Understanding the Financial Aspects and Impact of Hedging

This report reveals the key understanding on the financial aspects and impact of the hedging on the return on capital employed on the invested capital of the investor. It is found that while considering the recognition and measurement, the company uses AASB-139 to derive the use of financial instruments. The hedging is used to strengthen the return on capital employed and lower down the systematic an unsystematic risk of the investment.

HEDGING

Executive summary
This report reveals the key understanding on the financial aspects and impact of the
hedging on the return on capital employed on the invested capital of the investor. It is found
that while considering the recognition and measurement, the company uses AASB-139 to
derive the use of financial instruments. The hedging is used to strengthen the return on capital
employed and lower down the systematic an unsystematic risk of the investment.

Contents
Executive summary...............................................................................................................................1
Introduction...........................................................................................................................................3
Answer-1...............................................................................................................................................3
Answer-2...............................................................................................................................................4
Answer-3...............................................................................................................................................5
Advantages and disadvantages of hedge accounting........................................................................5
Answer-4...............................................................................................................................................6
Conclusion.............................................................................................................................................8
References.............................................................................................................................................8

Introduction
While investing in any organisation, hedging is defined as the exposure of risk
regarding the fluctuation in financial prices such as interest rates, commodity prices, equity
prices, and forex rate. Hedging is the way of managing the prices under the financial risks.
This report reveals the key understanding of the hedging funding and its impact on the
financial decision making.
Answer-1
. From the new reports, it is seen that foreign exchange has become the largest share of
market (Investing answers, 2019). Nearly, daily volume FX market is $5 trillion, which is
four times more than the trading organisations listed on FTSE 100 (Investing answers, 2019).
It is said that it is a good idea for the organisations to protect from the fluctuations in the
exchange rates by using hedging. This can have huge impact on fluctuations in the market
prices, which have destructing impact on organisation’s profitability (Investing answers,
2019). Nick Scali limited has recently adopted ISAB 9 in its accounting, which does not have
any affected the financial statements of the organisation i.e. it will be neither positive nor
negative. Companies are often exposed to financial risks when they deal or conduct overseas
transaction. However, it is important to know that separate organisations have different
concerns (PWC, 2019). Nick Scali has been handling concern regarding the exchange rates,
interest rates and other concerns related to commodity prices. Nick Scali company has been
implemented several different management risk strategies that could minimise the risk
associated with risk exposure such as scenario planning, risk matrix, hedge funding and other
investment derivatives options. The main objective of accounting of hedging is the way,
which can modify normal basis in order to recognise the losses and gains identified on
hedging instruments (PWC, 2019).

Answer-2
While complying with the (AASB) accounting standards, it is seen that nick Scali limited. In
2018, the organisation owns trade payable of nearly $3557300 that is being traded in US
dollars where $3729315 of stock is in transit (Nick Scali limited, 2018). This case is the part
of designed hedging cash flows. As an outcome, it is seen that that risks of changes in $US is
minimal (Nick Scali limited, 2018). Change in currency rate will lead to effect the profit and
there can be great occurrence of loss due to the effect of cost of goods sold as per the
(inventory) hedging items, which is sold to the customers. It is important to know each
hedging transaction and activity is subject to accounting principles (Investing answers, 2019).
During 2018, the company complied with the foreign currency in the forward contracts,
which is related to huge uncertainty for highly probable amount of purchases as it is expected
to suffer from fluctuations (Nick Scali limited, 2018). Both parties have fully cashed the
collateral with the foreign currency contracts in order to eliminate the risk of credit is
associated with contracts, contract is inclusive of organisation`s credit risk and counter party
risk. It is being observed that hedges were effective as in 2018; the company earned an
unrealised gain of $1403000, which was accounted in the comprehensive income statement
(PWC, 2016).
This favourable condition was due to the application of accounting aspects regulated for the
financial instruments. Nick Scali limited has adopted the components of hedging accounting
of the related standards that is related to the forward exchange for contracts. The company
follows new requirement that follows and finalised on November 2013 (Nick Scali limited,
2018). Moreover, IFRS 9 and other conceptual frameworks state that it is important to
provide general hedge requirements of accounting. The company is working on separate
projects where it was used to address the accounting for the hedging of open portfolios
(PWC, 2019).

Nick Scali limited has regulated risk management policies and procedures so that it can
identify and evaluate certain risk, which is faced by the company. The company set certain
risks limits and other controls in order to monitor risk and comply with the risks. By
complying with the risk management, procedures and policies are revised in order to reflect
several changes at the marketplace (Nick Scali limited, 2017). Majority of sales of Nick Scali
limited is dominated by either Australian dollar or New Zealand dollars mainly US dollars.
Therefore, it has to comply with the contracts of forward currency and options so that it can
manage several currency exposures. It is important to manage hedging risk to meet the
qualifying criteria (Nick Scali limited, 2018).
Answer-3
Advantages and disadvantages of hedge accounting
Advantages
Hedging through forward contracts helps to lower the risks in the transaction. For example-
while purchasing goods, the company enter into the hedging agreements in order to mitigate
the risks that is associated with the purchases (PWC, 2018).
IFRS-9 states that company designate the component of hedge in the non-financial items.
Accounting of hedging item does not affect the underlying exposure to risk to other financial
statements. As it is treated as another separate component of equity (PWC, 2016).
The company uses cash flow at risk in order to manage the risks by assessing the correlation
between the exposures of risk related to several asset classes, which further helps to drive the
analytics better (Sherman, 2018).
Disadvantages
Sometimes, the company takes pride in attempting to take risks and earn money. This
accounting concept would limit risk volatility by designating policies and procedures for

