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ACCOUNTING FOR HEDGE TRANSACTIONSHistorically, companies have been required to disclose hedge contracts, but not record them in financial statements. However, this has changed with the adoption of the Financial Accounting Standards Board (FASB) Statement No. 1331 (and its associated amendment, Statement No. 138). We do not believe these new accounting standards should significantly alter a company's approach to hedging.2 It is important for companies to consider hedging strategies based upon their specific business plan and economic outlook. For most companies, the economic protection provided by a well-designed hedging strategy should far outweigh the inconvenience created by the new accounting standards. Hedge transactions fall into three categories and accounting treatment varies by type:
Cash Flow HedgeA cash flow hedge is a hedging relationship in which the variability of the hedged item's cash flow is offset by the cash flows of the hedging instrument. In addition, the hedged item is a forecasted transaction or balance sheet item with variable cash flows.
Fair Value HedgeA fair value hedge is a hedge of the exposure to a change in fair value of a recognized asset, or liability, or of an unrecognized firm commitment attributable to a particular risk. In addition:
Net Investment in a Foreign Operation HedgeRelatively unchanged from FAS 52, FAS 133 calls for the changes in fair value of the hedge instrument to be consolidated with the translation adjustment in other comprehensive income with the difference between the total hedge results and the translation adjustment flowing through earnings. This statement:
1 In Statement No. 133, the FASB requires institutions to reflect the fair value of financial instruments on their balance sheets by requiring derivative contracts to be market-to-market and recorded as assets or liabilities. 2 While Wachovia is making this general background information available to its customers, Wachovia is not acting as a provider of accounting advice. Please check with your accountants to determine how FAS 133 would impact your company.
Wachovia Securities is the trade name for the corporate and investment banking services of Wachovia Corporation and its subsidiaries, including Wachovia Capital Markets, LLC ("WCM"), member FINRA/SIPC.
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