There are many reasons to use a hedging strategy in the forex futures market.

One main purpose is to neutralize the effect of currency fluctuations on sales revenue. For example, if a business operating overseas wanted to know exactly how much revenue it will obtain (in U.S. dollars) from its European stores, it could purchase a futures contract in the amount of its projected net sales to eliminate currency fluctuations.

Hedge accounting http://en.wikipedia.org/wiki/Hedge_accounting

Why is hedge accounting necessary?
Many financial institutions and corporate businesses (entities) use derivative financial instruments to hedge their exposure to different risks (for example interest rate risk, foreign exchange risk, commodity risk, etc.). Accounting for derivative financial instruments under International Accounting Standards is covered by IAS39 (Financial Instrument: Recognition and Measurement). IAS39 requires that all derivatives are marked-to-market with changes in the mark-to-market being taken to the profit and loss account. For many entities this would result in a significant amount of profit and loss volatility arising from the use of derivatives. An entity can mitigate the profit and loss effect arising from derivatives used for hedging, through an optional part of IAS39 relating to hedge accounting.

[edit] What hedge accounting options are available to an entity?

All economic hedges aim to manage foreign currency exposure, meaning they are undertaken for the economic aim of reducing potential loss from fluctuations in foreign exchange rates. However, not all hedges are designated for special accounting treatment. Accounting standards enable hedge accounting for three different designated forex hedges: A cash flow hedge may be designated for a highly probable forecasted transaction, a firm commitment (not recorded on the balance sheet), foreign currency cash flows of a recognized asset or liability, or a forecasted intercompany transaction. A fair value hedge may be designated for a firm commitment (not recorded) or foreign currency cash flows of a recognized asset or liability. A net investment hedge may be designated for the net investment in a foreign operation.

The aim of hedge accounting is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account. For a fair value hedge this is achieved either by

marking-to-market an asset or a liability which offsets the P&L movement of the derivative. For a cashflow hedge some of the derivative volatility into a separate component of the entity's equity called the cash flow hedge reserve. Where a hedge relationship is effective (meets the 80%125% rule), most of the mark-to-market derivative volatility will be offset in the profit and loss account. To achieve hedge accounting requires a large amount of compliance work involving documenting the hedge relationship and both prospectively and retrospectively proving that the hedge relationship is effective.
http://www.svtuition.org/2011/07/hedge-accounting.html
Hedge accounting has been included in financial reporting subject of CA- Final. Before learning hedge accounting with simple way, we should know about hedge or hedging. Hedge or hedging may be any investment which is done for protecting the company from future risk. Hedge may be used in All financial instruments and derivatives like financial futures, options and swaps. In hedge, we also may do agreement for buying the asset in future date but at current price. We do these type of contract because we forecast that prices in future date will increase.

As a accountant, for recording and accounting treatment transactions relating to hedge, you will divide transaction on basis of two type of hedge.

1. Fair Value Hedge

Illustration: 1. Assume that on April 1, 2008, Hayward Co. purchases 100 shares of Sonoma stock at a market price of $100 per share. Hayward does not intend to actively trade this investment. It consequently classifies the Sonoma investment as available-forsale. Prepare the journal entry that Hayward makes on April 1, 2008 to record this investment.

Available-for-Sale securities Dr. 10,000

Cash Cr. 10,000

Illustration: 2 The value of Sonoma shares increases to $125 per share during 2008. Prepare the journal entry that Hayward makes on December 31, 2008, to recognize the gain.

Security Fair Value Adjustment (AFS) Dr. 2,500

Unrealized Holding Gain or LossEquity Cr. 2,500

Illustration:3. Hayward is exposed to the risk that the price of the Sonoma stock will decline. To hedge this risk, on January 2, 2009, Hayward purchases a put option on 100 shares of Sonoma stock and designates the option as a fair value hedge. This put option (which expires in two

years) gives Hayward the option to sell Sonoma shares at a price of $125. What entry is required on January 2, 2009 to recognize the put option?

