Foreign Currency Forward Contracts and Cash Flow Hedging

Navigating Accounting and Disclosure Requirements

Josef Rashty, CPA, and John O'Shaughnessy, PhD, CPA (inactive)

Companies use futures contracts (i.e., derivative instruments) to manage exposure to various risks, such as interest rate risk, foreign exchange risk, acquisition of inventory or capital equipment price risk, and credit risk. Because of the great variety of these types of contracts, “instruments” generally refer to any such contracts that trade in markets such as the Chicago Mercantile Exchange as well as agreements developed strictly between companies. For example, one company may wish to trade a contract payment provision calling for fixed interest payment to another company for a variable interest payment. The instrument achieves the objectives of both: One company locks in a fixed cash flow and the other speculates on interest changes. The accounting literature uses the “derivative” to further describe such contracts.