Chapter 13 FINANCIAL RISK MANAGEMENT

A.      It Fundamental

The main objective of financial risk management is to minimize the potential loss arising from unexpected changes in currency rates, credit, commodities, and equities. The risk of price volatility faced is known as market risk. For example, a company in Sweden that issue new shares for domestic investors might view as the market risk exposure to rising stock prices. Stock price increase was unexpected undesirable if the company issuing the stock. Stock price increase is not unexpected desirable if the company issuing the shares should be issued a number of shares less to obtain the same amount of cash by delaying the issuance of stock for a while.

Market participants tend not to take risks. Thus, many of which will trade some of the profit potential for protection against adverse price changes. Intermediary financial services and a market maker responds by creating a financial product that allows a trader to shift the risk of unexpected price changes to others-the opponent. For example, a financial services intermediary to sell the option (ie right and not the obligation) to buy shares to a publishing company and an option to sell the stock immediately (short sales) to the investor (the opponent).

There is market risk in various forms. Although the focus of the volatility of prices or rates, management accountants need to consider other risks. Liquidity risk arises because not all the financial risk management products can be traded freely. Highly illiquid market is such as real estate and stocks with small capitalization. Market discontinuities refers to the risk that the market does not always lead to price changes gradually. Stock market crash in 2000 is a case in point. Credit risk is a possibility that the other side of risk management in the contract can not meet its obligations. For example, the parties agree to exchange the euro versus the French into the Canadian dollar may fail to submit the euro on the date promised. Regulatory risk is the risk arising from public authorities banned the use of a financial product for a particular purpose. For example, the Kuala Lumpur stock exchange does not allow the use of short sales as a hedge against a decline in equity prices. Tax risk is a risk that certain hedging transactions can not obtain the desired tax treatment. For example, treatment of foreign exchange losses as capital gains as ordinary income to be preferred. Accounting risk is the chance that a hedging transaction can not be recorded as part of the transaction hedged about. An example is when the advantage over a hedge against the purchase commitment is treated as "other income" and not as a reduction in purchasing costs.

B.      Why Managing Financial Risk?

The growth of risk management services that quickly shows that management can enhance shareholder value by controlling the financial risk. Investors and other interested parties the hope that the fund managers were able to identify and manage risks facing the market actively. If the value of the company to match the present value of future cash flows, active management of potential risks can be justified by several reasons.

First, exposure management helped in stabilizing the company's cash flow expectations. Flow is more stable cash flows that can minimize the earnings surprise, thereby increasing the present value of cash flow expectations. Stable earnings also reduces the likelihood of default and bankruptcy risk, or risk that profits may not be able to cover contractual debt service payments.

Active exposure management allows companies to concentrate on the major business risks. Thus, a manufacturing company can hedge interest rate risk and currency and concentrate on the production and marketing. The same benefits are also available for financial institutions.

Lenders, employees and customers also benefit from exposure management. Lenders generally have a lower risk tolerance than the shareholders, thereby limiting the exposure of companies to balance the interests of shareholders and bondholders. Derivative products also allow pension funds managed by the employer obtain a higher return by giving the opportunity to invest in certain instruments without having to buy or sell the related real instrument. Finally, because of losses caused by price and interest rate risk of certain transferred to the customer in the form of higher prices, limiting exposure management of risks faced by consumers.

C.      The Role of Accounting

Management accountants play an important role in the process of risk management. They assist in the identification of market exposure, quantify the balance associated with alternative risk response strategy, the company faced a potential measure of risk, noting certain hedging products and evaluate the effectiveness of the hedging program.

Identification of Market Risk

The basic framework is useful for identifying different types of market risk can potentially be called as risk mapping. This framework begins with the observation of the relationship of the various market risks triggering a company's value and its competitors.

Market risks include the risk of foreign exchange rates and interest rates, and commodity and equity price risk. The third dimension of the cube mapping the relationship between risk and market risk trigger values ​​for each of the company's main competitor.

