Identifying Sources of Risk Within Your Spreadsheets

It’s no secret that hedge accounting can be extraordinarily complex – particularly when it comes to accounting for derivatives used to hedge anticipated revenue and expenses.

Still, many professionals are using spreadsheets to administer their foreign currency hedge programs. This may be problematic for a number of reasons.

Spreadsheets are wonderful, flexible everyday tools for finance professionals. They are so critical, in fact, that it is hard to imagine a world in which they don’t exist. Spreadsheets are not, however, very well suited to derivative accounting processes, as they carry with them an inherent degree of risk.

PwC reports that 91 percent of sophisticated spreadsheets contain errors. And derivative accounting generally requires sophisticated calculations, like mark to market calculations involving interpolations, Other Comprehensive Income calculations including or excluding time value, disclosure values collected from both settled as well as open derivatives, and more. In the case of hedge accounting, the risk of error is particularly acute. A mistake, even a minor one, could result in incorrect mark-to-market accounting journals, which could trigger a disastrous financial restatement. Likewise, incorrect disclosures could result from a spreadsheet-triggered error, or hedge program performance could be negatively impacted, causing increasing discrepancies in the FX gain/loss line.

Of course, it is not enough to simply point out that using spreadsheets for the purpose of hedge accounting is risky. In this post, we dive into the spreadsheets and related processes themselves, with eyes on identifying exactly where this risk resides – and what can be done about it.

Math/Formula Errors

Whether the data is manually keyed or imported, everything that flows into an Excel spreadsheet ultimately comes from a human effort. In and of itself, this presents a risk, as we are not perfect, and inevitably we make mistakes and forget things. An incorrect rate being entered, for instance, can ruin an entire month or quarter’s worth of calculations. A formula can be accidentally replaced with a hard value, or information contained in “hidden” tabs can be forgotten.

What’s worse, hedge accounting spreadsheets are typically exceedingly complex. In-depth hedge accounting knowledge and great attention to details are often needed. This can be challenging even to a seasoned Treasury or Accounting professional. You might be lucky enough to have someone great at your organization who can handle all the spreadsheets – but what happens when he or she leaves the organization? Do you have the resources to train a new person? Do you have the right process documentation in place?

Transition issues often arise when there is departmental turnover, since spreadsheets rarely come with proper documentation. There is a high probability that something will be “lost in translation” when a spreadsheet is handed to a new owner. The inheritor of the spreadsheet is often overwhelmed. Customized models and calculations for technical aspects of hedge accounting (options, collars, average rate forwards, back-to-back hedging, swap-and-roll, early close, etc.) require a high level of domain knowledge, which comes with time. During the learning stage, errors may be introduced, or existing ones might propagate into the future.

Version Control & Security

For all its positives, Excel is lacking many of the version controls and security measures that are prevalent in most modern enterprise software solutions. Data in a hedge accounting spreadsheet can easily be changed by any individual with access. Whether the modification is malicious or a simple mistake, it is exceedingly difficult to detect, and almost impossible to avoid. Likewise, rows, cells or entire worksheets can be accidentally deleted, moved or saved over.

Inherent Challenges

The risks of using spreadsheets for hedge accounting don’t end in the spreadsheet itself. There are systemic challenges to worry about – particularly the risk of a corrupted file without an up-to-date backup. Interdepartmental communication is difficult, particularly when Treasury and Accounting are using the same spreadsheet. Trade information is usually maintained by Treasury, but they may lack of knowledge of how the data needs to be recorded and reported. The Accounting team may have the technical accounting knowledge, but lack understanding of the concept of derivatives and hedging strategies. Combined, these blind spots can make a spreadsheet a mess.

Conclusion

Spreadsheets are wildly valuable tools for finance professionals – but they are clearly not derivative accounting solutions. At any point, a spreadsheet used to maintain a hedge program is one stray “delete” or misplaced “paste” away from disaster. It is imperative that companies still using them evaluate their efficacy, and weigh their options. Specialized hedge accounting software capable of meeting even the most complex FX hedging needs is available on the market, and serves as a safe, secure and cost-efficient alternative to spreadsheets. For more information, contact us, or read more about CapellaFX, a SaaS solution designed to provide exposure tracking, trade management, journal entry preparation and disclosure reporting to manage foreign currency and derivative accounting risks.