July 2019 Newsletter

Explore our July 2019 newsletter and discover the latest blog posts and insights from FX Initiative. We help finance, accounting, treasury, and sales professionals stay up to date with new training content, CPE webinars, and helpful tips & resources.

Get started with our foreign exchange risk management training, which provides 24/7 365 access to our complete suite of foreign exchange (FX) continuing professional education (CPE), examples and events at FXCPE.com. Start Training >

View Newsletter

June 2019 Newsletter

Explore our June 2019 newsletter and discover the latest blog posts and insights from FX Initiative. We help finance, accounting, treasury, and sales professionals stay up to date with new training content, CPE webinars, and helpful tips & resources.

Get started with our foreign exchange risk management training, which provides 24/7 365 access to our complete suite of foreign exchange (FX) continuing professional education (CPE), examples and events at FXCPE.com. Start Training >

View Newsletter

Identify the Top Two FX Hedge Objectives

Companies that hedge foreign exchange must establish clear objectives in order to gauge the efficacy of their FX risk management program. While the priority of hedge objectives can vary between public and private companies, the same two overarching goals apply: (1) minimizing earnings volatility and (2) preserving cash flows. Gaining a better understanding of these two objectives can help organizations better decide how to allocate resources to achieve their desired economic and accounting results.

First, minimizing earnings volatility means neutralizing to the greatest extent possible the Income Statement impact of fluctuating foreign exchange rates. At the highest level, this requires aligning the accounting treatment for the derivative with the accounting treatment for the underlying exposure to achieve equal and offsetting gains and losses at the same time and in the same geographic area of the financial statements.

When hedging forecasted transactions that do not impact the Income Statement on a current basis, minimizing earning volatility often involves the use of elective “cash flow” hedge accounting treatment, which provides the timing benefit of deferring derivative mark-to-market gains and losses in equity during the forecast period and the geography benefit of accounting for the derivative gain or loss in the same financial statement line item as the forecasted exposure.

When hedging booked transactions that do impact the Income Statement on a current basis, neutralizing earning volatility refers to using the "default" accounting treatment, whereby the highly visible foreign exchange gains and losses related to the underlying exposure and the derivative hedging instrument work in tandem to create a largely equal offset in earnings that mitigates Income Statement volatility automatically at the end of each reporting period.

When hedging net investments in foreign subsidiaries that are accounted for in equity, reducing earning volatility means using elective "net investment" hedge accounting treatment, which allows for derivative gains and losses to be recorded in other comprehensive income (OCI), which is a component of equity, as part of the cumulative translation adjustment (CTA) until the point in time that a sale or liquidation event of the net investment occurs.

Second, preserving cash flows means reducing the variability in functional currency equivalent cash flows resulting from foreign currency transactions. When hedging booked and forecasted transactions, this means hedging to stabilize the amount of cash received or paid upon conversion of the foreign currency at a later date. When hedging net investments in foreign subsidiaries, preserving cash flows can involve a variety of strategies depending on the short and long term goals of the organization. For example, 3 different cash flow strategies include, (1) hedging excess cash balances that are held by foreign subsidiaries and that may eventually be remitted back to the parent, (2) hedging the value of a net investment position to preserve cash flows related to an anticipated sale or liquidation event of the foreign operation in the short or medium term, or (3) not hedging the position in a long term foreign subsidiary that may require cash settlement upon expiration of the derivative instrument.

While these concepts can get quite technical in detail, the overarching theme is that both public and private companies are focusing on the same two foreign exchange risk management hedging objectives: (1) minimizing earning volatility and (2) preserving cash flows. Public companies are often most concerned with mitigating periodic earnings volatility, which suggests they prioritize goal number 1 of minimizing earnings volatility over preserving cash flows. In contrast, private companies are usually more concerned about the economics over the accounting implications, which implies they focus more on preserving cash flows first and foremost. The key highlight is that public and private companies usually have different priorities between the same two FX hedge objectives.

To learn how your organization can prioritize and achieve your company’s specific hedging objectives, sign up for FX Initiative's currency risk management training to start learning best practices. We offer a complete continuing professional education (CPE) curriculum for controlling currency risk consisting of on-demand educational videos, interactive real-world examples, and live webinar events that can be customized to your organization’s particular needs. Take the FX Initiative today to learn how we help both Fortune 500 companies and small and medium-sized enterprises (SMEs) understand, identify, assess and mitigate foreign exchange risk.

Ready to achieve your FX Risk Management objectives? Click here to get started >

The FX Initiative Team
support@fxinitiative.com

Learn Best Practice Accounting for FX Derivatives

Foreign exchange accounting is a complex area of financial reporting that many global organizations struggle with. Adding to that complexity, companies engaged in foreign exchange risk management must also learn how to account for currency derivatives. While the specific accounting rules differ between generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS), the fundamental concepts are essential to understand when implementing foreign exchange risk management best practices for your international business.

Companies that hedge foreign exchange risk often have two main objectives: (1) To minimize the Income Statement impact of fluctuating foreign exchange rates, and (2) to reduce the variability in functional currency equivalent cash flows resulting from foreign currency transactions. In order to achieve the objective of minimizing the Income Statement impact of fluctuating foreign exchange rates, it is important to first consider the accounting treatment for the underlying position, and then to align the accounting treatment for the FX derivative accordingly.

At the highest level, companies can account for FX derivatives using “default” accounting treatment or “elective” accounting treatment. The “default accounting treatment requires that derivative gains and losses should be recorded in earnings on a current basis based on changes in their fair market value. The “elective” accounting treatment permits special accounting that results in changes in the fair value of the derivative to be recorded in the equity section of the balance sheet (rather than earnings) as part of other comprehensive income and then reclassified from the balance sheet to the income statement in the period or periods in which the underlying hedged item impacts consolidated earnings.

While the rules of elective accounting treatment can get quite complex, the key take away is that elective accounting treatment provides financial reporting benefits when hedging underlying exposures that do not impact the income statement on a current basis, such as forecasted transactions. Therefore, firms have a choice between the “default” and “elective” accounting treatment. FX Initiative’s currency risk management training addresses several variables to consider when choosing the most appropriate course of action for FX derivative accounting.

If you are interested in learning more about accounting for FX derivatives, FX Initiative’s currency risk management training walks you through real-world scenarios using Apple as an example. Specifically, we cover hedging forecasted revenue transactions, booked receivable transactions, and net investments in foreign subsidiaries using both elective and default accounting treatment. Learning how to account for FX derivatives is critical in order to achieve your foreign exchange risk management objectives. Start learning today by taking the FX Initiative!

Are you ready to learn best practice accounting for FX derivatives? Click here to take the FX Initiative!

Cheers,

The FX Initiative Team
support@fxinitiative.com