A memorandum entry only. Since the exercise price equals the current market price, no journal entry is necessary. Because this is just option offer. So, it will go to off balance sheet.

Illustration:4 At December 31, 2009, the price of the Sonoma shares has declined to $120 per share. Hayward records the following entry for the Sonoma investment.

Unrealized Holding Gain or LossIncome Dr. 500

Security Fair Value Adjustment (AFS) Cr.

500

What journal entry would Hayward record on Dec. 31, 2009, to recognize the increase in value of the put option?

Put Option Dr. 500

Unrealized Holding Gain or LossIncome Cr.

500

2. Cash Flow Hedge

Illustration: In September 2008 Allied Can Co. anticipates purchasing 1,000 metric tons of aluminum in January 2009. Allied wants to hedge the risk that it might pay higher prices for

inventory in January 2009. Allied enters into an aluminum futures contract that gives Allied the right and the obligation to purchase 1,000 metric tons of aluminum for $1,550 per ton. This contract price is good until the contract expires in January 2009. The underlying for this derivative is the price of aluminum. If the price of aluminum rises above $1,550, the value of the futures contract to Allied increases.

Allied enters into the futures contract on September 1, 2008. Assume that the price to be paid today for inventory to be delivered in Januarythe spot priceequals the contract price.

At December 31, 2008, the price for January delivery of aluminum increases to $1,575 per metric ton. What journal entry would Allied make to record the increase in the value of the futures contract.

Futures contract 25,000

Unrealized Holding Gain or LossEquity 25,000 ([$1,575 - $1,550] x 1,000 tons)

In January 2009, Allied purchases 1,000 metric tons of aluminum for $1,575 and makes the following entry ($1,575 x 1,000 tons = 1,575,000).

Aluminum inventory Dr. 1,575,000

Cash Cr. 1,575,000

At the same time, Allied makes final settlement on the futures contract and records the following entry.

Cash Dr. 25,000

Futures contract Cr. ($1,575,000-$1,550,000) 25,000

If you make any cash flow reserve, you can show this in liability side. If any advance amount is given for buying the asset in future date, it will be shown in the asset side.

Non-designated hedges Forward exchange contracts are generally used to hedge certain non-U.S. dollar denominated assets or liabilities. These derivatives are not designated for hedge accounting treatment. Accordingly, these outstanding non-designated derivatives are recognized on the balance sheet at fair value and changes in the fair value of these hedges are recorded in other income (expense), net, in the consolidated statements of operations.

The following table provides the types of derivative instruments outstanding as of April 3, 2009 (amounts in thousands):

Asset Derivatives April 3, 2009 Balance Sheet Fair Location Value

Liability Derivatives April 3, 2009 Balance Sheet Fair Location Value

Derivatives designated as hedging instruments: Foreign exchange contracts Derivatives not designated as hedging instruments: Foreign exchange contracts Other 1,13 assets Other liabilities $ 1 Other asset 54 Other liabilitie s $ 2 s

The following table provides the effect derivative instruments had on other comprehensive income (OCI) and consolidated statements of operations (amounts in thousands):

Location of Amount of Gain or (Loss) Reclassified from Accumulate d OCI into Income (Effective Portion) Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Six months ended April 3, 2009 $ (2,047) Effectiveness Testing) Other income (expense), net

Amount of Gain or (Loss) recognized in OCI on Derivative (Effective Portion)

Location of Gain or (Loss) Reclassified from Accumulated OCI into

Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)

Location of Gain or (Loss) Recognized in Income on Derivatives Not Designated

Amount of Gain or (Loss) Recognized in Income on Derivatives Not Designated as Hedging Instruments

Derivatives in Statement 133 Cash Flow Hedging Relationships Six months ended April 3, 200 9 $ (1,597)

Income (Effective Portion) Product revenue

Six months ended April 3, 2009 $ 127

as Hedging Instruments Other income (expense), net

Six months ended April 3, 200 9 $ (1,286)

Foreign exchange contracts