A forward contract will lock in an exchange rate today at which the currency transaction will occur at the future date.
[2] The main difference between the hedge methods is who derives the benefit of a favourable movement in the exchange rate.
An entity shall provide sufficient information to permit reconciliation to the line items presented in the balance sheet”.
IAS 39 gives further instruction, stating that the financial derivatives be recorded at fair value on the balance sheet.
Since the derivative instruments are required to be recorded at fair value, these adjustments must be made to the forward contract listed on the books.
[5] More simply, this type of hedge would eliminate the fair value risk of assets and liabilities reported on the Balance sheet.
The big difference here is that the adjustments are made directly to the assets and not to the other comprehensive income holding account.
This is because this type of hedge is more concerned with the fair value of the asset or liability (in this case the account payable) than it is with the profit and loss position of the entity.
SFAS 133, written in 1998, stated that a “recognized asset or liability that may give rise to a foreign currency transaction gain or loss under Statement 52 (such as a foreign-currency-denominated receivable or payable) not be the hedged item in a foreign currency fair value or cash flow hedge”.
[6] Based on the language used in the statement, this was done because the FASB felt that the assets and liabilities listed on a company’s books should reflect their historic cost value, rather than being adjusted for fair value.
Citing the reasons given previously, SFAS 138 required the recording of derivative assets at fair value based on the prevailing spot rate.
[7] Since 2004, the Bank of Canada has carried out a qualitative annual survey to assess the degree of activity in Canadian foreign exchange (FX) hedging.