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CPA Cash Flow Hedges - YouTube
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[5]
changes in external factors such as
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interest rates and exchange rates could
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have negative consequences for entities
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such changes would ultimately affect the
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cash flow upon settlement
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so to protect against uncertain cash
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flows entities take out cash flow hedges
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for recognized assets
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liabilities or for a highly probable
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forecast transaction
[27]
for example timeless limited is a
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company that sells exclusive watches
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which it imports from a supplier in
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neverland
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neverland's currency is the nev which
[38]
fluctuates drastically
[40]
on the 1st of april timeless limited
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signed a binding agreement to purchase 2
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000 watches from the neverland supplier
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the total purchase price was 1 million
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navs
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30th june is the date on which the
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contract will be settled
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in navs on 30th april the shipment
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arrived at timeless stores during the
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period between the signing of the
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purchase agreement
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and the settlement date the nev could
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have appreciated or strengthened
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against the australian dollar which
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would result in an additional cash
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outflow on settlement of the debt
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additional information indicated that
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the spot rates for the different dates
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were as follows
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so to protect against this fluctuation
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timeline is limited to cut a forward
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foreign exchange contract on the 1st of
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april
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with the broker to receive 1 million
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navs and to pay
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610 000 to settle the foreign exchange
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contract
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the forward rates for the delivery on
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30th june
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are as follows what would be the journal
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entries on the various dates
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on the 1st of april timeless limited
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entered into an agreement
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to purchase the watches no journal
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entries are required because the risks
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and rewards of ownership have not yet
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passed to timeless limited on the state
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timeless also entered into a foreign
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exchange currency contract
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or fec contract on the state
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there is no journal entries required
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since the value of the fec contract is
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zero
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note that the fec contract rate for one
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nev
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was 61 cents on first of april this
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times 1 million nivs is equal to 610 000
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dollars so timeless limited's right to
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receive
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one million navs is equal to its
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obligation to pay
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six hundred and ten thousand dollars on
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the first of april
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accordingly no general entry is required
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on the state
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on the 30th of april we need to
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re-measure the value of the fec contract
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you should note that the fec contract
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rate is used to re-measure the value of
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the fec
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contract the fec contract rate is 62
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cents for one nev
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this is an increase of one cent this
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times one million gives us an increase
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of ten thousand dollars
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efris nine paragraph 6.5.11
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provides an important rule at this stage
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since the inventory of watches
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has not yet been recognized the gains or
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losses from the changes in the fair
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value of the fec
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contract need to be recognized in other
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comprehensive income
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so the journal would be a debit to fec
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contract to recognize the receivable
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from the broker of ten thousand dollars
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and a credit to equity cash flow hedge
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in oci by the same amount
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on 30 april timeless received the
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shipment of watches
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thus the risks and rewards of ownership
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passed
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and this needs to record an increase in
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inventory and accounts payable
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the accounts payable would be calculated
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using the spot rate
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which was 61 cents for one nav so the
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journal would be a debit to inventory
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with six hundred and ten thousand
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dollars
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and a credit to accounts payable by the
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same amount
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efris9 paragraph 6.5.11
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provides another rule now that the
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inventory is recorded
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all gains and losses that were
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previously recognized in oci
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need to be reversed and recognized
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against the non-financial asset
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which is the inventory of watches so the
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journal would be a debit to equity cash
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flow h in oci
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to reverse the ten thousand dollars
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previously recognized
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and a credit to inventory by the same
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amount
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once the non-financial asset is recorded
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the general entries for the cash flow
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hedge are similar to that of a fair
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value hedge
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in other words gains or losses from
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changes in the fair value of the hedged
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item
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and hedging instrument are taken to
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profit and loss
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you should now attempt to do the
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remaining journals for the 31st of may
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and 30th june to recap
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prior to the recognition of
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non-financial assets gains or losses
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from the re-measurement of the cash flow
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hedging instrument
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are taken to oci after the non-financial
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asset is recognized
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the previously recognized amounts in oci
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must be reversed
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and adjusted against the value of the
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non-financial asset
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subsequent gains or losses from the
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re-measurement of the hedged item
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and hedging instrument are taken to
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profit and loss
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this is the same treatment as that of
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fair value hedges
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