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Reducing reporting risk: Designating foreign currency forward contracts as cash flow hedges

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  • Rambo, Robert G.
  • Main, Daphne
  • Beaubien, Louis

Abstract

We present an example that compares the effects on earnings of designating a foreign currency forward contract as either a cash-flow or fair-value hedge of a foreign currency denominated receivable. Entities engaging in exchange transactions not denominated in their functional currency frequently enter into foreign currency forward contracts in order to mitigate their foreign exchange rate risk exposure. The aggregate effect on earnings of the transaction gain or loss on the foreign currency receivable and the gain or loss on the forward contract is known on the date the forward contract is initiated. The effect on each period’s earnings during the term of a forward contract designated as a cash-flow hedge is also known on the date the contract is initiated; whereas the effect on each periods’ earnings from a fair-value hedge cannot be determined until the respective balance sheet dates. Therefore, designating forward contracts as cash-flow hedges may suppress volatility in reported earnings compared to designating forward contracts as fair-value hedges. In addition, the reporting risk (the amount of uncertainty surrounding the pending measure of an item to be reported in the financial statements) is lower when a forward contract is designated as a cash-flow hedge relative to designating it as a fair-value hedge. This suggests foreign currency forward contracts designated as cash-flow hedges are more consistent with the purpose of hedge accounting: to mitigate the effects on earnings of applying different measurement criteria for the hedge and the hedged item.

Suggested Citation

  • Rambo, Robert G. & Main, Daphne & Beaubien, Louis, 2011. "Reducing reporting risk: Designating foreign currency forward contracts as cash flow hedges," Journal of Accounting Education, Elsevier, vol. 29(4), pages 284-294.
    • Handle: RePEc:eee:joaced:v:29:y:2011:i:4:p:284-294
    DOI: 10.1016/j.jaccedu.2012.03.003
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    References listed on IDEAS

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    1. Francis, J & Schipper, K, 1999. "Have financial statements lost their relevance?," Journal of Accounting Research, Wiley Blackwell, vol. 37(2), pages 319-352.
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    Cited by:

    1. Naveed, Hafiz Muhammad & HongXing, Yao & Memon, Bilal Ahmed & Ali, Shoaib & Alhussam, Mohammed Ismail & Sohu, Jan Muhammad, 2023. "Artificial neural network (ANN)-based estimation of the influence of COVID-19 pandemic on dynamic and emerging financial markets," Technological Forecasting and Social Change, Elsevier, vol. 190(C).
    2. Apostolou, Barbara & Dorminey, Jack W. & Hassell, John M. & Watson, Stephanie F., 2013. "Accounting education literature review (2010–2012)," Journal of Accounting Education, Elsevier, vol. 31(2), pages 107-161.
    3. Arcelus, F.J. & Gor, Ravi & Srinivasan, G., 2013. "Foreign exchange transaction exposure in a newsvendor setting," European Journal of Operational Research, Elsevier, vol. 227(3), pages 552-557.

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