Case 16-6 Forward Exchange Contracts
Reporting forward exchange contracts continues to be a significant issue in accounting for foreign currency translation adjustments.
A. Describe a fair value hedge and discuss how to account for forward exchange contracts that are entered into for fair value hedges.
Fair value hedges can be defined as derivatives that can be used to hedge changes in the fair value (market value) of financial assets or liabilities like debt securities. Changes in the fair value of the derivative flow directly to the income statement, but are offset by changes in the fair value of the hedged item which are recognized in the income statement at the same time (Schroeder, Clark & Cathey, 2009).
They are designated to hedge the exposure to potential changes in the fair value of a recognized asset or liability such as available-for-sale investments or an unrecognized firm commitment for which a binding agreement exists. Forward Exchange Contracts recognize changes in the fair value in the accounts, but the specific accounting for the change depends on the purpose of the hedge. The basic rule is to use the forward exchange rate to value the forward contract (Journal of Accountancy, 1994).
B. Describe foreign currency fair value hedges and discuss the accounting for these types of hedges.
Foreign currency fair value hedges are a derivative instrument that is designated as hedging changes in the fair value of an unrecognized firm commitment qualifies for the accounting treatment of a fair value hedge if all of the specified criteria for hedge accounting under SFAS No. 133 are met. It is a commitment to enter into a foreign currency transaction and a hedge of a net investment in a foreign operation (Schroeder, Clark & Cathey, 2009).
Accounting for foreign currency hedge derivatives is the same fair value or hedge accounting as other contracts. If the exposure of a net investment in a foreign operation, the gain or...