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There are many reasons to use a hedging strategy in the forex futures market.

One main purpose is to neutralize the effect of currency fluctuations on sales revenue. For example, if a business operating overseas wanted to know exactly how much revenue it will obtain (in U.S. dollars) from its European stores, it could purchase a futures contract in the amount of its projected net sales to eliminate currency fluctuations.

Hedge accounting http://en.wikipedia.org/wiki/Hedge_accounting
Why is hedge accounting necessary?
Many financial institutions and corporate businesses (entities) use derivative financial instruments to hedge their exposure to different risks (for example interest rate risk, foreign exchange risk, commodity risk, etc.). Accounting for derivative financial instruments under International Accounting Standards is covered by IAS39 (Financial Instrument: Recognition and Measurement). IAS39 requires that all derivatives are marked-to-market with changes in the mark-to-market being taken to the profit and loss account. For many entities this would result in a significant amount of profit and loss volatility arising from the use of derivatives. An entity can mitigate the profit and loss effect arising from derivatives used for hedging, through an optional part of IAS39 relating to hedge accounting.

[edit] What hedge accounting options are available to an entity?
All economic hedges aim to manage foreign currency exposure, meaning they are undertaken for the economic aim of reducing potential loss from fluctuations in foreign exchange rates. However, not all hedges are designated for special accounting treatment. Accounting standards enable hedge accounting for three different designated forex hedges: A cash flow hedge may be designated for a highly probable forecasted transaction, a firm commitment (not recorded on the balance sheet), foreign currency cash flows of a recognized asset or liability, or a forecasted intercompany transaction. • A fair value hedge may be designated for a firm commitment (not recorded) or foreign currency cash flows of a recognized asset or liability. • A net investment hedge may be designated for the net investment in a foreign operation.

The aim of hedge accounting is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account. For a fair value hedge this is achieved either by

We do these type of contract because we forecast that prices in future date will increase.html Hedge accounting has been included in financial reporting subject of CA. In hedge. For a cashflow hedge some of the derivative volatility into a separate component of the entity's equity called the cash flow hedge reserve. http://www. As a accountant. for recording and accounting treatment transactions relating to hedge.org/2011/07/hedge-accounting.marking-to-market an asset or a liability which offsets the P&L movement of the derivative. Where a hedge relationship is effective (meets the 80%–125% rule). Hedge or hedging may be any investment which is done for protecting the company from future risk. Hedge may be used in All financial instruments and derivatives like financial futures. you will divide transaction on basis of two type of hedge. most of the mark-to-market derivative volatility will be offset in the profit and loss account.Final. we should know about hedge or hedging. To achieve hedge accounting requires a large amount of compliance work involving documenting the hedge relationship and both prospectively and retrospectively proving that the hedge relationship is effective. . options and swaps. we also may do agreement for buying the asset in future date but at current price. Before learning hedge accounting with simple way.svtuition.

Prepare the journal entry that Hayward makes on December 31. Hayward does not intend to actively trade this investment. Available-for-Sale securities Dr. Hayward Co. 10. 2008.000 Cash Cr. It consequently classifies the Sonoma investment as available-forsale. Fair Value Hedge Illustration: 1. Assume that on April 1.500 Illustration:3. 2.500 Unrealized Holding Gain or Loss—Equity Cr.000 Illustration: 2 The value of Sonoma shares increases to $125 per share during 2008.1. Prepare the journal entry that Hayward makes on April 1. 10. To hedge this risk. Hayward is exposed to the risk that the price of the Sonoma stock will decline. 2008 to record this investment. 2009. 2008. to recognize the gain. Security Fair Value Adjustment (AFS) Dr. purchases 100 shares of Sonoma stock at a market price of $100 per share. This put option (which expires in two . 2. Hayward purchases a put option on 100 shares of Sonoma stock and designates the option as a fair value hedge. on January 2.