Interest rate risk could affect the company's revenue in the following way. Credit sales are generally billed after a certain period, depending on the credit terms offered to the client (ie 30, 60, or 90 days). Usually, companies rely on short-term loans to fund the operation of the passage, such as salaries and other operating expenses. The increase in interest rates before the receivables are billed will reduce the company's return on sales. Credit sales are denominated in foreign currencies will result in a lower return than expected in the currency of the parent company if the foreign currency is losing its value prior to billing. Fluctuating commodity prices can have a significant effect on earnings. For example, the sugar industry in Hawaii is paralyzed when the price falls in the early 1970's. Finally, because managers know for certain investment funds, equity prices fall immediately worsen the statistical performance of investment funds.

How the three-dimensional cube of exposure management function? This dimension to see how the exposure faced by competitors in the form of market risk may affect the company. If you decide to sell the baseball team cap that you expect to win the next World Series. You decide to buy and sell these hats locally. Are you going to run the risk of foreign exchange rates? You might argue is not affected, but if a competitor to buy baseball caps from overseas source countries and the currency depreciates in value relative to the purchase of the currency your country, then these changes can cause your competitors are able to sell at lower prices than you. This is called competitive risks facing currency.

Balancing quantify

Another role played by accountants in the process of risk management includes the processes associated with the quantification peyeimbangan alternative risk response strategies. Management may prefer to retain some risks than to hedge perceived risk when the cost of protection higher than the benefits. For example, suppose that an importer has a firm purchase commitments denominated in foreign currencies may prefer not to hedge if he believes that foreign currency will weaken before the date of delivery of goods. Accountants must measure the benefits of protected areas assessed and compared to the cost plus the opportunity cost of lost profits from speculation and market movements.

Risk Management in the World with a Floating Exchange Rate

Limited analysis conducted on the potential risk of a certain price, namely: changes in foreign exchange rates. The risk of foreign exchange (forex) is one of the most common form of risk and will be faced by multinational companies. In addition, the concept of risk management and accounting treatment related to foreign exchange risks in line with interest rate risk, commodity prices and equity prices.

In a world of floating exchange rates, risk management include (1) anticipation of exchange rate movements, (2) measurement of exchange rate risk faced by the company, (3) design of appropriate protection strategies, and (4) the manufacture of internal risk management controls.

Forecasting the Exchange Rate Changes

In developing the program exchange rate risk management, financial managers must have information about the possible direction, timing, and magnitude of changes in exchange rates. Aware of the previous exchange rate outlook, financial managers can develop adequate defensive measures more efficiently and effectively. However, is it possible to predict accurately the movement of currency remains a problem.

The information is often used in making forecasting exchange rates (ie currency depreciation) related to changes in the following factors:

Differences in inflation. Evidence suggests that a higher inflation rate in a country, tend to be offset in some time with the movement with a value equal but opposite in value of its currency.

Monetary policy. An increase in money supply of a State that exceeds the rate of growth of real national output to encourage the emergence of inflation, which affects the exchange rate.

The trade balance. Governments often take advantage of the devaluation to resolve an unfavorable balance of trade (ie when exports <imports).

Balance of payments. A country that spends (import) and invest more outside than that produced (exported) or received in the form of foreign investment will experience a pressure decrease in the value of its currency.

Monetary reserves and debt capacity. A country's balance of payments deficit can continue to anticipate a devaluation by reducing savings (ie the number of international monetary reserves) or reduce the capacity of its foreign loans. Because the amount of resources decreases, the possibility of a devaluation increases.

National budget. Deficit caused by a huge government spending also aggravate inflation.

Forward exchange rate. A foreign currency that can be acquired for future delivery at a significant discount rate indicates reduced confidence in the currency.

Unofficial exchange rate. The increase in the difference between official and unofficial exchange rates or the black market shows an increasing pressure on the government to adjust the official exchange rate with a more realistic market rate.

Currency-related behavior. Currency of a country is generally moving in the same pattern in the currency of countries that have close economic ties.

Differences in interest rates. Interest rate differential between the two countries shows predicted changes in the future spot rate.

Option price of foreign equities. Because abitrase linking a foreign equity prices in the country of origin with the value of domestic currency, a change in an option price of foreign equity in domestic currency signifies a change in market ekpetasi of foreign exchange rates in the future.

The things above help in predicting the direction of currency movements. Usually, however, still not enough to predict the time and mangnitudo currency changes. Political factors strongly influence the value of currency in many countries. Political response to the pressure of devaluation or evaluation often yield measurements for the time being (temporarily) and not the exchange rate adjustment. Temporary measurements include certain taxes, control the import, export incentives, and control the currency. Political awareness in a country whose currency is under pressure is essential. This will help financial managers to digest whether the government will likely possibilities were intervening in the market or rely on free market solutions.

