the parties has performed its half of the transaction by
shipping the inventory. Thus assets and liabilities are not
created when an FX forward is entered into. For this reason,
in practice, companies do not make any general ledger entries
at the inception of a FX forward.6They track the FX forwards
they have outstanding, however, on a memorandum basis just
as they track their sales order backlogs on a memorandum
basis.
For pedagogical purposes only, however, it is useful to
show entries being made in the general ledger at the inception
of the FX forward—a "gross" or "broad" manner of
accounting—to best convey the concept of counterbalancing.
Accordingly. Later FX forward hedging illustrations {and all
solutions to the assignment material) reflect the customary
practice of not making entries at the inception of the FX
forward—a "net position" manner of accounting.
FAS 133 requires that the fair value of an FX forward be
calculated by (t) discounting estimated ture cash flows and
(2) basing estimated future cash flows on the change in the
forward rate— not the change in the spot rate—from the
contract inception date. The FASB's rationale is that the
valuation of an FX forward should consider that:
I .Currencies will be exchanged at a future date.
2.Relative interest rates determine the difference
between spot and forward rates.
3 .The time value of money affects valuation.
Tbe only valuation method that considers these three
items is the net present value method. Thus the FASB
concluded that the net present value method ¡s the only
valuation method that is consistent with the definition of fair
value in FAS 133.