ESTI

SLIDE 2
Learning objective
In our presentation there are 3 learning objectives that will be discussed, continuing the
material from Group 2.
13.5 Understand the special derivative accounting related to hedges of existing foreign
currency–denominated receivables and payables.
13.6 Comprehend the footnote disclosure requirements for derivatives.
13.7 Understand the International Accounting Standards Board accounting for derivatives.

SLIDE 3
Foreign currency–Denominated Receivables and payables
In Chapter 12, we discussed the accounting for foreign currency–denominated
receivables and payables. Companies frequently hedge their exposure to foreign currency
exchange risk for existing foreign currency–denominated assets and liabilities and
anticipated foreign currency–denominated transactions. In this section, we will focus on
hedge accounting when foreign currency transactions are involved. The accounting for such
foreign currency hedges is a bit different than for the derivatives discussed already.
FASB ASC Topic 830 requires marking to fair-value (the current spot rate) foreign
currency–denominated receivables and payables at period-end. The resulting gain or loss is
recognized immediately in income. Under FASB ASC Topic 815, a company may be able to
choose model to account for hedges of such receivables and payables using either a fair-
value hedge model or a cash-flow hedge model. The contract-term requirements for
selecting a cash-flow hedge model are stringent, as we will discuss next.
The forward premium or discount is the difference between the contracted forward
rate and the spot rate prevailing when the contract is entered into. This premium or
discount is amortized into income over the life of the contract if the hedge is designated as a
cash-flow hedge. The effective interest method is appropriate.

ISAM
SLIDE 4
CASH-FLOW HEDGES
For a forward contract to qualify for cash-flow hedge accounting, the contract must
have the following characteristics:
 1. Cash-flow hedges can be used in recognized foreign currency–denominated asset
and liability situations if the variability of the cash flows is completely eliminated by the
hedge. This requirement is generally met if the settlement date, currency type, and currency
amounts match the expected payment dates and amounts of the foreign currency–
denominated receivable or payable. If any of these critical terms don’t match between the
hedged item and the hedging instrument, then the contract is designated a fair-value
hedgewith current earnings recognition of changes in the value of the hedging derivative
and the hedged item. (This is illustrated later.)
2. According to GAAP, the transaction gain or loss arising from the remeasurement
of the foreign currency–denominated is offset by a related amount reclassified from other
comprehensive income to earnings each period.
Thus, the foreign currency–denominated asset or liability is marked to fair value at
period-end, and the gain or loss is recognized in income. The cash-flow hedge is also marked
to fair value at period-end. Like other cash-flow hedges, the gain or loss is included in other
comprehensive income. At period-end, a portion of the gain or loss included in other
comprehensive income is then recognized in income to offset the gain or loss on the foreign
currency-denominated asset or liability.
3. Finally, the premium or discount related to the hedge is amortized to income
using an effective interest rate.

SLIDE 5
Example of Accounting for a cash-Flow Hedge of an Existing Foreign currency–
Denominated Accounts Receivable
Assume that Win Corporation, a U.S. firm, sold hospital equipment to Howard Ltd. of Britain
on November 2, 2016, for 100,000 British pounds, receivable in 90 days, on January 31,
2017. In addition, on November 2, Win enters into a 90-day forward contract with Ross
Company to hedge its exposed net accounts receivable position. We will assume that the
forward contract allows for net settlement. Assume that a reasonable incremental interest
rate is 12 percent. Selected exchange rates of pounds are :
 NABILA
SLIDE 6
Because Win entered into a forward contract that is to be settled net, no entry is
necessary at the date that contract is entered into. Recall that if this were a futures or

option contract, an entry would be necessary because some cash would have been paid by
Win at the inception of these types of contracts.

SLIDE 7
FORWARD CONTRACT ADJUSTMENT

SLIDE 8
ENTRY TO OFFSET ACCOUNTS RECEIVABLE EXCHANGE GAIN
 ALIF
SLIDE 9
Fair-Value Hedge Accounting: Foreign currency–Denominated Receivable Example
ILLUSTRATION: HEDGE AGAINST EXPOSED NET ASSET (ACCOUNTS RECEIVABLE) POSITIONS
U.S. Oil Company sells oil to Monato Company of Japan for 15,000,000 yen on December 1,
2016. The billing date for the sale is December 1, 2016, and payment is due in 60 days, on
January 30, 2017. Concurrent with the sale, U.S. Oil enters into a forward contract to deliver
15,000,000 yen to its exchange broker in 60 days. Exchange rates for Japanese yen are as
follows :
TABELNYA GAUSAH DIBACA LIP LANGSUNG SLIDE SELANJUTNYA WKWK,

SLIDE 10
SLIDE 11
HEDGE AGAINST EXPOSED NET LIABILITY POSITION
Accounting procedures for hedging an exposed net liability position are comparable to those
illustrated for U.S. Oil Company except that the objective is to hedge a liability denominated
in foreign currency, rather than a receivable. Normally, the forward rate for buying foreign
currency for future receipt is greater than the spot rate. For example, a forward contract to
acquire 10,000 British pounds for receipt in 60 days might have a forward rate of $1.675
when the spot rate is $1.66. The forward contract is recorded as follows:

