5.4 Net Investment Hedging

Hedging Relationship Type	Possible Types of Foreign-Currency-Denominated Hedged Items (See ASC 815-20-25-28)	Permitted Hedging Instruments
Net investment hedge	Net investment in a foreign operation	Derivative or nonderivative

A net investment hedge is a hedge of the foreign currency exposure of a net investment in a foreign operation. Such an exposure is a result of the translation of the investment into the parent’s functional currency in accordance with ASC 830. The resulting gains and losses from translation are recognized in OCI as CTAs. The application of net investment hedging allows entities to defer recognizing the gains and losses on the hedging instrument that are included in the effectiveness assessment as a CTA in OCI in a manner consistent with the classification of the CTA that arises from the hedged item. As in cash flow hedging relationships, the gains and losses recognized in the CTA are reclassified into earnings when the hedged item (i.e., the net investment in foreign operations) affects earnings (see Section 5.4.3 for further discussion).

The concept of hedging a net investment in foreign operations, which is made up of assets and liabilities, is unique to this type of hedging relationship. Unlike fair value and cash flow hedging relationships, a net investment hedge permits hedge accounting to be applied to a group of items (the net investment) that typically includes both assets and liabilities that in many cases would not be considered similar items. Because of the unique nature of this hedging relationship, distinct qualification criteria must be met to qualify for this type of hedging.

5.4.1 Hedging Instruments in a Net Investment Hedge

ASC 815-20

25-66 A derivative instrument or a nonderivative financial instrument that may give rise to a foreign currency transaction gain or loss under Subtopic 830-20 can be designated as hedging the foreign currency exposure of a net investment in a foreign operation provided the conditions in paragraph 815-20-25-30 are met. A nonderivative financial instrument that is reported at fair value does not give rise to a foreign currency transaction gain or loss under Subtopic 830-20 and, thus, cannot be designated as hedging the foreign currency exposure of a net investment in a foreign operation.

25-67 Hedging instruments that are eligible for designation in a net investment hedge include, among others, both of the following:

A receive-variable-rate, pay-variable-rate cross-currency interest rate swap, provided both of the following conditions are met:
1. The interest rates are based on the same currencies contained in the swap.
2. Both legs of the swap have the same repricing intervals and dates.
A receive-fixed-rate, pay-fixed-rate cross-currency interest rate swap. A cross-currency interest rate swap that has two fixed legs is not a compound derivative instrument and, therefore, is not subject to the criteria in (a).

25-68 A cross-currency interest rate swap that has either two variable legs or two fixed legs has a fair value that is primarily driven by changes in foreign exchange rates rather than changes in interest rates. Therefore, foreign exchange risk, rather than interest rate risk, is the dominant risk exposure in such a swap.

25-68A Under the guidance in paragraph 815-20-25-71(d)(1), a cross-currency interest rate swap with one fixed-rate leg and one floating-rate leg cannot be designated as the hedging instrument in a net investment hedge.

An entity may use either a derivative or certain nonderivative instruments as hedging instruments in a net investment hedge. To qualify as a hedging instrument, a nonderivative instrument must be subject to the measurement requirements of ASC 830-20. ASC 815-20-25-66 notes that any nonderivative instrument that is reported at fair value does not qualify as a hedging instrument in a net investment hedging relationship because it “does not give rise to a foreign currency transaction gain or loss under Subtopic 830-20.”

Since the translation of net investments in foreign operations is based on changes in foreign currency exchange rates in accordance with ASC 830, ASC 815 requires the remeasurement of the hedging instrument to be predominantly based on changes in foreign currency exchange rates. That requirement limits the types of derivatives that can be used as hedging instruments in net investment hedges to those whose fair value is predominantly based on changes in foreign currency exchange rates. Accordingly, many compound derivatives and all synthetic instruments are precluded from qualifying as hedging instruments within net investment hedging relationships.

Generally, ASC 815 does not permit the use of a compound derivative that has multiple underlyings as the hedging instrument in a net investment hedge. As discussed in Section 2.4.1.3.4, the only compound derivatives that an entity may use as the hedging instrument in a net investment hedging relationship are:

Receive-variable-rate, pay-variable-rate cross-currency interest rate swaps in which (1) the interest rates are based on the same currencies contained in the swap and (2) both legs of the swap have the same repricing intervals and dates.
Receive-fixed-rate, pay-fixed-rate cross-currency interest rate swaps.

