364 Cash Flow Hedge of a Foreign Currency Forecasted Transaction Itis important to differentiate accounting treatment of a hedge ofa forecasted tra as acash flow hedge versus that of an identifiable foreign current commitment asi value hedge. Unlike a foreign currency commitmenta forecasted transaction is antici butnot guaranteed. Under cash flow hedge the changes in fair value of the hedging instrumentiis defe and recognized as other comprehensive income. This is accumulated andn a separate line in the stockholders’ equity section of the statement of financial posit Tlustration To illustrate the special accounting for a cash flow hedge of a forecasted transact assume the following: 1. OnJune 1, a company forecasted the purchase of 5,000 units of inventory fn foreign supplier for 100,000 FC. The purchase is forecasted to ocour on: 1 On June 1, the company purchased a forward contract to buy 100,000 FC forward rate of 1 FC= P5.42 on September 1. The hedgeis expected to be filly effective because the critical terms of the hedgi instrument match the terms of the hedged item. Changes in the fair value of the forward contract are to be discounted at a Tate. 5. . Spotrates, forward rates, and changes in value over time are as follows: Junel Sunes July 31. Sept. ‘Number of FC 100,000 100,000 100,000 100,000 Spotrate—1 FC 530 P52 P5.70 Forward rate for remaining time — 1FC P5A2 5.60 P52 Initial forward rate P52 P5A2 Fair value of forward contract Original forward value 542,000 P542,000 (Current forward value 560,000 572000 (Change - gain (loss) 18000 __P30,000 Present value of change: 2, 676/12 (0.990) 17,820 n=l, 616/12 (0.995) P2950 20, 6/12 Prior present value ° 17,820 Changein present value PITS P1203counting For Foreign Currency Transactions 365 -journal entries to account for the cash flows hedge of the above forecasted transaction the subsequent actual transactions are as follows: lustration 19-7 Forward Contract Receivable ~ FC Forward Contract Payable ~ P To record purchase of forward contract. Forward Contract Receivable ~ FC OCI~ Unrealized Gain To record change in value of the forward contract. Forward Contract Receivable - FC OCI~ Unrealized Gain To record change in value of the forward contract. Forward Contract Receivable ~ FC OCI~ Unrealized Gain To record change in value of the forward contract. tract Payable — P Forward Contract Receivable — FC 575,000 Cash 542,000 To record settlement. ‘The remaining entries relate to the iriventory assuming the purchase was made on September 1 at 100,000 FC and sold on September 15 at P958,000. >" CH 575,000 To vetord purchase of inventory: (100,000 FC x PS.75) Cash Sales To record sales Cost of sales Inventory To record cost of sales OCI — Unrealized Gain Realized Gain or cost of sales To close the balance of OCI — Unrealized Gain.366 Ananalysis ofthe entries in Hlustration 19-7 shows that the cash flow hedge was in accomplishing the concer of the Philippin= company. The effect of the cash hedge for the forecasted transaction can be summarized as follows: Sales Cost of sales Gross profit Realized gain on forward contract Net income effect: ‘Summary of Hedging Transactions Without the Forward Contract 1P958,000 With For Car Pos 575,000 383,000 383,000 ‘When transactions are denominated in one currency and measured in another, cl in currency exchange rates can expose the transacting party to potential exchange or losses. In order to reduce the uncertainty associated with exchange rate forward contracts and other derivatives are often used to hedge against this ex ‘The following table summarizes some of the details relating to forward contracts: 1 Tipe of hedge, 2._ Basie purpose of hedge. Recognition over time| ‘of changes in the value of the derivative Hedge of a Forecasied Transsction ‘Cosh Flow Hedge Hedge ogainst changes inthe eash flows duc to exchange Fisk occuring ‘between the rime of the probable forecasted transaction and the resulting actual (Changes in value are recognized as Component of oiher Comprehensive mocme ‘Hedge of an Identifiable Firm Commiment Fair value bode oF ‘ash flow hedge. Mast ‘often fair value. “Hedge against exchange ate risk occurring berween the commitment dale and the transaction date ‘Changes in value recognized cuerently ‘Changes in ~[ecognized currently 36 a component of | asa component of Hedge of Denomins ‘Asset or lability jt valve heldge or ‘ash ow hedge ‘often fur value, Hedge the exchange: Fisk between the transaction date and: the paymentsetlem date. ue are