500 Unrealized Holding Gain or Loss—Income Cr. Because this is just option offer. Illustration:4 At December 31. 500 2.years) gives Hayward the option to sell Sonoma shares at a price of $125. Cash Flow Hedge Illustration: In September 2008 Allied Can Co.000 metric tons of aluminum in January 2009. Unrealized Holding Gain or Loss—Income Dr. 2009. 2009. to recognize the increase in value of the put option? Put Option Dr. Since the exercise price equals the current market price. What entry is required on January 2. 31. Hayward records the following entry for the Sonoma investment. So. 500 Security Fair Value Adjustment (AFS) Cr. 2009 to recognize the put option? A memorandum entry only. no journal entry is necessary. Allied wants to hedge the risk that it might pay higher prices for . anticipates purchasing 1. it will go to off balance sheet. the price of the Sonoma shares has declined to $120 per share. 500 What journal entry would Hayward record on Dec.

000 tons = 1.000 Cash Cr. Allied makes final settlement on the futures contract and records the following entry.550.575 and makes the following entry ($1.000 Unrealized Holding Gain or Loss—Equity 25.000 metric tons of aluminum for $1. Aluminum inventory Dr. The underlying for this derivative is the price of aluminum. If the price of aluminum rises above $1.000 ([$1.000 .575 x 1. 1. Futures contract 25.550] x 1.575. What journal entry would Allied make to record the increase in the value of the futures contract. At December 31. This contract price is good until the contract expires in January 2009. the price for January delivery of aluminum increases to $1.575. Allied enters into an aluminum futures contract that gives Allied the right and the obligation to purchase 1. 1. 2008. the value of the futures contract to Allied increases.000).575 per metric ton.575. Allied enters into the futures contract on September 1.000 tons) In January 2009.550 per ton. 2008.000 At the same time. 25.$1. Cash Dr.575 .inventory in January 2009. Allied purchases 1.000 metric tons of aluminum for $1. Assume that the price to be paid today for inventory to be delivered in January—the spot price—equals the contract price.

S.000-$1.Futures contract Cr. dollar denominated assets or liabilities. net. Accordingly. these outstanding non-designated derivatives are recognized on the balance sheet at fair value and changes in the fair value of these hedges are recorded in other income (expense). . ($1.575.000 If you make any cash flow reserve. in the consolidated statements of operations.550. you can show this in liability side. If any advance amount is given for buying the asset in future date. it will be shown in the asset side. These derivatives are not designated for hedge accounting treatment. Non-designated hedges Forward exchange contracts are generally used to hedge certain non-U.000) 25.

2009 Balance Sheet Fair Location Value Liability Derivatives April 3. 2009 $ (2.286) Foreign exchange contracts .The following table provides the types of derivative instruments outstanding as of April 3.13 assets — Other liabilities $ 1 Other asset 54 Other liabilitie s $ 2 s — The following table provides the effect derivative instruments had on other comprehensive income (“OCI”) and consolidated statements of operations (amounts in thousands): Location of Amount of Gain or (Loss) Reclassified from Accumulate d OCI into Income (Effective Portion) Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Six months ended April 3.047) Effectiveness Testing) Other income (expense). 2009 $ 127 as Hedging Instruments Other income (expense). net Amount of Gain or (Loss) recognized in OCI on Derivative (Effective Portion) Location of Gain or (Loss) Reclassified from Accumulated OCI into Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) Location of Gain or (Loss) Recognized in Income on Derivatives Not Designated Amount of Gain or (Loss) Recognized in Income on Derivatives Not Designated as Hedging Instruments Derivatives in Statement 133 Cash Flow Hedging Relationships Six months ended April 3. 2009 (amounts in thousands): Asset Derivatives April 3. net Six months ended April 3. 200 9 $ (1. 2009 Balance Sheet Fair Location Value Derivatives designated as hedging instruments: Foreign exchange contracts Derivatives not designated as hedging instruments: Foreign exchange contracts Other 1. 200 9 $ (1.597) Income (Effective Portion) Product revenue Six months ended April 3.