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Hedge: Liability – Entries (cont.)

Hedge: Liability – Entries (cont.)

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Cash Flow Hedge: Anticipated
Cash Outflow
• On 12/2/08, Winkler anticipates purchasing equipment on
3/1/09 with payment on that date of £500,000.
• On 12/2/08, Winkler signs a 90-day forward contract to
buy £500,000 for $1.68 (the spot rate is $1.70)
• The contract discount is (1.70-1.68)x500,000=10,000
– Amortized to exchange gain over life of contract
– Use effective interest method
– Implied interest is:
• PV = 1.70(500,000) = 850,000
• FV = 1.68(500,000) = 840,000
• Period = 3 months
• Monthly rate using Excel =rate(nper,pmt,pv,fv)
=rate(3,0,850000,-840000)
Result: 0.003937
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Hedge: Anticipated Outflow
• Forward rates and fair value of contract:

 Date
12/2
12/31
3/1

Forward rate
$1.68
$1.69
$1.72

Notional
Amount
£500,000
840,000
845,000
860,000

Contract Discounted
Fair value Fair value
 
 
5,000
4,901
20,000
15,099

• The contract will be adjusted to its discounted fair value. Use the
incremental borrowing rate (12%, or 1% monthly), discounting
for the remaining contract life.
12/31: 5,000 / (1.01)2
3/1 (end of contract): 15,000
Note: 1/31 would be equal to fair value / (1.01)1

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Hedge: Anticipated Outflow Entries
12/2
12/31
 
 
12/31
 
 

no entry for forward contract - no cash exchanged
Forward contract
4,901  
OCI
 
4,901
Bring forward contract to discounted fair value.
OCI
3,346  
Exchange gain
 
3,346
Effective interest method amortization of the 10,000
discount. 850,000 x .003937

The change in value for the
forward contract is an
unrealized gain put into
OCI.

The discount on the
contract is amortized
over the 3 months of
the contract.

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Hedge: Entries (cont.)

The final
balance in
OCI is
$10,000 CR.
This will
reduce the
equipment's
depreciation
over its life.

3/1 Forward contract
15,099  
 
OCI
 
15,099
 
Bring forward contract to fair value, $20,000
3/1 Cash
20,000  
 
Forward contract
 
20,000
for net settlement of contract: 860,000 current  
840,000 contract
3/1 Equipment
860,000  
 
Cash
 
860,000
 
Purchase equipment from supplier
3/1 OCI
6,654  
 
Exchange gain
 
6,654
 
remaining amortization: 10,000 - 3,346

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Derivatives and Foreign Currency Transactions

11: IASB Standards

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IASB Similar to US GAAP
• IAS 21 – foreign exchange rates

– foreign denominated monetary amounts adjusted to
current rate at balance sheet date
– Translation of foreign currency statements
• IAS 32 – financial instruments

– Debt and equity instruments
• IAS 39 – derivatives and hedges

– Cash flow and fair value hedges
– Difference: hedges of firm commitments can be
either cash flow or fair value hedge

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Derivatives and Foreign Currency Transactions

12: Disclosures

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Footnote Disclosures
• Focus on risk management objectives and strategies
• Fair value hedges

– Net gain or loss in earnings, placement on
statements, effectiveness and ineffectiveness
• Cash flow hedges

– Hedge ineffectiveness gain or loss, placement
on statements, types of situations hedged,
expected length of time, effect of discontinuance
of hedge

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All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording, or otherwise, without the prior written
permission of the publisher. Printed in the United States of America.

Copyright © 2009 Pearson Education, Inc.  
Publishing as Prentice Hall
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