Question

A Japanese company, Keiko, majorly exports to customers in Hong Kong. The trading is agreed to be in HK$. Currently, the risk of forex exposure arising from the export sales is not hedged. However, the Board of Keiko has taken the decision to introduce a new hedging strategy with effect today. Under this new hedging strategy, forecast future HK$ sales receipts are to be hedged using forward contracts up to 12 months out on a rolling month-on-month basis. The first transaction under the new hedging strategy is to be carried out today, entering into a 12 month forward contract to hedge HKD 10 million sales receipts due 1 year from now. Keiko’s end of financial year is 3 months from today. IFRS 9 for hedge accounting is applied to record for the hedging system.

Additional information:

1. Today spot rate is 1HK$ = 12.76 ¥
2. 3-month forward rate is 1HK$ = 154¥
3. Japanese 3-month interest rate is 2%

Required:

1. Define the type of hedging by referring to the relevant paragraphs in IFRS 9
2. Calculate the fair value of the contract at the end of financial year!
3. Prepare the necessary journal entries at the end of financial year!

Answer 1

a) Under IFRS 9, There are three hedging types which are as follow: (i) Net Investment Hedge (ii) Cash Flow Hedge (I) Fair Value Hedge As per IFRS 9, Fair Value Hedge is a most appropriate Hedging type out of three hedging types mentioned. b) Contract of Hedging will be recorded as separate transaction and it will be valued at fair value while reporting in financials. so the value of contract at the end of Financial Year will be reported as below: = HKD 10 million x 154 1540 million c) Since the exchange rate at end of financial year is not given, hence the contracts can not be revalued and any gain or loss on valuation of contracts can not be journalized. (i) Any gain in valuation of contract will increase the value of receivables and on the other side, any loss in valuation will decrease the value of receivables.