Some parties claim that forecasting exchange rates is a futile act. In a world with freely fluctuating exchange rates, forex market can be said to be efficient. Current market exchange rate (ie the forward exchange rate) showed a consensus of all market participants on the foreign exchange rates in the future. The information is generally available immediately realized in foreign currency exchange rate now. Thus, the information is not very valuable in predicting future exchange rate. In this condition, changes in foreign currency exchange rate is a random response to new information or unexpected events. Forward exchange rate is the best estimate available for exchange in the future. Random changes in exchange rates on foreign currency exchange rate reflects the differences of opinion among market participants.

Are all of these factors involve the management accountant? In one aspect, an accountant must develop a system to collect and process comprehensive and accurate information on variables related to exchange rate movements. This system can include information provided by external forecasting services, financial publications that track the movement of currency and daily contact with the currency dealer. They should be on-line and computer-based to ensure managers obtain the most important source of information, which is used as the basis for forecasting currencies. Financial managers must also understand the consequences of not using other forecasting methods.

If the exchange rate forecasting is not possible or too expensive to do, then the financial managers and accountants must manage their company's problems in such a way as to minimize the adverse effect of exchange rate changes. This process is known as the management of potential risks.

Management of Potential Risks

Structuring the problem to minimize the adverse effect of exchange rate requires information on the potential risk faced by foreign exchange. Potential foreign exchange risk arises when the foreign exchange rate changes also change the net asset value, earnings and cash flows of a company. Traditional accounting measurement of the potential foreign exchange risk is centered on two types of potential risks: translation and transactions.

1.       Potential Risk of Translation

Translational gauge potential risk of exchange rate changes influence foreign exchange equivalent to the value of domestic currency assets and liabilities denominated in foreign currency held by the company. For example, a U.S. holding company that operates a fully owned subsidiary in Ecuador (the functional currency of U.S. dollars) to change the dollar value of net monetary assets in Ecuador to change relative to the dollar. Because the amount of foreign currency is generally translated into domestic currency equivalent value for purposes of monitoring or management of external financial reporting, this translational effect of the direct impact on reported earnings. Assets or liabilities denominated in foreign currency exchange rate against potential risks if a change in the exchange rate led to an equivalent value in the currency of the parent company changed. Based on this definition, balance sheet items in foreign currency exchange rate risk exposure is the posts are translated based on the exchange rate now (and not the historical rate). Thus, the potential risks of translational measured by the difference between assets and liabilities denominated in foreign currencies are exposed.

Excess of assets exposed to liability risk exposure (ie items in foreign currencies are translated based on the present exchange rate) led to the position of net assets are exposed. This position is often called potential positive risks. Devaluation of foreign currencies relative to the reporting currency translation losses caused. Revaluation of foreign currency translation profits. Conversely, if the firm has net exposed liability position or potential risk of negative when liabilities exceed assets exposed exposed. In this case, the devaluation of foreign currency translation gains cause.

2.       Potential Risk of Transaction

Potential risks associated with the transaction gains and losses in foreign exchange rates arising from the settlement of transactions in foreign currencies dominate. Unlike translation gains and losses, gains and losses the transaction has a direct impact on cash flow.

The reports generally do not appear in conventional financial statements but cause gains and losses of the transaction, such as foreign currency forward contracts, purchase commitments and future sales and long-term lease. The report does not include the potential risks that are not directly related to foreign currency transactions (such as cash in hand). The report also has the potential risks of the transaction a different point of view of translational potential risk reports. Report translational potential risks in light of the parent company.

Centralized control of the overall potential of a company's currency risk is still possible. To be implemented, each foreign affiliate companies must submit reports of potential risk to the multi-currency corporate headquarters on an ongoing basis. Once potential risks have been incorporated based on the currency and the State, corporate hedging policy can be centrally coordinated to eliminate potential losses.

Potential Risks of Accounting versus Economics. The reporting framework previously described demonstrates the potential foreign exchange risks facing the company at any given time. However, both translational and report potential risks of the transaction did not quantify the potential economic risks of a company. This is the effect of currency exchange rate changes on operating performance and cash flows of the company's future.

