A forward currency contract is a derivative, so a small company using FRS 102 must show it on the balance sheet at fair value at each year end, with the gain or loss in profit or loss, even if no cash has changed hands. Without hedge accounting, that gain or loss can fall in a different year from the purchase or sale the contract was taken out to protect. Micro entities using FRS 105 do not revalue forwards; they spread any cost over the term and record payments as they fall due.
Tax investigation insurance from £108.75 a year (£9.06 a month).Pays up to £100,000 of your accountant's fees if HMRC opens an enquiry. No excess. Buy online in a few minutes.
Why is a forward contract not a basic financial instrument?
FRS 102 splits financial instruments between Section 11 (basic) and Section 12 (other). Paragraph 11.6(b) lists derivatives, including forward contracts, as examples of instruments that do not normally meet the conditions for basic treatment and are therefore within Section 12. Being a small company using Section 1A does not change this: Section 1A relaxes disclosure, not recognition and measurement. The split is explained on the pages on basic financial instruments and other financial instruments.
A typical example is an importer that agrees with its bank in February to buy $120,000 for delivery in June at a fixed rate. The company now has a contract whose value moves every day with the exchange rate, long before any supplier invoice exists.
What goes on the balance sheet when the contract is signed?
Paragraph 12.7 measures a Section 12 instrument at fair value on initial recognition, normally the transaction price, and does not add transaction costs where the instrument will be measured at fair value through profit or loss. A forward agreed at the market rate on the day usually costs nothing to enter, so the opening carrying amount is normally nil or close to it. Any arrangement fee charged by the bank is expensed.
Nil is still a recognition decision. The contract exists from the trade date and must be tracked so that it is valued at the year end, together with any other forwards still open.
Worried about an HMRC check? Tax investigation insurance pays your accountant’s fees if HMRC opens an enquiry or compliance check. Solar Protect cover pays up to £100,000 with no excess. It never pays tax, interest or penalties.
From £108.75 a year (£9.06 a month) for individuals, £117.57 for sole traders and £207.50 for companies and partnerships, including IPT and the £20 admin fee.
See my price in 2 questions or call 01795 841 310.
★★★★★ Rated 4.9 out of 5 on Trustpilot from over 160 reviews
How is fair value worked out at the year end?
Paragraph 12.8 requires every Section 12 instrument to be measured at fair value at each reporting date, with changes recognised in profit or loss, unless hedge accounting applies or the instrument is one the Small Company Regulations do not allow to be measured at fair value. Section 2A defines the objective: the price at which an orderly transaction to sell an asset or transfer a liability would take place between market participants at the measurement date (paragraph 2A.2). Paragraph 2A.13 adds that the fair value of a liability reflects non performance risk.
In practice the calculation compares the rate locked into the contract with the forward rate available at the year end for the same settlement date, applied to the currency amount and discounted for the time to settlement. A valuation statement from the bank is a common starting point, but the directors are responsible for the figure and should check that it is a year end value for that contract.
- If sterling has strengthened against the currency the company has agreed to buy, the forward is a liability, because the company is committed to a worse rate than it could now get.
- If sterling has weakened, the forward is an asset.
What happens when the company does not use hedge accounting?
Hedge accounting is optional. Paragraph 12.15 allows it only where the conditions in paragraph 12.18 are met, including documenting the hedging relationship, the risk, the hedged item and the hedging instrument, and the causes of hedge ineffectiveness. Many small companies never prepare that documentation, so their forwards stay at fair value through profit or loss. The documentation route is covered on the page on hedge accounting under FRS 102.
Without hedge accounting, the forward is revalued at the year end but the future purchase it protects is not recognised at all until the goods arrive. Once the supplier invoice is recorded, it is a monetary item retranslated at the closing rate under paragraph 30.9, with exchange differences in profit or loss under paragraph 30.10, so from that point the forward and the payable tend to offset. The mismatch is greatest where the year end falls between signing the forward and receiving the invoice. See accounting for foreign currency transactions.
What does it look like in the numbers?
