AkuntansiAkuntansiDerivatif dan Hedging
Direktorat Jenderal Pengelolaan Utang
Presented : Dwi Martani
DJPU Derivative SecuritiesJ U e at e Secu t es
Latar Belakang
Market risksMarket risks
commodity price risk interest rate risk
foreign currency risk
DJPU Derivative SecuritiesJ U Derivative SecuritiesHedges adalah kontrak yang melindungi dari risikopasar – misalnya forward options and swapspasar – misalnya, forward, options, and swaps.
Derivative securities, or simply derivatives,adalah kontrak yang nilainya diturunkan dari nilaiadalah kontrak yang nilainya diturunkan dari nilaiaset lain atau item ekonomi tertentu – saham/stock, bond, commodity price, interest rate, or currency exchange rate
Sulit untuk mencari derivatif yang benar-benardapat melindungi diri dari risiko.Ri ik k tid k ti di d tRisiko ketidakpastian di masa mendatangMelindungi dari risiko = memastikanketidakpastian.Kontrak lindung nilai memiliki risikoKontrak lindung nilai memiliki risiko
DJPU Derivative Financial InstrumentsJ U Derivative Financial InstrumentsA derivative is a financial instrument that meets the following three criteria:following three criteria:
Its value changes in response to a Settled at a futureRequires little or in response to a
change in an “underlying”
Settled at a future dateno initial
investment
Scope Exemption:
IAS 39:5 exempts contracts which meet the definition of aIAS 39:5 exempts contracts which meet the definition of a derivative from the standard if the contract is entered into to meet the entity’s usual purchase, sale or usage
Tan & Lee Chapter 9 ©2009 6
requirements
DJPU Derivative SecuritiesJ U
Instrumen keuangan atau kontrak lain dengan karakteristik:
Nilainya berubah akibat dari perubahanvariabel yg mendasari (spt suku bunga hargavariabel yg mendasari (spt suku bunga, harga, nilai tukar, dll).Tanpa investasi awal neto atau nilainya lebihk il d i il i k t k j i b ikecil dari nilai kontrak sejenis yang memberipengaruh yang sama thd perubahan faktorpasar.Diselesaikan pd tgl tertentu di masa mendatang.
DJPU Klasifikasi DerivatifJ U Klasifikasi Derivatif
F t di d i tif ( tiFreestanding derivatif (option, forward contract, swap, future
t t)contract)Embedded derivatif
DJPU Derivative Financial InstrumentsJ U Derivative Financial Instruments
Example of derivative instruments and their underlying
Types of derivative instruments
Underlying Used by
Option contracts Security price Producers trading firmsOption contracts(call and put)
Security price Producers, trading firms, financial institutions, and speculators
F d t t F i V i iForward contractse.g. foreign exchange forward contract
Foreign exchange rate
Various companies
F t t t C dit P d dFuture contractse.g. commodity futures
Commodityprices
Producers and consumers
Swaps Interest rate Financial institutions
Tan & Lee Chapter 9 10©2009
DJPU Derivative SecuritiesJ U Derivative Securities
Derivativese at es
Hedge SpeculativeSpeculative
Fair Value Hedge
Cash Flow Hedge
Foreign CurrencyHedge Hedge Currency Hedge
Fair Value Hedge
Hedge of Net Investment in Foreign O ti
Cash Flow Hedge
Operation
DJPU Derivative Financial InstrumentsJ U Derivative Financial Instruments
• Use of derivatives1. Manage market risk 2. Reduce borrowing cost3. Profit from trading or speculation
• Types of derivatives1 For ard t pe deri ati es s ch as for ard contracts f t re1. Forward type derivatives such as forward contracts, future
contracts and swaps2. Option-type derivatives such as call and put options, caps and
collars and warrantscollars and warrants3. Free standing derivatives4. Embedded derivatives
Tan & Lee Chapter 9 12©2009
DJPU Forward ContractsJ U Forward Contracts
• An agreement between two parties (counterparties) whereby oneAn agreement between two parties (counterparties) whereby one party agrees to buy and the other party agrees to sell a specified amount (notional amount) of an item at a fixed price (forward rate) for delivery at a specified future date (forward date)
• Can either be a forward purchase contract or a forward sales contract, depending on the perspective of the counterpartiescontract, depending on the perspective of the counterparties
Sells Forward “A” Company “B” CompanyContract
“Forward sales contract” “Forward purchase contract”Tan & Lee Chapter 9 13©2009
DJPU Forward ContractsJ U Forward Contracts• Not standardized contracts as they are not traded on an
exchangeexchange– They entail counterparty risks– They are can be tailored to specific needs of counterparties– They involve lower transaction costsThey involve lower transaction costs
• Fair value of forward contract:Notional x
– Current forward rate׀) contracted forward rate ׀)Notional amount
x(1+r) t
whereContracted forward rate is forward rate r = discount rateContracted forward rate is forward rate fixed at inceptionCurrent forward rate is forward rate for remaining period to maturity
r discount rate
t = period to maturity
Tan & Lee Chapter 9 14©2009
At inception date, the fair value of a forward contract is nil.