NENSHI
SLIDE 12
RESULT OF HEDGING

 Forward rates are ordinarily set so that a cost is incurred related to the hedge.
Occasionally, the rates for futures contracts result in hedges that increase income.
 In summary, a forward contract is recorded at the forward rate, while the underlying
asset or liability is recorded at the spot rate (and adjusted to these respective rates
and values at the financial statement date). Over the life of the contract, the initial
difference between the spot and the forward rates is the cost of hedging the
exchange rate risk. Because the gains and losses on both the hedge and the
underlying asset or liability are recorded in current earnings, the net cost reported in
the income statement is the change in the relative values of the spot and forward
rates.
 If a firm enters a forward contract for foreign currency units in excess of the foreign
currency units reflected in its exposed net asset or net liability position (a
speculation in the currency), the difference ends up as a gain or loss. This is due to
the difference in the change in the value of the derivative and the change in the
value of the underlying item hedged both being reported in the income statement.

SLIDE 13
Fair-Value Hedge of an Identifiable Foreign currency commitment
  A foreign currency commitment is a contract or agreement denominated in foreign
currency that will result in a foreign currency transaction at a later date. For
example, a U.S. firm may contract to buy equipment from a Canadian firm at a future
date with the invoice price denominated in Canadian dollars. The U.S. firm has an
exposure to exchange rate changes because the future price in U.S. dollars may
increase or decrease before the transaction is consummated.
 An identifiable foreign currency commitment differs from an exposed asset or
liability position because the commitment does not meet the accounting tests for
recording the related asset or liability in the accounts. The risk of the exposure still
may be avoided by hedging. This situation is special because the underlying
transaction being hedged is not recorded as an asset or liability. Therefore, some
method must be established to record the change in the value of the underlying
unrecorded commitment in order to record the derivative instrument as a hedge of
the commitment.
 Once this mechanism has been created, the change in both the derivative
instrument and the underlying commitment are recorded—in effect, offsetting each
other. Because a forward contract that is a hedge of a firm commitment is based on
the forward rate, not the spot rate, any gain or loss on the derivative and underlying
contract is based on the forward rate.
 The forward contract accounting begins when the forward contract is designated as
a hedge of a foreign currency commitment.
THERE ARE TWO :
1. Hedge Of An Identifiable Foreign Currency Purchase Commitment
2. Hedge Of An Identifiable Foreign Currency Sales Commitment

HAIKAL
SLIDE 14
Cash-Flow Hedge of an Anticipated Foreign currency commitment

 Because this is an anticipated commitment, there is no hedged item on the balance

sheet that will be marked to fair value until the actual sale occurs, which will be in
three months.
 However, the company has engaged in this forward contract. The contract must be
recorded at estimated fair value at year-end. However, because this is considered a
cash-flow hedge of an anticipated foreign currency commitment, the resulting gain
or loss is deferred until the item being hedged actually affects income.
 The discount or premium related to the forward contract must be amortized to
income over time.
SLIDE 15
Speculation
  Exchange gains or losses on derivative instruments that speculate in foreign currency
price movements are included in income in the periods in which the forward
exchange rates change. Forward or future exchange rates for 30-, 90-, and 180-day
delivery are quoted on a daily basis for the leading world currencies.
 A foreign currency derivative that is a speculation is valued at forward rates
throughout the life of the contract (which is the fair value of the contract at that
point in time).
SLIDE 16
Example of Speculation

SLIDE 17
Solution of Speculation

VERA
SLIDE 18
Footnote-Disclosure Requirements

 Disclosure requirements focus on how its derivatives fit into a company’s overall
risk-management objectives and strategy. The company should be specific about the
types of risks being hedged and how they are being hedged. In addition, the
 company should describe initially how it determines hedge effectiveness and how it
assesses continuing hedge effectiveness.
 The disclosures related to fair-value hedges include reporting the net gain or loss
included in earnings during the period and where in the financial statements the gain
or loss is reported. This gain or loss is separated into the portion that represents the
hedge’s ineffectiveness and the portion of the gain or loss on the hedge instrument
that was not included in the assessment of hedge effectiveness.
 Cash-flow hedging instrument disclosures include reporting the amount ofany hedge
ineffectiveness gain or loss and any gain or loss from the derivative excluded from
the assessment of hedge effectiveness. In addition, location of these gains and losses
in the financial statements should be disclosed.
 The disclosures for cash-flow hedges also include a description of the situations in
which the gain or loss included in Accumulated Other Comprehensive Income is
reclassified to income. An estimate of the amount of reclassification to occur within
the next12 months should also be reported.
 Because cash-flow hedge accounting can be used for forecasted transactions, the
company should report the maximum length of time that the entity is hedging its
exposure to these forecasted transactions. This disclosure excludes transaction
hedges of variable interest on existing financial instruments.
 Finally, the company should report the amount of gains and losses that could be
reclassified to income if the cash-flow hedges were discontinued because the
original forecasted transactions did not occur.
SLIDE 19
International Accounting Standards
International standards for accounting for hedging and derivatives are controlled by two
companion standards.
1. International Accounting Standard (IAS) No. 32, “Financial Instruments: Disclosure
and Presentation”
2. International Accounting Standard No. 39, “Financial Instruments: Recognition and
Measurement” (a significant revision in December 2003.
are both related to the ASC Topic 815.