Illustration only. A company with a 31 March year end signs a forward on 1 February to buy $120,000 on 30 June at 1.20 dollars to the pound, a cost of £100,000. On 31 March the forward rate for 30 June is 1.25, so $120,000 would now cost £96,000. The goods arrive and are paid for on 30 June, when the spot rate is still 1.25. Ignoring discounting for simplicity:
| Date | Entry | Debit | Credit |
|---|---|---|---|
| 31 March | Profit or loss: fair value loss on forward | £4,000 | |
| 31 March | Derivative liability | £4,000 | |
| 30 June | Stock (invoice at spot 1.25) | £96,000 | |
| 30 June | Derivative liability | £4,000 | |
| 30 June | Bank (sterling paid under the forward) | £100,000 |
The company paid £100,000 for the dollars, as it planned. The accounts show a £4,000 loss in the year to 31 March, before any stock was bought, and stock at £96,000 in the following year. That timing difference is the price of not using hedge accounting.
What must a small company disclose?
Section 1A carries the company law disclosures for fair value accounting. Paragraph 1AC.22 requires the significant assumptions behind the valuation models and techniques, and for each category of financial instrument the fair value and the change in value included in the income statement. Paragraph 1AC.23 requires, for each class of derivatives, the extent and nature of the instruments, including significant terms and conditions that may affect the amount, timing and certainty of future cash flows. In practice that means the currency amounts, rates and settlement dates of open forwards. See Section 1A for small entities.
How do micro entities treat forwards?
FRS 105 takes a different approach. Paragraph 9.9 confirms that forward foreign currency exchange contracts are derivatives, but paragraph 9.10 does not use fair value: the transaction price plus any transaction costs not expensed, less impairment, is allocated to profit or loss over the term on a straight line basis. Paragraph 9.11 requires amounts payable or receivable under the contract to be recognised as they accrue. A forward taken out at market rates with no fee therefore has no year end entry for a micro entity. See FRS 105 micro entity accounts.
How are the gains and losses taxed?
For a company, a forward currency contract is normally a derivative contract within Part 7 of the Corporation Tax Act 2009. Section 595 says the general rule is that the amounts taxed are those recognised in profit or loss under generally accepted accounting practice. HMRC’s Corporate Finance Manual at CFM57071 confirms that for an undesignated hedge the company follows profit or loss, including fair value volatility, so the £4,000 loss in the illustration would normally be deductible in the year it is recognised.
A company can instead elect under regulation 6A of the Disregard Regulations for regulation 7 to apply to currency contracts, which disregards fair value movements and brings them into account in line with the hedged risk (CFM57075). HMRC says the election cannot be made for only some currency contracts (CFM57360), must be made in writing, and is subject to time limits and a lock in period (CFM57370).
What mistakes come up most often?
- Leaving open forwards off the balance sheet because no cash has moved.
- Recording the stock at the forward rate without having documented a hedge.
- Taking a bank valuation at a date other than the year end.
- Omitting the paragraph 1AC.22 and 1AC.23 disclosures from Section 1A accounts.
- Applying the FRS 105 straight line approach in FRS 102 accounts after a company stops qualifying as a micro entity.
Solar Protect provides tax investigation insurance for businesses and fee protection schemes for accountancy practices. Read how our cover works or get a quote.
Related Accountapedia entries
- Bookkeeping for foreign currency bank accounts
- Accounting for listed shares held by a company
- Loan arrangement fees and effective interest
- Moving from FRS 105 to FRS 102
- Other comprehensive income under FRS 102
Sources
- Financial Reporting Council: FRS 102 September 2024 tmKYWO6
- Financial Reporting Council: FRS 105 September 2024
- legislation.gov.uk: Act 2009 c. 4, section 577
- legislation.gov.uk: Act 2009 c. 4, section 595
- GOV.UK: Manual page CFM57071
- GOV.UK: Manual page CFM57075
- GOV.UK: Manual page CFM57360
- GOV.UK: Manual page CFM57370
Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.