Question

FASB Codification Project Value:

Read the case below and answer the 3 questions.

Jordan Corp is a US manufacturer of auto parts with branch operations in France. On December 31, 2016 wishes to use a foreign currency option to hedge a 10,000,000 euro denominated accounts receivable that is due in two years. Jordan plans to use fair value hedge accounting. Over the subsequent 4 quarters the following are the changes in the fair value of the receivable and the foreign currency option hedge.

Quarter ended March 31, 2017:

Euro receivable increases by $ 400,000

Option hedge declines by $350,000

Quarter ended June 30, 2017:

Euro receivable decreases by $500,000

Option hedge increases by $ 400,000

Quarter ended Sept. 30, 2017:

Euro receivable decreases by $800,000

Option hedge increases by $700,000

Quarter ended Dec. 31, 2017:

Euro receivable increases by $ 200,000

Option hedge decreases by $ 100,000

Answer the following questions:

1 . Structure the appropriate fair value hedge using an FX option. Your answer must state whether Jordan is purchasing or selling a call option or a put option, what is the maturity date of the option as well as whether it is an option to purchase euros and sell US dollars or an option to purchase US dollars and sell euros. (1 point).

2 . Identify by codification reference, e.g., xxx-xx-xx-xx, and attach AND HIGHLIGHT the appropriate section(s) of the FASB codification that describe the alternate criteria that can be used to determine at December 31, 2017 whether or not this has been an effective fair value hedge (2 points ).

3. Using one of the alternate criteria in your answer to #2 above, state your conclusion as to whether this is an effective hedge, meeting the FASB criteria. You must include a computation to support your conclusion. (2 points ).

Answer 1

Ans:

1. Hedging is offsetting of one risk against another. An option is the right but not the obligation to buy or sell an underlying asset or interest on a predefined date and price. A “call option” gives one the right to buy and a “put option” gives one the

right to sell.

Companies primarily use FX option to hedge future cash flows in foreign currency to mitigate the fluctuation risk. Generally, fixed amount of receivables are hedged with forwards and uncertain cash flows are hedged with options.

In the case of Jordan, the FX structure is: EURUSD

Since Jordan is purchasing the right to sell EUR 10 million and purchase USD on a predefined date. Therefore, it is put option.

The maturity date of this contract is 2 years from the date of purchase. So it is December 31, 2017.

1. ASC 815-25 Fair Value Hedge

This section provides incremental guidance to ASC 815-20 on accounting for and financial reporting of fair value hedge. As per the statement, an entity recognizes all derivatives as either assets or liabilities in the statement of financial position and measures those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as

(a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment,

(b) a hedge of the exposure to variable cash flows of a forecasted transaction, or

(c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction.

3. Criteria (c) applies to the above transaction. The foreign currency receivable in EUR is hedged to mitigate the currency fluctuation risk.