FX Cash Flow Risk Management: Financial Reporting Issues and Practical Implications

Abstract

Companies having foreign sales can avoid large fluctuations in earnings and cash flows caused by changes in foreign exchange (FX) rates through the use of foreign exchange derivatives (FXDs). FXDs used to mitigate the effect of FX rate changes on forecasted transactions can qualify as cash flow hedges under Statement of Financial Accounting Standards No. 133 (SFAS 133). According to SFAS 133, the mark‐to‐market (MTM) gains/losses on effective cash flow hedges are reported in other comprehensive income on the balance sheet, instead of on the income statement. This article explains how CFOs and treasurers may benefit from understanding the strategic and practical implications of reporting foreign‐exchange hedges, including the disclosure of hedge ratio data (i.e., the extent of cash flow hedge use).