Accounting for corporate finance: derivative contracts: accounting for forward contracts to hedge foreign exchange risk under Old UK GAAP
This guidance applies for Old UK GAAP (excluding FRS 26).
Forward contracts (forwards) may be used to hedge future commitments (or forecast transactions), or manage foreign exchange risk 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.
When forward contracts are held for the purposes of hedging a recognised asset or liability, the most common approach applied under SSAP 20 is for the reporting entity to apply contract rate accounting. Under this approach monetary foreign currency assets/liabilities are measured at the contracted rate used in the hedging forward contract rather than retranslated at each balance sheet date. In essence the forward contracts enable monetary foreign currency assets/liabilities to be measured as though they are sterling instruments.
See CFM11070+ for more detail on forwards and how they work.
Note on the accounting for forward contracts with IFRS, New UK GAAP and FRS 26 under Old UK GAAP
Forward contracts over foreign currency are derivative contracts, which are required to be measured at fair value in the balance sheet at each reporting date. In general, profits and losses arising on these contracts are recognised in profit and loss, apart from when the derivative is designated as the hedging instrument in a cash flow or net investment hedge and hedge accounting applies (see CFM27000).