 IAS No. 32’s major points include clarifying when a financial instrument issued by a
company should be classified as a liability or as equity and requiring a wide range of
disclosures regarding financial instruments, including their fair values. In addition,
the statement defines and provides examples of many terms, such as financial
assets, financial liability, equity instrument, and fair values.
 IAS No. 39 addresses many of the same issues as ASC Topic 815, including defining
and providing examples of derivatives as well as hedge accounting.
 In fact, the conditions that must be present to use hedge accounting, such as
formally designating and documenting the corporation’s risk-management objective
and strategy for undertaking the hedge, as well as the need to assess hedge
 effectiveness initially and during the hedge’s existence, are almost identical to GAAP.
For example, the 80 percent to 125 percent range mentioned in ASC Topic 815 is also
mentioned in IAS 39 to assess effectiveness.
 Under U.S. GAAP, such firm sale or purchase commitments are accounted for as fair-
value hedges, but under International Financial Reporting Standards (IFRS) they can
be accounted for as either fair-value hedges or cash-flow hedges. Despite some
differences, U.S. GAAP and IFRS standards relating to derivatives are converging.

YUNI
SLIDE 20

Exercise 13-5
[Based on AICPA] Various foreign currency hedge situations
On December 12, 2016, Car entered into three forward exchange contracts, each to purchase
100,000 Canadian dollars in 90 days. Assume a 12 percent interest rate. The relevant exchange
rates are as follows:

SLIDE 21
Before answering this question, I will explain a little about forward contracts because
exercise 13-5 is related to forward contracts.
Forward Contract:

 Forward contract, These are the contracts that are to be settled at a future
date. These contracts or the agreements are settled to sell the currency,
commodity or any other documents or assets which are specified.
 The said assets are to be sold at a future date and at a price which is
determined in advance. The determined price can take the form of the current
market price, and forward price or any price which is determined on the basis
of the exchange rate. The said price can be on a premium or even it can be
on discount.
SLIDE 22
OK, Next we move to required 1.

1. Car entered into the first forward contract to hedge a purchase of

inventory in November 2016, payable in March 2017. At December 31,
2016, what amount of foreign currency transaction gain should Car
include in income from this forward contract? Explain.
In the given case, the details regarding the spot rate and the forward rate are provided.
The interest rate is 12 percent.
Pass the journal entry for recording the forward contract at the market value in the
manner which is as follows:
 The forward contract which was entered will be booked at its market value. The amount
of the contract is to receive therefore the contract receivable account is debited. The
income on the contract is credited because all the incomes are credited as per the rules
of accounting.

SLIDE 23 CONTINUED FOR REQUIRED 1

The contract is entered for 71 days in the given case. The amount of contract as per the rates
are given in the question comes out to be $9,000. This amount is to be computed for 71 days
with 12 percent rate of interest. Therefore the amount of gain comes out to be $8,794.
Pass the journal entry for recording the amount of payable at their fair value as follows:

There will be a loss in the given transaction to the person, and the loss is debited in the books
of the person and therefore the exchange loss account is debited. Accounts payable has a
credit balance and the amount of contract has to be paid to them, therefore the accounts
payable accounts are credited.

BARRA
SLIDE 24

2. Car entered into the second forward contract to hedge a commitment to

purchase equipment being manufactured to Car’s specifications. At
December 31, 2016, what amount of net gain or loss on foreign
currency transactions should Car include in income from this forward
contract? Explain

Pass the journal entry for recording the forward contract at the market value in the manner which
is as follows:
The forward contract which was entered will be booked at its market value. The amount of the
contract is to receive therefore the contract receivable account is debited. The income on the
contract is credited because all the incomes are credited as per the rules of accounting.

SLIDE 25 CONTINUED FOR REQUIRED 2

Pass the journal for recording the firm commitment in the manner which is as follows:

There is a loss on the settlement of the forward contract and the losses are debited in the books
of the person, therefore the exchange loss is debited. The amount of the contract is to be settled
in the near future and this is done on the commitment made by the person, therefore the firm
purchase commitment account is credited.

SLIDE 26

3. Car entered into a third forward contract for speculation. At December 31,
2016, what amount of foreign currency transaction gain should Car include in
income from this forward contract? Explain.
In the given case, the gain that will be recorded by the person will be $9,000 which represents
the forward contract at its market value. This gain will be recorded at the fair value of the contract
and the same will booked for the entire period till the contract lasts.