What Is a Balance Sheet Hedge?

Domestic corporations involved in international business operations experience significant financial risks associated with currency fluctuations. Balance sheet hedges are accounting techniques designed to reduce these risks. Balance sheet hedges document and translate foreign assets into U.S. dollars as protection against currency fluctuations, allowing companies to control currency transactions. Assets documented in balance sheet hedges are subject to regulation by domestic and foreign regulatory agencies.

You can use the current-rate method to translate a foreign currency your company is holding to the U.S. dollar. If you are translating revenue and expense accounts, use the value the asset had at acquisition. If you are translating asset and liability accounts, use the value the asset had at the end of the accounting period. When documenting an asset on domestic financial statements, you are required to utilize generally accepted accounting principles (GAAP).

When you use the temporal-rate method, you are required to document the value of cash holdings, accounts payable, and accounts receivable at the current exchange rate. Translate foreign asset and liability accounts you are holding at their historical value. Since currency exchange rates fluctuate significantly, you will need to maintain a verifiable record of the value of each foreign asset and liability at the time of acquisition. Accounting irregularities can bring stiff penalties from the Securities and Exchange Commission.