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IBM Japan’s contribution Essay

This paper takes the example of IBM to consider the impact of a foreign subsidiary on the financial accounts of the parent firm as a result of foreign exchange fluctuations. IBM Japan’s contribution in this regard has been examined and the company’s hedging strategies are described. The paper concludes with a look at how the Current Account balance of the US of America are at a deficit, and what can be done to change that if it is considered to be problematic for the economy. IBM Revenues & Costs.

As of December 31, 2008 IBM earned a total of $103,630 Million of which Services contributed around 57%, while the rest of the components included Sales and Financing with 41% and 2%, respectively. However, when looking at the costs of their respective contributions, it was seen that Services created 71% of the total of $57,969 Million total costs, whereas Sales and Financing created 27% and 2% respectively. Therefore, the company recorded an operating profit of $45,661 Million, of which the greatest contribution came, not from Services, but from Sales, approximately 58% (IBM, 2008).

IBM Japan is responsible for $10,403 Million or 10% of the total revenue of IBM globally. In Yuan, this figure

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comes to around 1,132,932 Million for IBM Japan. The revenues and costs of IBM Japan are calculated as per local accounting practices, as well as being adjusted according to the GAAP (Generally accepted accounting practices) standards. Consistency in accounting is thus assured for firms with global operations that follow GAAP. The currency denomination is in Yuan, but is also stated in US dollars for comparability and consistency.

Hedging Since IBM operates in many currencies and is a major player in the global markets as a borrower and lender it is exposed to interest rate changes and foreign currency fluctuations. In order to limit the impact of these risks IBM follows policies and procedures which include the use of derivatives. Where foreign currency exposure is greatest derivatives are employed to mitigate the impact of changes in the foreign exchange rates on financial results (IBM, 2008).

As a result of the use of derivative instruments, the company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, the company has a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors, and maintains strict dollar limits that correspond to each institution’s credit rating (IBM, 2008). Derivative instruments are designated as net investment hedges as per the SFAS No.

133. These instruments expose IBM to liquidity risk as they have an instant cash flow effect upon maturing that is not compensated by the translation of the original hedged equity. Some of the instruments used include: forward and future contracts, and interest-rate and currency swaps (IBM, 2008). A significant portion of IBM’s royalties and goods and services will be received from non-US subsidiaries. As a result of the volatile nature of the foreign currency market IBM uses foreign exchange forward contracts as mentioned earlier.

These contracts can be employed as long as their maximum maturity is within the 4 year period. According to IBM (2008), as at December 31, 2008, the weighted-average remaining maturity of these derivative instruments was approximately 446 days as compared to 281 days at December 31, 2007. IBM also manages its subsidiaries cash reserves through its GTC (Global Treasury Centers), which use currency swaps to translate cash flows. Unlike the contracts for royalties conversions the forward instruments used here can be for a maximum term of 6 months (IBM, 2008). Change in Dollar Exchange Value & Profits

According to Wang (2009, p. 367) accounting exposure measures how the consolidated financial statements of an MNC will be affected by exchange rate fluctuations. However, it does not directly affect cash flows. The accounting exposure is in turn affected by the accounting method used to translate the accounts of a foreign subsidiary into US dollar denominated figures. With US based firms increasing their contribution in the global market they are becoming increasingly concerned with the issue of translation method choice of foreign currency values into US Dollar values.

Their foreign concerns need to send back their earnings report to the parent company in the currency denomination of the US Dollar, regardless of which currency their operations take place in. The parent companies often have to decide between Number 8 and Number 52 of the Statement of Financial Accounting Standards. The latter is the temporal method, where all current assets are translated at the exchange rate prevailing at the time of the balance sheet date, while fixed assets are translated at the exchange rate that was in effect during purchase date (Pinto, 2002).

The former is the current rate method, where the translation adjustment according to Pinto (2002) is the annual change in dollar equivalents of the total net assets of the foreign subsidiary. The adjustments made in the current rate method are not reflected in the income statement, and are instead reported to the statement of stockholders’ equity (Pinto, 2002). According to the financial statements of IBM, the company follows the current rate method of SFAS No. 52. This method is the simplest and arose after companies complained about the difficulty of using the temporal method.

Since the gains or losses upon translation are submitted to an equity reserve account called the cumulative translation adjustment, the balance sheet will always be balanced by it in this method according to Wang (2009, p. 367). Current Account Deficit The level of international trade a country engages in is recorded in the Balance of Payments accounts. The Current account is one of the two essential components of the Balance of Payments accounts; the other one being the Financial or Capital account. There are further three divisions within the Current account: Trade, Income, and Transfer accounts.

According to Holman (2001, p. 7) the first measures “the difference between the value of exports and imports of goods and services,” the second measures “the income payments made to foreigners net of income payments received from foreigners,” and the third measures “the difference in the value of private and official transfer payments to and from other countries. ” Problem for the Economy? In order for the Country to finance its deficit it needs to attract almost $8 Billion worth of foreign investment every working day.

If these inflows were to be curtailed, or reversed, for any reason the dollar would suffer a severe depreciation. The result would be a rise in prices of imports as well as, subsequently, in the prices of competing domestic goods. The fall in dollar currency value would also raise inflationary pressures which would cause the government to raise interest rates, leading to a sharp fall in the equity and housing markets. The consequence of such actions could be a slowdown of the country’s economy, and maybe even a recession (Bergsten, 2007).

Advice One possible solution to this large current account deficit is to decrease investment to decrease demand for foreign and domestic goods. However, this would result in low productivity growth and a depressed economy. Another alternative is to raise the level of private savings in the economy. This solution requires a two-pronged effort in the form of a shift in the tax structure to focus on consumption and not on income, and in the form of a mandatory saving scheme, as proposed by Bergston (2009).

Conclusion While IBM uses several techniques to protect itself against the impact of unfavorable foreign currency fluctuations, the impact of these foreign exchange inflows and outflows have an overall macroeconomic affect that is important for the entire country. The large Current Account deficit of the US is a feature that is directly impacted by the actions of IBM and its subsidiaries. The deficit, normally considered to be a show of economic well being of the US has recently caught flak in the wake of the recent financial crisis, which has prompted the discussion about whether it is a problem and how to reduce the deficit.

References Style for Books Bergsten, C. F. (2007). The Current Account Deficit and the US Economy. Peterson Institute for International Economics Testimony before the Budget Committee of the United States Senate. Retrieved May 30, 2010, from Ebsco. Bergsten, C. F. (2009). The Dollar and the Deficits: How Washington Can Prevent the Next Crisis. Foreign Affairs, Volume 88 Number 6, pp. 5. Retrieved May 30, 2010, from Ebsco. Holman, J. A. (2001). Is the Large U. S.

Current Account Deficit Sustainable? Economic Review, Volume 86 Issue 1, pp 19. Retrieved May 30, 2010, from Ebsco. IBM (2008). Annual Report. Retrieved May 30, 2010, from www. ibm. com Pinto, J. A. M. (2002). Foreign Currency Translation Method Choice: Insights From Game Theory. The Journal of Applied Business Research, Volume 18 Number 4, pp. 10. Retrieved May 30, 2010, from Ebsco. Wang, P. (2009). The Economics of Foreign Exchange and Global Finance. Edition 2. Springer.

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