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I didn’t get this.
I think we are buying the asset on 01/11/20X2 and we’re asked to prepare the entries as at that day. Can you please explain further? Thanks.The way I understand it, subject to the tutor’s confirmation, is this:
1. The fear at the beginning was that the price will rise hence the reason for betting against the fear. So if price rises you’ll gain on the instrument & the price falls, you’ll loose on the instrument. The whole idea is to use one gain to offset a loss.2. Because the transaction is taking place on 01/11/20X2, which is the date Cash would flow, you will not do anything until that day. It’s on this day that you’ll know if you had made a loss or gain on the item. So, on the 31/12/20X1 nothing will be recorded as far as the item is concerned. But on this day, you’ll determine if gain or loss was made on the instrument. This will probably be a gain because at inception the fair value of the instrument was zero, so the gain will be 48,387,097 (I’m using your figures; I’ve not confirmed their accuracy). So on 31/12/20X1 you credit OCI and debit the instrument.
3. On the transaction date, you re-measure the fair value of the instrument by comparing the 31/12/20X1 value of 48,387,097 with its value on transaction date which is 60,000,000. So on the instrument a gain of 11,612,903 was made. With this you’d be put on the alert that there will be a loss on the item.
4. Similarly, on the transaction date, you determine if a gain or loss was made on the item. At the inception, the forward exchange rate agreed was €1.5 to $1. So you had fixed your mind to paying $40,000,000 (60,000,000/1.5). But on this day € strengthen against $, so instead of paying $40,000,000 you will now be paying $60,000,000 therefore making a loss of $20,000,000.
5. You made a gain of 11,612,093 on the instrument and a loss of 20,000,000 on the item. The net loss to you is 8,387,987. This is the beauty of the hedging exercise. If there was no hedging, the loss would have been 20,000,000 but with the hedge the loss was reduced to 8,387,987.
6. On effectiveness. We are accounting for the instrument and not for the loss on the item. Because the gain on the instrument (11,612,093) is less than the loss (20,000,000) there is ineffectiveness – the gain did not fully cover the loss. This ineffective portion of 8,387,987 is debited to Profit or Loss account and credit the item’s account.
7. This is the way I would have approached the question. Is the approach ideal? Over to the tutor, please.
I think what it means is that IFRS 9 does not deal with presentation of Financial Instruments which is the purview of IFRS 32. It deals with measurement, recognition and derecognition of Financial Instruments.
With IFRS 32 the focus is on obligation. If there is to obligation to pay you simply classify the instrument as equity. This classification escapes the need to go through the treatment in IFRS 9 that needs to do with the likes of amortised cost measurement, which is a bit complex.
I think what it means is that IFRS 9 does not deal with presentation of Financial Instruments which is the purview of IFRS 32. It deals with measurement, recognition and derecognition of Financial Instruments.
With IFRS 32 the focus is on obligation. If there is to obligation to pay you simply classify the instrument as equity. This classification escapes the need to go through the treatment in IFRS 9 that needs to do with the likes of amortised cost measurement, which is a bit complex.
In my opinion your calculation seems to be right, going by the way study text materials treat this type of loss of control transaction. The area of contention was the way NCI was treated on disposal. The study texts suggest that it should be derecognised but in this example it was not considered for derecognition. Rather, the part of the post acquisition reserve that was taken to OCI was recycled wholly, on the disposal, for derecognition and this was in line with the suggested treatment in the article. The way the article treated it is alien to the suggested ways in study texts that I’ve read treated it, except there has been a revision to the standard approving of such treatment lately.
