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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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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.

Publishing as Prentice Hall

© 2009 Pearson Education, Inc. publishing as Prentice

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Hedge: Liability – Entries (cont.)

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