31 July Discover the Details of FX Hedge Documentation July 31, 2017By FX Initiative FX Transaction Simulator, General, Hedging Foreign Subsidiaries, Hedging FX Transactions , Accounting, ASC 815, ASC 830, Benefits, Best Practices, Derivative, Documentation, FAS 133, FAS 52, FASB, Financial Reporting, Foreign Exchange, Geography, Hedge, Management, Private, Public, Risk, Timing, FX 0 When accounting for FX derivatives, firms have a choice between the “default” and “elective” accounting treatment. Elective accounting treatment is not required and involves extra preparation and utilization of resources, but for forecasted transactions and hedges of net investments in foreign operations, the benefits can outweigh the costs particularly for publicly traded firms most concerned with mitigating periodic earnings volatility. The “elective” accounting treatment permits special accounting for items designated as being hedged and offers 2 main financial reporting benefits; Timing & Geography: (1) timing refers to reducing periodic earnings volatility by deferring derivative mark-to-market gains and losses in equity and (2) geography refers to accounting for the derivative gain or loss in the same geographic area of the financial statements as the hedged exposure. It is important to emphasize that elective hedge accounting never changes the economics of a hedge, only the financial reporting. The choice of whether or not to use “elective” accounting treatment will depend on the foreign exchange risk management objectives of each organization, and part of the strategic decision making process involves determining if the financial reporting benefits outweigh the administrative and compliance costs. To satisfy the requirement for elective accounting treatment, companies must prepare formal contemporaneous hedge documentation at the inception of the hedge. The hedge documentation outlines the hedging relationship, and the entity's risk management objective and strategy for undertaking the hedge, including identification of following 5 components: The hedging instrument The hedged item or transaction The nature of the risk being hedged The method that will be used to retrospectively and prospectively assess the hedging instrument's effectiveness The method that will be used to measure ineffectiveness Effectiveness is an assessment of the degree by which the derivative offsets the hedged transactions changes in cash flows that are attributable to foreign exchange risk. While hedge documentation and effectiveness testing can range significantly in detail and complexity, two simplified examples of hedge documentation are addressed in FX Initiative’s currency risk management training. Our Hedging FX Transactions and Hedging Foreign Subsidiaries courses walk you through real world scenarios using Apple, Inc. as an example, and show you the required documentation as well as the timing and geography benefits using our FX Transaction Simulator and Foreign Subsidiary Consolidator. Hedging documentation can be daunting, but our training makes preparation practical so you can achieve for your foreign exchange risk management goals. Are you interested in discovering the details of FX hedge documentation? Take the FX Initiative by subscribing today! Cheers, The FX Initiative Team support@fxinitiative.com Related Posts Documenting FX Cash Flow Hedges Documenting FX Cash Flow Hedges (Video): Discover the details of FX cash flow hedge documentation and recognize how underlying exposures impact the financial statements. This video is a preview of FX Initiative’s Hedging FX Transactions course as part of Learning Objective #1. To learn more, start your FX risk management training today, which provides 24/7 365 access to our complete suite of foreign exchange (FX) continuing professional education (CPE), examples & events at FXCPE.com. Start FX Training Cash Flow Hedge Considerations Are you curious about “cash flow” hedge considerations? FX Initiative’s Cash Flow Hedging webinar covers corporate best practices and case studies on hedging forecasted FX transactions, and walks you through pros and cons public and private companies can consider when deciding whether or not to elect “cash flow” hedge accounting treatment. 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 > Download the PDF Identify The Top Two FX Hedge Objectives Ready to optimize your firm’s FX hedge objectives? FX Initiative’s Hedging FX Transactions course covers best practices employed by Fortune 500 companies and small and medium-sized enterprises (SMEs) for achieving the top two FX hedge objectives, illustrated in detail with real world economic and accounting examples. 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 > Download the PDF 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 ... Learn How to Test FX Transaction Hedges Do you test the economic and accounting implications of your FX hedge strategies prior to trading? Testing by definition involves checking the performance of something before putting an idea into practice. This is a prudent and practical step to take when managing foreign exchange risk across the enterprise. When it comes to hedging specific foreign exchange transactions, companies can benefit greatly from testing the most common derivative strategies such as forwards, options, and collars, stress testing the economic scenarios, and comparing the accounting treatment available. By employing this approach, companies can more reliability predict both the cash flow and financial reporting implications of a hedged FX transaction. FX Initiative’s FX Transaction Simulator allows companies to input their ”assumptions" such as exchange rates, interest rates, and market volatility, as well as company specific variables such at the transaction dates, the amount of the transaction, and the desired hedging strategy. Correspondingly, these assumptions are reflected in our proprietary risk analysis model which visually charts the payoff profile of the selected hedge strategy, ranks the economic performance of the alternative spot, forward, vanilla ... Highlighting FX Hedge Objectives Highlighting FX Hedge Objectives (Video): Discover how public and private companies prioritize earnings and cash flows when hedging foreign exchange (FX) risk. This video is a preview of FX Initiative’s Hedging FX Transactions course as part of Learning Objective #1. To learn more, start your FX risk management training today, which provides 24/7 365 access to our complete suite of foreign exchange (FX) continuing professional education (CPE), examples & events at FXCPE.com. Start FX Training Comments are closed.