DJPU Future ContractsJ U Future Contracts
• A future contract is similar to a forward contract except that it is aA future contract is similar to a forward contract except that it is a standardized contract and is traded on an exchange
• Futures contracts are marked-to-market and settled on a daily basis• Futures contracts are marked-to-market and settled on a daily basis
• Futures contracts require payment of a margin deposit which has tobe maintained throughout the contract period
• Wide range of exchange-traded future contracts– Commodity futures– Interest rate futures– Currency futuresy
Tan & Lee Chapter 9 ©2009 15
DJPU Option ContractsJ U Option Contracts
• Contract that gives holder the right but not the obligation to buy orContract that gives holder the right but not the obligation to buy or sell a specified item at a specified price
• 2 type of option contracts• 2 type of option contracts1. Call option – right, but not obligation to buy2. Put option – right, but not obligation to sell
• Can be American option (exercisable anytime to expiration) or European option (exercisable only on maturity date)
• Can also be customized (not traded) or standard contract quoted on exchange (listed options)
Tan & Lee Chapter 9 ©2009 16
DJPU Option ContractsJ U Option Contracts
• Main featuresMain features– Purchaser (holder) pays premium to seller (writer of option)– Holder has the right, but not obligation to perform; while write has
obligation to performg p– Asymmetrical pay-off profile
• Holder has limited loss (due to premium) and unlimited gain• Writer has limited gain and unlimited lossg
Relationship between the strike price and the underlyingStrike price> Underlying
Strike price> Underlying
Strike price> Underlyingy g
(spot price)y g
(spot price)y g
(spot price)Holder of call option
Out-of-the-money At-the-money In-the-money
Tan & Lee Chapter 9 ©2009 17
Holder of put option
In-the-money At-the-money Out-of-the-money
DJPU Option ContractsJ U Option Contracts
• Fair value of option contractFair value of option contract
Fair value of an option = Intrinsic value + Time value
Diminishes over timeListed options = quoted priceNot traded options = Valuation Zero at expiration Not traded options = Valuation model ( Black-Scholes model)
Call option = Max [0, Notional amount x (Spot price – Strike Price)Put option = Max [0, Notional amount x (Strike price – Spot Price)
Tan & Lee Chapter 9 ©2009 18
DJPU Embedded DerivativesJ U Embedded Derivatives
• Derivative that is part of a hybrid financial instrumentDerivative that is part of a hybrid financial instrument
Host Instrument
Hybrid Instrument
Host Instrument
Embedded derivative:Linked to underlying and change inLinked to underlying and change in
underlying causes change in cash flow
• Example is bond whose ultimate proceed are linked to price of commodity, such as oil, or to a consumer price index
Tan & Lee Chapter 9 ©2009 19
DJPU Split Accounting of Embedded DerivativesJ U Split Accounting of Embedded Derivatives
• IAS 39 requires embedded derivatives to be separately recognizedIAS 39 requires embedded derivatives to be separately recognized from the host instrument and accounted for in the same way as a stand-alone derivative if the following conditions are met:
Conditions for separation of embedded derivative
Economic characteristics and risk of host instrument are
Hybrid instrument is not measured at fair value,
with changes in fair
There is a separate instrument with same of host instrument are
not closely related to that of the derivative
with changes in fair value recognized in
profit and loss
terms as the embedded derivative
Tan & Lee Chapter 9 ©2009 20
DJPU Accounting for DerivativesJ U Accounting for Derivatives
Default accounting treatment for derivatives under IAS 39:• Derivatives are classified under the Fair Value through Profit or
Loss category and changes in their fair values are taken to incomeLoss category and changes in their fair values are taken to income statement
