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Difference 71
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Silvia, I get the definitions. I just dont
get the difference. I mean the real
substance of a difference between fair
value hedge and cash flow hedge. It
looks the same in many cases. Can you
shed some light there?
Of course.
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39.
Step 1:
Determine the fair value of both
your hedged item and hedging
instrument at the reporting date;
Step 2:
Recognize any change in fair value
(gain or loss) on the hedging
instrument in profit or loss (in most
cases).
You need to do the same in most
cases even if you dont apply the
hedge accounting, because you
need to measure all derivatives
(your hedging instruments) at fair
value anyway.
Step 3:
Recognize the hedging gain or loss
on the hedged item in its carrying
amount.
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Loss on the P/L Loss FP
hedged item on the Hedged
hedged item (e.g.
item inventories)
Step 1:
Determine the gain or loss on your
hedging instrument and hedge item
at the reporting date;
Step 2:
Calculate the effective and
ineffective portions of the gain or
loss on the hedging instrument;
Step 3:
Recognize the effective portion of
the gain or loss on the hedging
instrument in other comprehensive
income (OCI). This item in OCI will
be called Cash flow hedge
reserve in OCI.
Step 4:
Recognize the ineffective portion of
the gain or loss on the hedging
instrument in profit or loss.
Step 5:
Deal with a cash flow hedge reserve
when necessary. You would do this
step basically when the hedged
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step basically when the hedged
expected future cash flows affect
profit or loss, or when a hedged
forecast transaction occurs but
lets not go in details here, as its all
covered in the IFRS Kit.
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What kind of item are we
hedging?
Basically, you can hedge a fixed item or
a variable item.
Why is that?
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much lower interest in the future than
you will be paying at the fixed rate of
2%).
Why is that?
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undertake the hedging instrument.
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accounting in practice, what issues you
faced and how you solved them. Thank
you!
71 Comments:
anilla May 29, 2014
thank you for this. we
do foreign currency
forwards at the year-
end, cause we buy in
usd. but they are
short-term and we
dont book them as
hedges. is it wrong?
Reply
Silvia M.
May 29, 2014
Hi Anilla, no, its OK.
Hedge accounting
is OPTIONAL, not
obligatory. So if you
prefer to keep it
simple, its OK to
revalue your
forwards to fair
value and thats it.
Mainly when the
forwards expire
within some short
term. S.
Reply
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Silvia M.
May 29, 2014
Hi, Oomesh, yes,
basically it is. The
gain or loss from
change in FV of
hedging instrument
= effective portion
(to OCI) +
ineffective portion
(to P/L). Take care!
S.
Reply
Silvia M.
June 2, 2014
Mayur, please
revise the 2 tables
above where you
can see the tables
with journal entries
for both hedges.
But the main
difference is, that at
CF hedge you dont
touch the hedged
item and you
revalue only
hedging instrument
+ you need to split
the gain/loss to
effective and
ineffective
portion+effective
goes to OCI and
ineffective to P/L.
At FV hedge, you
revalue both
hedging instrument
and hedged item
and if the hedge is
effective, you put
gain/loss from both
elements to P/L.
S.
Costina Gafita
March 30, 2015
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March 30, 2015
Hi Silvia,
in this case with short
term forward
agreements classified
as CF hedge what will
be the accounting
entries? I will go for a
forward agreement for
21 days to buy a fixed
amount of USD
(functional currency is
RSD) in order to pay
for the acquisition of a
PPE (I know the exact
amount of this order).
How can I record the
loss calculated for this
agreement as being
the difference between
spot rate and the
actual exchange rate
at the settlement date?
Many thanks
Reply
James Oguns
May 30, 2014
Thank you very much
Silvia. When are you
going to take us
through Hedge of net
investment in a foreign
operation in this
manner?
Reply
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Silvia M.
May 30, 2014
Hi James, well, I did
not want to cover it
here, because once
you see this type of
a hedge, you can
clearly identify it
theres no doubt
about the type of
the hedge But Ill
do it. The thing is
that not many
people are
interested in this
topic, because that
type of hedge is
taken mostly by
bigger companies
or corporations and
some IFRS expert
solves it for them
S.