ASC 815-20-25-71(d) precludes synthetic instruments that consist of a combination of a debt instrument and derivative instrument from qualifying as hedging instruments in a net investment hedging relationship. If such instruments were viewed as one, the measurement principles of the individual components under ASC 830-20 and ASC 815 would be contravened. ASC 815-20-55-49 and 55-50 provide an example of a synthetic instrument:

55-49 A debt instrument denominated in the investor’s functional currency and a cross-currency interest rate swap cannot be accounted for as synthetically created foreign-currency-denominated debt to be designated as a hedge of the entity’s net investment in a foreign operation.

55-50 For example, a parent entity that has the U.S. dollar (USD) as its functional and reporting currency has a net investment in a Japanese yen- (JPY-) functional-currency subsidiary. The parent borrows in euros (EUR) on a fixed-rate basis and simultaneously enters into a receive-EUR, pay-Japanese yen currency swap (for all interest and principal payments) to synthetically convert the borrowing into a yen-denominated borrowing. The parent entity cannot designate the EUR-denominated borrowing and the currency swap in combination as a hedging instrument for its net investment in the JPY-functional-currency subsidiary.

5.4.2 Accounting for a Net Investment Hedge

ASC 815-35

35-1 The gain or loss on a hedging derivative instrument (or the foreign currency transaction gain or loss on the nonderivative hedging instrument) that is designated as, and is effective as, an economic hedge of the net investment in a foreign operation shall be reported in the same manner as a translation adjustment (that is, reported in the cumulative translation adjustment section of other comprehensive income).

35-2 The hedged net investment shall be accounted for consistent with Topic 830. The provisions of Subtopic 815-25 for recognizing the gain or loss on assets designated as being hedged in a fair value hedge do not apply to the hedge of a net investment in a foreign operation.

As in a cash flow hedging relationship, the hedged item is not adjusted in a net investment hedging relationship. The gain or loss on the hedging instrument in a qualifying net investment hedging relationship is reported in the CTA component of OCI in a manner consistent with the translation of the net investment under AC 830. There are two circumstances that result in a modification to this model:

An entity designates a derivative as the hedging instrument in a qualifying net investment hedging relationship and assesses the effectiveness of the hedging relationship under the spot method (see Section 5.4.2.1.1.1).
An entity elects to hedge on an after-tax basis (see Section 5.4.2.2).

5.4.2.1 Differences in Methods of Assessing Effectiveness

ASC 815-35

35-4 If a derivative instrument is used as the hedging instrument, an entity may assess the effectiveness of a net investment hedge using either a method based on changes in spot exchange rates (as specified in paragraphs 815-35-35-5 through 35-15) or a meth-od based on changes in forward exchange rates (as specified in paragraphs 815-35-35-17 through 35-26). This guidance can also be applied to purchased options used as hedging instruments in a net investment hedge. However, an entity shall consistently use the same method for all its net investment hedges in which the hedging instrument is a derivative instrument; use of the spot method for some net investment hedges and the forward method for other net investment hedges is not permitted. An entity may change the method that it chooses to assess the effectiveness of its net investment hedges in accordance with paragraphs 815-20-55-55 through 55-56A.

Section 2.5.2.1.2.5 discusses the two different methods for assessing the effectiveness of a net investment hedging relationship. The table below summarizes the different types of hedging instruments and the effectiveness assessment methods available for each type of instrument.

Hedging Instrument	Effectiveness Assessment Methods
Nonderivative instrument	Spot method
Derivative instrument	Spot method or forward method

As indicated in ASC 815-35-35-4, an entity must “consistently use the same method for all its net investment hedges in which the hedging instrument is a derivative instrument.” It is not permitted to “use . . . the spot method for some net investment hedges and the forward method for other net investment hedges.” For most entities, the selection of an assessment method is driven by the difference in the accounting for the relationships under each method. These differences are described in Sections 5.4.2.1.1 (the spot method) and 5.4.2.1.2 (the forward method).