More and more companies begin to differentiate between static and potential risks are very smooth in nature. They prepared a report on multi-currency cash flows to assist in overseeing the cash receipts and disbursements for each currency used in business activities. The report considered the potential influence of the traditional risk of exchange rate changes on the account balance as of the date the financial statements. Report multi-currency cash flows to potential risks produced by changes in exchange rates prevailing during the budget period. Cash receipts for each of the national currency credits include sales receipts now and that will be done in the future, asset sales and other activities that generate cash. Multi-currency cash outlay of expenditure on liabilities now and that will be done in the future, loan services, and other cash purchases.

The term suggests that the potential economic risks of exchange rate changes affect the company's competitive position by changing the input and output prices relative to the price of competitor companies overseas. For example, suppose the hypothesis Philippine subsidiary was a labor and raw materials locally. Devaluation of the peso relative to all other foreign currencies can improve and not worsen the position of the subsidiary. The company can increase its exports to Australia and the United States because of the devalued peso value will cause the price of goods become cheaper in Australia and the U.S. dollar. Domestic sales may increase as the value of the peso devaluation will cause the value of imported goods become more expensive in local currency. Devaluation did not lead to price increases impact on the cost of input materials sourced from local. Thus, the future profitability of a subsidiary of the Philippines may increase due to currency depreciation. Under these circumstances, a loss against the potential risks of transactions would distort the translation of the positive economic implications stemming from the devaluation of the peso.

On the other hand, a German manufacturing company that became an affiliate of a British holding company, which was established to serve the German market, may have a positive translational potential risks. Appreciation of the euro relative to the pound would result in translation gains at the time of consolidation. If the company's German affiliate is acquiring the entire input of resources from Germany, the potential economic risks would appear to be protected from exchange rate risk. However, if a major competitor of Germany gained its manufacturing component of Russia, the main competitor of the German competitors acquire the manufacturing component of Russia, competitors can enjoy a cost advantage if the lower relative value of the ruble against the euro.

This example shows that the potential economic risks or operations related or not has little to do with the translation or the potential risk of the transaction. Thus, management of potential risks of such technology requires more hedging is strategic rather than tactical. Newer technologies include the option of hedging options below.

Companies can choose to structural hedge which includes the selection or relocation of manufacturing to reduce the potential risk of overall business operations. However, such measures may sacrifice economies of scale that already exist, which can reduce the estimated rate of return business.

As an alternative, the parent company can take a portfolio approach to risk reduction by selecting the types of businesses that can reduce potential risks. Thus, the potential risks facing the company's operations as a whole can be minimized. This strategy requires a careful observation of the operating results of each business unit after correction of the influence of the potential risks of surgery. A company may choose to take advantage of exchange rate volatility by rearranging its business. The objectives are to maintain maximum flexibility through the ability to increase production and perform a search of resources in countries with a currency that is considered very low in real terms. This gives rise to additional costs of relocation of production facilities and make more capacity. On the other hand, this strategic move to reduce the average operating costs are expressed in a range of rates.

Term potential for economic risk or operation that puts a new burden on the shoulders of management accountants. Resource-traditional power sources do not contain much information is required. Measurement of the potential risks requires an understanding of the proper operation of the market structure in which the company and its competitors do business, as well as the influence of the real exchange rate (as opposed to nominal). This influence is difficult to measure. Because of the potential risks of surgery tend to be in a period of time, uncertainty in terms of measurable or not, and not based on a commitment to open, then the accountant should provide information that includes a variety of operating functions and a period of time.

Protection Strategy

Once the potential risks faced by the exchange rate can be identified, the next step is to design hedging strategies to minimize or eliminate potential risks. This strategy includes balance sheet hedging, operational, and contractual.

a.       Balance Sheet Hedging

Balance sheet hedging can reduce the potential risks facing the company by adjusting the level and value-denominated monetary assets and liabilities are exposed. For example, increased cash balances in foreign currencies to offset the decline in interest rates and the income derived from fixed-income instruments in the local market. Potential method of hedging risks in a more positive corporate subsidiaries located in countries that are vulnerable to devaluation include:

1.       Maintain cash balances in local currency at the minimum level necessary to support continuing operations.

2.       Restore earnings above the amount required for expansion capital to the parent company.

3.       Speed ​​up (ensure-leading) the receipt of the outstanding trade receivables denominated in local currency.

4.       Delay (slow-lagging) the payment of debt in local currency.

5.       Accelerate the payment of debts in foreign currencies.

6.       Invest excess cash into the stock of debt and other assets in local currency which was less affected by devaluation losses

7.       Invest in overseas assets with a strong currency.

b.      Operational Hedging

Form of risk protection is focused on the variables that affect the revenue and expenses in foreign currencies. Through increased selling prices (for sales billed in the currency vulnerable to devaluation) in proportion to the estimated depreciation of the currency will help protect gross margin targets. One variation on this is to collect the sales in hard currency. More stringent cost control allows a greater margin of safety against potential currency losses. The last example for instance structural hedge. These hedges include relocation of manufacturing to reduce the potential risks facing the company or changing the State which is a source of raw materials or component manufacturing.

Balance sheet and operational hedging is not without cost. Foreign subsidiaries located in countries that are vulnerable to devaluation often urged to minimize their working capital balances that exist in local currencies (especially cash and receivables), and simultaneously improve the balance of debt in local currency. Unfortunately, such measures are often not profitable. The increase in export potential derived from the devaluation may require more working capital and not less. Opportunity cost of lost sales can far exceed the translational loss. Also, loans in local currency before the devaluation may be very expensive. Other foreign subsidiaries generally have similar ideas at the same time, and consequently, the local banking system to meet demand as it is only with very expensive. Moreover, bank credit during this period is usually very rare to obtain because most countries apply very strict credit restrictions to address the problems that led to the devaluation pressure in the first place. The cost of borrowing in these circumstances often beyond the existing protection.

Strategic hedging has its limitations. For example, a strategy is to vertically integrate operations to minimize risks to the resource companies are sensitive to exchange rates. However, this resulted in a series of actions the company faces additional costs associated with the establishment of new overseas affiliates and the potential loss of economies of scale. Vertical integration also requires a long time for implementation.

c.       Contractual Hedging

Various contractual hedging instruments have been developed to provide greater flexibility for managers to manage the potential risks faced by foreign exchange.

Most financial instruments are derivative, and not an instrument basis. Basic financial instruments such as repurchase agreements (accounts), bonds, and capital stock, meet the definition of conventional accounting for assets, liabilities, and owner's equity. Derivative instruments are contractual agreements that give special rights or obligations and obtain the value of financial instruments or other commodities. Many of these events are based on contingency. As a result, most do not have anymore the same characteristics as the basic instrument.

Accounting for Hedging Products

Product contractual hedge is a contract or financial instrument that allows its use to minimize, eliminate, or at least divert the market risk on the shoulders of others. These products include, among others, the contract forward, future, swap, option, and the combination of all three, but not limited to these four. While many of these derivative instruments have become increasingly complex, a survey of user preferences management record of the most basic or simple form of this instrument.

Knowledge of accounting rules for derivative measurement is critical when designing an effective hedging strategy for the company. To understand the importance of hedge accounting, hedge accounting practices exemplified some basic values​​.

Analysts usually focus on operating earnings when evaluating how well management has run its core business. Net income includes the effect of extraordinary events or events that rarely occur are quite confusing.

Accounting treatment for financial derivatives that have been accepted internationally are set according to market the product with gains or losses arising are recognized as part of the profit nonoperasi. At least in the United States, there are exceptions in some cases if the transactions meet the hedging criteria are adequate, include the following:

1.       Items that are being hedged pose a risk to face corporate market.

2.       Company's hedging strategy described.

3.       The Company determines the instrument to be used for hedging.

4.       The reason why the record companies do hedge is likely to be effective.

Forward Foreign Currency Contracts

A number of importers and exporters generally uses foreign currency forward contract if the goods are invoiced in foreign currencies were bought from or sold to foreigners. Forward contracts offset the risk of gain or loss on the transaction due to fluctuating exchange rate between the transaction date and settlement date. Also protects the value of forward contracts in anticipation of debt or receivables in foreign currency (foreign currency commitments) and can be used to speculate in foreign currencies. This contract is not traded on an organized stock exchange, so no need illiquid when compared with other types of contracts. On the other hand, forward contracts are more flexible in the amount and duration.