Reply
Rajesh Thakur
May 31, 2014
Hi Silvia,
Kindly explain the
meaning of effective
and ineffective portion
as I m unable to
understand it.
Reply
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value hedge
accounting treatment
for interest rate
movements.
Reply
Silvia M.
June 2, 2014
Hello, Mayur, this is
a great and
interesting
question.
The answer
depends on the
construction of the
hedging
relationship, but to
make it short: what
you described is
totally doable. If
your CCIRS (cross-
currency interest
rate swap) is
constructed in a
way that currency
risk element is
separable from
interest rate risk
element, and if
these two elements
can be separated
and measured
separately also for
your fixed interest
rate bond, then you
can do it. You just
need to designate it
in your hedging
strategy that way.
I have seen that
CCIRS can be used
in various types of
hedges, for
example, pure cash
flow hedge (if swap
is fixed for fixed, just
in a different
currency), also pure
FV hedge (fixed for
floating). By the
way, if you want to
keep your life
easier, you can
designate your
hedge as CF or FV
only, depending on
the type and
conditions of
CCIRS. Have a nice
day! S.
Reply
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Fadi Rabadi
June 8, 2014
Thank you Silvia for
the explanations above
, i have one question ,
can we have a fair
value hedge against a
Fixed rate bond
classified At Amortized
cost to hedge the
interest rate risk ?
Reply
Silvia M.
June 8, 2014
Yes, you can. In
that case, any
hedge adjustment is
amortised to profit
or loss based on a
recalculated
effective interest
rate so not right
away to P/L. S.
Reply
Silvia M.
June 25, 2014
Hi Visar,
OK, let me go
straight to your
questions:
1) Yes, IRS can be
arranged between 2
related parties. But
in this case you
need to make
appropriate
disclosures and
also, you need to
be careful because
IRS between related
parties are not
necessarily
arranged at market
conditions (=fair
values) and as a
result, you would
need to make
appropriate
adjustment to bring
it to the fair value.
Maybe its not your
case though.
2) Of course. Is it
officially designated
and treated as a
cash flow hedge?
Because if not, then
you dont have any
other choice but to
recognize all gains
or losses from
derivative in profit
or loss.
3) This is much
more complex topic.
I have covered it in
my IFRS Kit where I
show how to
calculate the fair
value of plain
vanilla interest rate
swap (same
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swap (same
currency, fixed for
floating). However,
the calculation of
IRSs fair value
depends on HOW
exactly it is
constructed and
may require
complex modelling.
Have a nice day!
Silvia
Reply
Silvia M.
June 26, 2014
That would be a
cash flow hedge for
the bank A. If the
swap is opposite (A
pays floating,
receives fixed), then
its a fair value
hedge. S.
Reply
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examples as the Swap
is the hedging
instrument in this case.
Regards
Amit
Reply
Silvia M.
September 17, 2014
Yes, Amit, thats
what I wrote above.
Reply
Silvia M.
September 24, 2014
Hi Amit, my head
turns around now
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Visar June 27, 2014
Thank you very much
Silvia,
Kind regards
Visar
Reply
SAMBHAV
July 15, 2014
Can you tell me how
many types of risks are
there for which
hedging can be done.
As per me there are
four risks market
price risk, interest rate
risk, credit risk and
foreign currency risk.
Regds
Sambhav
Reply
Manish
September 20, 2014
Hi Silvia,
Very helpful article and
thanks for explaining
such a complex area in
a very simple manner.
I understand that when
a company goes for
fair value hedge
accounting, they take
the accounting
priviledge on the
hedged item unlike a
cash flow hedge where
the same is taken on
the hedging
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the hedging
instrument.
I have couple of
questions;
1. Can a fair value
hedge be applied to
Available for Sale
securities? If yes then
do we take the FV
changes to P/L instead
of OCI?
2. When I am entering
into a FV hedge for a
fixed rate debt (as
mentioned in your
example), I understand
we do a fair valuation
of the interest
component for the debt
(since FV of debt might
also include other
variable factors like
credit risk, liquidity risk
etc). In such case do I
split the FV component
and show them
separately from the
host debt contract?
Many thanks in
advance
Regards,
Manish
Reply
Silvia M.
