Accounting for Currency and Commodity Hedges
Multinational corporations conduct cross-border activities such as foreign direct investment and the sale of goods and services. The international integration of goods, services, technology, and equity or debt capital often leads to financial risks resulting from foreign currency and production materials exposure. Risky exposures can hinder investment and normal business activities, as companies strive to protect their financial position. The fear of increased currency volatility concerns many managers who are obliged to protect and preserve shareholder equity. Hedging is a strategy to help minimize potential losses by taking an offsetting position in a related derivative to hedge the volatility of the “underlying.” Hedging is not intended to make extra money on the investment, but rather to protect one’s company against uncertainty in the currency or the product market. This paper will address hedge accounting, touching key strategies such as a foreign currency forward exchange contract, designated as a fair value hedge, and a commodity futures contract designated as a cash flow hedge.