Hedging issues

Replies to This Discussion

Permalink Reply by Richard Starkey on July 7, 2010 at 2:17am

Hi Trung

Assuming you are reporting under IFRS, IAS39 would be applicable.

There is not sufficient information to give an exact accounting treatment, but the point of hedging (assuming underlying transaction has occurred and the hedge is a fair value hedge and not a cash flow hedge of a highly probable forecast transaction) is that the gain or loss on the underlying transaction should be offset by the gain or loss on the hedging instrument.

That is to say, the hedge loss should go to the same line item as the gain that you would have on the underlying aluminium transaction.

If you would like a more detailed analysis please let me know and I can try assist.

Regards
Richard

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Permalink Reply by Khuong VIet trung on July 8, 2010 at 11:48pm

Thanks Richard for your support
I would like to further clarify this issue then you may able to get further platforms. This issue is expressed as physical on Aluminum will be shipped within the next 3 months (invoice price) since hedging has been actively implemented.
Then we would take physical aluminum to run the production for customers requirement (both hedged by customers and no-hedged by the others). How can I determine cost of goods sold for Aluminum which is used to produce both being hedged and not being hedged? Can I use physical price to compute costing and then adjust cost of goods sold in favor of undelying gain or underlying loss

Your prompt feedback is much apprecitated

Thanks
Trung

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Permalink Reply by Richard Starkey on July 9, 2010 at 1:49am

Hi Trung

Firstly, are you reporting under International Reporting Standards? (Apo

If you are, before you can start applying any hedge accounting you need to ensure you have complied with the hedging criteria as laid out in IAS39, paragraph 88:

A financial instrument qualifies as a hedge for accounting purposes if: (Para 88)

1) Needs formal documentation of the hedging relationship and the entities risk management objectives for undertaking the hedge.
2) Hedge is expected to be highly effective. (offset profit / lossess within 80% to 120% range of underlying transaction gains / losses)
3)In the case of a forecast transaction - must be highly probable or a non cancelable agreement.
4)Hedge is assessed on an ongoing basis and determined to be highly effective.

Assuming the above is complied with, I need some clarity on the following:

It is not too clear on when you order the goods and payment dates etc. This is important as it defines the type of hedge you would be dealing with (cash flow or fair value hedge).

Could you answer the following questions (send me a direct message if you need to):
1) What is the purchase contract and delivery date;
2) What is the hedging instrument (futures contract?) - date contract entered into and date of close out.
3) Is the hedge expected to be 100% effective (ie within the effectiveness range of 80% to 125% of the underlying transaction?

This will help me ascertain if the hedge is a cash flow hedge or a fair value hedge. I would also need to know if you hedge from date that you have placed the order or if you hedge from date of delivery
(I presume that you hedge from date you order - if so is it a non cancellable order?).

This is a complex area of accounting, I hope I can help you efficiently.

Kind regards
Richard

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Permalink Reply by Khuong VIet trung on July 9, 2010 at 5:13am

Hi Richard,

Thanks for your support. My firm is to start hedging M+3 on behalf of customers. It is not meet mark-to-market condition to reclass it as comprehensive income in the balance sheet and then will revert it back to P&L upon earning recognition of hedged items are treated (cash-flow hedge)

If customer A hedges in May (future contract) at price of 2000USD/MT then M+3 in August physical will be shipped at price of 2100USD/MT. I can unable to split which coils for hedged or NOT hedged. My headache is how to compute coils used for production to determine costing to reflect fair number for customers who is hedged and NOT hedged

Your question as above is clrearly stated as below:
1) My firm has to commit with supplier for coils in term of certain volume. Must ship / must take is applied (M+3 forward contract)
2)This is future contract / Dec-10 will be at the end
3) at least 80% effectiveness is required to meet the requirement

Please have a look at my question. I am looking forward to hearing from you

Thanks
regards
Trung

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Permalink Reply by Richard Starkey on July 11, 2010 at 1:58am

Hi

If I understand correctly.....

You take out futures contract to hedge against price movements for future delivery of aluminium. I assume that the contracts are non cancellable but are still highly probable forecaste transaction.