ASC 815-35-35-4 also notes that an “entity may change the method that it chooses to assess the effectiveness of its net investment hedges in accordance with paragraphs 815-20-55-55 through 55-56A.” However, in a manner consistent with the overall guidance for changing assessment methods (see Section 2.5.4), a change in methods:

May only be done if the entity can demonstrate that the new method of assessing effectiveness is an “improved method,” in accordance with ASC 815-20-35-19 and ASC 815-20-55-56.
Would apply to all net investment hedging relationships in which the hedging instrument is a derivative.
Would be accomplished for any outstanding hedging relationship by dedesignating the original hedging relationship and then designating a new hedging relationship.

ASC 815-20-55-56 notes that the requirement to demonstrate that the new method of assessing effectiveness is an “improved method” does not mean that the new method must be deemed “preferable” under ASC 250; however, once an entity switches from one method to the other and asserts that the new method is “improved,” it would most likely be unable to switch back to its original method of assessing hedge effectiveness at a later date because it would be difficult to support an argument that the original method has reverted to being an “improved” method.

5.4.2.1.1 The Spot Method

5.4.2.1.1.1 Hedging Instrument Is a Derivative

ASC 815-35

Hedging Instrument Is a Derivative Instrument

35-5A An entity shall recognize in earnings the initial value of the component excluded from the assessment of effectiveness using a systematic and rational method over the life of the hedging instrument. Any difference between the change in fair value of the excluded component and amounts recognized in earnings under that systematic and rational method shall be recognized in the same manner as a translation adjustment (that is, reported in the cumulative translation adjustment section of other comprehensive income).

35-5B An entity alternatively may elect to record changes in the fair value of the excluded component currently in earnings. This election shall be applied consistently to similar hedges in accordance with paragraph 815-20-25-81.

35-6 The interest accrual (periodic cash settlement) components of qualifying receive-variable-rate, pay-variable-rate and receive-fixed rate, pay-fixed-rate cross-currency interest rate swaps shall also be reported directly in earnings.

35-7 The change in fair value of the derivative instrument attributable to changes in the spot rate shall be reported in the same manner as a translation adjustment (that is, reported in the cumulative translation adjustment section of other comprehensive income).

If an entity designates a derivative instrument in a hedge of a net investment in foreign operations and elects to assess hedge effectiveness under the spot method, it must recognize the excluded component’s initial value in earnings over the life of the hedging relationship in a manner similar to any other relationship in which components are excluded from the effectiveness assessment. The default treatment under ASC 815 is to recognize the initial value of the excluded component in earnings by using a systematic and rational method. Alternatively, as noted in ASC 815-35-35-5B, an entity may elect to record the changes in the excluded component’s fair value currently in earnings.

ASC 815-35-35-6 notes that the “interest accrual (periodic cash settlement) components of qualifying receive-variable-rate, pay-variable-rate and receive-fixed rate, pay-fixed-rate cross-currency interest rate swaps shall also be reported directly in earnings.”

If an entity designates an at-market cross-currency interest rate swap (i.e., its fair value is zero) with standard terms as the hedging instrument and recognizes the periodic interest accruals in earnings, there are no other excludable components to recognize in earnings. A standard cross-currency interest rate swap has the following terms:

The exchange of currencies at inception and the return of those same amounts upon final settlement of the swap are based on the spot exchange rate at the inception of the derivative.
The periodic interest accruals are calculated in the same manner for each settlement:
- For a fixed-for-fixed swap, each leg has the same fixed rate for the life of the swap.
- For a variable-for-variable swap:
  - Each leg has the same contractually specified rate over the life of the swap.
  - Any fixed spread added to a leg of the swap is the same fixed spread over the life of the swap.
  - The contractually specified interest rates for both legs are based on comparable interest rate curves (e.g., three-month LIBOR and three-month commercial paper rates are not considered comparable under ASC 815-35-35-18(b)).

5.4.2.1.1.1.1 Hedging With Derivatives That Are Off-Market or Have Nonstandard Terms

The designation of a derivative that is off-market (i.e., its fair value is other than zero at hedge inception) or has other than standard terms (see Section 5.4.2.1.1.1) as a hedging instrument in a net investment hedge raises other accounting issues. Such a situation may arise when an entity designates (1) a preexisting cross-currency interest rate swap instead of a new at-market cross-currency interest rate swap or (2) a cross-currency interest rate swap that is highly structured. If a net investment hedging relationship includes an off-market derivative, an entity must consider the derivative’s initial fair value as representing an in-substance financing that must be factored into the accounting for the new hedging relationship.

