Case 1 - Hedging

Case study:

Hedging 1

1. A metal refining company has inventory of a precious metal for resale which it carries at the lower of cost or net realisable value under IAS 2. In order to protect itself from the economic effect of fluctuations in metal prices, it enters into a short futures contract in respect of half of the quantity of this metal. Metal prices rise, and at the balance sheet date the fair value of the futures contract is a liability of 50,000. Can such a transaction qualify as a hedge under IAS 39 (assuming the other requirements concerning designation etc. are satisfied)? If so, is it a cash flow hedge or a fair value hedge, and how is the 50,000 accounted for? Draft the necessary journal entries at the year end. 2. On 15 November 2011, a company places an order with a foreign supplier to purchase an item of heavy machinery, which will be invoiced in foreign currency (FC) at a price of FC10,000 and payable on delivery of the machinery in the middle of February 2012. In order to fix the price in its own local currency (LC), it contracts with a bank to buy the required amount of foreign currency for delivery on 15 February for LC4,000, i.e. at a forward rate of FC2.5 = LC1. At the year end the foreign currency has strengthened against the local currency and the forward currency contract has a positive value of LC500. How is this accounted for under IAS 39? Draft the necessary journal entries.

Case hedging 1

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