September 23, 2014
Hi Nena, dont worry
about this, you will
be told in the
question what to
use. If not, and the
accounting
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accounting
treatment in IAS 39
is different from
IFRS 9, then simply
make your choice
and dont forget to
write it clearly in
your answer.
Remember that
ACCA examiners
give marks for
stating the obvious,
so do it S.
Reply
Silvia M.
October 7, 2014
Well, when you
account for cash
flow hedges, then
you calculate
effective and
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effective and
ineffective portion
of FV change in
your hedging
instrument. The
ineffective portion is
recognized in P/L
and the effective
portion in OCI. This
effective portion in
OCI is then called
hedging reserve
hope thats clearer.
S.
Reply
Silvia M.
October 9, 2014
Hi Gail,
IAS 39/IFRS 9 do
not state this
requirement.
Notional values can
be different, but in
such a case, youll
have a harder time
to prove that your
hedge is effective
and qualifies for
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and qualifies for
hedge accounting
(as the terms in
your hedged item
and hedging
instruments do not
match). But I dont
say its impossible.
S.
Reply
Silvia M.
October 12, 2014
Hi Harry,
it depends on what
you hedge. For
example:
1) If you know your
machine will cost
the exact amount in
the foreign currency
in the future, and
you want to protect
just against foreign
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just against foreign
currency rate
movements, then
you can treat as a
cash flow hedge.
2) If youre not sure
about the future
price of your
machine and youre
afraid of the price
increase in the
foreign currency,
then its basically
fair value hedge.
And there are lots
of combinations,
too. Hope its
clearer! S.
Reply
Silvia M.
October 15, 2014
Dear Harry,
the thing with
unrecognized firm
commitments is that
IAS 39 permits to
hedge foreign
currency risk under
both fair value and
cash flow hedge.
Above, I suggested
to treat it as a cash
flow hedge,
because in your
case, the amount to
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pay in the foreign
currency is fixed
thats true, but in
fact, the amount to
pay in your own
currency is variable
as it fluctuates with
the changes in the
foreign exchange
rates. Its very
similar to typical
receivable or
payable.
But as I wrote, IAS
39 allows you to
account for hedge
of unrecognized
firm commitment
under both types of
hedges.
Reply
Silvia M.
October 10, 2014
Non-distributable.
At some point in the
future, it will reverse
in P/L. S.
Reply
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a particular type of
hedge accounting, can
you explain with the
reasons.
Regards
Harry
Reply
Nacho Medina
October 19, 2014
We are an European
country (EUR) and we
have a contract in
Middle East (AED) for
the next 5 years (long
term), so our risk is a
foreign currency risk,
thus, Should we do a
cash flow hedge better
than fair valur hedge?
Are there some clues
to identify the choice
(FV hedge or CF
hedge) in this kind of
situations? For
example:
-> Contracts > 1 year
or
-> Hedges > EUR 500k
etc.
You recommend to
work with CF hedge
btter than FV hedge
Thank you.
Reply
saeed bux
October 20, 2014
How to determine the
effective and
ineffective portion of
cash flow hedge.
Thanks
Reply
Silvia M.
October 26, 2014
OK, let me reply,
although its not
really a topic to
cover in 1 comment:
You simply need to
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You simply need to
compare the
change in FV of
your hedged item
and the change in
FV of your hedging
instrument (in CF
hedges).
Lets say change in
FV of hedging
instrument is +100,
and change in FV
of hedged item is -
90. It means that
this hedge is not
perfectly effective
(in such a case,
change in FV of
hedging instrument
would be 90 and
there would be
100% offset).
However,
percentage of
offsetting is 111%
(100/90) which is
very effective.
Now, the effective
part of change in
FV of hedging
instrument is then
90, and ineffective
part is 10 (100-90).
Is it clear, guys?
Reply
Silvia M.
November 3, 2014
Hi Anas,
above, I described
over-hedge. Here,
you described
under-hedge.
In CF hedges, if
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theres under-
hedge, then theres
no ineffective
portion and you
should take all the
change in FV of
hedging instrument
to OCI.
If theres over-
hedge in CF hedge,
then you split
change in FV of
hedging instrument
to effective and
ineffective portion
just as I described
above.