For example, if a fixed-for-fixed cross-currency interest rate swap has a fair value of $1 million (an asset) at the time of designation, that initial fair value indicates that the entity will either receive $1 million more or pay $1 million less (on a present value basis) than it would have if it had designated an at-market swap as the hedging instrument at hedge inception. As a result of this implicit financing element, there is an additional excluded component (other than the forward points and the cross-currency basis spread) that the entity must amortize into earnings, which is essentially the “interest” on the financing element of the swap.

In a public FASB meeting on February 14, 2018, the staff indicated that when the hedging instrument in a net investment hedge (in which effectiveness is assessed by using the spot method) is a cross-currency interest rate swap that is off-market at hedge inception, an entity should amortize the excluded component in a manner that would not violate the guidance in ASC 815-35-35-6 and 35-7. The FASB staff clarified that “at the end of the hedging relationship, only amounts of the swap related to spot changes on the notional amount of the net investment [that occurred during the life of the hedge] should remain in” the CTA. Such amounts would be computed as the product of (1) the notional amount and (2) the difference between the market-based foreign currency spot exchange rates at hedge maturity and hedge inception. Therefore, an entity can apply any systematic and rational amortization approach in which the off-market amount of the swap would equal zero at the end of the hedging relationship. The staff cautioned, however, that any structuring of the designated hedging cross-currency swap designed to “achieve a specific accounting result [would not be] considered rational in the context of a systematic and rational approach.” The Board agreed with the staff’s conclusions.

To ensure that the off-market amount of a swap is amortized to zero by the end of the hedging relationship, an entity may be able to use one the following amortization methods (not all-inclusive):

At hedge inception, compute the time value or basis spread component of the fair value of the swap as the difference between its full fair value and its intrinsic value (the intrinsic value would be computed as the notional amount multiplied by the difference between the foreign currency spot exchange rates at (1) hedge inception and (2) the inception of the actual swap contract). Over the life of the hedging swap, amortize that time value component into earnings on a straight-line basis and recognize the interest settlements on the actual off-market swap in income each period.
Determine what the interest settlements would be for a hypothetical swap that has a fair value of zero at hedge inception2 and use those amounts as the basis for amortizing the initial value of the excluded component (attributable to the forward points and the cross-currency basis spread) out of CTA and into earnings in each period. In addition, the entity would separately determine the amount of “interest” on the implicit financing component3 and amortize that amount into earnings over the life of the hedging instrument on either a straight-line basis or by using an effective interest method.

As indicated above, the FASB staff noted that when an entity chooses its amortization method for the excluded component of a hedging instrument that is off-market at hedge inception, it must be mindful that any structuring of the designated cross-currency swap designed to achieve a specific accounting result would not be considered a rational method of amortization in the context of the systematic and rational amortization approach required under ASC 815-35-35-5A. The amortization method described in the first bullet above is more likely to be susceptible to inappropriate structuring than the method described in the second bullet; therefore, entities using the method in the first bullet should closely review the terms of the hedging swap to ensure that those terms would result in a rational amortization pattern.

For example, a cross-currency interest rate swap could be structured so that the rates earlier in the swap are below-market and the rates later in the swap are above-market, which would also represent an in-substance financing arrangement.

5.4.2.1.1.1.2 Income Statement Classification

ASC 815-35 is silent on the income statement classification of amounts related to excluded components of the derivative that are recognized in earnings in connection with a hedging relationship in which the spot method is used. We believe that the FASB intended to allow entities to continue the practice they had used before the issuance of FASB Statement 133. In many cases, entities had viewed the “cost or income” of derivatives related to foreign currency hedging as a financing cost, so they had recognized such amounts, whether positive or negative, in interest expense. For many entities, the decision to recognize such costs in interest expense was also driven by the fact that they may also have issued foreign-currency-denominated debt to finance the foreign operations. We believe that an entity should establish a reasonable, consistently applied income statement classification policy and disclose that policy in its financial statements.

See Examples 5-18 and 5-19 for detailed illustrations of the application of the spot method to a net investment hedge involving a forward contract and Example 5-21 for an illustration of the application of the spot method to a net investment hedge involving a cross-currency interest rate swap.