Currency forward contract is an agreement to send or receive a certain amount of currency is exchanged with their domestic currency, at some future date, based on fixed exchange rates are referred to as forward exchange rate. Difference between forward and spot exchange rate prevailing on the date the forward contract raises the premium (if the forward rate> spot) or discount (forward rate <spot rate).

Premium and the discount rate multiplied by the amount of foreign currency to be received or the number of nominal contracts are to be delivered produce premium or discount on forward contracts. Forward contracts also raises the gain or loss transaction if the rate of exchange on the date the transaction is different from the exchange rate prevailing on the date of the financial statements of internal or completion date.

Future of Finance

A financial futures contract has properties similar to forward contracts. As well as forward, futures are commitments to buy or deliver a series of foreign currency at a specified future date at a price that is determined. Or the other way, future cash settlement is also used for other than submission, and may be canceled prior to shipment by performing the contract balance for the same financial instrument. Opposite of forward contracts, futures contract is a contract in standard form, which contains standard provisions related to the size and date of delivery, and traded on an organized exchange, are valued at market value at the end of each day and shall comply with periodic margin. Losses on futures contracts raises additional margin (margin call), while profit raises cash payments.

The treasurer of the company generally uses futures contracts to transfer the risk of price changes to other parties. This contract can also be used to speculate in anticipation of price movements and to take advantage of short-term anomalies in the pricing of futures contracts.

How financial futures contracts can be used? If Alpha Corporation to borrow yen for 3 months and the company was willing to protect themselves against the appreciation in the yen before the due date, then it can be bought forward contracts to receive the same amount of yen in 90 days. Appreciation of the yen led to gains on futures contracts, which offset losses from loans in yen.

Currency Options

Currency option entitles the buyer to buy (call) or sell (put) a currency of the seller (manufacturer) based on the price (of execution) on or before the specified expiry date. American type options can be exercised at any time until the expiration date. Call option buyer pays a premium for the option and its benefits if the underlying asset price is higher than the exercise price at maturity, the put option buyer to benefit if prices fall below the exercise price at expiration date.

Currency options can also be used to manage earnings. Suppose that an option trader believes that the euro will increase the value in the short term. He will buy a naked call. If the value of the euro appreciation on the date of execution, the buyer was going to execute the option and will receive the difference between now and the exercise price, less the call premium. To limit the risk of decline in value, the buyer can obtain the bull call spread. This trading strategy includes buying call and simultaneously sell a similar call with an exercise price higher. Premium paid on execution of the lower call will be partially offset by amounts received from sales call to a higher value. The maximum profit is obtained here is the difference between the exercise price minus the net premium. Premium here is actually the maximum number of potential harm to the difference (spread), ignoring transaction costs.

Straddle is a sales call and put in the same terms. Here the manufacturer the option to gamble that rates will not change much during the option period. Makers the option of premium income received from the creation options. However, this is a high risk strategy. If the exchange rate changes in an amount sufficient to cause one or both options had been executed, then the potential loss is limited to the manufacturer's option.

Currency Swap

Currency Swap includes the exchange of current and future of two different currencies based on a pre-determined exchange rate. Currency swaps allow companies to gain access to capital markets can not be obtained before access to a relatively low cost. Swap It also allows companies to hedge against exchange rate risks arising from international business activities.

Accounting Treatment

FASB FAS No. deliver. 133, which were clarified by FAS 149 in April 2003, to provide a single, comprehensive approach to accounting for derivatives and hedging transactions. IFRS (formerly IAS) No.. 39, the newly revised, contains guidelines for the first time provide universal guidance on accounting for financial derivatives. Although the two standards have the same tone, there is a difference between them in terms of number of detailed implementation guidance.

Before the standard was made, global accounting standards for derivative products is incomplete, inconsistent and developed gradually. Most financial instruments, that are executable, required as outposts beyond the balance sheet. The situation is full of prudence (caveat emptor) perceived by the readers of financial statements that attempt to measure the volume and the risks of using derivatives.

Basic provisions of this standard are:

·         All derivative instruments are recorded on the balance sheet as assets and liabilities. Derivative instruments are recorded at fair value, including those attached to the main contract is not carried at fair value.

