Set 7 Hedge Accounting

Question 1

List 4 eligible hedged items

Answer 1

existing asset or liability position
unrecognized firm commitment
highly probable future transaction
net investment in foreign operations

Question 2

Two types of eligible hedging instruments

Answer 2

• derivatives, such as forward-contracts

- non-derivatives such as monetary assets and liabilities

Question 3

3 criteria to be able to apply hedge accounting

Answer 3

1. heding relationship consists of eligible hedged items and eligible heding instrument
2. relationship is formally designated and documented
3. 3 effectivess criteria are met. - economic relationship exists between hedged item and elig hedge instrum. - credit risk does not dominate change in value. - hedge ratio the same for the hedging relationship AND quantity of the hedged item actually hedged, and the quantity of hedging instrument used to hedge it.

Question 4

hedge ratio - what

Answer 4

change in FV of hedging instrument/ change in FV of hedged item

Question 5

Define fair value hedge

Answer 5

When an asset is fixed at a certain rate (i.e. a/r in a foreign currency) but the rate on the books changes due to fluctatations in fx rate.

Question 6

Define forward contract

Answer 6

an agreement to exchange, at a predetermined future date, currencies of different countries at a specified exchange rate.

Question 7

Name the two accounts which will be on balance sheet during forward contracts

Answer 7

Due to broker - amount payable to broker
Due from broker - amount received from broker

one will be fixed, one will be variable at the forward rate

Question 8

When is due to broker fixed? and due from broker fixed?

Answer 8

Hedge a receivable for sale of goods - due from broker fixed

Hedge a payable for payment of goods - due to broker fixed

Question 9

FV hedges initiation date entries

Answer 9

Record FV of hedged item

Record FV of hedging instrument AT FORWARD RATE ON DATE OF PURCHASE

Question 10

FV hedges reporting date entries

Answer 10

Update hedged item to spot rate - record any gain/loss in net income
Update variable side of hedging instrument to FORWARD rate on reporting date - record any gain/loss in net income

Question 11

FV hedges settlement date entries

Answer 11

Update hedged item to spot rate - update hedged item to spot rate; record gain/loss in net income
Update variable side of hedging instrument to spot rate - record gain/loss in net income
Record settlement of hedged item
Record settlement of hedging instrument

Question 12

Main difference between cash flow and fair value hedge

Answer 12

Cash flow hedges are for speculative items - they are entered into before the hedging item

Question 13

Cash flow hedge - forward contract - initial entries

Answer 13

Record FV of hedging instrument (remember that this may not be appropriate - the item may not be recorded until later on!)
Record FV of hedged item at FORWARD rate on date of purchase

Question 14

Cash flow hedge - forward contract - reporting dates

Answer 14

Updated hedged item and hedging instrument to FV, record gain/loss in OCI or income statement, depending upon whether hedged item is yet recorded on the books. USE FORWARD RATE FOR HEDGED ITEM

Question 15

Cash flow hedge - forward contract - derecognition date

Answer 15

Update hedging instrument to FV; record gain/loss in OCI
Derecognize hedging instrument
Derecognize hedged item if previously recorded; record if not
Move gain/loss in OCI to net income by adjusting hedged item - not gain/loss but the HEDGED ITEM ITSELF
ONCE HEDGED ITEM HAS BEEN RECOGNIZED, ANY FURTHER ADJUSTMENTS ARE TO NET INCOME

Question 16

Cash flow hedge - using debt or loan rec as hedging instrument - initial entries

Answer 16

Record FV of hedged item (if transaction has actually occurred)
Record FV of hedging instrument on SPOT rate of transaction

Question 17

Cash flow hedge - using debt or loan rec as hedging instrument - reporting dates

Answer 17

Update hedged item and hedging instrument to FV; record gain/loss in OCI or income statement as appropriate (if item has been recognized or not)
Update any accrued interest in P/L - use spot rate for int receivable, average rate for int rev, and fx gain/loss for difference

Question 18

Cash flow hedge - using debt or loan rec as hedging instrument - derecognition date

Answer 18

Update hedging instrument to FV, record gain/loss in OCI
Derecognize hedging instrument
Update interest and translate revenue using average rate for period and translate interest rec at spot rate
Derecognized hedge item if previously recorded; record if not done
Move gain/loss in OCI to net income by adjusting hedged item (NOT GAIN/LOSS)

Question 19

ASPE differences - using hedge accounting conditions (all must be met)

Answer 19

• hedging relationship is designated and documented
• hedging instrument and hedged item must have same critical terms
• for anticipated transactions (cash flow hedges), the expected transaction must be probable

Question 20

ASPE differences - allowing hedge accounting to be used when (3 times)

Answer 20

• forward contract used to hedge an anticipated foreign currency cash flow
• forward contract used to hedge an anticipated purchase or sale of a commodity
• interest rate swap is used to hedge interest rate risk in a recognized interest bearing-loan receivable or loan payable