5.4.2.1.1.2 Hedging Instrument Is a Nonderivative Instrument

ASC 815-35

Hedging Instrument Is Not a Derivative Instrument

35-12 The translation gain or loss determined under Subtopic 830-30 by reference to the spot exchange rate between the transaction currency of the debt and the functional currency of the investor (after tax effects, if appropriate) shall be reported in the same manner as the translation adjustment associated with the hedged net investment (that is, reported in the cumulative translation adjustment section of other comprehensive income) if both of the following conditions are met:

The notional amount of the nonderivative instrument matches the portion of the net investment designated as being hedged.
The nonderivative instrument is denominated in the functional currency of the hedged net investment.

In that circumstance, the hedging relationship would be considered perfectly effective, and no prospective quantitative effectiveness assessment is required at hedge inception (see paragraph 815-20-25-3(b)(2)(iv)(01)).

If an entity designates a nonderivative instrument as the hedging instrument in a qualifying net investment hedge, it must apply the spot method because the hedging instrument is remeasured at spot rates in accordance with ASC 830-20. ASC 815-35-35-12 states, in part, that if the “notional amount of the nonderivative instrument matches the portion of the net investment . . . being hedged” and “is denominated in the [same] functional currency” as the net investment, the translation gain or loss on the nonderivative instrument is recognized in a CTA along with the translation adjustment associated with the net investment. We believe that even in situations in which one of the two conditions in ASC 815-35-35-12 is not met, as long as the hedging relationship qualifies for hedge accounting, the entire translation gain or loss on the nonderivative instrument is recognized in a CTA in a manner consistent with the guidance in ASC 815-35-35-1.

In some cases, a nonderivative instrument is both the hedging instrument in a net investment hedge and the hedged item in a fair value hedge. For example, an entity may designate a pay-variable, receive-fixed interest rate swap as a fair value hedge of foreign-currency-denominated fixed-rate debt for changes in its fair value that are attributable to changes in the benchmark interest rate. As a result of the fair value hedge, the carrying amount of the debt will be adjusted for changes in its fair value that are attributable to changes in the designated benchmark interest rate. This debt may also be the hedging instrument in a hedge of a net investment in foreign operations.

Changing Lanes

In its November 2019 proposed ASU of Codification improvements to hedge accounting, the FASB proposed to eliminate the recognition and presentation mismatch related to these “dual hedges” (described above) that results from adjusting the carrying amount of the debt in a fair value hedge.

At the October 11, 2023, FASB meeting, the Board decided to affirm the proposed amendments to eliminate the recognition and presentation mismatch related to dual hedges. Under the proposed amendments, an entity would eliminate that mismatch by excluding the foreign-currency-denominated debt instrument’s fair value hedge basis adjustment from the net investment hedge effectiveness assessment. As a result, an entity would immediately recognize the gains and losses from the remeasurement of the debt instrument’s fair value hedge basis adjustment at the spot exchange rate in earnings. Entities would be prohibited from applying this guidance by analogy to other circumstances. The FASB’s September 2024 proposed ASU included these amendments, but a final ASU has not been issued as of the date of this publication.

5.4.2.1.2 The Forward Method

ASC 815-35

35-17 Under a method based on changes in forward exchange rates, an entity shall report all changes in fair value of the derivative instrument in the same manner as a translation adjustment (that is, reported in the cumulative translation adjustment section of other comprehensive income), including the following amounts:

The time value component of purchased options
The interest accrual/periodic cash settlement components of qualifying receive-variable-rate, pay-variable-rate and receive-fixed-rate, pay-fixed-rate cross-currency interest rate swaps.

Under the forward method, an entity would report all changes in the derivative instrument’s fair value in the CTA portion of OCI for a qualifying net investment hedging relationship. See Example 5-17 for a detailed illustration of a forward contract hedging a net investment in foreign operations under the forward method and Example 5-20 for a detailed illustration of a fixed-for-fixed cross-currency interest rate swap hedging a net investment in foreign operations under the forward method.

5.4.2.2 Hedging on an After-Tax Basis

ASC 815-35

35-3 If an entity has designated and documented that it will assess effectiveness and measure hedge results on an after-tax basis as permitted by paragraph 815-20-25-3(b)(2)(vi), the portion of the gain or loss on the hedging instrument that exceeded the loss or gain on the hedged item shall be included as an offset to the related tax effects in the period in which those tax effects are recognized.

