Concept of Hedge Instrument: Accounting | PPT

Option #2: Hedging Transactions On September 30, we enter into a futures contract to hedge the value of gold which we will use in our manufacturing process and report on our balance sheet at $500,000. On December 31, the market value of gold has declined to $450,000. However, the futures contract that we had purchased increased in value by $45,000. Submission Requirements: Prepare a PowerPoint slide presentation illustrating the following: The basics of a hedge instrument Recognition criteria under a GAAP versus IFRS basis How much net profit or loss will we recognize? How any profit or loss will be recognized under a GAAP basis. Review the grading rubric following this assignment, to understand how you will be graded on this assignment. Reach out to your instructor if you have questions about the assignment.

ACCOUNTING

Hedge Instrument
 Hedge Instruments are the financial instruments that has been used by
most of the investors to offset the change value of the hedged items.
 It is used to minimise the risks and to secure their exchange rate in the
future.
 This is done in the form of contracts to eliminate the risks & acquire a
potential gain in the future.
 Hedge instruments includes various financial instruments like stocks,
forward contracts, future contracts, swaps and options.

Hedging Techniques
 Contracts for forward exchange of currencies/interest
 Future contract for currencies/interest
 Money market operations
 Calls on equities

Hedged instrument under GAAP
 Under GAAP accounting system, the hedging instruments must
be highly effective in achieving the changes in the fair value
that has been attributed to the hedged risks.
 This means that, the changes in fair value of hedging
instrument is in the range 80%-125% of the changes in fair
value that has been attributed to the hedged risks.

Hedged Instrument under IFRS
 According to IFRS 9, all the hedge ineffectiveness must
be recognised in a company’ comprehensive income.
But, there is an exception to hedge of equity
investments that has been designated at the fair value.
 A hedged relationship must be effective if there is a
good economic relation among the hedged item &
hedged instrument that is offset, the credit risk effect
doesnot dominate the change in value, the entity uses
hedged ratio under its risk management strategy.

Recognition under GAAP vs IFRS
GAAP
 Hedged effectiveness is not separately
measured for cash flow & net investment
hedges in the income statement.
 The changes in fair value of hedge item & the
derivative hedging instruments both are
recorded in the current earnings
(Cmegroup.com, 2020).
IFRS
 The changes in fair value of hedge instrument
is written in OCI.
 The effective proportion of changes in fair
value of hedge instrument is recognised in
OCI & the ineffective proportion of hedging
relationship is recognised in profit or loss.

Hedging Transactions for net
profit or loss
The value of gold reported in balance sheet= $500,000
The market value of gold declined = $450,000
Total gain according to the market value= $500,000-$450,000
= 50,000
Increased value in future contract= $45,000
The net loss of the value of gold= $50,000-$45,000
=$5000

Profit or loss under GAAP
 There is a net loss achieved in the future contract of gold due to
increase in purchase value of gold by $45,000. Therefore, there is a
net loss of $5000 in the value of gold.
 Under GAAP, it is mentioned that, any changes in the fair value of a
financial liability due to changes in specific risk, a fair value of
hedge will be used with respect to the hedged risks (Pwc.com.
2020) The adjustment of this carrying amount of gold will be
recognised in profit or loss even if the changes is normally
recognised in other comprehensive income (OCI).

Conclusion
 There is a net loss achieved in the future contract of gold that will
be used in the manufacturing process due to increase of
purchasing value of gold by $45,000. The total net loss was $5000.
 Under GAAP, the changes should be directly recognised in profit or
loss even if it is normally recognised in other comprehensive
income.

References
 Cmegroup.com. (2020). Retrieved 24 February 2020, from
https://www.cmegroup.com/education/files/fincad-hedge-accounting-kpmg-
whitepaper.pdf
 (2020). Pwc.com. Retrieved 24 February 2020, from
https://www.pwc.com/hu/en/szolgaltatasok/konyvvizsgalat/treasury_advisory/
publications/hedge_accounting_contrasting_us_gaap_and_ifrs.pdf

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