• Exception - when a derivative is designated as a hedge of an identified risk and the hedge is effective In this case accounting foridentified risk and the hedge is effective. In this case, accounting for the derivative follows hedge accounting rules
Tan & Lee Chapter 9 ©2009 21
DJPU Accounting for Forward ContractJ U Accounting for Forward Contract
At inception During life of contract Closing position orAt inception During life of contract Closing position or at expiration
Dr Forward Contract (asset)
Dr Cash
No journal entry as
(asset)Cr Gain on forward contractor
Cr Forward contract
j yfair value is nil Dr Loss on forward
contractCr Forward Contract
or
Dr Forward contract
Cr Cash(liability)
Adjust fair value and Close out and record
Cr Cash
Tan & Lee Chapter 9 ©2009 22
jrecord gain/loss net settlement of
contract
DJPU Accounting for Future ContractJ U Accounting for Future Contract
At inception During life of contract Closing position orAt inception During life of contract Closing position or at expiration
Dr CashCr Gain on future
Dr CashDr Gain on f t reCr Gain on future
contract
or
Dr Gain on future contractCr Margin ContractDr Margin deposit
Dr Loss on futurescontractCr Cash
Dr CashCr Loss on future contract
Cr Cash
Record daily Close out and recover
Cr Margin Contract
Record payment of
Tan & Lee Chapter 9 ©2009 23
ysettlement of future contracts
margin depositp y
initial margin deposit
DJPU Purchased Option ContractJ U Purchased Option Contract
At inception During life of contract Closing position orAt inception During life of contract Closing position or at expiration
Dr Option ContractCr Gain on future
Dr Cash*Dr Gain on optionCr Gain on future
contract
or
Dr Gain on option contractCr Option ContractDr Option contract
(asset)Dr Loss on futurescontractCr Option Contract
or
Dr Cash*Cr Loss on option contract
(asset)Cr Cash
p
Adjust for fair value Close out and record
Cr Option Contract
Record payment of
(* assume expires in-the-money)
Tan & Lee Chapter 9 ©2009 24
jand record gain/loss net settlement of
contract
p yinitial margin deposit
DJPU Written Option ContractJ U Written Option Contract
At inception During life of contract Closing position orAt inception During life of contract Closing position or at expiration
Dr Option ContractCr Gain on future
Dr Option contractCr Gain on OptionCr Gain on future
contract
or
Cr Gain on Option Contract
Dr CashCr Option contract
(Expires out-of-the-money)
Dr Loss on futurescontractCr Option Contract
or
Dr Option contractDr Loss on optionCr Cash
Cr Option contract (liability)
money)
p
Adjust for fair value Close out and record Record payment of
(Expires in-the-money)
Tan & Lee Chapter 9 ©2009 25
jand record gain/loss net settlement of
contract
p yinitial margin deposit
DJPU HedgingJ U Hedging
• Propose is to neutralize an exposed riskPropose is to neutralize an exposed risk– Loss on hedge item offset by gain on hedging instrument– Reduce volatility than preserve gains
• Other ways of hedging through non-derivative derivatives– Money market instruments (money market hedge)
Natural hedge (offsetting foreign currency assets and liability in the– Natural hedge (offsetting foreign currency assets and liability in the same currency)
• Special accounting rules called “hedge accounting” applies when• Special accounting rules called hedge accounting applies when derivatives are used for hedging purposes
Tan & Lee Chapter 9 ©2009 26
DJPU Rationale of Hedge AccountingJ U Rationale of Hedge Accounting
• Arises because of the mismatch of income-offsetting effect betweenArises because of the mismatch of income offsetting effect between hedged item and hedging instrument
• Situations requiring hedge accounting• Situations requiring hedge accounting– Hedge item and hedging instrument are measured using different bases
