Derivatives Hedging Translation

Question 1

How are derivatives recorded?

Answer 1

At cost when acquired re-valued to fair value each period on Balance Sheet.

Question 2

What is a Fair Value Hedge? How is it recorded?

Answer 2

Fair Value Hedge offsets exposure to changes in the value of a recognized asset/liability or of an unrecognized commitment

Initially recorded on Balance Sheet at Fair Value

Gains/Losses recorded on Income Statement

Question 3

What is a Cash Flow Hedge? How is it recorded?

Answer 3

Cash flow hedges protect from exposure to fluctuations in cash flows.

Initially recorded on Balance Sheet at Fair Value

Gains/Losses going to OCI

Example: A cereal company enters into a futures contract on grain purchases to offset the risk that grain will go up in price.

Question 4

Where are gains and losses on foreign currency hedges recorded?

Answer 4

In Other Comprehensive Income (OCI)

Question 5

What disclosures are required for derivative transactions?

Answer 5

Objectives and Strategies

Context to help investor understand the instrument

Risk Management Policies

Complete List of Hedged Instruments

Question 6

How do transactions denominated in in a currency other than a company’s functional currency affect the income statement?

Answer 6

Fluctuations in that currency cause a gain or loss that must be recognized on the income statement as Income from Continuing Operations

Question 7

For the balance sheet which date’s translation rate is used to report assets and liabilities?

Answer 7

The current translation rate as of the balance sheet date is used to report assets and liabilities.

Question 8

Which date’s currency translation rate is used for the reporting of revenue and expense transactions in a foreign currency?

Answer 8

Use the weighted average exchange rate for the current year.

Question 9

If the functional currency is the reporting currency which exchange rate is used on the foreign currency financial statements?

Answer 9

Foreign Currency Financial Statements are remeasured into the Reporting Currency (Dollar) using the weighted-average exchange rate

Question 10

Where are re-measurement gains and losses due to foreign currency translation reported?

Answer 10

On the income statement as Other Income.

Question 11

A derivative always possesses which 3 characteristics?

Answer 11

(S) Settlement in Cash or Equivalents - at a future date
(U) Underlying (index) and Notional Amount (units)
(N) No Net Investment

Question 12

Futures Contract

Answer 12

Right / Obligation to Purchase/Deliver foreign currency or goods in the future at a price set today

Question 13

Forward Contract

Answer 13

Right/Obligation to Buy/Sell a commodity at a future date for an agreed upon price

Question 14

Interest Rate Swap Agreement

Answer 14

Forward-Based Contract between two private counter-parties to exchange streams of cash flows over a specified period in the future.

Question 15

Embedded Derivative

Answer 15

Hybrid Instrument - contains a “host” instrument and an “embedded derivative” - if they stood alone, would meet the definition of a derivative instrument

(Ex of an embedded derivative that cannot be separated from it’s host—> convertibility provision on a convertible bond)

Question 16

Bifurcation

Answer 16

When a embedded derivative is separated from the host contract - treated as a stand alone instrument

((Ex: Stock Purchase Warrant - can be separated from the bonds that were purchased with it)

Question 17

Accounting for Embedded Derivatives: When can they be accounted for as a whole?

Answer 17

If the holder elects to account for the whole instrument on a fair value basis

Question 18

3 conditions must be met to report the sale of a financial asset:

Answer 18

1) asset must be beyond the reach of the transferor & creditors
2) Transferror cannot place any restrictions on what the transferee can do with the asset
3) No repurchase or redemption agreement that might allow the transferror to force a return of the asset.

Question 19

3 Types of Derivatives under IFRS:

Answer 19

1) Cash Flow Hedge
2) Fair Value Hedge
3) Hedge of Net Investment

(Foreign Currency is replaced with Hedge of Net Invest.)

Question 20

What is the difference between Re-measurement and Translation?

Answer 20

Re-Measurement is the process of converting foreign currency financial statements from the local currency (US$) to the functional currency –> Begin with the Balance Sheet to figure out ending RE. Plug the difference to Net Income

Translation is the process of converting or restating foreign financial statements from the functional currency into the local currency (US$) –> Begin with Income Stmt to figure out the ending Net Income. Transfer Net Income to RE. Then Translate the Balance Sheet and hit OCI for any adjustment needed.

Question 21

Two Types of Foreign Currency Transactions:

Answer 21

1) Operating Transactions (Buying/Selling from a foreign company)
2) Forward Exchange Contracts (agreement to exchange 2 different currencies at a future date)

Question 22

When remeasuring for foreign transactions, when do you use the current market rate and when do you use the historical rate?

Answer 22

Use the current market rate for all monetary items and for non-monetary items that are carried at the current market rate.

Use the historical rate for all non-monetary items that are carried at cost.

Question 23

Difference between the Direct Quotation and Indirect Quotation:

Answer 23

Direct Quotation is expressed in terms of US $ to Foreign

Indirect Quotation is expressed in terms of Foreign Unit to US $

Question 24

What rates may be used to translate the cash flow statement?

Answer 24

Cash Flows are translated at the rate in effect that the transaction occurred (not the current market rate as of year-end) or they can be measured using the Weighted Avg Rates (if not substantially different)