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After writing down the steel from $8m to $6m, why should Cloud reclassify an equivalent $2m from equity to profit or loss ?
Plus in this case,
does equity mean “revaluation reseve” and
profit or loss mean “retained earnings” ?Thank you for your help!
Hi,
Cloud have designated the steel as the hedging item in a cash flow hedge. Therefore when the item changes in value, an equivalent amount is reclassified from OCI to profit or loss to offset the amounts in profit or loss.
The equity refers to the cash flow hedge reserve, whilst any impact on profit or loss will hit retained earnings.
Thanks
Hi Sir
Good day
My question is with change in value of steel Value, don’t we need to check hedge effectiveness, as gain in OCI is 3 and Loss on inventories is 2, so on May x4 we will reclassify ineffective portion to Profit and loss that is only 1 million and on sale in April 20×5 we will reclassify remaining 2 million from OCI to Profit and loss.
As per my understanding We need to keep hedge reserve to lower of accumulated fair value change of hedged item or hedge.
on I may X4
DR profit and loss 2million
Cr inventory 2millionDr OCI 1 million
Cr profit and loss 1 million
being ineffective portionOn April 20×5
we will
DR OCI. 2
Cr Profit and Loss 2
Reclassification entryDr cash 6.2
Credit Sale 6.2Please correct my understanding if I am wrong as in BPP they reclassify 2 million on 1may X4.
Before I forget to say please make sure that in the exam when they ask you to explain that you do not just write down the journals – they will not get credit! That is why you generally do not see journals in the printed answers.
Before the steel was purchased a gain on the derivative was correctly recognised in OCI. If the gain on the derivative has been greater than the loss on the underlying at that time then some of the gain of that on the derivative would go to profit and loss. But we are not told anything about that.
Once the steel is purchased I would normally have recycled the gain to profit and loss. It seems to me that in the suggested answer they don’t want to recycle the gain until the steel is sold or decreases in value. Not what I personally would’ve done.
Keep it simple in the exam.
Thanks alot sir.. I noted your advice
so actually we hedge the purchase of inventory. so at the time of purchase we need to settle the instrument right? so your point is we should recycle at the time of purchase. its not clear in this question but I am asking logic.
and if they want to hedge the fair value of inventory it shouldn’t be cashflow hedge.
You are really a great help for me. God bless you
What you are saying is correct. Recycle when the inventory is purchased.
And if you have some existing inventory and are worried about the fair value changing then you would have a fair value hedge
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