question archive (a) Provide a brief overview of financial reporting requirement for hedge accounting as prescribed by MFRS 9 Financial Instruments
(a) Provide a brief overview of financial reporting requirement for hedge accounting as prescribed by MFRS 9 Financial Instruments
Subject:AccountingPrice: Bought3
(a) Provide a brief overview of financial reporting requirement for hedge accounting as prescribed by MFRS 9 Financial Instruments.
(b) i) Determine the information (i.e. asset/liability, revenue/expense and disclosure) to be reported in the financial statements for the year ended 31 December 2019 with regard to the use of derivative instrument.
ii) Show the necessary journal entries for 2019 and 2020.
Bina Auto (BA) is a Malaysian company that produces components for automotive industry. The production of the components requires electronic parts produced by the manufacturer in China. Purchases of the electronic parts are in Chinese yuan (CNY). The management of BA is aware that the company is exposed to foreign currency risk as purchases are denominated in CNY. Should the Chinese yuan become stronger again the ringgit, BA has to pay more for the purchase of the electronic parts. Hence, the management adopts a risk management policy that requires the company to hedge the foreign currency risk arising from its highly probable forecast purchase.
In December 2018, the production manager estimated that 200,000 electronics parts would be required for the production in the third quarter of 2020. Purchase of the electronic parts was expected to be made in early 2020. BA had negotiated with the manufacturer in China to secure a purchase price of CNY25 per unit. Therefore, the cost of the purchase would be CNY5,000,000 (200,000 x CNY25).
The trend in foreign exchange rate had shown that CNY had been strengthening. BA believed that CNY strengthening would affect its income. Therefore, on 1 January 2019, BA purchased a call option to purchase CNY against RM to protect against the risk of CNY strengthening. The purchase of foreign currency call option to hedge the highly probable forecast purchase was as follows:
Amount purchase CNY5,000,000
Strike price RM0.6189/CNY
Spot rate on 1 January 2019 RM0.6189/CNY Intrinsic value of option on 1 January 2019 0
Option premium RM154,725
Start date 1 January 2019
Maturity date 31 July 2020
The fair value of the option and the exchange rates during the hedging period were as follows:
1 January
2019
30 June
2019
31
December
30 June
2020
31 July
2020
2019 Fair value of option RM154,725 RM318,728 RM16,092 RM928 0a
Intrinsic value of option
0
278,500b
0
0
0
Time value of option
154,725
40,228
16,092
928
0
Spot rate
RM0.6189
RM0.6746
RM0.5936
RM0.5698
RM0.5584
Strike rate
RM0.6189
RM0.6189
RM0.6189
RM0.6189
RM0.6189
a At maturity date the fair value of option is zero as the option expired out of money.
b Intrinsic value is computed as the difference between the strike rate and the spot rate multiplied by the nominal amount.
In January 2020, BA placed order with the manufacturer in China to purchase 200,000 electronic parts at a price of CNY25 per unit. The delivery date was scheduled on 30 June 2020 and payment was made on 31 July 2020. All the electronic parts were used in the production in the third quarter of 2020. The finished goods were sold to customers in November 2020. Cost of goods sold was recorded in profit or loss in November 2020.
BA applied hedge accounting to account the hedge of foreign currency risk. It was able to demonstrate that it met all the requirements for hedge accounting. The hedge was classified as cash flow hedge. Only the intrinsic value was designated as hedging instrument as allowed by MFRS9. The intrinsic value was discounted at 6% to reflect time value of money.
