cash flow hedge
Raven is buying a machine from supplier $50m
Payment 31 Jul 20x7 - there is foreign exchange risk- if £ weakens the machine cost more pounds so to hedge the future cash outflow - entered in Forward contract 1 mar 20x7 to buy $50m at fixed rate £1=$7.4 will be paid in 5mths time
30 Apr 20x7 - forward contract gained value becoming financial asset £705,930 so DR financial asset 705,930, CR OCI CF hedge reserve 705,930
31 Jul 20x7 = machine bought and paid for - forward contrat is settled £1=$7.4
Actual spot rate £1=$5.7 so Raven saved money because without the forward cost more £ to buy $50m
They did DR suspense £8771,930 CR cash
DR cash £2,015,173 CR suspense
Net cost of machine = £6,756,757
Forward rate
1 Mar 20x7 = $50m was £1=$7.4 meaning = £6.76m
30 Apr 20x7 £1=$6.7 so $50m/6.7 =£7.46m
there was a gain of £705,930 so the cash flow hedge was effective so it is correct to recognise as financial asset and cr OCI
At spot rate
1 Mar 20x7 = $50m was £1=$7.3 meaning = £6.85m
30 Apr 20x7 £1=$6.5 so $50m/6.5 =£7.69m
Gain of £843k
as this change in FV is greater than the gain on forward contract - hedge is fully effective and whole gain on forward contract recogniesed through OCI
31 jul 20x7 - the machine was bought and paid for - so need to remeasure the financial asset
forward contract
30 Apr 20x7 50m/6.7=£7.46m
31 Jul 20x7 50m/5.7 = £8.77m
Gain on contract £1,309,243
spot rate (hedged item )
30 Apr 20x7 50m/6.5=£7.69m
31 Jul 20x7 50m/5.7= £8.77m
Gain on contract is £1.10m
the change in FV of hedged item is less than the gain on forward contract - so part of the gain on forward contract is ineffective and this is recognised in P&L
effective part is calculated on cumulative basis companring the cumulative gain on fowrard contract at inception with the cumulative gain in FV of hedge ditem from inception
Gain on forward - 795,930+£1,309,243=£2,105,173
The change in value of hedged item 842,993+1.10m = £1,922,615
Ineffecitve portion of hedge 2,105,173-1,922,615=£92,558 is recog P&L
Effective portion is recognised in OCI 1,309,243-92,558=£1,216,685
So the journal is
DR financial asset £1,309,243
CR OCI £1,216,685
CR P&L 92,558
Subsequent trestament of cum gain
705,930+1,309,243=£1,922,615 is recognsied in OCI in equity
This is cash flow hedge of new machine which is non financial asset
Hence IFRS 9 requires cash flow hedge transferred in the initial cost or carrying amount of non financial item.
At date of purchase - the machine recognsiedd at FV -
Dr the cash flow reserve £1,922,615 CR PPE
so 5 years useful life
YE 30 Apr 20x7 - 9mths
the depreciation is 8,771,930-1,922,514/5*9/12=£1,027,397 DR P&L CR depreciation