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HMRC internal manual

Corporate Finance Manual

Accounting for corporate finance: hedging: hedge of net investment in a foreign operation

This guidance applies to companies which apply IFRS, New UK GAAP or FRS 26.

Hedge of net investment in a foreign operation

A company may wish to hedge against the risk of changes in exchange rates in its net investments of foreign operations. Net investment is the amount of the reporting entity’s interest in that operation. Foreign operations can be subsidiaries, associates, joint ventures or branches.

Hedging a net investment in a foreign operation can only be performed at the consolidated level - it is in effect the hedge of the translation foreign currency risk arising on the foreign operation and included in the consolidated accounts of the reporting entity (or in the solus entity accounts in respect of branches).

The hedged item can be an amount of net assets equal to or less than the carrying amount of the net assets of the foreign operation in the consolidated financial statements of the parent entity.

The hedged risk must relate to the functional (rather than presentational) currencies of the operation and either its intermediate or ultimate parent.

The hedging instrument can be a derivative or a non-derivative and may be held by any entity in the group (except the foreign operation that is being hedged).

Effectiveness is determined by calculating the gain or loss of the hedging instrument by reference to the functional currency of the entity holding the instrument. This is then compared to the gain or loss on the hedged instrument.

Where a net investment hedge meets all the criteria for hedge accounting, the hedging instrument (whether a derivative or non-derivative) is accounted for in a similar way to a cash-flow hedge, and is re-translated at the closing rate with the gain or loss on the effective hedge also being recognised in equity. This is matched by the gain or loss on translation of the net investment which is recognised in other comprehensive income (OCI), typically within the foreign currency translation reserve.

On disposal of the foreign operation, both the gain or loss on the effective portion of the hedging instrument, and the amount included in the foreign currency translation reserve in respect of that foreign operation is transferred to profit or loss (‘recycled’) under IAS 39/FRS 26/IFRS 9. Under FRS 102 such ‘recycling’ is prohibited.