(One is at cost while the other is at fair value)– Hedged item yet to be recognized in financial statementHedged item yet to be recognized in financial statement– Different treatment for changes in fair value (changes taken to equity
while the other is taken to income statement)
Tan & Lee Chapter 9 ©2009 27
DJPU Risks That Qualify for Hedge AccountingJ U Risks That Qualify for Hedge Accounting
Specific risksInterest rate risk Price riskSpec c s sthat qualify for
hedge accountingForeign exchange risk Credit risk
Risks must be specific risk, not general business risks
Possible for a derivative to hedge more than one risk
Tan & Lee Chapter 9 ©2009 28
DJPU Qualifying Hedging Instruments J U(IAS 39: 72 – 73)
• Instruments that qualify include:D i t d d i ti ( t itt ti )– Designated derivatives (except written options)
– Embedded Derivatives– Designated non-derivatives financial asset/ liability that hedge
f i h i k lforeign exchange risks only• Value used to determine hedge effectiveness
– If used in its entirety, fair value is used– If broken into time value and intrinsic value, permissible to use
intrinsic value. However, it must be explicitly documented at inception
• If derivative is used as a hedge of more than 1 risk– Individual designated component must meet hedge accounting
criteria– Permissible for portion of notional amount to be designated
Tan & Lee Chapter 9 ©2009 29
DJPU Qualifying Hedged Items J U y g g(IAS 39: 78 -79)
Qualify Do not qualify
• Financial assets and liabilities with exposure to changes in fair value
• Held-to-maturity instruments (regardless of fixed rate or variable rate)value
• Non-financial assets exposed to foreign exchange or price risks
variable rate)
• Investment in an associated company
• Firm commitment
• Highly probable forecast g y ptransaction with exposures to future cash flows
• Net investment in foreign entity
Tan & Lee Chapter 9 ©2009 30
• Net investment in foreign entity
DJPU Criteria for Hedge Accounting(IAS 39 88)J U (IAS 39: 88)
C diti t b t f h d ti t l
Enterprise must have exposure to risk that affects income
Conditions to be met for hedge accounting to apply
statement
Derivative contract specifically entered to hedge underlying exposureexposureHedge must be highly effective
Effectiveness of hedge can be reliably measuredEffectiveness of hedge can be reliably measured
Hedging relationship must be formally documented at the inception of the hedge
Tan & Lee Chapter 9 ©2009 31
inception of the hedge
DJPU Assessing Hedge EffectivenessJ U Assessing Hedge Effectiveness
• IAS 39:9 - The degree to which changes in the fair value or cashIAS 39:9 The degree to which changes in the fair value or cash flows of the hedged item that is attributable to a hedged risk are offset by changes in the fair value or cash flow of the hedging instrument
• Hedge effectiveness is evaluated– Prospectively on inception of hedge; and– Retrospectively on an ongoing basisp y g g
• On inception, hedge effectiveness is assessed on– Comparison of the principal or critical terms– Historical analysisHistorical analysis– Correlation analysis
Tan & Lee Chapter 9 ©2009 32
DJPU Efektivitas HedgingJ U Efektivitas Hedging
Efektifitas dihitung secara prospektif danEfektifitas dihitung secara prospektif danretrospektifH il kt l b d d l ki 80Hasil aktual berada dalam kisaran 80 -125%Seluruh lindung nilai yang tidak efektif diakui dalam laporan L/R (termasukketidakefektifan dalam kisaran 80 -125%)
DJPU Efektivitas HedgingJ U Efektivitas Hedging
Risks must be identifiableRisk must be foreseeableRisk must be realistically measuredyPrecise attribution of hedging instrument to hedged itemg
Reason:Impact of hedging in financial report should be p g g pas neutral as possible
DJPU Kriteria & DokumentasiJ U Kriteria & Dokumentasi
KriteriaTdpt kebijakan tertulis, tujuan manajemen risiko & strategi lindung nilai.H b li d il i dih k f ktif tk liHubungan lindung nilai diharapkan efektif utk salingmenghapuskan perubahan nilai wajar.
