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