Question

The note below is an extract from the 2018 financial statements of Mercury Energy Limited, a New Zealand energy company.

NOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED) The majority of interest rate derivatives, short-term low value foreign exchange derivatives, and short-term low value exchange traded energy contracts, while economic hedges, are not designated as hedges under NZ IAS 39 but are treated as at fair value through profit and loss. All other interest rate derivatives (predominantly forward starting derivatives), foreign exchange and electricity prices derivatives (except those described below) are designated as cash flow hedges under NZ IAS 39.

Required: a) In the note above, some of Mercury’s hedges are designated as cash flow hedges, whereas others aren’t. Give TWO reasons why this might be the case. (2 marks) b) What are the THREE criteria required in order to apply hedge accounting? (3 marks) c) Explain the benefits of being able to apply hedge accounting, specifically for cash flow hedges. (3 marks)

Mercury Energy Limited is planning to buy some new solar panel equipment from a supplier based in Australia, which invoices in AUD. AUD $10,000,000 will be payable to the supplier on 30 September 2019. To protect against the foreign exchange risk on this transaction, Mercury Energy enters into a forward contract on 1 March 2019 to buy AUD$ 10,000,000 at a rate of AUD$1:NZ$1.05. Mercury Energy reports its results in NZ$, and has a reporting date of 30 June 2019. Exchange rate on 30 June 2019: AUD$ 1 : NZ$1.03 Predicted exchange rate on 30 September 2019: AUD $1 : NZ$1.08

Assuming that Mercury Energy satisfies hedge accounting criteria and uses hedge accounting for the above transaction, show the journal entries that would be required on the following dates: (i) On 30 June 2019 (2 marks) (ii) On 30 September 2019 (8 marks)