Hope its clearer
now. S.
Manish
November 24, 2014
Hi Silvia,
Very helpful article and
thanks for explaining
such a complex area in
a very simple manner.
It would be great if you
can clear my dobut. I
had asked this before
and guess it was
missed.
I understand that when
a company goes for
fair value hedge
accounting, they take
the accounting
priviledge on the
hedged item unlike a
cash flow hedge where
the same is taken on
the hedging
instrument.
I have couple of
questions;
1. Can a fair value
hedge be applied to
Available for Sale
securities? If yes then
do we take the FV
changes to P/L instead
of OCI?
2. When I am entering
into a FV hedge for a
fixed rate debt (as
mentioned in your
example), I understand
we do a fair valuation
of the interest
component for the debt
(since FV of debt might
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also include other
variable factors like
credit risk, liquidity risk
etc). In such case do I
split the FV component
and show them
separately from the
host debt contract?
Many thanks in
advance
Regards,
Manish
Reply
Helena Wu Huie
December 12, 2014
Hi Silvia, thanks for
being helpful and so
clear! In the case of a
variable rate bond, why
would a fair value
hedge be needed?
Since by its very
nature, a variable rate
bond would be at fair
value.
Reply
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us.
Reply
Silvia M.
January 14, 2015
For me it seems like
it is a fair value
hedge, meaning
that the hedged
item is a fixed-rate
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item is a fixed-rate
interest rate.
Reply
Silvia M.
January 14, 2015
Dear Rima,
it really depends on
the type of the
hedge.
If you have a fair
value hedge, then
you book both FV
gain/loss on
hedging instrument
and FV loss/gain on
hedged item.
In a cash flow
hedge, you need to
measure
effective/ineffective
portion of the
loss/gain on
hedging instrument
and if the hedge is
still effective, you
book ineffective
part in P/L and
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part in P/L and
effective part in
OCI.
If I understand it
correctly, the
supplier holds
aluminium for its
client and contracts
price is fixed, so is
supplier hedging
the fair value of its
inventories of
aluminium? If yes,
then its FV hedge.
Reply
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exposure (variable
here). I am assuming
that this is cash flow
hedge
Thank you I stumbled
upon your resource
its brilliant
Reply
Silvia M.
February 5, 2015
Hi Aparna,
thank you!
You can hedge
highly probable
forecast
transactions this
would be your case.
You dont have to
purchase the
inventory in order to
hedge, but the
transaction must be
highly probable.
And yes, that would
be a cash flow
hedge.
S.
Reply
Tony W
February 6, 2015
Hi Silvia. In relation to
an investment in a
foreign currency, does
the hedge term have to
meet the expected life
of the investment. If so,
what would occur if you
cannot get a hedge to
match the expected life
of the asset, or if there
was no defined term
for the life of the asset,
eg if you were buying
property.
Reply
Silvia M.
February 6, 2015
Hi Tony, not
necessarily. If you
can demonstrate
that the hedge will
still be effective and
meets its objective,
then OK. But in this
case, it is very
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probable that there
will be some
ineffectiveness in
the hedge, caused
by different
maturity periods of
hedging instrument
and hedged item. S.
Reply
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compare to spot rate
when we receive or
pay the CCIRS, is it my
accounting treatment is
not proper?
5. For a perfectly
match condition of
Hedge Items versus
Hedge Instruments,
can we only applied for
critical match method
for hedge accounting?
I would like to thanks in
advance for your
favourable reply.
Rgrds,
Ferry
Reply
Priyanka
February 21, 2015
Hi Silvia,
Needed a clarification:-
In case a Co whose
reporting currency is
INR & has fx risk on
account of export
receivables in USD,
has a fixed rate debt
issued in INR in its
books.
The Co intends to
swap this INR debt with
a CCIRS where it
receives fixed rate INR
Interest & pays floating
libor USD. On the final
prinicipal exchange it
receives INR & pays
USD.
Through this the Co
intends to naturally
offset USD payment
against its forecast
receivables in USD.
Can this CCIRS be put
into a cash flow hedge
against highly probable
forecast exports? The
following issues may
arise:-
1)Through the swap I
am converting a fixed
liability into floating
which will require fair
value hedge
accounting.
