Forex Hedge Accounting Treatment

Why Hedge?

Tapping into the global economy can be an effective way to expand your business. However, the success of your company’s international business is tied to foreign exchange rate volatility, with constant rate fluctuations contributing to unexpected profits or losses. Forex hedging is meant to reduce the risk associated with a company’s exposure to foreign currency balances and transactions. It is in your company’s best interests to recognize these risks and formulate a hedging strategy to safeguard against currency fluctuations, thereby creating cost and revenue certainty for your foreign currency transactions.

What Is Hedging?
Basic Concept: The forex hedge’s change in value is opposite to the change in value of the foreign currency exposure (hedged item). These two amounts offset each other to obtain cost certainty or revenue certainty.

What Is Hedge Accounting?
Hedge accounting is a privilege, not a right. It is special accounting treatment for designated hedges that meet the required criteria outlined in the accounting standards. In typical accounting treatment, forex hedges are carried on the balance sheet at their fair market value, with any changes in the carrying value impacting the income statement in each reporting period. Sometimes this typical treatment creates a timing mismatch in terms of when the forex hedge impacts earnings and when the hedged item impacts earnings. Forex hedge accounting, on the other hand, overrides this method of recording the impact on earnings in the reporting period because the gain/loss of the hedged items and the gain/loss of the forex hedge are recorded in earnings at the same time. In this way, hedge accounting reduces the earnings volatility caused by changes in foreign currency rates. Forex hedging accounting treatment can be relatively easy or very complex, depending on the nature of your company’s forex activities and its hedging products. In general, the fair market value of foreign currency hedges is recorded, often referred to as the "mark-to-market" position (the value of the forex hedge as at the financial reporting date). With forex carry spot hedges, the mark-to-market information is readily available. However, the more challenging component of recording the mark-to-market value is deciding how to record the other side of the journal entry. Some of the key standards related to forex hedge accounting include: International Accounting Standard 39 (IAS 39), Financial Instruments:

Recognition and Measurement Financial Accounting Standard 133 (FAS 133), Accounting for Derivative
Instruments and Hedging Activities (United States)

Pip Booker
Chairman & Founder
Booker and Cropper Capital Group