You are the controller/treasurer for a small import-export company. You make all the finance and accounting decisions. Your company makes sales in Germany, Poland, and the Czech Republic. Historically, your Polish sales have been denominated in zlotys. Early this year, you decided to enter into some zloty futures contracts to protect against the effect of changes in the dollar/zloty exchange rate on the cash flows from next year’s sales in Poland. In accordance with proper accounting procedure, you formally designated the futures contracts as a cash flow hedge.
In December of this year, your customers in Poland notified you that they are nervous about the impact of European currency consolidation on the strength of the zloty, and they wish all future sales prices to be denominated in U.S. dollars. The good news is that this action removes the need to worry about the effect of exchange rate changes on Polish sales. The bad news is that you have already entered into the futures contracts and, at the end of the year, the futures have a fair value of $5 million (liability).
Your dilemma is this: The futures no longer serve as a hedge because future Polish sales will be denominated in U.S. dollars. However, if you account for the futures as speculative investments, you will be forced to recognize a loss in earnings this year of $5 million. This entire hedging operation was your idea, and you convinced the president of the company that you knew what you were doing and there was no chance of a major loss. If this loss is recognized, reported profits for the year will be wiped out, and the company will show a net loss for the first time in its history.
What should you do?