ISSN 1940-204X
Pounds of Trouble: Analyzing Exchange Rate Variances
Michael A. Harris
Graduate Student
Brigham Young University
Steven D. Smith
Associate Professor
Brigham Young University
Monte R. Swain
Professor
Brigham Young University
“This is the worst EAPC conference ever; and it’s happening
on my watch! Look at all these complaints! You’re going to
find out what’s going on and who’s to blame.”
You’ve had a rough first week at the European
Accounting Professionals Coalition (EAPC), and the stack of
comment cards EAPC president Shirley Brisbe just handed
you is a guarantee that this afternoon won’t be much better.
You joined the EAPC events team just days before the
opening of the EAPC Annual Conference, a week-long
gathering of professionals from around the world that is held
at various locations in Europe in May. This year, the 2015
conference is in London, England. By many accounts, it
should be a huge success: most members of the association
speak English, the weather is outstanding, and the 2015
British economy is booming.
But everything is going wrong. You started to suspect
there was a problem based on the mood of some attendees
as they walked past your hotel room the first night while
you were quietly working on some minor conference
arrangements. Though your door was closed, you could
hear them complaining (rather loudly) about the conference
dinner. You couldn’t make out the details through the door,
but you learned during breakfast the next day that more than
a thousand people crowded into a restaurant that typically
only hosts up to 800 people and that the food fell far below
expectations. After the conference’s first two days, attendees
were asked to comment on their experience thus far. The
number of negative responses was eye-opening, and Brisbe
has called you aside privately to ask for your help.
“It seems that the root cause of the dissatisfaction is
IM A ED U C ATIO NA L C A S E JOURNAL
William B. Tayler
Associate Professor
Brigham Young University
that there just isn’t enough money to pay for everything. I
understand that funds can be short, but why here, and why
now? The conference in Amsterdam went so smoothly last
year and in Milan, Lisbon, and Munich the years before—
look, we’ve never come up short until now. Is someone
robbing the till? What’s different this year that’s turning the
London conference into such a disaster?”
You promised to get to the bottom of things, which
seemed to calm Brisbe’s temper for the time being. As
you peruse the pile of comments she handed you, a few
sentences catch your eye:
“Coffee breaks are low on coffee.”
“ Crowded, disappointing venue for dinner. I had
expected a lot more from this organization.”
“ In view of many other failings at this event, it’s no
surprise that my cocktail glass arrived with inferior wine,
which, if I am to judge by the amount poured, our hosts
were stretching across far too many guests. In fact, it
matched my metaphorical glass at this conference—
half empty.”
A slight smile flickers across your face as you finish
reading the last lyrical comment, and you resolve to salvage
some cheer in the day by asking a few of the more agreeable
EAPC members you find for their candid feedback.
Additionally, you use your phone to send off quick emails
to a few departments asking for cost-related data from the
first days of the conference so that you’ll have some hard
numbers for your analysis.
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Having finished that task, you notice that the attendees
have begun to file out of their conference rooms. You put
your phone in your pocket, tuck the cards away, and set
your eye on the nearby coffee area as a likely place to have
a conversation about these shortcomings at the London
conference. You set off to mingle and see what you can learn.
Sterling continues: “It makes sense; the pound has moved
quite a bit against the euro this year. The rumor going around
now is that the EAPC probably didn’t see this economic
growth coming, so it planned everything for the conference
using whatever the exchange rate was back at the time the
budget was set. Obviously, that rate has changed. The boom
is great for some people, sure, but it makes everything more
expensive for the EAPC in Britain if its home currency is the
euro. No wonder it’s short on funds this year.”
Thinking further on this idea, you recognize that if prices
have been stable in Britain, then as the pound rises against
the euro, each euro will buy fewer pounds and, hence, fewer
British products than it did before. So, put another way,
British products would indeed be more expensive in euros
than they were before. Sterling’s hunch may just be a vital
clue in solving this mystery.