2) The risk being
hedged is fx risk for
forecast trnsaction
which will require cash
flow hedge accounting.
3) At the time of taking
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3) At the time of taking
the swap, the INR debt
in the books has no
risk involved.
Your guidance on the
same would be
appreciated.
Reply
OLUWASEUN
February 21, 2015
Thanks So Much Silvia.
This Is Hedge
Accounting Made
Easy.
Please i really ned to
get your IFRS KITS,
but i need You to
confirm to me the pric
and the last edition
Specifically, does the
newest dition of the
IFRS KIT covers the
completed version of
IFRS 9- Financial
Instruments.(i.e
Released July 2014).
Please i need a
response as urgent as
possible.
thanks.
Reply
Silvia M.
February 21, 2015
Hi Oluwaseun, Ive
just responded by
e-mail, but to
answer: YES, the
IFRS Kit does
include the newest
version of IFRS 9.
S.
Reply
Jacinto Cho
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March 7, 2015
Hi Silvia, thanks for
such great explanation.
I have been reading
IAS 39, IFRS 7 and 9
and I still did not had
an clear understanding
between Fair Value
and Cash Flow Hedge.
I knew that I have to
identify the risk, the
hedge item, hedge
instrument, strategy,
economic relationship,
effective and inefective
portion and many other
issues.
I work in treasury and
am responsible for the
follow up of financial
instruments and their
accounting/financial
treatment. My industry
is Coffee, a well known
Commodity. So I will
make up the context to
you.
Hedge item: Arabica
Coffee inventory
bought at a fixed price.
Hedge instrument:
Arabica Coffee Futures
Contracts traded in
Intercontinental
Exchange (ICE, NY).
Economic relationship:
the item is arabica
coffee and the
instrument is Arabica
coffee futures. So the
economic principle is
very clear for me.
Strategy: Short
Hedging for selling
commodities.
Risk: possible decline
price
Action: when we buy
the coffee in the cash
market, we hedge the
inventory doing the
oposite in the futures
market (Sell) and
buying futures later
(buy) when is time to
sell.
We do not have risk on
the buying side of
coffee in cash market
since, we buy on spot
price always. We never
buy on a forward or
time in advance later.
In the same day we
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make a purchase
contract of coffee(1 lot
375 bags of 46 kg), we
fix a buying price, and
that is the entry price
for us to enter the
futures market and
start the Short hedge
by selling (1 lot 375
bags of 46kg) futures
Arabica coffee
contracts in the futures
market. Giving us a
short position on the
futures market, and
long position on the
cash market.
Now, on the sell side,
we do make forward
contracts to deliver an
exact amount of coffee
(e.g. 5 lots) at an exact
quality(High Grown
European Preparation
HG EP), exact time
(shipment on May N15
July expiration month),
and exact place (Port
FOB). But we do not fix
a price, so we call
these forward
contracts Price to be fix
(PTBF).
Now, that I have
explain you the
context, I will get you to
the big deal I have.
Our company is
implementing IFRS Full
for the first time on
FY14. Our Auditors are
Deloitte. On the
previous year we have
been using Local
GAAP. (Which does
not even know or
recognize financial
instruments accounting
treatment other than
ordinary Assets and
Liabilities.
We have these
Derivaties (Financial
Instruments) and we
use them as hedging
instruments, both item
and instrument are well
defined as I have
mentioned before. Now
lets try to find out if
the hedge item is a Fix
or Variable item.
You mentioned that
inventories are Fix
item. That is ok for
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item. That is ok for
inventories of items
that are not listed on
Exchanges. For
example, cars, iPads,
beds, shoes, etc. But
for coffee, we have an
active market (Level
1). The information of
these prices are
available for everyone
and they are a
common ordinary item.
Nonetheless,
commodity prices are
very volatile, and
prices can vary more
than 100% in less than
one year.
We can say we have a
fix item on the buy
side, but as I
mentioned before we
do not make
commitments to buy on
forward prices just spot
prices. And we sell on
PTBF that means our
value of our sales are
unknown, and so are
the cash flows related
to the income of our
physical inventory of
coffee.
