5.6. USING THE FORWARD RATE IN COMMERCIAL, FINANCIAL AND ACCOUNTING
DECISIONS 207
information, notably in the case of valuation for management accounting purposes.
This is discussed in the next section.^16
5.6 Using the Forward Rate in Commercial, Financial and Accounting Decisions
and Accounting Decisions
5.6.1 The Forward Rate as the Intelligent Accountant’s Guide
Suppose a Canadian exporter sells goods in New Zealand, on anzd2,5m invoice.
This transaction has to be entered into the accounts,^17 and as the exporter’s books
arecad-based, the accountants need to translate the amount intocad. In this
context, many accountants fall for the following fallacy: “if we sell fornzd2.5m
worth of goods, and onenzdis worthcad0.9, then we sellcad2.25m worth of
goods.” So these accountants would naturally use the spot rate to convertfcA/R
orA/Pintohc.
Why is this called a fallacy? What’s wrong with the argument is that it is glossing
over timing issues. True, if today we sell our waresandget paid second working day
andwe already convert thenzdspot intocadright now, we’ll getcad2.25m in our
bank account on dayt+ 2. But almost all real-world deals involve a credit period.
So the above story should be modified: today we sell, and we will receivenzd2.5m
in, say, 45 days. At what rate we will convert this amount intocaddepends on
whether we sell forward or not. This is how a finance person worth her salt would
think:
- If we do sell forward, then it would look natural to book the invoice at the forward-
based value. After all, if we sell fornzd2.5m worth of goods, and we know we’ll
receivecad0.88 pernzd, one would logically book this atcad2.5×0.88 =
2.2m. - If we do not sell forward, we do not know yet what the exactcadproceeds will
be. So we have to settle for some kind of expected value or equivalent value, for
the time being. Since we know that hedging does not change the economic value
(at the moment of hedging, at least), we should use the same valuation procedure
as if we had hedged—the forward rate, that is. So we still book this as acad
2.20m sale even if there is no hedging.
(^16) Of course there are more exchange-rate related issues in accounting than what we discuss here,
but they are not directly related to the forward rate; we relegate those to Chapter 13.
(^17) In traditional accounting this is done as soon as the invoice has been sent or received. Under
IFRS, this can be done as soon as there is a firm commitment. More precisely, the firm commitment
is then entered at initially a zero value but can and must be updated when the invoice arrives or
leaves and at any intervening reporting date. See Chapter 13 for more.