Fair Value Hedges/Cash Flow Hedges

Question 1

What is overall goal of a fair value hedge?

Answer 1

Convert a fixed price to a floating price

Meaning the FV is uncertain and the cash flow is fixed

The hedge would convert the FV to a certain amount and the cash flow to an uncertain amount

Question 2

What are the requirements of a fair value hedge?

Answer 2

1) Formal documentation- what’s your objective, relationship between the instrument and hedge, how are you going to access effectiveness.

Question 3

On the date you enter into a futures contract with a broker, what is the journal entry?

Answer 3

No journal entry for that date

Question 4

What is the journal entry if the futures rate decreased subsequent to the date you entered into the contract with the broker? What is the entry with the supplier?

Answer 4

Futures Contract XX
Gain/Loss ( XX)

Gain/Loss                   XX 
Firm Commitment    (XX) 

*You could record to COGS if you want, it doesn’t matter because it nets to zero

Question 5

What is the overall goal of a cash flow hedge?

Answer 5

Convert a floating price to a fixed price. Cash flow hedge is the hedge changes in the cash flow associated with an asset, liability or foretasted transaction

Question 6

How do you qualify for a cash flow accounting?

Answer 6

1) Formal documentation: Objective, relationship, hedged item, how to measure effectiveness

Question 7

What items can you NOT use cash flow hedges for?

Answer 7

• Business Combinations
• Parent’s equity in a sub
• An entity’s own equity instruments

Question 8

What is the journal entry when you enter on the day you into a futures contract with the broker?

Answer 8

No entry

Question 9

If the futures contract increases under a cash flow hedge, what is the journal entry you would record? What is the entry you record with the supplier?

Answer 9

Futures Contract XX
G/L (OCI) (XX)

No entry for the supplier

Question 10

On the settlement date, what are the journal entries made with the broker and supplier under a cash flow hedge?

Answer 10

Future Contract XX
G/L XX

Cash                              XX 
Futures Contract          (XX)

Inventory at fair value XX
Cash (XX)

Question 11

When does OCI get closed under a cash flow hedge?

Answer 11

It does not get closed of OCI until the item you have hedged goes to the income statement.

Example:
Cost of Goods Sold XX
Inventory (XX)

OCI XX
Cost of Goods Sold (XX)

Question 12

Any foreign currency hedge dominated in a foreign currency is what type of hedge?

Answer 12

Cash Flow Hedge

Question 13

Any firm commitment dominated in a foreign currency is what type of hedge?

Answer 13

Fair Value Hedge

Question 14

In order to use a hedge instrument, the correlation between the hedged item and hedging instrument must be highly ______________ in reducing risk?

Answer 14

Effective. it has to be correlated between 80-125%

Question 15

When does a company need to assess effectiveness of a hedged item?

Answer 15

Balance Sheet Date (quarterly)

The entity must document how it will assess effectiveness.

Question 16

The hedging disclosures are extensive, what are the major disclsoures?

Answer 16

• Objectives, giving enough context to understand what those objectives are.
• For fair value: state the gain or losses and where are they reported
• Cash flow: Disclosure the gains and losses in OCI, the amount and where it is reported on the income statement