Accounting Treatment Of Foreign Exchange Hedges

Risk management has been the subject of numerous theoretical and empirical researches. With the continuing integration of the world economy, multinational and trading firms are no longer alone in their exposure to changes in foreign exchange rates. Changes in foreign exchange rates can cause uncertainty regarding the expected earnings of the firms. All these factors have contributed to the increased importance of foreign exchange risk management. The major objective of risk management is to maximize the value of the firm. This value is at risk to the extent that it fluctuates in response to foreign exchange rate fluctuations. Previous researches in different literature showed that one of the most important aims of risk management is to provide smooth earnings. That means that managers would prefer to bring the current year’s earnings in line with the previous earnings. One of the method by which firms can achieve smooth earnings is hedging by using derivatives. Therefore, this paper is primary focused on the use of the derivatives to minimize the impact of changes in foreign exchange rates on reported earnings. By using simulation, it explores how use of accounting choices can influence whether the use of foreign exchange derivatives will increase or decrease firm earnings volatility.