Financial Reporting

This report analyzes the concept of hedge accounting and its application in the financial reporting of OFX, an Australian online foreign payment and exchange enterprise. It examines the advantages and disadvantages of hedge accounting, the measurement of hedging instruments and hedged items, and provides examples from OFX's annual report. The report concludes with a discussion of the effectiveness of hedge accounting as a risk management tool.

Financial Reporting

Table of Contents
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
1. Concept of hedge.....................................................................................................................1
2. Example of a hedge presented in the annual report of the company.......................................2
3. Advantages and disadvantages of hedge accounting for organisation.....................................3
4. Measurement of hedging instruments and hedged item made by organisation.......................4
CONCLUSION................................................................................................................................4
REFERENCES................................................................................................................................5

INTRODUCTION
Financial reporting can be defined as the process of recording financial information in
different types of statements including balance sheet, income and cash flow statements. With the
help of it stakeholders can evaluate actual performance of business entity. Nowadays most of the
companies are using hedging in order to reduce risk of price movement (Choi, Mao and
Upadhyay, 2014). Organisation which is selected for this report is OFX which is an Australian
online foreign payment and exchange enterprise. It was founded by Matthew Gilmour in year
1998. Its headquarter is in Sydney, Australia. This report covers various topics such as concept
of hedge and its presentation in the annual report of company, advantages and disadvantages of
hedging etc. Measurement of hedged items and instruments are also covered under this report.
MAIN BODY
1. Concept of hedge
The tool which is used by organisations to reduce price movement risk is known as
hedge. It intends to offset potential losses or gains which may be incurred by a companion
investment. With the help of it possibility of loss from changes in the price of currency, security
or commodity can be reduced. Business entities use hedging for the purpose of limiting losses
from unpredicted fluctuations which may take place in future. When companies plan to hedge, it
means they are trying to limit loss. This technique cannot prevent the event which is going to be
occurred in future but tries to reduce impact of it. All the risks cannot be reduced by hedging
procedure as it can limit most of the risk but sometimes investors wind up trading one hazard
with another (Cohen, Krishnamoorthy and Wright, 2017).
In other words it can be defined as an investment which helps to protect monetary
resources of business entities from risky situations. Main purpose of it is to minimise the
possibility of reducing value of an asset or financial instrument or security. It is also used to
protect capital of the company against impacts of inflation with the help of making investment in
high yield securities such as shares, bonds and precious metals or real estate. When investors
realise that they are going to invest in a risky instruments they select hedging in order to protect
them from bearing such risks that they can't afford or losing everything. In OFX it is also used
for the purpose of limiting risk of losses which may take place in future.
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2. Example of a hedge presented in the annual report of the company
From the annual report of OFX company it has been analysed that organisation is using
hedge and made investment in derivatives in order to reduce risk of loss in future. For year 2017
net financial instruments were 6803 and for 2018 these were 2240. For both the years these were
at fair value. Value of forward contract assets for 2017 and 2018 were 14154 and 12930
respectively. For liabilities these values were 7351 and 10690 for 2017 and 2018 respectively.
Fee and trading income which is recorded in the final accounts of the organisation consist
foreign currency transaction margins, fees which are charged on low value transaction and
fluctuation in exchange rates between the time when customer's rate is agreed. It is a hedging
elements which is presented in the financial statement of the company (Flower, 2018).
According to AASB 9, definition of hedge accounting is also provided in annual report of
OFX which states that, it is more closely aligned with fiscal risk management and can be applied
to a greater assortment of instruments and hazards. Net amount of hedging which is recorded in
other comprehensive income of OFX's financial statements for year 2017 and 2018 are 65 and 29
respectively.
In order to qualify criteria of hedging, business entities such as OFX are required to meet
following requirements:
 Hedging relationship only consists hedged items and hedging instruments.
 At the origination of such type of relation there is a conventional denomination and
procedure of certification of hedging relationship and organisation's hazard management
strategy and objective for undertaking a hedge (Qualifying criteria for hedge accounting,
2017).
In order to meet hedging relationship requirement entities are required to meet following
criteria:
 There should be an economic relation between hedging instrument and hedged items.
 Results derived from economic relation should not be dominated by credit risk.
 Hedge ratio of results from the quantity of hedges items should be same as hedging
relationship.
From the annual report of OFX company it has been identified that it meets all the
requirements of effectiveness of hedging. All the derivatives which are included in final accounts
