen as equivalent to official par values, were 
 considered adequate for accounting translation purposes. Indeed, attempts to 
 be precise by using specific market rates at year end, for example, were 
 viewed by Parkinson as unconstruetive. -* 
 
 C hanges i n Parity 
 Parity Change as a Political Decision 
 
 A change in parity results from a decision by government executives and, 
 therefore, economic considerations are often outweighed by political considera- 
 tions. 
 
 The executive making the decision is a political realist balancing 
 his (or his party's) political future against current economic 
 need. Ke is free, to adjust the exchange rate by an amount that 
 
 ^ -'Parkinson » p. 2. King agrees, maintaining that material distortion can 
 result and suggesting that par values be used. Alfred M. King, "The Choice of 
 a Foreign Exchange Rate," Management Account ing , XLIX, No. 8 (April, 1968). p. 13 
 

 
23 
 
 will produce an equilibrium rate, or he can undervalue or over- 
 value. Recent cases in support of all three types of decisions 
 can be cited. ■*** 
 
 The important point is that the establishment of a parity value may easily 
 rest on non-economic factors, factors unrelated to or in conflict with setting 
 a realistic value for a currency. Such factors would include the characteris- 
 tics of the decision makers, the outlook of advisors and domestic political 
 considerations . j:) 
 Too Much. — Too Little 
 
 There is ample evidence to show that parity changes will often be too 
 great or too little in terms of establishing equilibrium rates. Long-term 
 overvaluation or undervaluation of a currency can be expected to be common- 
 place. The establishment and maintenance of a par value which undervalues a 
 currency may be motivated by a desire to minimize the possible necessity of 
 later devaluation with attendant inflationary effects. 3" Another reason may 
 be to increase demand for export goods. In contrast, overvaluation may be 
 maintained to retain the favorable position this gives in international trade. 
 
 Devaluation, in particular, is often excessive as it is nearly impossi- 
 ble to determine the precise effect on international payments which will re- 
 sult. As a result, excessive devaluation tends to accentuate the speed and 
 magnitude of retaliatory actions by other countries. 37 Zenoff and Zwick note 
 another cause of excessive devaluation, that being a desire to avoid disturbing 
 
 34 ShuIman, p. 57. 
 
 * 5 Zencff and Zwick, pp. 68-69. 
 
 3°Samue.l R„ Hepworth, Reporting For eign Oper ations, (Michigan Business 
 Studies, Vol. 12, No. 5), (Ann Arbor: University of Michigan, 1956), p. 105. 
 
 37 Ibid., p. 133. 
 
24 
 
 investor confidence in the country. When economics make devaluation inevitable, 
 the size of the adjustment may be founded on the expectation "that one big de- 
 valuation now will preclude having t"; make a series of changes over the ensuing 
 year or two."^" Also* an overly large devaluation may be required to convince 
 speculators that no further devaluation will occur in the immediate future. 39 
 In still other cases there may exist an overriding intent to maintain stability 
 in an exchange rate whether or not warranted. Mexico is a ready example. ° 
 
 Reference to specific cases of par value changes noticeably imprecise, 
 and perhaps intentionally so, can be made. Other cases can be cited where, 
 intuitively, there is no reason to believe realistic currency value adjustment 
 was even involved. For example,. the mark was revalued in 1969 by only 4% and 
 the continuing trade surplus after revaluation demonstrated that the adjustment 
 was clearly insufficient to correct the existing disequilibrium. A more re- 
 cent example can be found in the first revaluation of the yen.**-*- Another ex- 
 ample is provided by England's devaluation in 1967 where 22 countries closely 
 tied to Great Britain economically also devalued, 17 doing so by the exact 
 same percentage as that of the original adjustment .^ 
 
 Bach has observed the tendency lo postpone a parity rate change "until 
 financial and political pressures made it imperative."* 3 In particular, he 
 
 38 Zenoff and Zvick, p. 87. 
 
 -"Don Schilling, "Devaluation Risk and Forward Exchange Theory," American 
 Econom ic Review , LX t No. 4 (September, 1970), p. 722. 
 