DokumentasiDokumentasiIdentifikasi hedged items vs hedging instruments.Sifat risiko yang dilindungiSifat risiko yang dilindungiStrategi manajemen risiko dan lindung nilaiPenilaian efektifitas instrumen lindung nilai
DJPU Assessing Hedge EffectivenessJ U Assessing Hedge Effectiveness
• During the duration of hedge, hedge effectiveness is assessed onDuring the duration of hedge, hedge effectiveness is assessed on dollar-offset method:
• Hedge effectiveness ratio (HER):
Hedge effectiveness(or delta ratio) =
Changes in fair value or future cash flow of hedging instrumentChanges in fair value or future cash flow of hedged item
0 8 1 20.8 1.25
• Exceptions for effective hedge even if HER falls out of range– IAS 39 allows hedge effectiveness to be assessed on cumulative basis
Effective hedge (IAS 39: AG 105b)
S 39 a o s edge e ect e ess to be assessed o cu u at e bas sif hedge is designated and conditions are properly documented
Tan & Lee Chapter 9 ©2009 36
DJPU Assessing Hedge EffectivenessJ U Assessing Hedge Effectiveness
• Exclusion of time value of certain derivatives to be excluded fromExclusion of time value of certain derivatives to be excluded from hedge relationship– Derivative separated into 2 component
1. Time value (options) or interest (forwards)1. Time value (options) or interest (forwards)2. Intrinsic (options) or spot element (forwards)
– Excluded time value taken to income statement as per default treatment– Should result in highly effective hedge, as intrinsic/ spot componentShould result in highly effective hedge, as intrinsic/ spot component
moves in tandem with underlying, while time/interest component does not
– If critical terms of hedging instruments and hedged item are exactly the same, HER should be equal or around 1
Tan & Lee Chapter 9 ©2009 37
DJPU Classification of Hedging RelationshipsJ U Classification of Hedging RelationshipsCauses Explanation
Hedge of “the exposure to changes in fair value of aHedge of the exposure to changes in fair value of a recognized asset or liability or an unrecognized firm commitment, or an identified portion of such asset, liability or firm commitment, which is attributable to a particular i k d ld ff t fit l ” (IAS 39 86 )
Fair valuehedge
risk and could affect profit or loss” (IAS 39:86a)
Hedge of “the exposure to variability in cash flows that(i) is attributable to a particular risk associated with a
i d t li bilit ( h ll f tCash flow
recognized asset or liability (such as all or some future interest payment on variable debt instrument )or a highly probable future transaction, and(ii) could affect profit or loss” (IAS 39:86b)
hedge
( ) p ( )
Hedge of a net investment in a f i tit
Hedge of the foreign currency risk associated with a foreign operation whose financial statements are required to be translated into the presentation currency of the
Tan & Lee Chapter 9 ©2009 38
foreign entity to be translated into the presentation currency of the parent company
DJPU Classification of Hedging RelationshipsJ U Classification of Hedging Relationships
• The designation of a derivative as a fair value hedge or a cash flowThe designation of a derivative as a fair value hedge or a cash flow hedge is determined by the hedged risk, that is, whether the entity has a fair value exposure or a cash flow exposure
• An exception where a derivative can be designated as either a fair value hedge or a cash flow hedge is where the hedged risk is the foreign exchange risk of a firm commitmentforeign exchange risk of a firm commitment
Tan & Lee Chapter 9 ©2009 39
DJPU Accounting for a Fair Value HedgeJ U Accounting for a Fair Value Hedge
Hedged Item (recognized asset or liability or firm commitment) Hedging Instruments
Income statementGain (loss) on hedging instrument
Change in fair value Change in fair value
Gain (loss) on hedging instrument offset loss (gain) on hedged item
Balance sheet
Change in fair value adjusted against carrying amount
Change in fair value adjusted against carrying amount
Tan & Lee Chapter 9 ©2009 40
against carrying amount against carrying amount
DJPU
Illustration 1:Hedge of inventory (fair valueJ U Hedge of inventory (fair value hedge)
ScenarioScenario31/10/20x3
Inventory of 10,000 ounces of goldCarried at cost of $3 000 000 ($300 per ounce)Carried at cost of $3,000,000 ($300 per ounce)Price of gold was $352 per ounce