·         Advantages and disadvantages of the change in fair value of derivative instruments is not the asset or liability. By default, both are recognized as income if it is planned as a hedge. There are three types of hedging relationships who want to be recognized, measured, and expressed; fair value hedge (fair value-FV) which includes the assets and liabilities denominated in foreign currencies are recognized and firm commitments denominated in foreign currencies, hedging net investment in foreign operations (NI) and hedging cash flow which includes foreign currency denominated transactions are expected to occur.

·         Hedging should be very effective in order to deserve a special accounting treatment, ie the gain or loss on the hedging instrument exactly offset the gains or losses should be something that protected values​ ​.

·         Hedging relationship must be documented in full for the benefit of readers of the report. To hedge the assets or liabilities denominated in foreign currencies are recognized and firm commitments denominated in foreign currencies that have not been recognized, gains or losses arising from changes in fair value of derivative instruments (and nonderivatif financial instruments) are included as income immediately. Changes in the value of assets, liabilities, or firm commitments denominated in foreign currencies are protected value is also recognized in profit now.

·         Gains or losses from net investment in foreign currency (position of the net asset or liability exposure) were initially recorded in other comprehensive income. Next, reclassified into current earnings if the subsidiary is sold or liquidated.

·         Gains or losses from hedging future cash flows are uncertain, such as export sales forecasts, are initially recognized as part of comprehensive income. Gains or losses are recognized in earnings when the transaction is expected to occur that affect earnings.

Practice Issues

Although the guiding rules issued by the FASB and IASB has clarified a lot of recognition and measurement of derivatives, there are still some problems. The first relates to the determination of fair value. Wallace said there are 64 possible calculations to measure the change in fair value of risk is being protected value of the risk being protected value of the hedging instrument. He said there are four ways to measure the change in fair value being hedged risk: the fair market value, the use of spot-exchange rate to another spot, the use of forward exchange rate to another currency forward exchange rate, and the use of option pricing models . There are many ways to calculate the change in value of investments of the hedge. Finally, this calculation can be done either before or after taxes.

The complexity of financial reporting have also increased if the hedge is not considered "highly effective" to offset the foreign exchange risk. However, this term is very effective is something that is subjective. In theory, there is a very effective means perfect negative correlation between changes in derivative values ​​or cash flows and changes in value or cash flows for something that is protected value. This suggests a range of changes in value of derivatives that can be accepted. FASB recommends the range of 80-120%. If the relationship is not met, the hedge was stopped and the deferred gain or loss previously recognized in current earnings. In turn, this will bring back unwanted volatility into the company reported earnings stream.

4. Hedging assets, liabilities are recognized or unrecognized firm commitment.

Gain on forward contract has effectively offset the devaluation of the peso. Estimated gross margin and operating profit can be made. Discount on forward contracts is the cost of hedging foreign exchange risk.

The same accounting treatment can occur if Canadian exporters make sales agreement on 1 September to deliver the goods and receive payment of Mp 1 million from the importer of Mexico in the next 3 months, and to deliver the goods immediately and wait a while to receive payment. This type of contract shall be known as foreign currency commitments.

Hope this is not the result of past transactions or also not the result of the commitment of the company's sales. This is a form of future cash flow uncertainty (anticipated transaction). Thus, gains or losses on forward contracts to hedge against the estimated revenues in pesos will initially recorded in equity as part of comprehensive income. This amount will be reclassified into earnings in the period of time now export sales actually made.

5. Hedge net investments in foreign operations

Translation losses also occur if the foreign subsidiary has a net liability position and exposure to foreign currency exchange rate currency increases relative to the parent company. One way to minimize this loss is to buy forward contracts. This strategy means using transaction gains realized from forward contracts to offset the translation loss.

6. Speculate in Foreign Currencies

There are opportunities to increase reported earnings by using forward contracts and options in the foreign exchange market. Forward contracts in the previous example does not qualify for hedge accounting treatment if the contract is purchased only to gain profits from the estimated increase in the yen. Forward contracts purchased for speculation was initially recorded by forward exchange rate. (Forward exchange rate is the best indicator of the spot rate prevailing when the contract expired). Gains or losses are recognized prior to the completion of the transaction depends on the initial forward rate and exchange rate available for the remaining period of the contract.

Accounting treatment for foreign currency instruments to be discussed is similar to the treatment of forward contracts. The accounting treatment described here is based on the nature of hedging activities, ie, whether the derivatives to protect the value of the company's commitment, the transaction will occur, the net investment in foreign operations, and so forth.