As indicated in ASC 815-35-35-3, if an entity has designated and documented that it will be hedging on an after-tax basis, as permitted by ASC 815-20-25-3(b)(2)(vi), “the portion of the gain or loss on the hedging instrument that [exceeds] the loss or gain” from translating the net investment is recognized as an offset to the related tax effects in the period in which those tax effects are recognized. See Section 5.1.3 for further discussion of hedging on an after-tax basis.

5.4.3 Discontinuing a Net Investment Hedge

Gains and losses on the hedging instrument that are recorded in the CTA portion of OCI are treated consistently with all other amounts in the CTA related to a net investment in foreign operations. ASC 830-30 includes guidance on the circumstances under which a CTA may be released, including scenarios involving (1) full and substantially complete liquidations and (2) partial sales and liquidations. See Section 5.4 of Deloitte’s Roadmap Foreign Currency Matters.

ASC 815-35

40-1 When applying the guidance in paragraph 815-35-35-5A and a hedge is discontinued, any amounts that have not yet been recognized in earnings shall remain in the cumulative translation adjustment section of accumulated other comprehensive income until the hedged net investment is sold or liquidated in accordance with paragraphs 830-30-40-1 through 40-1A.

In accordance with ASC 815-35-40-1, if an entity discontinues a hedging relationship in which a derivative was the hedging instrument and the spot method was applied, any amounts that were recognized in the CTA related to excluded components that have not yet been recognized in earnings should remain in the CTA.

We do not believe that it would be appropriate for an entity to effectively “freeze” amounts in CTA that are related to excluded components by dedesignating a hedging relationship and immediately redesignating it in exactly the same manner with the same hedging instrument and hedged net investment in foreign operations.

As discussed in Section 2.5.2.2.4, because of the nature of the hedged item, the process for periodically monitoring a net investment hedging relationship is a bit unique. The balance of an entity’s net investment in foreign operations is subject to change in each reporting period on the basis of (1) the operating results of the investee and (2) capital transactions between the entity and the investee (dividends, etc.). Accordingly, the entity should continually assess the balance of the net investment to ensure that it is not overhedged before the start of a reporting period (i.e., when it would be performing the prospective assessment for the upcoming period). If the balance of the net investment drops below the amounts designated as the hedged item, the entity would need to consider the one of following alternatives:

Dedesignate the proportion of the hedging relationship related to the “shortfall” of the net investment.4 Any portion of the hedging instrument that is no longer in the net investment hedge could potentially be (1) designated in a new hedging relationship or (2) simply reported at fair value in subsequent periods, with changes in fair value recognized in earnings.
Dedesignate the entire hedging relationship and redesignate a new one. The entity would need to identify a different notional amount for the hedged net investment because the amount of the hedged item cannot exceed the balance of the net investment. As discussed in Section 2.5.2.2.4, an entity could purposely overhedge the net investment, but the new hedging relationship would need to be highly effective and the entity could not assume perfect effectiveness.
Dedesignate the entire hedging relationship and consider whether to either designate the hedging instrument in a new hedging relationship or simply report it at fair value in subsequent periods, with changes in fair value recognized in earnings.

5.4.4 Illustrative Examples

Example 5-17

Forward Contract Hedging a Net Investment in Foreign Operations (Forward Method)

SimpleBand, a U.S. multinational company, has a wholly owned German subsidiary, Skyscraper Co., with a euro functional currency. SimpleBand’s investment in Skyscraper Co. is EUR 10 million. In accordance with ASC 830, SimpleBand records the translation adjustments related to its German subsidiary in the CTA component of OCI.

On June 30, 20X0, SimpleBand enters into a six-month forward contract to sell EUR 10 million for USD 11,772,000 (a EUR/USD forward rate of 1.1772). The EUR/USD spot exchange rate on June 30, 20X0, is 1.1667. SimpleBand designates the forward contract as a hedge of the foreign currency exposure of its net investment in Skyscraper Co.

SimpleBand elects to apply the forward method to assess the effectiveness of the hedge. The hedging relationship is considered to be perfectly effective under ASC 815-35-35-17A because:

The notional amount of the forward matches the portion of the net investment designated as being hedged.
The underlying of the forward (EUR/USD) is related solely to the foreign exchange rate between the functional currency of Skyscraper Co. (EUR) and the functional currency of SimpleBand (USD).