are recorded according to their contractual maturity.
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3. Advantages and disadvantages of hedge accounting for organisation
Hedge accounting: It can be defined as a method of accounting which is used by
business entities to treat opposing hedge and ownership of security as one. With the help of it
volatility which is created by repeated adjustments of a commodity's value can be reduced. It is a
type of portfolio accounting method which is used by companies such as OFX to combine value
of a security and offsetting hedge instruments.
According to IFRS 9, main goal of hedge accounting is to adjust management of financial
instruments which includes forward contracts. It also states that value of the commodity which is
being hedged can fluctuates during sales cycle. It helps to accurately reflect economic reality and
also avoid misleading investors (Hedge accounting, 2017).
There are various advantages and disadvantages of hedge accounting for OFX company.
All of them are described below:
Advantages of Hedge accounting:
 Volatility in profit and loss can be minimised with the help of hedge accounting by
addressing all the timings which are mismatched with standard derivative. It results in
effective presentation of economic performance of OFX.
 With the help of hedge accounting creditworthiness of organisation can be enhanced
which is evaluated by various elements, such as forecasting of earnings in future. It is
beneficial for OFX because banks and other financial institutions provide credit on the
basis of creditworthiness of company (Steffen, 2018).
 Compensation of top executives depends upon performance of company. As hedge
accounting impacts upon profits and losses of company so it can also result in enhanced
compensation of them if organisation earns higher profits.
Disadvantages of Hedge accounting:
 Hedge accounting is an expensive procedure which requires premium or brokerage in
case of derivatives or other financial instruments.
 If organisations such as OFX invest in hedging then their profit gets limited to the price
which is being decided by them. If the market price is more than the limited price then
companies may have to bear certain loss (Martin and Roychowdhury, 2015).
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 Hedge accounting is not able to reduce all the losses and does not cover risks fully. As
OFX has made investment in foreign market which does not provide corresponding
hedge to all asset class.
4. Measurement of hedging instruments and hedged item made by organisation
OFX invests in hedged items and hedging instruments in order to reduce pricing risks that
may take place in future and results in higher losses for the company. From the annual report of
OFX it has been identified that organisation make investment in financial instruments such as
forward contract. Expenses which are related to hedging and added to income statement of the
company are realised margins and fee on foreign exchange contracts, unrealised losses on
foreign exchange contracts, revaluation of foreign exchange assets and liabilities (Annual report
of OFX, 2018).
Realised margins and fee on foreign exchange contracts costs around 112279 for 2017
and 122501 for 2018. Unrealised losses on foreign exchange contracts are 79 for year 2017 and
4204 for year 2018. Revaluation of foreign exchange assets and liabilities shows an amount of
1863 for 2017 and 725 for 2018 which is added to the net income of the company. Fair values of
net financial instruments of OFX are 6803 and 2240 for year 2017 and 2018 (Mullinova, 2016).
CONCLUSION
From the above project report it has been concluded that hedging is a risk reduction tool
which is used by most of the business entities in order to limit possibility of losses which could
be faced by them in future due to fluctuations in prices of commodities. With the help of it
volatility in profits and losses can be measured and reduced which help to enhance performance
of company and results in increased compensation of executives. On the other hand its negative
implication is that it is an expensive method which requires higher costs in the form of brokerage
and all the business entities are not able to bear the same.
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REFERENCES
Books and Journals:
Choi, J. J., Mao, C. X. and Upadhyay, A. D., 2014. Earnings management and derivative
hedging with fair valuation: Evidence from the effects of FAS 133. The Accounting
Review. 90(4). pp.1437-1467.
Cohen, J., Krishnamoorthy, G. and Wright, A., 2017. Enterprise Risk Management and the
Financial Reporting Process: The Experiences of Audit Committee Members, CFO s,
and External Auditors. Contemporary Accounting Research. 34(2). pp.1178-1209.
Flower, J., 2018. Global financial reporting. Macmillan International Higher Education.
Martin, X. and Roychowdhury, S., 2015. Do financial market developments influence
accounting practices? Credit default swaps and borrowers׳ reporting
conservatism. Journal of Accounting and Economics. 59(1). pp.80-104.
Mullinova, S., 2016. Use of the principles of IFRS (IAS) 39" Financial instruments: recognition
and assessment" for bank financial accounting. Modern European Researches. (1).
pp.60-64.
Steffen, T. D., 2018. Improving financial statement footnotes: Evidence from derivative and
hedging disclosures. Available at SSRN 2739883.
Online
Hedge accounting. 2017. [Online]. Available through:
<https://www.kantox.com/en/marketing/hedge-accounting/>
Qualifying criteria for hedge accounting. 2017. [Online]. Available through:
<https://medium.com/@diego_Gozer/qualifying-criteria-for-hedge-accounting-and-
effectiveness-testing-75b1e2345a94>
Annual report of OFX. 2018. [Online]. Available through:
<https://www.ofx.com/-/media/Files/PDFs/Investors/ASX%20Announcements/
2018/22052018/2-OFX-AnnualReport-2018_WEB.ashx?la=en-GB>
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