Balance Sheet Exposure Basics
Practical Corporate FX Risk Management Series, Part 1
This article is part one of an eight-part series on FX risk management.
When does a balance sheet FX exposure occur?
When an entity has an account with a transaction on the balance sheet that is in a currency other than the functional currency of the entity AND where that balance sheet account is re-measured (often referred to as a revaluation) each month.
How does a company determine which accounts are remeasured?
ASC 830 (previously FAS52) drives this determination, 'monetary' accounts such as cash, AR, AP, and other liquid accounts (maturing within a short period) that are included in the ERP's remeasurement program.?
Non-monetary accounts such as fixed assets, equity, inventory, etc. are not remeasured and remain at historic rates (the rate that prevailed when the transaction was first booked). The subset of monetary accounts should be consistent across all entities in the company for US GAAP purposes (they are all following the same rules).
Which rates are used in the remeasurement process?
There are two approaches to how new transactions are booked during a financial period:
1) At the prior month end rate.
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2) At the spot rate on the date of the transaction.?
The decision on which approach to adopt can be down to the accounting team's interpretation or the auditor’s direction; the wording of the directive is vague and we have seen an equal split among corporations. Also, this decision has the single biggest influence on how the balance sheet hedging program operates so the pros and cons of each approach should be given much thought before deciding (more on this in later dispatches).
Why should a company hedge its balance sheet FX exposure?
The remeasurement of the balance sheet is booked to the income statement (normally in the other income and expense) section. Without a hedging program to offset the impact from remeasurement, there will be volatility to earnings.
Explore the other articles in this series
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