For this example, assume that the net investment in Skyscraper Co. does not decline below EUR 10 million. Skyscraper Co. records the following journal entries:

June 30, 20X1

No entry is required. The forward contract is at-the-money.

September 30, 20X1

The table below shows (1) the three-month EUR/USD forward rate as of September 30, 20X1, (2) the forward contract’s fair values at the beginning and end of the period, and (3) the change in the forward contract’s fair value.

The table below shows (1) the EUR/USD spot exchange rates at beginning and end of the period and (2) the related CTA for Skyscraper Co. in accordance with ASC 830.

The journal entries are as follows:

December 31, 20X1

The table below shows (1) the EUR/USD spot exchange rate as of December 31, 20X1, (2) the forward contract’s fair values at the beginning and end of the period, and (3) the change in the forward contract’s fair value.

The table below shows (1) the EUR/USD spot exchange rates at the beginning and end of the period and (2) the related CTA for Skyscraper Co. in accordance with ASC 830.

The journal entries are as follows:

Example 5-18

Forward Contract Hedging a Net Investment in Foreign Operations (Spot Method — Systematic and Rational Amortization)

Assume the same facts as in Example 5-17, except that SimpleBand elects to assess the effectiveness of the hedging relationship by using the spot method. The hedging relationship is considered to be perfectly effective under ASC 815-35-35-5 because:

The notional amount of the forward matches the portion of the net investment designated that is being hedged.
The underlying of the forward (EUR/USD) is related solely to the foreign exchange rate between the functional currency of Skyscraper Co. (EUR) and the functional currency of SimpleBand (USD).

SimpleBand elects to recognize the initial value of the excluded component (the forward/spot difference) in earnings over the life of the hedging relationship in a systematic and rational basis. It has a consistently applied policy of recognizing the earnings effect of the excluded components of derivatives related to net investment hedges in interest expense because it views those components as a financing cost of the derivatives.

The calculation of the excluded component’s initial value (i.e., the difference between the forward and spot rates) is as follows:

For this example, assume that the net investment in Skyscraper Co. does not decline below EUR 10 million. Skyscraper Co. records the following journal entries:

June 30, 20X1

No entry is required. The forward contract is at-the-money.

September 30, 20X1

The table below shows (1) the EUR/USD spot exchange rates at the beginning and end of the period and (2) the related CTA for Skyscraper Co. in accordance with ASC 830.

The journal entries are as follows:

December 31, 20X1

The table below shows (1) the EUR/USD spot exchange rates at the beginning and end of the period and (2) the related CTA for Skyscraper Co. in accordance with ASC 830.

The journal entries are as follows:

Example 5-19

Forward Contract Hedging a Net Investment in Foreign Operations (Spot Method — Change in the Fair Value of Excluded Components in Earnings)

Assume the same facts as in Example 5-18, except that SimpleBand elects to assess the effectiveness of the hedging relationship by using the spot method and recognizes the changes in the excluded component’s fair value (the forward/spot difference) in current earnings, as allowed by ASC 815-35-35-5B. SimpleBand has a consistently applied policy of recognizing the earnings effect of the excluded components of derivatives related to net investment hedges in interest expense because it views those components as a financing cost of the derivatives.

For this example, assume that the net investment in Skyscraper Co. does not decline below EUR 10 million. Skyscraper Co. records the following journal entries:

June 30, 20X1

No entry is required. The forward contract is at-the-money.

September 30, 20X1

The table below shows (1) the EUR/USD spot exchange rates at the beginning and end of the period and (2) the related CTA for Skyscraper Co. in accordance with ASC 830.

The journal entries are as follows:

December 31, 20X1

The table below shows (1) the EUR/USD spot exchange rates at the beginning and end of the period and (2) the related CTA for Skyscraper Co. in accordance with ASC 830.