 Price Waterhouse & Co., p. 57. 
 
 ^"Sinking Feelings in the Land of the Rising Sun," Forbes , CX, No. ? 
 (October 1, 1972), p. 30. 
 
 / 
 
 Zenoff and 2wick, p. 88. 
 
 Christopher L. Bach, "Problems of the International Monetary System and 
 Proposals for Reform— 1944-1970, " Federal Reserve Bank of St. Louis Monthly Re- 
 view, LIV, No. 5 (May, 1972), p. 31. 
 
25 
 
 refers to the observable sluggishness in changing par values from 1958 to 
 the devaluation of the pound in 1967 and the fairly extensive use of tariffs, 
 quotas and other controls as alterna ivas to devaluation during the 1960s. 
 Similarly, Mandich asserts that, there is generally "a long prelude of deteriora- 
 tion covering several years" before devaluation occurs, especially with 
 regard to more developed nations with substantial reserves to draw on to de- 
 fend an existing par value. ^ Indeed, for developed countries generally, de- 
 valuation has become a policy measure of last resort." 4 -* Less developed coun- 
 tries will similarly avoid devaluation in order to not discourage foreign 
 investment. 
 
 For example, Zenoff and Zwick observe that during 1965-1967 many viewed 
 India's devaluation of the rupee as resulting from intense pressure by the 
 United States on an Indian government that was not inclined to devalue. " 
 Shulman cites the British situation in 1964 where the Prime Minister was faced 
 with immediate devaluation or postponing such devaluation and chose the lat- 
 ter. *' Instead of devaluing Britain instituted a 15% surcharge on imports in 
 October, 1964 which was reduced to 10% in 1965 and then lifted in November of 
 1966. Britain was eventually forced to devalue in November, 1967. 
 Implicat ions 
 
 It appears that any expectation that par values will tend toward being 
 reasonable equilibrium rates and be adjusted on a reasonably timely basis is 
 unfounded. As a result, placing reliance on par values instead of market rates 
 as surrogate measures of relative value will still not lead to satisfactory 
 
 44 
 
 Mandich, p. 29. 
 
 '^Schilling, p. 722. 
 
 46 
 
 Zenoff and Zwick, p. 85. 
 
 47 
 
 Shulman , p. 58. 
 
26 
 
 accounting results. Since these par values will often entail considerable 
 currency overvaluation or undervaluation over extended periods of time, their 
 use in translation will result in persistent overvaluation or undervaluation 
 of the net assets of foreign-based firms. 
 
 If and when devaluation or revaluation occurs any one of a number of fac- 
 tors , economic, political and so on, may underlie the change. A complex in- 
 teraction process involving numerous variables in any number of possible com- 
 binations is involved. Directly linking any change in an exchange rate, a 
 market rate or a parity value, to identifiable and measureable individual 
 effects on firm accounting values at the time of such an event seems an im- 
 possible task. 
 
 Excha nge Rates and Price Levels 
 
 Our third criterion briefly reiterated was if exchange rates reasonably 
 approximated equilibrium rates, such rates would also need to reflect fairly 
 clearly cost-price relationships between internationally traded goods. The 
 fourth criterion was these goods would, in turn, have to be somewhat repre- 
 sentative of goods generally. As noted, these criteria reduce essentially to 
 a single, directly assessable proposition: exchange rates are reasonable sur- 
 rogates for the relative purchasing power value of currencies and their move- 
 ments reasonably parody relative inflation, 
 
 If this proposition is true, then the economic impact of an important 
 environmental variable would be associated with accounting adjustments for 
 changes in exchange rates and a sound basis for cross-national valuation would 
 be provided. An account such as "exchange gain or loss" would then be related 
 to indirect measurement of a relevant environmental variable — inflation. Any 
 gain or loss recognized would be definable in real economic terms. Unfortunately, 
 