derivative instruments. There are restatements of risks, which is linked to hedging
accounting, which is related to checking and documentation of the hedging effectiveness
(Accounting and tax, 2008).
During the application of accounting of hedging, it is seen that volatile earning has negative
impact on organisation`s value. For instance- if a hedging contract is made on fix decided
price with the bank, then the company will be liable or rewarded to only that particular
amount and it will not get any gain.
Earlier, the company have not adopted and it was not easy to qualify hedging because it was
costly too. The documentation were also untimely, unavailable, and inadequate (Drew, 2018).
As per Nick Scali limited, the risk is explicit and there are various reasons of not treating it in
the financial statements and its effect too because its documentation will be a burden on the
ongoing effectiveness of hedging (Drew, 2018).
This accounting standard is highly effective in regards to fixed specific risks but is does not
work in the changes in fair value and the variability of the cash flows. Hurdles brought by the
hedging risks are very costly (Drew, 2018).
Answer-4
Application of hedging instrument
While considering the recognition and measurement, the company uses AASB-139 to derive
the use of financial instruments. Among the instruments, the company uses derivative
financial instruments where it is recognised at the fair value for the data when the derivative
contract is made and entered into by measuring the fair value on the reporting date.
Identifying the resulted loss and gain, which depends on whether the derivative is considered
as hedging instrument by including the nature of account transaction that is being hedged. As
far as the hedging instrument is considered, nick Scali entitle derivative as effective hedging

tool for the fair value of the assets and liabilities in the commitment procedure of the
organisation and hedging of the probable transaction that will be effected by the transactions
(Kota, 2018).
Nicks Scali limited has started adopting the new policies and procedure according to IFRS-9.
This requires that there is strong economic between hedging instrument and hedged item. If
there is, a huge risk associated with the trade payable (in regards to foreign currency
transaction). It is important to know value of hedged item and hedging instrument move in
opposite direction because of regular underlying and hedged risk (Nicks Scali limited, 2017).
Nicks Scali limited conducts exports its goods and sell its products overseas, where it is
exposed to credit risk and currency risks (Nicks Scali limited, 2018). A change in credit risk
related to derivative hedging instrument and the hedged item should not be of that magnitude,
which further dominates the change in the values, resulted from the economic relationships.
This hedging instrument of derivate when register through an agreement with the bank will
be associated with the hedging accounting model, which is based on general notions of the
offset between hedged item and the hedging instrument (Nicks Scali limited, 2017). The
effect of credit risk will be dominated with the changes in the values related with the hedged
risks. For instance- when nicks Scali decides and forecasts the price of the inventory purchase
due to commodity risk then it undertakes to agree into a derivative agreement or contract with
the bank so that it can purchase the inventory at the fixed price and on forecasted future date
(Wolf, 2019). In case, the derivative contract remains uncollateralised and at the same time if
it can face severe deterioration in the credit standing of the bank considered (Wolf, 2019).

Conclusion
The strong economic between hedging instrument and hedged item. If there is, a huge risk
associated with the trade payable (in regards to foreign currency transaction). It is important
to know value of hedged item and hedging instrument move in opposite direction because of
regular underlying and hedged risk (Nicks Scali limited, 2017). Further, the impact caused
from the changes in the risk associated with the changes that created a disproportionate risk
to the effect of change on the fair value of derivative contract as well as the price of
commodity prices. Therefore, the risk of the company will totally depend on the statements
and conservation between the bank and the company.
References
Accounting and tax, (2008) Why CFOs Still Don’t Like Hedge Accounting. Available on:
http://www.cfo.com/accounting-tax/2008/09/why-cfos-still-dont-like-hedge-
accounting/ [Accessed on: 16/05/19]
Drew, J., (2018) Hedge Accounting: 3 Key Benefits of IFRS 9. Available on:
https://www.reval.com/hedge-accounting-3-key-benefits-ifrs-9/ [Accessed on:
16/05/19]
Investing answers, (2019) Hedge. Available on:
https://investinganswers.com/dictionary/h/hedge [Accessed on: 16/05/19]
Kota, H.B., 2018. Determinants of Financial Derivative Disclosures in an Emerging
Economy: A Stewardship Theory Perspective. Australasian Accounting, Business and
Finance Journal, 12(3), pp.42-66.
Nick Scali limited, (2017) Annual report, 2018. Available on:
https://www.nickScali.com.au/media/wysiwyg/pdfs/NCK_-
_Annual_Report_2017.pdf [Accessed on: 16/05/19]

Nick Scali limited, (2018) Annual report, 2018. Available on:
https://www.nickScali.com.au/media/wysiwyg/pdfs/NCK_-
_Annual_Report_2018.pdf [Accessed on: 16/05/19]
PWC, (2016) Practical guide General hedge accounting. Available on:
https://www.pwc.com/gx/en/audit-services/ifrs/publications/ifrs-9/practical-general-
hedge-accounting.pdf [Accessed on: 16/05/19]
PWC, (2019) International Financial Reporting Standards IAS 39 – Achieving hedge
accounting in practice. Available on:
https://www.pwc.com/gx/en/ifrs-reporting/pdf/ias39hedging.pdf [Accessed on:
16/05/19]
Sherman, F., (2018) Advantages and disadvantages of hedging. Available on:
https://bizfluent.com/info-8456302-advantages-disadvantages-hedging.html
[Accessed on: 16/05/19]
Wolf, F., 2019. Hedging decisions and firm value: a cross-validation study of Australian and
Canadian industries (No. Ph. D.). Deakin University.