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Wiley lFRS: Practical Implementation Guide and Workbook
To hedge the exposure. Entity B enters into a five -year interest rate swap under which the entity
pays fixed rate payments
(5%)
and in return receives floatin g rate payments that exactly offset the
floati ng rate payments it makes on the liability. Entity B designates and documents the swap as a
cash flow hedge of its exposure to variable interest payments on the bond. On entering into the in–
terest rate swap. it has a fai r value of zero. The effect of that interest rate swap is to offset the expo–
sure to changes in interest cash flows to be paid on the liability. In effect. the interest rate swap con–
verts the liability 's floating rate payments into fixed rate
payments,
thereby eliminating the entity 's
exposure to changes in cash flows attributab le to changes in interest rates resulting from the liabil–
ity.
At the end of 20X5. the bond has accrued interest of $6,000. Entity
A
makes this journal entry:
Dr Interest expense
6,000
Cr Bond interest payable
6,000
At the same time. a net interest payment of $1.000 has accrued under the swap fo r the year. There–
fo re, Entity
A
makes this journal entry:
Dr Swap interest receivable
1,000
Cr Interest expense
1.000
The net effec t on profit or loss isrued net interest expense of $5,000
( =
6.000
-
1.000).
Because the swap is a derivati ve. it is measured at fair value. Entity
A
determines that the fair value
of the swap (excludin g accrued interest) has increased by $5,200. As the swap is designa ted as a
hedging instrume nt in a cash flo w hedge, the change in fair value is not recognized in profi t or loss
but as a separate component of equity to the extent the swap is effective. In this case. Entity
A
de–
termines that the swap is 100% effective. Theref ore, Entity
A
makes this journa l entry:
Dr Swapasset
5,200
Cr Equity (hedging reserve)
5,200
Because the fair value of the swap will converge to zero by its maturity, the hedging reserve fo r the
swap will also con verge to zero by its maturity to the extent the hedge remains in place and is effe c–
tive.
Case
Study 16
This case illustrates the accounting fo r a cash flow hedge.
Facts
Entity A is a producer of widgets . To hedge the risk of declines in the price of 100 widgets that it expects
to sell on December 3 1, 20X8, Entity A on January I, 20X?, enters into a net-settled forward contract on
100 widgets for delivery on December 31, 20X8 . During 20X? , the change in the fair value of the for–
ward contract is a decrease of $8,000 . During 20X8 , the change in the fair value of the forward contract
is an increase of $2,000 . On December 31, 20X8. Entity A settles the forward contract by paying $6,000 .
At the same time, it sells 100 widgets to customers for $93,000 .
Required
Prepare the appropriate jo urnal entries on January I, 20X? , December 3 1, 20X?, and December 3 1,
20X8 . Assume that all conditions for hedge accounting are met and that the hedging relationship is fully
effective (100%).
Solution
January
1
20X7
No entry required.
December 31, 20X7
Dr Equity
8.000
Cr Derivative liability
8,000
(To record the decrease in/air value a/ the hedging instrument)
December31 20X8
Dr Derivat ive liability
2.000
Cr Equity
2,000
(To record the increase in/air value a/the hedging instrument)
Dr Derivative liability
6.000
Cr Cash
6.000
(To record the settlement a/the hedginginstrument)