Hedging Foreign Exchange Risk

63

Expected Purchase Fair Value

The changes in fair value of the expected cash flow were calculated as follows:

Expected cash flow in USD

Spot rate
Cash flow value in EUR at
spot
Difference
Discount factor for 30
June 20X5
Cash flow fair value due to
spot
Cash flow fair value due to
spot change

Oct 1, 20X4

Dec 31, 20X4

Mar 31, 20X5

Jun 30, 20X5

100,000,000
/ 1.2350
80,972,000

100,000,000
/ 1.2700
78,740,000

100,000,000
/ 1.2950
77,220,000

100,000,000
/ 1.3200
75,758,000

0
x 0.9804

<2,232,000>
x 0.9839

<3,752,000>
x 0.9901

<5,214,000>
x 1.0000

<2,196,000>

<3,715,000>

<5,214,000>

<2,196,000>

<1,519,000>

<1,499,000>

Retrospective Tests
A retrospective test was performed at each reporting date and at hedge maturity. ABC used
the ratio analysis method. The ratio compared (i) the change (since hedge inception) in the
fair value due to changes in the spot rate of the expected cash flow with (ii) the change (since
hedge inception) in fair value due to changes in the spot rate of the FX forward. The hedge
was assumed to be effective retrospectively if the ratio was between 80 % and 125 %.
All the changes in fair value of the FX forward due to changes in the forward points were
excluded from the hedge relationship, and consequently were considered ineffective. The hedge
relationship terminated on 31 March 20X5, so no further calculations of the hedge effective
and ineffective parts were needed after that date.
31 Dec 20X4

31 Mar 20X5

Cumulative fair value change of expected cash

flow due to spot movement
Cumulative fair value change of hedging
instrument due to spot movement
Retrospective test: Ratio

<2,196,000> <3,715,000>

Cash flow fair value change during period

Forward fair value change due to spot rate
Hedge: effective part

<2,196,000> <1,519,000>
2,196,000
1,519,000
2,196,000
1,519,000

Hedge: ineffective part due to spot rate

Forward fair value change due to forward points
Hedge: total ineffective part

2,196,000

3,715,000

100 %

100 %

0
<351,000>
<351,000>

0
<317,000>
<317,000>

Accounting Entries
The required journal entries were as follows:
1) To record the forward contract trade on 1 October 20X4:
No entries in the financial statements were required as the fair value of the forward contract
was zero.