27 
 
 such a proposition is patently false. 
 Authoritative Support 
 
 Authoritative support for the proposition that a reasonable relationship 
 exists between exchange races and price levels is for ail practical purposes 
 non-existent* Instead* the conclusion generally reached by those who have 
 addressed the question is that such a relationship does not hold with any 
 regularity that would make exchange rates useful from an accounting valua- 
 tion standpoint. Some maintain that the pure form of the relationship prob- 
 ably could never exist. Paul Rosenfieid expresses such reservation: 
 
 "Ideally, under complete freedom of trade and of the deter- 
 mination of exchange rates, the exchange rate would reflect the 
 relative purchasing power of the two currencies. . .Actually, the 
 ideal situation seldom, if ever exists. ,r The ideal situation in 
 fact may never exist if the goods and services exchanged between 
 the two countries are not representative of the goods and ser- 
 vices in general purchased within each country. 48 
 
 David » viewing the problem from an economics perspective of measuring real 
 per capita income differences, maintains that sufficient reason exists to 
 expect marked differences between the relative prices of traded and non- 
 traded commodities. 
 
 Whether or not a perfect relationship between exchange rates and price levels 
 can exist is really not that important. From an accounting standpoint all that is 
 sought is reasonable corresponds^. The consensus opinion is that such correspon- 
 dence does not generally exist. For example, Hepworth saw "no reason to believe 
 
 ^"Paul Rosenfieid, ''"General Price-Lave! Accounting and Foreign Operations,'' 
 Journal of Accountancy , CXXXI, No. 2 (February, 1971), Footnote 11, p. 65. His 
 
 reference is to Staff of the Accounting Research Division, American Institute 
 of Certified Public Accountants, Accounting Research Study No. 6, "Reporting 
 the Financial Effects of Price-Level Changes," (New York;, AICPA, 1963), pp. 
 148-149, 
 
 49 Dav±d, p. 979. 
 

 
28 
 
 that the adjustment in the external value of a currency caused by devaluation 
 
 will bear a close relationship to the degree of internal price inflation. "^^ 
 
 Business Wee k maintains that official rates "are frequently a poor measure of 
 
 the actual purchasing power of a country's currency" and Zenoff and Zwick 
 
 assert that empirical evidence tends to support this contention. •*- Along 
 
 the same lines, a committee examinirg the Argentina exchange rate situation 
 
 found : 
 
 ...foreign currencies have their own variations in purchasing power 
 and* as the reality of our own country ? s situation teaches us, the 
 variations in the value of foreign currencies have a direction and 
 intensity different from those manifested by internal prices. Dt - 
 
 In general, the opinion of those who have examined closely the question 
 
 of whether exchange rates mirror price levels seems captured in the following: 
 
 There is often considerable difference between these rates so stated 
 by a government and the price structure within a country, that is, 
 the changes in local price structure of a country are not neces- 
 sarily expressed sympathetically and automatically in the current 
 
 exchange rates . ^3 
 
 Finally, when a relationship does appear to exist, the sequence in which events 
 occur may vary. Where normally inflation comes first and then currency depre- 
 ciation, in ether situation the opposite occurs where devaluation comes first 
 and inflation follows.-'' 4 
 
 50 Hepworth, p. 139- 
 
 5"! 
 
 Special Report on Multinational Companies," p. 85 and Zenoff and 
 
 Zwick, p. 498. 
 
 52 
 
 • Adjustment of Financial Statements to Reflect Variation in the Purchasing 
 
 Power of Money in Periods of Inflation," unofficial translation of recommenda- 
 tions reached by a committee formed by the Buenos Aires Stock Exchange published 
 by Bolsa de Comerclo de Buenos Aires as reprinted in Berg, Mueller and Walker, 
 
 p. 237. 
 
