Question

QUESTION 1 Ithe question is adapted from 2018SC exam a) Under NZ IFRS 9, all financial assets can be subsequently measured using one of three classifications. Required: Describe how an entity can classify a financial asset into each of the three classification categories described in NZ IFRS 9. (6 marks) (b The Warehouse is a listed company on the New Zealand Stock Exchange. The company buys its inventory mainly in US Dollars and borrows funds for business investment and acquisition Required Describe TWO potential market risks to which The Warehouse is exposed in its business (4 marks) (c) A New Zealand exporter, Export Ltd, sells goods overseas. On 1 September 2018, Export Ltd sold US$200,000 worth of goods, with receipt due in two months. The spot rate at the date of sale is NZ$1US$0.65. Export Ltd faces exchange rate risk from this transaction. On the same day, Export Ltd decides to use a put option to hedge this risk and buys the right to sell US$200,000 at an exercise price of US$0.65 in two months time. The cost of the option is $8,000. Export Ltd prepares monthly accounts. The relevant figures are given in the table below: Spot exchange rateOption fair value $8,000 14,000 1 September 2018 (date of sale) 1 month after sale 2 months after sale (settlement date 0.65 0.67 0.63 Required: In accordance with NZ IFRS 9, provide monthly journal entries to record the sale of goods and the purchase of the put option and any additional journal entries that are required through to (and including) settlement of these items. Also calculate the overall gain or loss from both the accounts receivable and the put option. Show all workings. (10 marks) (Total for question: 20 marks)

Answer 1

1. Financial Assets are classified as either:
(1) Amortised Cost,
(2) Fair value through profit or loss and also a third optional category
(3) Fair Value through other comprehensive income (investments in equity instruments).

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2)

Economic uncertainty: This in one country can have a ripple effect to the next, as debt issues and currency devaluations are impacted. What businesses need to understand is that all supply chains are global nowadays.

Exchange Rates:
Any exchange rate shift should be at the forefront of a business’s risk assessment plan. It is important that companies keep ahead and understand the impact of currency fluctuations. One of the main problems for exporters is when buying in a currency with a high valuation and then selling in a weaker currency. Any strong changes affecting either currency will impact profit margins.

There is also the issue when currency changes are adjusted for differences in inflation as well as mismatches between costs and investment in one currency and revenues in another.

Structural Risks
Structural risks come about when a business’s cash flow coming in and cash flow going out reacts differently to currency fluctuations. These types of risk are hard to manage because there is a fundamental mismatch in cash flows.

Transaction Risks
These risks are considered the easiest to measure and manage. These types of risks often come about with timing differences from cash flows and contractual commitments. These risks will affect cash flow in the short-term and these risks are usually easily identifiable.

It is important to understand where and how currency risks exist within a business. Understanding how currency fluctuations impact a business in different areas can help in planning for offsetting any risk and aid effective management of that risk. Whatever the type of risk, businesses need to assess them, plan against them and look for growth opportunities. Businesses need to explore the likely impact of the risk and plan for those eventualities.

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3.

1/9 Accounts Receivable Debited to Sales(200000/0.65) 307692.

1/9 Premium on Option Account Debited to Bank Account 8000.

1/11

Bank Account Dr 317460 (200000/0.63)

To Accounts Receivable 307692

To Foreign Exchange gain 9768

1/11 Profit And Loss Dr 8000

To Premium On Option Account 8000

So, net profit is 9768-8000= 1768.