Accounting for corporate finance: foreign exchange: SSAP 20: hedging using the cover method: example
This guidance applies to companies which have adopted SSAP 20 under Old UK GAAP.
Cover method: example
Vizwayl plc has a US subsidiary, Vizwayl (US Holdings) Inc, whose share capital is denominated in US dollars. The subsidiary starts life as a shell company with a share capital of only $100. On 1 September 2005, Vizwayl plc increases the share capital of the company to $200 million to fund the purchase of a US trading company. The equity investment is partially financed by a $150 million bond issue, which also takes place on 1 September 2005.
The company draws up accounts to 31 December 2005. On 1 September 2005, the exchange rate is £0.640/$; on 31 December, it is £0.655/$.
The initial cost, in sterling terms, of the equity investment made on 1 September is £128 million. The company retranslates the investment to the closing rate, giving a carrying value of £131 million at 31 December 2005. The exchange gain of £3 million is taken to reserves.
The company has, in sterling terms, a liability to bond holders of £96 million on 1 September and £98.25 million on 31 December - an exchange loss of £2.25 million. This is also taken to reserves and offset against the exchange gain.
Assuming that no other exchange gains or losses are taken to reserves, the notes to the accounts would include, under reserves:
|Profit and loss account|
|At beginning of year||X|
|Exchange gains for the year||3,000|
|Offset of loss on hedging liability||2,250|
|Net movement on exchange gains||750|
A similar disclosure of the total exchange gain, and the amount of the loss on the liability that had been offset, will occur in the Statement of Total Recognised Gains and Losses (STRGL).