Question

On 1 June2020, Purchase Limited enters into a firm commitment Supply Limited to buy USD 100,000 of
inventory. On 1 July 2020, the Purchase Limited enters into a hedging arrangement which meets the hedge
accounting criteria stipulated by the accounting standards (Australian Accounting Standards Board (AASB) 9).
Purchase Limited has designated the firm commitment hedging arrangement as a fair value hedge. On 1 August
2020, Supply Limited transfers the inventory to Purchase Limited, and on that date, the Purchase Limited makes
the payment. The spot and forward rates are as follows.

Date	Spot rate in AUD	Forward rate in AUD
1 June 2020	0.19	0.2
30 June 2020	0.2	0.25
1 August 2020	0.3	0.3

Required:
a) Explain at least two determinants of determining an effectiveness of a hedge instrument against a
hedge
5 Marks
b) Provide journal entries to account for the hedged item (firm commitment to buy inventory) 8 Marks
i. On 1 June 2020
ii. On 30 June 2020
iii. On 1 August 2020
c) Provide journal entries to account for the hedge instrument (forward contract) 7 Marks
i. On 1 June 2020
ii. On 30 June 2020
iii. On 1 August 2020

Answer 1

Requireed a

Effectiveness of hedge instruments means how effective an hedging instrument is to reduce the effect of changes in foreign exhange rates on the foreign currency receivables and payables of the organization.

The determinants / methods for testing the effectiveness of a hedge instrument are:

The Dollar Offset method: This method determines what percentage of the future expected cashflows from the hedged item is hedged against the risk of changes in the foreign currency rates by way of an offsetting cashflow from the hedging instrument.

Regression Analysis: It is a statistical tool which determines how strong is the relationship between the change in the future expexted cash flow and the change in the cash flows from hedging instrument.

Required b

Journal entry for firm commitment

Required c)

Journal entry to record forward contract

   

Debit Credit Date 01-Jun-20 Accounts and explanation No entry i) ii) 30-Jun-20 No entry 30,000 $ 30,000 01-Aug-20 Purchase (import) Accounts Payable (to record purchase of goods as per firm commitment) 01-Aug-20 30,000 Accounts Payable Cash (to record payment to Accounts payable) 30,000