>The following was stated and hopefully some confusion and
>misunderstanding can be cleared. It was stated that:
>" My feeling is that SEG probably had offseting option position and
>decided to write off the losing position first (maybe they're
>required to do so...). So, they'll realize the profit of the
>opposite position in the future."
>
> If I understand this statement correctly then it is grossly
> incorrect, for the following reason:
>
> Segate (SEG) can not write off losing positions without
>taking into consideration gain positions. They are required to
>account for these in the aggregate. If there are any gain
>positions they must be netted against the loss positions.
>Refer to Financial Accounting Standard 115 (Accounting
>for Certain Investments in Debt and Equity Securities).
>The hedging contracts were probably classified as "trading
>securities" so they are accounted for as follows:
>
> "Debt and equity securities that are bought and held
>principally for the purpose of selling them in the near
>term are classified as trading securities and reported at fair
>value, with unrealized gains and losses included in earnings."
>
> If you are hoping that there are unrealized gains
>around the corner from not reporting them in the last
>quarter and only reporting the unrealized losses, I am sorry
>to say that there are no unrealized deferred gains which will
>materialize in the next quarter due to trading activity in
>the last quarter.
>
> The net effect of the gains and losses on unrealized
>transactions has been recorded in the last quarter. The
>only chance of a gain in a subsequent quarter is if (i) the
>market turns around before the hedges are covered, or (ii)
>Segate continues to venture in hedging and gets extremely
>lucky at it. Based on what is happening in Asia, I would
>think Segate would be lucky if the losses are not
>exacerbated, least of all to expect a gain. These losses will
>probably become realized.
>
> Besides FAS 115, FAS 119 (Disclosure about Derivative
>Financial Instruments and Fair Value of Financial Instruments)
>determines how the foreign currency hedges are reported.
>
> To say the least Segate should stick to manufacturing disk
>drives and not attempt to become global investors in
>financial derivatives. They have shined in the DD arena
>and hopefully will shine again one day.
>
> This mess is not over it will take a few quarters to get
>out of it.
>
> Of Course, IMHO
With all due respect, your position is incorrect. SFAS No. 115 does
not apply to currency hedges; it applies only to debt and non-marketable equity securities. SFAS No. 119 deals with disclosure, not reporting. The relevant standard is SFAS No. 52, "Foreign Currency Translation."
Under SFAS No. 52, if the foreign exchange contracts are true hedges (as defined), gains and losses are not reported in the income statement but as a separate component of stockholders' equity, i.e. "Cumulative translation adjustment." If they are not true hedges, then transaction losses and gains flow through the P&L.
The valuation of the losses depends on whether the contracts are for speculation or not. This affects whether the instruments are measured at the differences in the spot rates or the forward rates.
The facts in Seagate's situation are on page 8 of the Annual Report,
in the MD&A. Seagate has certain hedges which are not true hedges for SFAS No. 52 purposes. (Under SFAS No. 52, a company cannot hedge generalized "cash flows," but only specific transactions.) Seagate has unrealized losses on these hedges, which were recognized in the P&L for the quarter ending September 30, 1997. For periods after this date, the related cash flows will result in higher income than would otherwise have occurred.
It's actually odd, because that income will probably flow into income from operations, while the current period loss will likely be in other expense.
An example should help. Let's say we expect to pay out 3 million ringgits in 6 months, for payroll, equipment, etc. Let's also say these are not hedges under SFAS No. 52. When we make the contract today, 3 million ringgits is worth $1 million. So we agree to buy 3 million ringgits from Goldman Sachs in six months, for a million dollars, payable in six months. Four months later, 3 million ringgits is worth only $750,000. So we have to recognize a $250,000 unrealized loss at the four-month date. At the end of the contract two months later, we get the ringgits from Goldman, and pay them out to our Malaysian suppliers and employees. If the exchange rate doesn't move any more, the ringgits are translated so that we have a $750,000 cost of sales entry instead of $1,000,000.
Of course, the total expense is still $1,000,000, but $250,000 is recognized in the first period as "other expense" and $750,000 is recognized in the second period as "cost of sales". If no currency fluctuation had occurred, we would have seen a $1,000,000 "cost of sales" expense in the second period, and no surprise loss in the first period. This is just a book loss; it means very little in reality. In fact, the gross and operating margin numbers will probably look better than they should this quarter because of this "income statement geography" effect.
As you can see, these hedges are not wild speculation. They are used to lock in the $1,000,000 expected cost. Without the hedge, Seagate would have had a windfall. But a priori it could have had an unexpected loss if the U.S. dollar suddenly had devalued. According to the 10-K, Seagate has stopped hedging not because of the losses, but because of "volatility." Whether these means contracts are too expensive to obtain (due to high option volatility premiums) or whether Seagate is actively betting on further declines is unclear, but probably the former.
At any rate, this should clarify the accounting taking place here.
Regards,
Winston |
