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HMRC internal manual

Corporate Finance Manual

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HM Revenue & Customs
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Accounting for corporate finance: foreign exchange: SSAP 20: hedging using the cover method: conditions

This guidance applies to companies which have adopted SSAP 20 under Old UK GAAP.

Use of the cover method

SSAP20 lays down three conditions for the use of the cover method:

  • the exchange gains and losses on the borrowing can be offset in reserves only to the extent of exchange differences arising on the equity investment. Any ‘unmatched’ gains or losses on the borrowing must be taken to profit and loss account.
  • the accounting treatment must be applied consistently from period to period.
  • the foreign currency borrowings should not exceed the total amount of cash that the investments are expected to generate, whether from profits or otherwise.

There is no requirement in SSAP20 that the equity investment and the borrowing should be in the same currency, provided the above conditions are satisfied. For example, a company that financed a purchase of Swiss franc denominated shares with a loan in euros would not be debarred from offsetting exchange differences on the loan against those on the shares.

When talking about the cover method, SSAP20 refers only to ‘foreign currency borrowings’. However, companies often use currency contracts, such as a currency forward or a swap, to hedge an investment in a foreign subsidiary. In practice, exchange gains or losses on the related currency contract will frequently be offset in reserves against the corresponding exchange differences on the investment.