The journal entries are as follows:

Example 5-20

Fixed-for-Fixed Cross-Currency Interest Rate Swap Hedging Net Investment in Foreign Operations (Forward Method)

TreyCo wishes to hedge its exposure to changes in its SEK 50 million net investment in its foreign subsidiary (Kasvot) that are attributable to changes in the USD/SEK foreign currency exchange rate. On March 5, 20X6, TreyCo enters into a fixed-for-fixed cross-currency interest rate swap to hedge that risk. The terms of the cross-currency interest rate swap are as follows:

Pay leg — SEK 50 million notional at a rate of 1.75 percent per annum.
Receive leg — USD 55,025,000 notional at a rate of 3.4 percent per annum.
Quarterly periodic settlements beginning March 31, 20X6.
Initial exchange — TreyCo receives SEK 50 million and pays USD 55,025,000.
Final exchange — TreyCo receives USD 55,025,000 and pays SEK 50 million.
Maturity date — September 30, 20X7.

TreyCo designates the cross-currency interest rate swap as a hedge of SEK 50 million of the beginning balance of its net investment in Kasvot and elects to assess the effectiveness of the hedging relationship by using the forward method. TreyCo may assume that the hedge is perfectly effective under ASC 815-35-35-17A because:

The swap’s notional amount matches the amount of the net investment being hedged.
The swap’s underlying is related solely to the foreign currency exchange rate between the functional currency of the parent (USD) and the functional currency of the hedged subsidiary (SEK).

For this example, assume that the net investment in Kasvot does not decline below SEK 50 million.

Below is a table of key assumptions.

TreyCo would record the following journal entries for each reporting period to account for the hedge and the translation of its net investment in Kasvot:

March 31, 20X6

Translation of the foreign subsidiary is not required because the spot rate has not changed.

June 30, 20X6

September 30, 20X6

December 31, 20X6

March 31, 20X7

June 30, 20X7

September 30, 20X7

Example 5-21

Fixed-for-Fixed Cross-Currency Interest Rate Swap Hedging Net Investment in Foreign Operations (Spot Method)

Assume the same facts as in Example 5-20, except that TreyCo elects to assess the effectiveness of the hedging relationship by using the spot method. Because the swap is an at-market swap with standard terms, there are no excluded components to recognize in earnings separately from the periodic settlements. TreyCo has a consistently applied policy of recognizing the earnings effect of the excluded components of derivatives related to net investment hedges in interest expense because it views those components as a financing cost of the derivatives.

TreyCo may assume that the hedge is perfectly effective under ASC 815-35-35-5 because:

The swap’s notional amount matches the amount of the net investment being hedged.
The swap’s underlying is related solely to the foreign currency exchange rate between the functional currency of the parent (USD) and the functional currency of the hedged subsidiary (SEK).

For this example, assume that the net investment in Kasvot does not decline below SEK 50 million.

Below is a table of key assumptions.

TreyCo would record the following journal entries for each reporting period to account for the hedge and the translation of its net investment in Kasvot:

March 31, 20X6

Translation of the foreign subsidiary is not required because the spot rate has not changed.

June 30, 20X6

September 30, 20X6

December 31, 20X6

March 31, 20X7

June 30, 20X7

September 30, 20X7

Footnotes

The terms of the hypothetical derivative should reflect those of a receive-fixed-rate, pay-fixed-rate cross-currency interest rate swap that has (1) a fair value of zero at hedge inception and (2) terms (other than the notional amount and fixed interest rate on the leg whose interest payments are not denominated in the functional currency of the designated hedged net investment) that match those of the actual hedging derivative (e.g., maturity date, repricing, and payment frequencies of any interim settlements). Furthermore, the notional amount of the leg of the hypothetical swap denominated in the functional currency of the net investment being hedged should match the amount of that hedged net investment. The notional amount of the leg that matches the hedging entity’s functional currency would be set by converting the foreign-currency-denominated leg on the basis of the current foreign exchange rate (i.e., the spot foreign currency exchange rate at hedge inception). The interest rate on the functional currency leg would then be set at whatever rate results in the swap’s having a fair value of zero at inception of the hypothetical derivative.

This element can be determined by looking at the difference between the payments on the off-market (actual) swap and the payments on the at-market (hypothetical) swap. The difference between the fair value of the swap and the undiscounted “extra” payments is the interest element that would be amortized out of CTA on a systematic and rational basis in a manner consistent with the treatment of other excluded components under the amortization approach.

See Sections 3.5.1.3.1 and 4.1.5.1.3.1 for a discussion of partial dedesignations for fair value hedges and cash flow hedges. The concepts are similar for a net investment hedge, as supported by ASC 815-35-55-1.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.