ACC803- Advanced Financial Accounting

Week 5- Tutorial 4

Financial Instruments

1. Describe the main risks that pertain to financial instruments with reference to a SPSE listed
entity.

2. On 1st July 2009 ABC Ltd, an Australian company, borrows $US 1.5 million at a rate of 6%
from a US Bank, repayable in US dollars. The loan is for a period of 3 years.

At the same time, XYZ Ltd, also an Australian company borrows A$2.2 million from an
Australian bank at a fixed rate of 5%. The loan is for a period of 3 years.

As a result of perceived benefits to both parties, ABC Ltd and XYZ Ltd decide to swap their
interest and principal obligations on the same date that they take out the loans, that is 1st July
2009. Under the swap terms, each party agrees to take control of the other party’s principal and
interest obligations.
The relevant exchange rates are:

1st July 2009 A$1.00 = US$0.70

30th June 2010 A$1.00 = US$0.67

Required:
a) Provide the accounting entries in the book of ABC Ltd.

b) Provide the accounting entries in the book of XYZ Ltd.

3. i) What is hedge accounting and what are the 3 types of hedges identified in IFRS39.
ii) What is a ‘hedge item’ and what is a ‘hedge instrument’
iii) For the different types of hedges, how are gains and losses on the hedging instrument to be
treated for accounting purpose?
4. ABC Ltd manufactures electric cars. On 4 June 2011 ABC Ltd enters into a non-cancellable
purchase commitment with XYZ Ltd for the supply of batteries, with those batteries to be
shipped on 30 June 2011. The total contract price was US$3,000,000 and the full amount was
due for payment on 30 August 2011.

Because of concerns about movements in foreign exchange rates, on 4 June 2011 ABC Ltd
entered into a forward rate contract on US dollar with a foreign Bank (Westpac) so as to
receive US$3,000,000 on 30 August 2011 at a forward rate of $A1.00 = US$0.78

We will assume that ABC Ltd prepares monthly financial statements and that it elects to treat
the hedge as a cash flow hedge. Further, we will assume that ABC Ltd elect, pursuant to
IAS39, to adjust the cost of the inventory as a result of the hedging transaction.

Other information:
The respective spot rates, with the spot rates being the exchange rates for immediate delivery
of currencies to be exchanged, are provided below. The forward rates offered on particular
dates, for delivery of US dollar on 30 August 2011 are also provided. It should be noted that
on 30 August 2011, the last day of the forward rate contract, the spot rate and the forward
rate will be the same.

Date Spot rate Forward rates for 30 August

delivery of US$
4 June 2011 $A1.00 = US$0.80 $A1.00 = US$0.78
30 June 2011 $A1.00 = US$0.78 $A1.00 = US$0.76
31 July 2011 $A1.00 = US$0.75 $A1.00 = US$0.74
30 August 2011 $A1.00 = US$0.72 $A1.00 = US$0.72

Required:
Provide the journal entries to account for the hedged item and the hedging instrument
for the months ending 30 June, 31 July and 30 August 2011. No entry is required on 4
June 2011 as fair value assessed of the forward rate agreement is assessed as being zero.

The End