ACCT 403 Week 5 Group Discussion Board Forum 3 Example

Group Discussion Board Forum 3: Foreign Currency Transactions and Hedging

ACCT 403 Fund Accounting for Government and Not for Profits, Group Discussion Board Forum 3

Thread by [Student Name]

The company, the exchange rates and the classmate are composites; the textbook and the peer-reviewed research cited are real.

On November 1, 2025, Delmar Outfitters, a U.S. retailer, buys hiking boots from an Italian manufacturer for €500,000, payable on February 1, 2026. On the same day it signs a forward contract to buy €500,000 on February 1 at $1.09.

Hoyle et al. (2018) explain that a foreign currency payable is a monetary liability remeasured at the current spot rate at each balance sheet date, with the change recognized in income. Delmar records inventory and a payable of $540,000 on November 1. At December 31, the euro has strengthened, so the payable is remeasured to $560,000 and Delmar recognizes a $20,000 transaction loss in 2025. On February 1, the euro has eased to $1.10, so the payable falls to $550,000 and Delmar recognizes a $10,000 gain in 2026 when it pays. Without a hedge, the boots cost $550,000, and reported income swings by $20,000 one way and $10,000 the other across two fiscal years. The inventory itself stays at $540,000, since it is a nonmonetary asset recorded at the transaction-date rate.

With the forward, Delmar has the right to buy €500,000 at $1.09. Ignoring discounting for clarity, its value at December 31 is the difference between the forward rate then available for February 1 and the contract rate, the $0.035 by which $1.125 exceeds $1.09, times €500,000, or $17,500, an asset and a gain in 2025. At settlement, its value is $0.01 times €500,000, or $5,000, so Delmar recognizes a $12,500 loss on the forward in 2026. The combined effect is a $2,500 net loss in each year, and Delmar's total cost is $545,000, exactly the forward price. Because both the payable and the forward are remeasured through income, they offset without any special hedge accounting election. The forward does not make the euro cheaper; it makes the cost known on the day the order is placed.

Was the hedge worth it? In this case Delmar would have paid $5,000 less without it, so hindsight says no. But the purpose of hedging is to remove uncertainty, not to win a bet on the euro. Allayannis and Weston (2001) studied large U.S. nonfinancial firms exposed to exchange rates and found that the firms that hedged with currency derivatives were valued more highly than those that did not, a premium of close to 5% of firm value on average. Their finding suggests investors value the predictability hedging provides, perhaps because it protects cash flow for investment and reduces the risk of financial distress. For a retailer whose margins depend on what it pays European suppliers, that predictability is worth more than the occasional saving an unhedged purchase might produce.

Reply to Grace

Grace, your thread used the same rates to analyze the payable, and you noted that Delmar might also want to hedge next season's order before it is placed. That is a different situation, and I think it shows why hedge accounting exists. Suppose that on November 1 Delmar expects to order another €500,000 of boots in March and buys a forward to lock in the rate. At December 31 there is no payable to remeasure, because no purchase has happened yet, but the forward's change in value still exists. Without hedge accounting, the $17,500 gain would appear in 2025 income while the purchase it hedges falls in 2026, creating exactly the volatility the hedge was meant to remove. Hoyle et al. (2018) explain that when the forward qualifies as a cash flow hedge of a forecasted purchase, its gains and losses wait in other comprehensive income and move into earnings only when the hedged purchase affects income, which for inventory is when the boots are sold. The documentation requirements are strict: Delmar must identify the hedging relationship, the risk being hedged and how effectiveness will be assessed at the start. Allayannis and Weston (2001) measured their hedging premium among firms exposed to exchange rate movements, which fits your suggestion, since a retailer that buys from Europe every season has exactly that kind of recurring exposure. A documented program of cash flow hedges would match accounting to the business purpose. Hedge accounting is optional, so Delmar could also choose to accept the earnings volatility, but most importers with steady European purchases elect it to keep their quarterly results meaningful.

References

Allayannis, G., & Weston, J. P. (2001). The use of foreign currency derivatives and firm market value. The Review of Financial Studies, 14(1), 243-276. https://doi.org/10.1093/rfs/14.1.243

Hoyle, J. B., Schaefer, T. F., & Doupnik, T. S. (2018). Advanced accounting (13th ed.). McGraw-Hill Education.