AN IMPORTANT EXCHANGE
As you approach a pleasant-looking gentleman, he takes it
upon himself to break the bad news: “The coffee is—”
“Gone?” You ask.
He grins, and you get the feeling this has been a common
topic of conversation here. Seizing the opportunity, you
introduce yourself and learn his name: Curt Sterling.
You ask Sterling if he’s noticed anything else that seems
to be going wrong. As you listen to his answers, you notice
that his observations are in line with the comment cards—
most things at the conference just seem to be in poor quality
and short supply. You mention that this wasn’t a problem
with other recent conferences.
“Well, you’ve got to consider exchange rates,” Sterling
says. “Someone here pointed out to me that out of all the
countries where we’ve had conferences recently, Britain
is the only one not using the euro. She figured the EAPC
keeps most of its financial records and budgets in euros and
that they haven’t had to deal with volatility in currencies
until now.”
“Interesting thought,” you acknowledge. Sterling is right
about at least two points. First, you do happen to know that
all of the budgeting for this event was, in fact, prepared in
euros. Second, Britain is the only host country for the EAPC
whose currency, the pound, floats independently of the euro.
SOME HISTORY
Before the introduction of the euro in the European Union
in 1999, many European countries were already pegging
their currencies together, allowing for only slight fluctuations
between them. This arrangement, known as the Exchange
Rate Mechanism (ERM), began in Europe in 1979. It came
after the breakdown of the earlier Bretton Woods system,
which pegged many currencies to the U.S. dollar and gold
from World War II to 1971. See the timeline in Exhibit 1.
Britain briefly attempted to join the ERM in 1990, but
its interest rates were much higher than those of Germany,
whose currency, the mark, had become the de facto ERM
currency. Speculators began taking the position that keeping
the pound tied to the mark in the face of such a large
interest rate difference between the two countries would
Exhibit 1. Evolution of the European Union Exchange Rate Mechanism
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WHO’S TO BLAME?
be unsustainable for Britain. On September 16, 1992, a day
known as “Black Wednesday” in Britain, those speculators
noticed market signals and began a massive short sale of the
pound. The British government, suddenly facing enormous
downward pressure on its currency not only from market
forces but now also from the speculative short sales, could
no longer keep the pound above the lower limit allowed by
the ERM and was forced to withdraw from the program.
The pound was allowed to float, temporarily losing much
of its value, and George Soros, the most prominent of the
speculators, made US$1 billion on the transaction.1
Due to these events, when most ERM countries adopted
the euro in 1999, Britain wasn’t among them, despite being
a member of the European Union. Those who adopted the
euro formed a new economic area called the Eurozone, and
the euro became their accounting currency on January 1,
1999. But no euro banknotes or coins existed for three more
years. The euro currency was finally introduced on January 1,
2002, and on that day nearly all merchants, banks, and ATMs
in the Eurozone started dispensing only euros rather than the
legacy national currency. Legacy currency was still accepted
in most of those countries during a brief transition period
(change would be given in euros); by the end of February
2002, however, the euro was the only currency recognized
in the Eurozone. Today, the economic area has grown to
include 19 members, but still not Britain.
Besides the London conference, the only EAPC Annual
Conference held outside the Eurozone since that area’s
creation was in Copenhagen, Denmark, in 2002. Denmark
uses the krone as its national currency, but in an arrangement
known as ERM II, it pegs the value of the krone directly
and tightly to the euro. There couldn’t have been much
volatility between the two currencies in 2002, and from what
you understand, there were no budget problems for the
Copenhagen conference.
The EAPC no longer stores its financial records for years
before 1999, but all of its budgeting was done in German
marks during those years. While foreign exchange was
an issue, the other currencies were mostly in the ERM,
meaning that there was little volatility for most years. In
any case, none of the people who would have dealt with
occasional volatility in foreign exchange then are involved
with the budgeting or execution of the London conference
now. Further, none of the longest-term EAPC members you
talked to remember any apparent problems with conference
funds until now.
