From the Desk of Helen Kane:
Hedging foreign currency denominated revenue in a cash flow hedge program is probably one of the simplest applications of special hedge accounting. However, there are nuances to hedging revenue that Treasury departments need to consider in managing their hedge programs. Please review the nuances associated with the three scenarios outlined below to ensure that you are properly managing the derivative gains/losses associated with revenue hedges.
In cash flow hedge programs corporations are permitted to park derivative gains and losses in Other Comprehensive Income (OCI) for all changes between the designation of the hedge relationship and the recognition of the hedged transactions in the financials. The gain/loss then remains in OCI until the hedged item is reported in consolidated earnings. Note the distinction between the “trigger event” that stops the collection of OCI and the “release event” that controls the release.
Scenario #1: Hedging revenue that is deferred
When deferred revenue is first reported on the financial statements, only the balance sheet is impacted (DR Receivable, CR Deferred Revenue). This recording of the hedged item meets the trigger criteria to stop accumulating gains and losses. However, without an income event, the gain or loss must remain in OCI awaiting the reclass of the deferred revenue to regular revenue in the P&L. Processes must be in place to recognize the reclass of the hedged revenue to income.
Frequently, descriptions of hedged revenue will exclude deferred revenue to eliminate the burden of tracking the reclassification the hedged item from deferred revenue to revenue. This is becoming increasingly difficult as many more companies are (reluctantly) moving to deferred revenue models. Companies hedging deferred revenue may execute separate hedges for the deferred revenue or just bifurcate the hedge gains and losses into portions to be released immediately and those stored and released separately. AcappellaFX® is designed to support the independent “trigger” and “release” functions necessary when hedging deferred revenue.
Scenario #2: Hedging interco transactions where the 3rd party sale by the foreign currency functional subsidiary is in a later period
Many corporations hedge the intercompany transaction between two entities as a proxy for hedging 3rd party revenue. It is important that the gains and losses on these hedges of interco revenue or intercompany inventory purchase are released contemporaneous with the third party recognition of revenue or cost of sales. Few corporate treasury teams focus on how this lag will be reflected in their consolidated financials when the subsidiaries are foreign functional. If the hedge is executed at the subsidiary level to hedge the interco purchases, the hedge will succeed in protecting local currency margin—but will not provide any visibility into theexpected USD value of the consolidated results.
If the hedge is executed at the parent level it provides even less protection of foreign functional earnings. The gain or loss representing the value between hedge designation and recording of interco revenue will give no visibility into the value at which the consolidated margin will be recorded in the period the inventory is reclassed to Cost of Sales. However, if hedging is maintained through the payment of theintercompany, the hedge will succeed in economically protecting cash flows. For the curious few wondering where the delta between cash and the earnings values reported are captured: the answer is the cumulative translation adjustment. This concept will be fully explored in our ASC 830 Advanced Workshop on July 15, 2011.
Scenario #3: Hedging gross revenue impacted by credit memos
For the purposes of this discussion, we will assume that a credit memo is issued and a new invoice is generated for an equal or close to equal amount. Credit memos and currency don’t mix well. They create havoc on remeasurement results as ERP systems frequently reverse original entries at the historic rate at which the original invoice was issued and the new invoice is re-issued at current rates, creating a slippage in value between the FX Gain/Loss and Revenue. The slippage between the lines can be calculated as the revenue value at the income statement rate at first invoice vs. the revenue value at the income statement rate at re-issue.
Things are complicated further when revenue transactions are hedged. The reissued revenue should not be captured in the hedged revenue calculation. This might result in a single transaction being hedged twice: the original revenue recognition event and a second time when the revenue value was included in the “gross revenue” amounts recorded in re-issue period (ASC815 precludes the hedging of “net” amounts). Companies should have processes to identify and exclude the reporting of “re-invoiced revenue”and other credit memos in the values used to trigger cash flow or fair value hedges of revenue. For further information on how your revenue hedges are impacted by these scenarios please contact your Hedge Trackers consultant, or send an inquiry to email@example.com.