 "'Sapienza, p. 28. See also "Population, Per Capita Production and Growth 
 Rates,"' Finance and development^ IX, No. 1 (March, 1972), pp. 55-56. 
 
 54 Wells» p. 262. 
 

29 
 
 Empirical Validity 
 
 Correspondence between exchange rates and price levels is essentially an 
 empirical question, Final validity c invalidity of a proposition that ex- 
 change rates can serve as reasonable surrogates for relative value in account- 
 ing lies ultimately in empirical observation. Such an observation forces 
 rejection of this proposition. 
 
 Any number of specific contrary cases can be cited. Consideration of 
 
 the countries which have recently revalued relative to the dollar will show 
 
 that several have consistently experienced greater rates of inflation than has 
 
 the U.S.; Germany, France and Great Britain are examples. As Zenoff and Zwick 
 
 have pointed out: 
 
 If this assumption is correct that devaluation and revaluation 
 move together there should have been, for example, a steady de- 
 valuation of. European currencies against the dollar during the 
 last twenty years since inflation in Europe has generally been 
 higher than in the United States. Not only has the anticipated 
 devaluation not occurred, but the Deutsch mark and the Cilder 
 have been revalued upward in relation to the dollar. Nor is the 
 assumption any more accurate in the case of countries that have 
 experienced much higher rates of inflation than has Europe. Bra- 
 zil is a case in point. During the recent past the cruzeiro has 
 remained at 2,200 to the dollar during a twelve-month period 
 when internal prices have risen more than 40 per cent per annum. -> 
 
 Argentina provides a case similar to that cited by Zenoff and Zwick for 
 Brazil. If the exchange rate had moved tandem with the relative prices struc- 
 tures of the U.S. and Argentina between 1953 and 1960 the exchange rate, in 
 1960 would have been about 35 pesos to the dollar; in point of fact the offi- 
 cial rate in I960 was 82.7 pesos to the dollar. -> 6 In the case of Peru, Wells 
 has observed that where, internal inflation had reached 20% per year in 1965, 
 
 55 Zenoff and Zwick, p, 498. 
 -^Sapienza, p. 29. 
 
30 
 
 57 
 during the five previous years no devaluation had occurred. 
 
 Parkinson has made similar observations regarding correspondence between 
 exchange rates and inflation. First ha has observed that changes in one 
 currency relative to another currency do not follow the same pattern as do 
 changes in either of the currencies relative to the U,S, doilar s the Cana- 
 dian dollar or other currencies. Second, he notes that: 
 
 Prices appear to increase in Canada when there is "full em- 
 ployment" and when there is much unemployment; prices increase 
 when the Canadian dollar goes up in value and when it goes down. 
 A review of price changes following upward and downward changes 
 in the external value of the Canadian dollar (in terms of the U.S. 
 dollar) fails to indicate any direct relationship between the two 
 phenomenon . J ° 
 
 Parkinson cites the specific example of the decline of the U.S. dollar by 
 approximately 7% relative to the Canadian dollar in June, 1970. He maintains 
 it was reasonably. clear that the change was not a direct consequence of infla- 
 tion in the U.S. or inflation in the U.S. relative to Canada. ^ One can 
 return to Germany for an even more recent example. During the first six months 
 of 1971 the consumer price index in Germany rose from 121.1 to 126.1, the same 
 period in which Germany revalued. 
 
 Additional single cases of a lack of correspondence between relative costs 
 and prices and exchange rates could be cited. This is not necessary, however, 
 since several broad empirical studies of the relationship of purchasing power 
 to exchange rates are available and all show similar results. One such study 
 was conducted by Milton Gilbert and Associates.^ The NAA refers to this study 
 in the following: 
 
 57 
 
 "* Wells, p. 271a 
 
 58 
 
 ' Parkinson a pp. 86-87. 
 