1/11/20x3Sold forward contract on 10 000 ounce for forward price of $350 ounceSold forward contract on 10,000 ounce for forward price of $350 ounce Forward contract matures on 31/3/20x4
31/12/20x3F d i f 31/3/20 4 t t $340 d t iForward price for 31/3/20x4 contract was $340 per ounce and spot price of gold was $342 per ounceHedge effective ratio of 1 on 31/12/20x3
Tan & Lee Chapter 9 ©2009 41
DJPU
Illustration 1:Hedge of inventory (fair valueJ U Hedge of inventory (fair value hedge)
1/11/20x31/11/20x3No entry or just a memorandum entry as the fair value of the forward
contract is nil
31/12/20 331/12/20x3
Dr Forward contract ………………. 100,000Cr Gain on forward contract ……... 100,000C Ga o o a d co t act 00,000Gain on forward contract: 10,000 x ($340 -$350)
Dr Loss on inventory 100 000
Taken to income statement
Dr Loss on inventory ……………… 100,000Cr Inventory ……………………….. 100,000Gain on forward contract: 10,000 x ($342 - $352)
Tan & Lee Chapter 9 ©2009 42
DJPU
Illustration 1:Hedge of inventory (fair valueJ U Hedge of inventory (fair value hedge)31/3/20x4
Inventory is sold to third-party at $330 per ounce (also maturity date of y p y $ p ( yforward contractDr Forward contract ………………. 100,000Cr Gain on forward contract 100 000Cr Gain on forward contract ……... 100,000Gain on forward contract: 10,000 x ($330 -$340)
Dr Loss on inventory 120 000Dr Loss on inventory ……………… 120,000Cr Inventory ……………………….. 120,000Gain on forward contract: 10,000 x ($330 - $342)
Dr Cash …………………………….. 3,300,000Cr Sales ……………………………. 3,300,000Sale of inventory: 10 000 x $330
43
Sale of inventory: 10,000 x $330
Tan & Lee Chapter 9 ©2009
DJPU Accounting for a Cash Flow HedgeJ U Accounting for a Cash Flow Hedge
Effective Cash Flow Hedge (IAS 39:95)39:95)
Effective portion of gain/ loss
Ineffective portion of gain/ loss
Recognized directly in equity
through statement Recognized in profit or lossof changes in
equity
or loss
Tan & Lee Chapter 9 ©2009 44
DJPU Accounting for a Cash Flow HedgeJ U Accounting for a Cash Flow Hedge
Cash flo hedges are applicable to the follo ingCash flow hedges are applicable to the following:
ForecastedForecasted transactions
involving financial d fi i l
Other transactions I t t tand non-financial
assets/liabilities which will result
which affect future cash flows
Interest rate swaps
in cash inflow/ outflow
cash flows
Tan & Lee Chapter 9 ©2009 45
DJPU Effective and ineffective portionsJ U Effective and ineffective portions
Scenario1/1/20 11/1/20x1
Entered into futures contract to hedged forecast transaction at 30/4/20x1Classified as cash flow hedge
Period ending
∆ in fair valueof future contracts
∆ in present value of expected future cashending of future contracts expected future cash
flow31/1/20x1 $100 $(105)28/2/20x1 90 (80)31/3/20x1 103 (105)30/4/20x1 (38) 45
Tan & Lee Chapter 9 ©2009 46
30/4/20x1 (38) 45
DJPUIllustration 2:Effective and ineffective portions of aJ U Effective and ineffective portions of a cash flow hedge
Determination of effective and ineffective portions of a cash flow hedge
Cumulative Cumulative
Lesser of two
cumulative
Effective portion
credited/ (debited)
Ineffectiveportion
credited/ (debited)
Period
Cumulative ∆ in FV of
future contracts
Cumulative∆ in PV of expected cash flow
cumulative amount in absolute
terms
(debited)to equity in
current period
(debited) to income statement in current
ending (a) (b) (c) ( period31/1/20x1 $100 $(105) $100 $100 $028/2/20x1 190 (185) 185 85 5( )31/3/20x1 293 (290) 290 105 (2)30/4/20x1 255 (245) 245 (45) 7
Tan & Lee Chapter 9 ©2009 47
DJPU Hedge of a Net Investmenti F i E titJ U in a Foreign Entity
• Hedge risk is foreign exchange riskHedge risk is foreign exchange risk– Applies to foreign operations whose functional currencies are the
currencies of the country where the foreign operations are located– Closing rate method may result in significant translation loss from g y g
depreciating currencies
• Accounting treatment similar to cash flow hedgeg g
Hedge effectiveness=Cumulative change in fair value of hedging instrument (A)Cumulative translation difference on net investment (B)
– Hedge is effective if the delta ratio is between 0.8 and 1.25.– Unlike a fair value hedge or a cash flow hedge, a non-derivative is
allowed to be the hedging instrument for example a foreign currencyallowed to be the hedging instrument, for example, a foreign currency loan.