The difficulty in measuring fair value and changes in value of hedging instruments occurs when the derivative gains are not actively traded. For example, the measurement of gain or loss associated with option contracts will depend on whether the option is traded on a stock exchange outside of the primary or major exchanges. Assessment of options can be easily done if the option is recorded on a major stock exchange. Assessment will be more difficult if the option is traded through intermediaries (over-the-counter). Here, in general, the pricing formula will be used mathematically. Option pricing model called Black-Scholes models can be used to determine the value of the option at a time.

7. Disclosure

Prior to the issuance of standards such as FAS 133 and IAS 39, the company's financial disclosures do not tell the reader whether or the extent to which management has used derivative contracts. Analyzing the potential effect of derivative contracts are reported on the performance and risk characteristics of an enterprise is a difficult thing to do. Disclosures required by FAS 133 and IAS 39 has more or less solved this problem. Disclosure, among others:

·         Aims and risk management strategies for hedging transactions.

·         Description of the items hedged.

·         Identification of market risk from outposts of the hedged item.

·         Description of the hedging instrument.

·         Amount not included in the assessment of hedge effectiveness.

·         Justification of the initial (a priori) that the hedging relationship will be very effective to minimize market risk.

·          Assessment runs on actual hedge effectiveness of all derivatives that are used during the period.

Full Finance

Any financial risk management strategy should evaluate the effectiveness of the hedging program. Feedback from the evaluation system that is running will help to develop the institutional experience in risk management practices. Performance assessment of risk management program also provides information about when the current strategy is no longer appropriate.

Control points of Finance

System performance evaluation proved useful in various sectors. These sectors include, but are not limited to, the corporate treasury, purchasing and overseas subsidiaries. Control of the treasury company-wide performance measurement program include exchange rate risk management, hedging is used to identify, and reporting the results of the hedge. The evaluation system also includes documentation on how and to what extent the company's treasury to help other business units within the organization.

Similar considerations apply to the purchase function. Here, the exchange rate risk management services is one of the overall risk management program. Control is required to oversee the performance of programs designed to hedge against risk and commodity price mix.

In many organizations, foreign exchange risk management is centralized at corporate headquarters. This allows the managers of subsidiaries to concentrate on its core business. However, when comparing the actual and expected results, the evaluation system must have a reference that is used to compare the success of the company's risk protection.

8. Reference is Right

The object of risk management is to achieve a balance between risk and cost reduction. Thus, the proper standard by which to judge actual performance is a necessary part of any performance appraisal system. This reference should be made clear at the beginning before the creation and protection program should be based on the concept of opportunity cost. In the foreign exchange risk management, the following questions should be considered when they wanted to choose a reference.

·         What is the appropriate benchmark represents a policy that should be followed?

·         What reference can be made clear at the beginning?

·         Is this a reference to a strategy with a lower cost than other alternatives?

If a centralized foreign exchange risk management program, then the appropriate references can be used to measure the success of the company's risk protection program is a program that can be implemented by local managers. In other cases, the company refused to exchange rate risk may automatically hedge against the potential risks that may be encountered abroad through the forward market or borrowing in local currency. This strategy was also a natural benchmark used to assess the financial risk management. Performance of a particular hedging products (such as currency swaps), or the performance of a risk manager, will be assessed by comparing the economic benefits resulting from the transactions that are actively hedged with economic benefits that should be obtained if a treatment of reference have been used.

Reporting System

Financial risk reporting system should be able to reconcile the internal and external reporting system. Risk management activities (especially those managed by the treasury companies) have a future orientation. However, in the end they have to reconcile with the measurement of the potential risks and financial accounts for external reporting purposes. This is generally a corporate controller department's territory. Team approach is an effective way of formulating the goals of financial risk, performance standards, as well as monitoring and reporting system. Financial risk management is a prime example in which corporate finance and accounting are closely related.

Referensi:

1. Choi, Frederick D.S., and Gerhard D. Mueller, 2005., Akuntansi Internasional – Buku 1, Edisi 5., Salemba Empat, Jakarta.
2. Choi, Frederick D.S., and Gerhard D. Mueller, 2005., Akuntansi Internasional – Buku 2, Edisi 5., Salemba Empat, Jakarta.