 Ibid^, p. 73. 
 
 uw Milton Gilbert and Associates, Comparative National Products and Price 
 
 Levels, (Paris: Organization for European Economic Cooperation, 1958). 
 
31 
 
 . . . , common experience Indicates that relative price levels in 
 the United States and other countries do not correspond closely 
 to rates of exchange between the currencies. A study of compara- 
 tive national price levels in the United States and eight Euro- 
 pean countries supplies statistical evidence to support this ob- 
 servation. For example, this study shows that in 1955 an expen- 
 diture of $1.20 was required to buy in the United States what 
 could be purchased in West Germany for $1.00 converted to marks 
 at the current rate of exchange. If consideration was given to 
 differing expenditure patterns in the two countries, $1.66 was 
 required to purchase in the U.S. what $1.00 converted to marks 
 would buy in West Germany. *~ 
 
 Table 1 shows for the yeans 1950, 1955 and 1960 the ratio of the pur- 
 chasing power of selected currencies to their official dollar exchange rates. 
 Several aspects of the table are worth noting. First, the countries listed 
 are particularly relevant. Multinational activity therein easily account for 
 the bulk of foreign operations. Also, the discrepancies between external 
 value and internal value are both material and unstable over time. Though, 
 on the whole, differences have tended to consistently diminish over time, 
 specific contrary cases are present; i.e., France and Belgium. Finally, the 
 patterns of change over time vary dramatically from country to country so 
 that the bias of exchange rates is not systematic. In other words, accounting 
 valuations based en exchange rates cannot even be expected to involve com- 
 parable degrees of overvaluation or undervaluation. 
 
 National Association of Accountants, N.A._A_._ Research Report No. 36, 
 "Management Accounting Problems in Foreign Operations," (New York: National 
 Association of Accountants, 1950), p. 24, 
 
32 
 
 Table 1 
 
 RATIOS OF PURCHASING P WER TO EXCHANGE PvATE 
 FOR SELECTED COUNTRIES 
 
 Country 
 
 1950 
 
 1955 
 
 1965 
 
 United States 
 
 1.00 
 
 Germany 
 
 1.68 
 
 Canada 
 
 — 
 
 Denmark 
 
 1.64 
 
 Norway 
 
 1.74 
 
 United Kingdom 
 
 1.68 
 
 France 
 
 1.53 
 
 Belgium 
 
 1.35 
 
 Netherlands 
 
 1.90 
 
 U.S.S.R. 
 
 — 
 
 Italy 
 
 1.87 
 
 Japan 
 
 — 
 
 1.00 
 1.67 
 
 1.48 
 1.46 
 1.51 
 i.19 
 1.32 
 1.72 
 
 1.84 
 
 1.00 
 1.41 
 .93 
 1.25 
 1.38 
 1.38 
 1.35 
 1.36 
 1.40 
 1.16 
 1.52 
 1.86 
 
 Source; Appendix Table A in Paul A. David, "Just How Misleading 
 are Official Exchange Rate Conversions?," The Economic 
 Journal , LXXXII, No. 327 (September, 1972), p. 989. 
 
33 
 
 Conclu sions 
 We have assessed justification for the use of exchange rates to translate 
 foreign accounts in terms of two concepts of relevance— -direct and indirect. 
 With regard to the first, that exchange rates might be directly relevant as 
 commodity prices, we found this approach requires a concept of the firm which 
 is unrealistic and theoretically unsatisfactory. With respect to the second 
 concept (i.e., indirect relevance), we. found that the available evidence does 
 not suggest that exchange rates are reasonable surrogates for measures of 
 relative currency value. Hence, we conclude there is no readily apparent 
 basis for using exchange rates in lieu of other data, except that the nature 
 of that other data and the theoretical structure to underlie its use remains 
 unspecified. The specification of an alternative theory of translation and 
 an alternative to exchange rates will be the subject of a future paper. 
 
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