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Based in large part on your findings, Brisbe will hold one
or more people within the EAPC accountable. This means
that your task of pinning down the source of the problems
is inseparable from implicating at least one person in the
debacle, whether or not you actually name that person in
your report. You feel the need to be extremely careful in your
analysis, not only for the sake of correcting mistakes, but also
to be fair to your colleagues in the organization.
You find the exchange rate theory intriguing, but
you know it’s also possible that the explanation could be
something else. For example, you know that more people
are attending this conference than were originally planned,
though you aren’t sure how big the discrepancy is. Could
over-attendance be the reason for the budget woes? Cathy
Hansen, EAPC membership director, was responsible for
managing outreach, invitations, and registration for the
London conference, and she provided the estimated number
of attendees during budgeting. If Hansen is behind the
supposed budget shortfall, Brisbe will investigate further
from there. Higher attendance may be commendable
since one goal of the EAPC is to increase attendance at its
conference events, but Hansen should probably be expected
to give a fairly accurate estimate (even if those estimates
include substantial growth). It’s possible that Hansen was
intentionally sandbagging—predicting low attendance to set
a lower bar she would easily clear.
Todd Harmon, the head of purchasing for events, was
responsible for estimating the per-person costs of the various
goods and services to be used at the London conference.
If anyone should be able to give good price estimates, it’s
Harmon, who’s been managing purchasing at the EAPC
for the last eight years. Under normal circumstances, if it
could be shown that the current catastrophe is a result of
underestimating prices, then Harmon and his budgeted costs
would face serious scrutiny. But these may not be normal
circumstances. Offhand, you aren’t aware of any major
economic swings that would have impacted pricing; but the
details are in the data.
If the shortfall was driven by price fluctuations, you
recognize that Harmon’s best defense would be that factors
outside of his control in London—namely, an unfavorable
movement in exchange rates—were what caused prices
to be higher than expected. But that, in turn, could put
some pressure on EAPC treasurer Mike Cannon for failure
to properly plan for, or perhaps even hedge, the foreign
exchange risk ahead of the London conference.
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QUESTIONS
Of course, there’s always the possibility that there’s no
significant budget shortfall and that from the outset the
event was simply planned to have poorer quality goods and
services than in previous years. In that case, Harmon would
bear some responsibility, but the bulk of the responsibility
for low quality would be borne by Lisa Stevens, director
of the London conference. In the end, you have no reason
to suspect foul play—this particular mystery isn’t likely to
involve fraud—but you haven’t ruled out negligence.
You keep all of these possibilities in mind as you begin
your analysis.
1.
What is the static budget variance (that is, the difference
between the original budget and actual results) for the
dinner?
2.
Break down the static budget variance into a volume
variance and a flexible budget variance for the dinner.
What do these variances tell you?
3.
Break down the flexible budget variance into price and
efficiency variances. What do these variances tell you?
4.
Break down the price variance into a charge variance
and an exchange variance. What do these variances tell
you? Note that the charge variance is based solely on the
difference between the budgeted price and actual price
(based on the currency rate used in the organization’s
budget). The exchange variance is based solely on the
difference between budgeted exchange rate and the
exchange rate actually used in paying the invoice.
5.
Based on your calculations, what is the primary source of
the problems with the dinner? Who appears to be most
directly responsible for the dinner failure? Assuming that
the problem behind the dinner is the general cause of
the EAPC’s challenges this year, what recommendations
would you make to avoid these problems in the future?
HARD DATA
As you look through the responses to your emailed requests
for information, you recognize that much of the cost data
are incomplete—many expenses haven’t yet been paid
from EAPC accounts. You determine that the best place to
start your analysis is with the disastrous welcome dinner,
since that bill has already been paid. Hopefully the dinner
information will help you find out what went wrong.
The data you have to work with, at least for now, are as follows:
Actual attendees: 1,234
Expected attendees: 1,220
EPILOGUE
Actual cost per dinner: £58
udgeted cost per dinner: €60
B
(The budget was set at the beginning of December 2014.)
