International accounting standards and practices

Hedging may be used to reduce risk. The three predominant types of hedging activities are fair value hedges, cash flow hedges, and foreign currency hedges. In this assignment, you will examine how hedging activities are reported.

Download (attached file) and complete the computational problem, which illustrates hedge computations. Show or explain the calculations.

The current price of his bushel slightly decreased in July at $9.98 and then increased in December at $10.09.

In July, he sold 100,000 bushels at $9.99 with spot price being $10.00. He lost nothing.

In December the spot price was $9.98; the price decreased. He sold at $9.95 per bushel and actually made a profit of $4,000.

In December, however, the spot price for soybeans ($10.09) was higher than his future offset price making it non-profitable for him, $10,000

He won $4,000, he lost $1,000. His liability was $6,000

Compare and contrast the requirements for investments in derivative instruments and hedging activities under both U.S. GAAP SFAS No. 133 (R) and IFRS No. 39.

IFRS 39 permits investments in derivative instruments and hedging activities under certain circumstances as long as the hedging relationship is:

Thoroughly delineated and defined as well as the circumstances in which it will be used, the objective, the nature of the risk, and how the entity will assess the hedging instrument's effectiveness

It is determined to be effective in achieving changes in fair value or cash flows and that this effectiveness can be reliably measured

It is regularly assessed and determined to be effective (Deloitte IAS 39)

The U.S. GAAP on the other hand requires that an entity recognize all derivatives unconditionally as either assets or liabilities in the financial statement and measure those instruments at fair value. Certain conditions make the derivative fall into a hedge of a particular category. All accounting and tasks of the derivative (and upon whether it can be used as a hedge) depend upon its objectives, descriptions, variables, and so forth (FASB Summary of Statement No. 133.)

Identify the accounting rules for periodic computation of unrealized gains and losses on investments in derivative instruments classified as hedge investments and their financial statement disposition.

IAS 39 requires recognition of a financial asset or a financial liability only when the entity becomes part of the contractual provisions of the instrument. There are also various conditions outlined as per its requirements (see for instance Deloitte IAS 39).

Unrealized gains and losses occur if the hedge option has not expired at the end of the year. In that case, Nardozzi advises that the hedger "marks to market" and records any unrealized gain or loss as comprehensive income/loss. This is called hedge accounting. For tax purposes, the unrealized gains or losses should not be recorded

Provide current or historical examples of hedge accounting requirements and activities.

An example is that of Southwest airlines that used derivatives to hedge their risk of the price of jet fuel. Fuel prices are unpredictable, but airlines need fuel to stay in business, so they use crude oil futures contracts and other extremely complex derivatives to hedge their risk. Hedging their future prices helped Southwest stay in business during the Iraqi War of 2003 and the chaos caused by Hurricane Katrina.

Another historical example of a hedging activity is the "credit-default swap" that can become complex since it involves the seller of the swap, the buyer of the swap and an underlying credit asset, (e.g. A bond or loan). Many banks In Europe have used these swaps in order to reduce the amount of cash that they have to keep in regards to loans. Investors have also used this type of swap as bets on companies that may be unlikely to pay their loans.