- Advanced Financial Accounting Theory and Analysis: Forward Exchange Contracts
- Describe a fair value hedge and discuss how to account for forward exchange contracts that are entered into for fair value hedges
- There is a great exposure to change in fair value of a recognized firm’s commitment resulting to a certain risk and could affect the profit and loss in the operations of the firm in a fair value hedge (Deloitte, 2007). Fair value also refer to the exposure to changes in value of unrecognized firm participating in certain contract or an identified portion of liability that is exposed to a particular risk and may contribute to the change in profit and loss in the firm’s operations. In this type of hedges, there are various income generator ought to recognize the financial gains on the hedging instrument.
- In order to account for forward exchange rate entered into fair value hedges, the concerned firms must account for the interest rate that ought to after a given period. The firms in the hedges ought to monitor the financial risks by using value-at-risk models. The firm should always calculate and stimulate the possible rates derived from the sales made (Deloitte, 2007).
- Describe foreign currency fair value hedges and discuss the accounting for these types of hedges
- Foreign currency fair value hedges refer to hedges that assist a firm to focus on the transactions with other institutions outside the home country (Fischer, Taylor & Cheng, 2011). In this type of hedges, the financial instruments cannot perform the obligation of a hedging instrument in a foreign currency. A forecasted transaction is suited to use these types of hedges.
- In a recognized foreign currency dominated asset or liability, a firm establishes the financial gains associated with this type of hedge in its earnings (Fischer, et al., 2011). However, even after the firm recognizes the profit and loss in the earnings, it does not have a system to prevent the exposed positions from being hedged with a fair value hedge (Deloitte, 2007). Only derivative instruments ought to be employed as a hedge of foreign currency that has a dominated asset or liability.
- Describe foreign currency cash flow hedges and discuss the accounting for these types of hedges
- Inforeign currency cash flow hedges, a certain firm enters into contracts designed for the foreign exchange forward contracts and manages to get the effect of the exchange rate of the financing transactions. It is only in this type of hedges that there is a possibility to get an option contracts (Green, 2007). In a foreign currency debt, a cash flow hedge of accounting is permit- able in order cover the exchange risk that might occur.
- In this type of hedges, the financial statements in earning of the currency transaction on a denominated asset or liability cannot be used to evaluate any changes in the assets or the liabilities in fair attribute to exchange risk recognized in earnings (Green, 2007). In foreign cash flow hedges, the financial results are reported in an income outside the earnings as part of the collective adjustment. This is possible especially for a derivative designated hedging with exposure to a foreign investment outside the home country. If the cash flow hedge is designed to be used in a market of a foreign country, the entity of the currency may be a forecasted transaction (Green, 2007).
- Reference
- Deloitte. (2007). iGAAP Financial Reporting in Malaysia. Kuala Lumpur. CCH Asia Pte Ltd.
- Fischer, P. M., Taylor, W. J. & Cheng, R. H. (2011). Advanced Accounting. New York: Cengage Learning.
- Green, J. F. (2007). CCH Accounting for Derivatives and Hedging 2008. New York: CCH.
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