It’s June 2016, and work is going well. In May, you had
helped pull off a tremendous (and euro-based) success at the
EAPC Annual Conference in Vilnius, Lithuania, and you
were recently promoted. Things have slowed down briefly
in the lull between the European conference in Vilnius and
the upcoming regional conferences, which will take place in
various places across Europe in August. As you eat your lunch,
you mull over the possibility of taking the rest of the day off.
Then you receive a frantic phone call. Maria Duval,
an EAPC volunteer, introduces herself quickly and then
explains the situation:
“I’m overseeing the Northwest region’s conference,
and we decided to have it in London. Why did we have to
choose London? We planned all the budgets meticulously;
we checked and re-checked the prices, the invite lists,
everything—and now this news breaks. I don’t want to see
another London disaster; Shirley Brisbe told me you have
some well-earned experience with exchange rates, and that
last year’s London conference failed much more gracefully
than it might have otherwise thanks to you. Could you help
us here in the Northwest?”
inner costs (in British pounds) were incurred on
D
May 19, the day of the event.
Dinner costs were invoiced and paid (in euros) on
May 21 from EAPC accounts.
Daily midpoint exchange rate information are listed in Table 1.
Table 1. Daily Midpoint Exchange Rates
Date
Cost of £1, in euros
December 1, 2014
€1.25789
December 31, 2014
€1.28261
May 19, 2015
€1.38764
May 21, 2015
€1.40346
You called the restaurant, and the manager confirmed
that menu price changes take effect only once a year, in
September.
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ADDITIONAL QUESTION:
“Of course,” you say.
The news Duval is talking about has been the dominant
story in many outlets for the past few days. Contrary to
most expectations, on June 23, 2016, Great Britain voted in
a referendum to withdraw its membership in the European
Union. The market reacted strongly, and the value of the
pound has fallen to a 31-year low.
This wasn’t Great Britain’s first referendum vote
relating to European Union membership. Britain joined the
European Community (EC) in 1973 and held a referendum
vote on membership two years later in 1975. That vote
turned out differently: the majority voted to stay in the EC.
The EC existed alongside, and then was absorbed by, the
European Union. The Union was created in 1993 when the
Maastricht Treaty, signed by the EC member countries the
previous year, took effect. The treaty also provided for a
European economic and monetary union, which eventually
led to the creation of the euro. However, in negotiations,
Great Britain received an opt-out that would allow it to
continue using the pound if desired. Britain also received
an opt-out from the Schengen Agreement, which abolished
border controls within the European Union, and from a
social chapter of the Maastricht Treaty, which Britain has
since accepted. Those are the conditions under which Great
Britain agreed to join the European Union. Now it appears
that Great Britain will be leaving, and it’s a tumultuous time
for the British pound, as shown in Exhibit 2.
6.
Assuming the pound doesn’t reverse course, what type
of exchange rate variance—favorable or unfavorable—do
you expect for Duval’s Northwest region conference in
August? Should she be concerned about another major
conference failure in London? Assume, for example, that
the EAPC continues to budget conference dinners at
€60 per plate. If the actual cost in August turns out again
to be £58, and Duval planned for and actually has 100
attendees, what happens with the price variance?
ENDNOTES
See “Billionaire who Broke the Bank of England,” The Telegraph,
September 13, 2002, http://www.telegraph.co.uk/finance/2773265/
Billionaire-who-broke-the-Bank-of-England.html.
1
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Exhibit 2. €/£1 Exchange Rate History
(Daily Spot Rates – Mid)
1.3200
1.3000
1.2800
1.2600
1.2400
1.2200
1.2000
Jun 1, 2016
Jun 8, 2016
Jun 16, 2016
Jun 23, 2016
Budgets for the regional conference were set on March 1,
2016, when the exchange rate was 1.28280. Today, June 28,
2016, the exchange rate is 1.20402.
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