Foreign currency transactions and hedging activities
Adidas arranges and hedges their contract as well as the organized currency option and swap to reduce the risk associated with foreign exchange transactions. In the year 2010, the company had currency options of about € 7million. It recognizes hedging in the financial statement by having hedging reserved in the balance sheet and posting hedging cost in the income statement. For example, in 2010, the company recorded € 16 million for currency options and € 25 million for forward contract in the hedging reserved. In the income statement, € 4million was recorded as premium. Most purchases were made from the U.S. and recorded in dollars (Adidas-group, 2011).
From the financial statements, one can note that in 2010, there was a figure of negative € 3 million, which was in hedging reserved relating to foreign entity investments (Adidas-group, 2011). These figures can only be removed from the books if the foreign entity is disposed off. “Contracts, transactions, or balances that are, in fact, effective hedges of foreign exchange risk will be accounted for as hedges without regard to their form” (Financial Accounting Standards Board, 1981, p. 4). “The currency of the primary economic environment in which the entity operates” is the entity’s functional currency (IASCF, 2009, p. 1383). “The currency of the economic environment in which cash is generated and expended by the entity” (Financial Accounting Standards Board, 1981, p. 5). Operational forms, such as a subsidiary, division, branch, or joint venture, can make an entity. If a foreign entity’s books are not kept in the functional currency, then the book must be re-measured into the functional currency, prior to translation (Westerfield & Jordan, 2007; Gustafson, Peroni & Pugh, 2006).
Functional Currency of the Company ADIDAS AG
The functional currency of Adidas is Euro, but the group makes most purchases in dollars. For example, in 2010, the company made purchases of $ 3.7 billion. All transactions of the company and those related to subsidiaries are translated into reporting currency that is Euro (Adidas-group, 2011). All assets and liabilities denominated in other currencies apart from the functional currency of Addidas are adjusted to reflect the current exchange rate on that date. Transaction gains and losses, which result from adjusting assets and liabilities denominated in a currency other than the functional currency or from settling such items, are recognized in the income statement. All gains and losses attributable to a foreign transaction that is hedged and of investment in a foreign entity are recognized separately as a component of shareholders’ equity, in which adjustments arising from transaction foreign currency financial statements are accumulated. Meanwhile, gains and losses attributable to intercompany foreign currency transactions that are of a long-term investment nature are recognized separately as a component of shareholders’ equity. Last, the company defers and includes in the measurement of the basis of the related foreign transactions gains and losses attributable to foreign currency transactions that hedge identifiable foreign currency commitments.
The objective of the re-measurement process is to produce the same results that would have been reported if the accounting records were kept in Euros rather than the local currency. Translation of the local currency accounts into Euros takes place according to the temporal method; thus, the resulting translation gains and losses must be included in the functional currency for most of their subsidiaries. For those fluctuations that do not impact cash flows, the adjustments for currency exchange rate charges are excluded from net income (Schlosser, 2002). However, for those fluctuations that do affect cash flows, the adjustments for currency exchange rate changes are included in the net income. “Translation adjustments that arise from consolidating that foreign operation do not impact cash flows and are not included in net income” (Financial Accounting Standards Board, 1981, p. 4). However, the translation adjustments affect the cash flows directly in the case of domestic operation, and such gains or losses are included in the net income (Brealey, Myers, & Marcus, 2007).
References
Adidas-group (2011). Additional disclosures on financial instruments. Web.
Brealey, R., Myers, S. & Marcus, A. (2007). Fundamentals of corporate finance. Sydney: McGraw-hill.
Financial Accounting Standards Board. (1981). Statement of Financial Accounting Standards No. 52. Web.
Gustafson, C., Peroni, R., & Pugh, R. (2006). Taxation of International Transactions: Materials, Text, and Problems. Sydney: Thomson West.
IASCF. (2009). Informational Financial Reporting Standards. London: IASCF Foundation Publication Department
Schlosser, M. (2002). Business finance: Application, models, and cases. New York: Prentice Hall.
Westerfield R. & Jordan, J. (2007). Corporate finance core principles and applications. New York: McGraw-Hill.