CFM24120 - Accounting for corporate finance: derivative contracts: accounting for forward contracts to hedge foreign exchange risk

Forward contracts

Forward contracts (forwards) may be used to hedge future commitments (or forecast transactions) relating to:

  • the purchase or sale of foreign currency
  • existing foreign currency assets and liabilities
  • investments in foreign operations
  • the results of a foreign operation.

There are two ways of accounting for the forward contract. For example, assume the purchase of an asset.

  1. The asset and the liability are both recorded at the contracted rate. This method is permitted by SSAP20, but will not be allowed once FRED24 becomes a standard.
  2. The forward is treated as a separate transaction from the purchase of the asset. This method is mandatory under US GAAP, for example, and will become so in the UK once FRED24 becomes a standard.

See CFM11070+ for more detail on forwards and how they work.