FASB Foreign Currency Hedges Frequency of Designation of Hedged Net Investment

FASB: Foreign Currency Hedges: Frequency of Designation of Hedged Net Investment

Derivatives Implementation Group

Statement 133 Implementation Issue No. H7

Title: Foreign Currency Hedges: Frequency of Designation of Hedged Net Investment
Paragraph references: 42
Date cleared by Board: November 23, 1999

QUESTION

If an entity documents that the effectiveness of its hedge of the net investment in a foreign operation will be assessed based on the beginning balance of its net investment, how frequently must an entity consider the need to redesignate the hedging relationship to reflect a revised beginning balance?

RESPONSE

If an entity documents that the effectiveness of its hedge of the net investment in a foreign operation will be assessed based on the beginning balance of its net investment and the entity's net investment changes during the year, the entity must consider the need to redesignate the hedging relationship (to indicate what the hedging instrument is and what numerical portion of the current net investment is the hedged portion) whenever financial statements or earnings are reported, and at least every three months.

For example, assume that a company enters into a foreign currency forward contract that has a notional amount that is equal to the beginning balance of its investment in a foreign operation (for example, 100,000 foreign currency units-FCUs). This foreign currency forward contract is immediately designated as a hedge of the entire beginning balance of the net investment at the inception of the hedge. As the net investment changes, the company would periodically assess the original hedging relationship and decide whether it needs to remove (that is, dedesignate) that original relationship and designate a new hedging relationship for the following assessment period. The following presents one method of such redesignation in those circumstances in which the entity chooses not to obtain a new derivative:

  • If the net investment had increased (for example, to 120,000 FCUs), the entire forward contract would be designated prospectively as hedging only a portion of the beginning balance of the net investment in that foreign operation. The hedged portion would be the ratio of the net investment at the inception of the hedge to the net investment at the beginning of the new assessment period (for example, five-sixths of the 120,000 FCUs).

  • If the net investment had decreased (for example, to 90,000 FCUs), only a proportion of the forward contract would be designated prospectively as hedging the entire beginning balance of the net investment in that foreign operation. The proportion of the forward contract designated prospectively as the hedging instrument would be the ratio of the net investment at the beginning of the new assessment period to the net investment at the inception of the hedge (for example, nine-tenths of the forward contract). The proportion of the forward contract not designated prospectively as the hedging instrument in the net investment hedge could be designated as a hedging instrument in a different hedging relationship or simply reported at fair value with its gain or loss subsequent to the dedesignation date recognized currently in earnings pursuant to paragraph 18(a).

An entity is not required to redesignate the hedging relationship more frequently than discussed above even when a significant transaction (for example, a dividend) occurs during the interim period.

The above response has been authored by the FASB staff and represents the staff's views, although the Board has discussed the above response at a public meeting and chosen not to object to dissemination of that response. Official positions of the FASB are determined only after extensive due process and deliberation.