Therefore the hedging instrument (the 3 month futures contract) will be restated at physical delivery date with gains or losses on the futures contract going to other comprehensive income (assuming IFRS adopted) as far as the hedge has been assessed as being effective.

TO calculate the hedge effectiveness you need to look at the movement on the aluminium physical delivery prices (calculate a hypothetical gain or loss) and then calculate if the gain or loss on the hedging instrument (futures contract) has offset this gain or loss within the range of 80% to 120% (divide one by the other).

If the hedge has been effective then upon the actual purchase of the physical aluminium (NB date risks and rewards of ownership pass), you restate the hedge gains or losses to other comprehensive income (OCI) and you then have to follow your companies accounting policy choice on what to do with the OCI balance to date.

You have two choices under IFRS. IAS39 paragraph 98a OR paragraph 98b. Described as follows:

98a - recognise the OCI over the life of the underlying asset (inventory), ie as and when the inventory is sold. If you had a credit OCI balance you would then debit OCI and credit your cost of sales account as and when you inventory is sold.

98b - offset the OCI against the inventory cost directly upon recognition of the inventory. ie Debit the OCI (assuming credit balance) and credit the inventory account.

If any portion of the hedge is not effective, you may not use hedge accounting (ie, the amount of the gain or loss on the hedging instrument that exceeds the 80 to 120% range) and this portion of the gain or loss must be treated as a speculative derivative instrument and taken to its own P/L account that is below the gross profit line (NOT cost of sales).

I hope this has helped.
Kind regards
Richard

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Permalink Reply by Khuong VIet trung on July 12, 2010 at 10:05pm

Thanks Richard. It was nice for me to further study on this issue given by you
If something is uncleared, may I disturb you again
Thanks so much Richard
regards
Trung

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Permalink Reply by Elices M Roman A on July 12, 2010 at 2:14pm

neither of them. this cost should be disclosed separately and not under cost os sales or manufacturing cost. If disclose in that way would give a misleading imporession of the P&L account. As a financial analyst , we we to see how the company is managing its cost and hedging strategies.
cheers

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Permalink Reply by Steven Domalik on July 13, 2010 at 1:43pm

If hedging on the purchase of your raw materials causes’ loss I would chalk this up to a cost of sales. Many companies are pressured by customers to hold pricing regardless of the reasoning. These costs are related to sales more than manufacturing. No manufacturing activity caused the loss and no manufacturing activity can correct the loss. Only sales activities have an effect on this type of loss or gain.
I forgot to ask. Are you talking about accounting for internal control or reporting to your shareholders? My answer assumed accounting for internal control. In either case the degree of loss or gain may cause you to rethink burrying this cost in sales or manufacturing accounts. You may want to track raw material hedging as a separate accounting activity.

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Permalink Reply by Khuong VIet trung on July 14, 2010 at 12:02am

Hi Steven,

Thanks for your comments. I am also thinking that gain/loss should be classified into cost of sales account and allocate it on profit center where identified customers are to implement hedged. To be fair for some customers who do not carry-our hedging

Purposely, I am focussing internal report
Please share with me some thing if you can
Thanks
Trung

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Permalink Reply by Steven Domalik on July 14, 2010 at 12:42am

I asked my professor the question during a break in my MBA level accounting class tonight. Ian agrees the gain or loss related to hedging your raw material purchases should be carried in a separate account to properly evaluate the hedging activity and maintain a clear picture of the company's financial state. My prof, Ian A. Van Deventer, holds two master's degrees, one in German and one in accounting, and is working toward his Phd in accounting.

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Permalink Reply by Amlan Roy Chowdhuri on July 14, 2010 at 1:51am

Hi Trung,

I gone through your ba

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Permalink Reply by Mpafya Mutapa on July 14, 2010 at 3:18am

hi the cost should be treated as a cost of sale seeing that the hedging loss is mainly to handle the purchasing pcosts,hence consistency has to be applied to reflect the true picture of the financials and cost of sale is the right treatment.
regards,
Mpafya Mutapa.

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