Tan & Lee Chapter 9 ©2009 48
DJPU Hedge of a Net Investment in a Foreign EntityJ U g g y
ScenarioScenarioFunctional currency is the dollar ($)Acquired 100% interest in foreign company (functional currency is FC)
31/12/20x3Exchange rate is $1.85 to FC1Loan of FC1 200 000 at 5% interest taken to hedge foreign investmentLoan of FC1,200,000 at 5% interest taken to hedge foreign investmentForeign currency translation reserves showed $15,000 (credit balance)
31/12/20031/12/200x4Exchange rate is $1.70 to FC1Average rate is $1.78 to FC1Foreign company reported net profit of FC380,000
Tan & Lee Chapter 9 ©2009 49
DJPU Hedge of a Net Investment in a Foreign EntityJ U g g y
Translation difference in foreign investment’s FS for 31/12/20x4
On net assets on 1/1/20x4 (FC 1,200,000 x $(1.70-1.85) ……. $(180,000)On net profit for 20x4 (FC380,000 x $(1.70-1.85) …………….. (30,400)Translation loss for 20x4 $(210,400)Foreign currency translation reserves (credit balance) (195,400)
Journal entries for parent31/12/20x3
Dr Cash 2 200 000Dr Cash …………………………….. 2,200,000Cr Loan payable …………………... 2,200,000The loan payable is designated as a hedge of the net investment:FC1 200 000 t t f $1 85
Tan & Lee Chapter 9 ©2009 50
FC1,200,000 x spot rate of $1.85
DJPU Hedge of a Net Investment in a Foreign EntityJ U Hedge of a Net Investment in a Foreign Entity31/12/20x4
Dr Interest expense ………………. 106,800p ,Cr Accrued interest ……………….. 106,800Interest expense during the year at 5% x FC1,200,000 x $1.78
Dr Accrued interest ……………….. 106,800Cr Cash …………………………….. 102,000Cr Exchange gain 4 800
Taken to equity t ff tCr Exchange gain …………………. 4,800
Settlement of accrued interest at year-end
Dr Loan payable …………………... 180,000
to offset translation loss
Dr Loan payable …………………... 180,000Cr Foreign currency translation
reserves …………………………180,000
Exchange gain on FC loan taken directly to equity:Exchange gain on FC loan taken directly to equity:FC 1,200,000 x ($1.70 - $1.85)
Tan & Lee Chapter 9 51©2009
DJPU Discontinuation or Termination J Uof Hedge Accounting
Consideration for discontinuation or termination of hedge accounting
Hedging instrument has reached maturity date or is closed off or
Hedge designation is revoked
Criteria for hedge accountingdate or is closed off or
terminatedis revokedis no longer met
Accounting treatment depends on type of hedge
Tan & Lee Chapter 9 ©2009 52
DJPU Evaluation of Hedge AccountingJ U Evaluation of Hedge Accounting
• Objective of hedge accountingObjective of hedge accounting– Reflect effectiveness of hedging activities of a firm– Reduce volatility of reported earnings
• Compliance with hedge accounting may result in considerable expenditure of resources
• There are challenges in compliance with hedge accounting criteria for macro hedges
• Issue is whether the additional costs of compliance more than offset the benefit of applying hedge accounting
Tan & Lee Chapter 9 ©2009 54
DJPU ReferensiJ U Referensi
Tan & Lee Advance Financial Accounting, ch 9: Accounting f D i ti d H d A tifor Derivatives and Hedge Accounting
PSAK 50 dan 55
IAS 32 dan 39
International Financial Reporting Standards – Certificate Learning Material The Institute of Chartered AccountantsLearning Material The Institute of Chartered Accountants, England and Wales
Materi Public Hearing PSAK 55Materi Public Hearing PSAK 55
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