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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: foreign operations: hedging

SSAP 20 under Old UK GAAP permitted an individual company to hedge the exchange risk of holding an investment in a subsidiary with a loan or a currency contract. The company can take exchange differences on the hedging loan or contract to reserves and offset them against exchange differences on the investment - see CFM26120. This particular option is not open to companies adopting FRS 23 under Old UK GAAP, IFRS and New UK GAAP.

Companies can however apply a similar offset in foreign operations (eg branches), where the closing rate/net investment method is used to translate the results of a subsidiary. Exchange differences arising on translation of the company’s net investment in the foreign operation are taken to reserves (see CFM26220). But the company may have borrowings that hedge that net investment. Since, in economic terms, the company is hedged against movements in exchange rates, it is reasonable for exchange differences arising on the borrowing to be offset in reserves. SSAP 20 and FRS 23 under Old UK GAAP, IFRS and New UK GAAP all allow this to be done.

The following conditions must be satisfied in order to offset such exchange differences in reserves if applying SSAP 20 under Old UK GAAP:

  • exchange differences on the foreign currency borrowings can be offset only to the extent of the exchange differences arising on the net investments in foreign operation during the period;
  • the foreign currency borrowings must not exceed the total amount of cash that the net investments are expected to generate; and
  • the method must be applied consistently from one accounting period to the next.

In addition:

  • the relationships between the reporting entity and the foreign operation must justify the use of the closing rate/ net investment method.

FRS 23 under Old UK GAAP, IFRS and New UK GAAP achieve a similar effect by requiring that only the portion of the gain or loss on the hedging item that is an effective hedge shall be taken to reserves. In addition, under these standards the company must have formally designated the instrument as part of a hedging relationship.