Mini Case

MEASURING INCOME IN A MULTI

CURRENCY ECONOMY
Professor, as you know, I did very well in your financial accounting class last year but
now I think that what I learned doesnt work here. No matter what I do in my new
business. I never show a profit. Maybe your American accounting doesnt fit here in
Armenia.

Those words were spoken by David Avakian. a recent graduate of the new
American University of Armenia. He had recently graduated from the MBA
program and started his own business in currency trading. Now he was frustrated
by his failure to make money and his inability to use the accounting that he had
learned.
Background
The Republic of Armenia is the smallest of the former Soviet republics As
part of the Soviet Union its economy had always been based on cash with no
credit cards checking accounts and so on As such its citizens were used to dealing
in cash including an active black market in foreign currencies. Since the collapse
of the Soviet Union. Armenia had gone through dramatic political and economic
change Holding and trading foreign currencies are no longer illegal so no black
market exists. As a result many people have started businesses to take advantage
of the new opportunity. Armenias economic experience since independence, has
been tumultuous Immediately after independence it became part of the
Commonwealth of Independent States and continued to use the Soviet Ruble as
its currency. The Ruble experienced tremendous inflation from 1991 through 1993
at which time Russia dropped the Soviet Ruble in favor of a new Russian Ruble
(RR) and Armenia adopted its own currency called the Dram.
Subsequently the Russian Ruble continued to fall against most Western
Currencies. while the Dram stabilized after an initial period of devaluation.
However as a practical matter most aspects of economic activity are conducted in
any of three currencies. the Russian Ruble the Armenian Dram or the American
Dollar. These three currencies are actively traded and each is used commonly for

everyday transactions. although the Dram is required for official transactions. The
widespread availability of the three currencies has led to a very large number of
currency exchange and speculation businesses. In some areas, virtually every shop
also functions as a currency exchange In other cases a business may be strictly
engaged in currency exchange and speculation. David Avakians business was of
the latter type.
The Problem
As David expressed it to his former professor his problem seemed simple.
No matter what he did at the end of the day he never had a profit or a loss. This
result was frustrating to him for obvious reasons and he was beginning to think
about getting out of the business altogether. His professor asked him to bring in
all the information he had about a typical days transactions and to show how he
calculated his profit and loss for the day. A simplified version of the information
he provided appears as Exhibit 1 but without his calculation of income. David he
started with the equivalent of $300 although he only actually had $100 in
American currency.

Start of Day
Event 1 Russian Ruble falls 10% against
the
Dollar
Trade 1
Event 2 Dram falls 10% against the Dollar
Trade 2
End of Day

Dollars

Russian Rubles

Dram

100

400000

45000

-10

+44000

-10

80

444000

+4950
49950

START OF DAY
Dollar Equivalent
R[R[ Equivalent
Dram Equivalent

Dollars

Rubles

Dram

100
100
400000
45000

400000
100
400000
45000

45000
100
400000
945000

Dollars

Rubles

10

+44000

EVENTS
Ruble falls 10% against dollar
Trade 1

Total $300
Total 1200000
Total 135000
Dram

Dram falls 10% against

dollar
Trade 2

10
Dollars

END OF DAY
Dollar Equivalents
Total $ Equiv!end
Total $ Equiv!start
$Loss

+4950

Rubles

Dram

80
80

444000
+100.91

49950
+100.91 =$281.82

444000

444000

281.82
30000
18.18

END OF DAY
Ruble Equivalents
Total RR Equiv!end

1240000

Total RR Equiv!start

1200000

352000

RR Gain

+40000

Dram Equivalents

39600

Total Dram Equiv!end

139500

Total Dram Equiv!start

Dram Gain

135000

49950

49950

+4500

Aggregate Income In :
Dollars: - 18.18 + 9.09 + 9.09 = 0 (-18.18+40000/4400+4500/495)
Rubles: - 79992+ 40000 + 40000 = 0 (Rounding Error)
Dram: - 9000+ 4500+ 4500 = 0

Questions
1. What principle has David overlooked ?
2. What factors should David consider in selecting his functional
currency ?
3. As far as you can tell, which currency do you think David should
select ?