What Hedge Accounting Options Are Available To An Entity That Wants To Manage Foreign Currency Expos
A specific type of hedging transaction that entities can engage in aims to manage foreign currency exposure. These hedges are undertaken for the economic aim of reducing potential loss from fluctuations in foreign exchange rates. However, not all hedges are designated for special accounting treatment. Accounting standards enable hedge accounting for three different designated forex hedges:
- A cash flow hedge may be designated for a highly probable forecasted transaction, a firm commitment (not recorded on the balance sheet), foreign currency cash flows of a recognized asset or liability, or a forecasted intercompany transaction.
- A fair value hedge may be designated for a firm commitment (not recorded) or foreign currency cash flows of a recognized asset or liability.
- A net investment hedge may be designated for the net investment in a foreign operation.
The aim of hedge accounting is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account. For a fair value hedge this is achieved either by marking-to-market an asset or a liability which offsets the P&L movement of the derivative. For a cashflow hedge some of the derivative volatility into a separate component of the entity's equity called the cash flow hedge reserve.
Where a hedge relationship is effective (meets the 80%–125% rule), most of the mark-to-market derivative volatility will be offset in the profit and loss account.
To achieve hedge accounting requires a large amount of compliance work involving documenting the hedge relationship and both prospectively and retrospectively proving that the hedge relationship is effective.
Read more about this topic: Hedge Accounting
Famous quotes containing the words hedge, accounting, entity, manage, foreign and/or currency:
“There’s such divinity doth hedge a king
That treason can but peep to what it would,
Acts little of his will.”
—William Shakespeare (1564–1616)
“At the crash of economic collapse of which the rumblings can already be heard, the sleeping soldiers of the proletariat will awake as at the fanfare of the Last Judgment and the corpses of the victims of the struggle will arise and demand an accounting from those who are loaded down with curses.”
—Karl Liebknecht (1871–1919)
“What is this world of ours? A complex entity subject to sudden changes which all indicate a tendency to destruction; a swift succession of beings which follow one another, assert themselves and disappear; a fleeting symmetry; a momentary order.”
—Denis Diderot (1713–1784)
“There often seems to be a playfulness to wise people, as if either their equanimity has as its source this playfulness or the playfulness flows from the equanimity; and they can persuade other people who are in a state of agitation to calm down and manage a smile.”
—Edward Hoagland (b. 1932)
“Europe has a set of primary interests, which to us have none, or a very remote relation. Hence she must be engaged in frequent controversies, the causes of which are essentially foreign to our concerns. Hence, therefore, it must be unwise in us to implicate ourselves, by artificial ties, in the ordinary vicissitudes of her politics or the ordinary combinations and collisions of her friendships or enmities.”
—George Washington (1732–1799)
“One of the reforms to be carried out during the incoming administration is a change in our monetary and banking laws, so as to secure greater elasticity in the forms of currency available for trade and to prevent the limitations of law from operating to increase the embarrassment of a financial panic.”
—William Howard Taft (1857–1930)