Accounting for Hedging and FASB 133
Companies have a greater incentive for systematizing their hedging practices since FASB issued its Statement of Financial Accounting Standards No. 133 (FASB 133) to establish accounting and reporting standards for derivative instruments and for hedging activities. Under FASB 133, a foreign currency derivative that qualifies as a foreign currency hedge gets special hedge accounting treatment that essentially matches gains or losses resulting from the changes in the value of the derivative with losses or gains in the value of the underlying transaction or asset, thereby removing these hedging gains and losses from current income. However, any change in the value of the derivative not offset by a change in the value of the hedged item is recorded to earnings in the current period. Foreign currency hedges include hedges of net investments in foreign operations, of forecasted foreign currency transactions, and of foreign-currency-denominated assets or liabilities.
Under FASB, an entity that elects to apply hedge accounting is required to formally document each hedging transaction from the outset, explain its risk management objective and strategy for undertaking the hedge and the nature of the risk being hedged, and establish the method it will use for assessing the effectiveness of the hedging derivative and its measurement approach for determining the ineffective aspect of the hedge.