My boss financial
controller says that the
inventories are an
asset an therefore
should be treated as a
fair value hedge. The
auditos initially wanted
to treat the inventory
with IAS 2, and Net
realizable Value NRV. I
do not agree. I have
change auditors mind
that commodity
inventories should not
be treated as NRV
since the IAS 2 clear
states it should be
treated as Fair Value.
That is ok if the
inventories were not
hedge. And since we
do not like risk, and we
want to offset market
price risk, we use
coffee futures to
mitigate that risk.
If we had firm
commitments or
contracts that
represent the sale of
our inventory we could
treat them as Fair
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treat them as Fair
value less cost to sell.
But since we do not
have a fix price, and
we are hedging them, I
think, understand and
belief they should be
treated as a Cash Flow
Hedge.
To add more context,
we do have the
practice of making the
mark-to-market
valuation approach,
which in other words
represent fair value of
inventories.
As we are hedging the
inventory that Is ready
for sale but with a
PTBF contract, there
should be an account
that records the
variation on fair value
of the hedge item (lets
call PNL of the
inventorie) and should
be recorded against a
reserve of equity,
called (Reserve of PNL
of coffee inventory)
although they are
called PNL that does
not mean I am saying
the effects should be
taken to P/L statement.
On the financial
instrument (derivative)
[by the way I read
commodity contracts
are not financial
instruments how is that
possible or when is
it????] And this should
have an impact on its
fair value depending
on the market price. If
prices goes down I will
have an unrealized
gain, and if prices go
higher I will have an
unrealized loss, ok?
Because the futures
market position is
Short Hedge.
MY approach is the
following.
Any variation of the
hedge item and hedge
instrument should be
taken to :
Price Hedge item Dr.
Cr.
Higher Gain Asset
(Gain inventorie) Cash
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(Gain inventorie) Cash
flow Reserve (Gain)
Lower Loss Cash Flow
Reserve (Loss)
Liabilitie (Loss)
Hedge instrument
Higher Loss OCI (Loss)
Liabilitie (Loss)
Lower Gain Asset
(Derivatie gain) OCI
(Gain)
If the hedge is 100%
effective, any
ineffectiveness should
be taken to Income
statement for the FY of
the change in price as
the date of the FP.
We then arrive to the
time to make the sell,
and we have a known
sell price.
Cash market (offset
gain or loss on Cash
Flow reserve Equity)
Future market
(reclassify gain or loss
to income statement
when the price is know,
and we buy the futures
contract we had initially
sold. That exit price will
be my new fix price for
the sale and the PTBF
expires so I do not
need any hedge since
the market price risk
have disappeared.
The main reason for
these treatment I recall
again, is the condition
that I have a variable
item hedge and not a
fix variable hedge
(coffee inventory).
Who makes more
sense, me or my boss?
Or the auditors?
Reply
Silvia M.
March 7, 2015
Dear Jacinto,
thank you for your
comment, and really
let me thank you for
your trust you
placed in me and
for posting me this
question. However,
to answer this
question properly, I
would need to
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would need to
dedicate more time
than I currently can
afford. I believe
quick response
would not give you
the quality and
diligence that
everybody (also
you) expect from my
work.
Hence I leave it to
other readers to go
through your
questions and tell
you their opinion.
When I have more
time, I may
eventually come
back to it.
Hope you
understand. S.
Reply
Adam French
March 11, 2015
Hi Silvia, thanks for you
explanation, very
useful. Assuming a
perfect hedge lets say
either in the form of a
cash flow hedge or fair
value hedge. A fair
value hedge will have
zero FX impact
because underlying is
at same spot rate as
hedge and they both
mature at same rate.
For cash flow hedges
the spot will be taken in
advance of the
underlying being on
your balance sheet so
although they mature
on the same date the
initial value will be
different and so FX
gain/loss will be
recognised. Is that a
fair synopsis?
Reply
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and protect it against
foreign currency risk.
Equally, you can
hedge a variable rate
debt against fair value
changes and thats
the fair value hedge.
In this example you
said, we can hedge a
variable debt against
fair value changes and
thats fair value hedge.
This is exceptional,
right. Can you please
explain how are we
hedging this?
Reply
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