ACCT333: Advanced Financial Accounting Module: Consolidation and Hedge Accounting (Derivates) Question 1 Diversico Ltd (“Diversico”) is a Singapore-incorporated company whose functional and presentation currency is both Singapore Dollar (S) and whose accounting year-end is 31 December. As part of its investment diversification strategy. the Board of Directors of Diversico had approved a plan to acquire 10 million shares in a target company X (-the target shares’) from the stock market. Company Xis a company incorporated and domiciled in Singapore and listed on the Singapore Exchange.

Module: Consolidation and Hedge Accounting (Derivates)

Question 1

Diversico Ltd (“Diversico”) is a Singapore-incorporated company whose functional and presentation currency is both Singapore Dollar (S) and whose accounting year-end is 31 December.

As part of its investment diversification strategy. the Board of Directors of Diversico had approved a plan to acquire 10 million shares in a target company X (-the target shares’) from the stock market. Company Xis a company incorporated and domiciled in Singapore and listed on the Singapore Exchange.

As part of its operational diversification strategy. the Board of Directors of Diversico had also approved a plan to acquire a piece of specialised machinery (“the specialised machine’) from a manufacturer in Malaysia. The acquisition of the target shares is planned to be executed on 31 December 20×2. As such. in line with its risk management objective and strategy, on 1 January 20×1.

Diversico hedges its planned acquisition of the target shares by purchasing a call option at a premium of $200.000 on 10 million of the target shares at a strike price of $5.00 per share, exercisable on its maturity date of 31 December ?Oa?.

1 January 20×1 31 December 20×1 31 December 20×2 31 December 20×3
Target sharer Call option on target share.: Price per share Price per unit 5.00 0.02 5.20 0.21 5.30 0.30 4.90 Not applicable The acquisition of the specialized machine is also planned to be executed on 31 December 20×2 based on its quoted price as at that date as Diversico does not plan to enter into a purchase agreement with the manufacturer.

As suck in line with its risk management objective and strategy, on 1 January 20×1. Diversico hedges its planned acquisition of the specialised machine by entering into a forward foreign exchange contract to buy Y0415.000.000 at an exchange rate of ELM1.00 = S0.33 from the exchange dealer on 31 December 20×2.

The accounting policy of Diversico is to comply with the requirements of SFRS(I) 9 Financial Instruments and apply hedge accounting for hedging transactions executed in line with its investment risk management objectives and strategy. In its documentation for hedging, the Company designates:

• changes in the intrinsic %nine of call options to hedge against the changes in price of hedged items based on their spot rates; and

• changes m the spot element of forward exchange contracts to hedge against changes in spot exchange rates of hedged items. As an accounting policy choice. interest element of forward exchange contracts excluded from hedging relationships shall be expensed off On 31 December 20×2. the call option on the target shares of target company Y.

was duly exercised. and the target shares were duly acquired and classified as ‘Fair value through Profit or Loss” financial asset in accordance with SFRS (I) 9 Financial Instruments. Diversico sposed the target shares on 31 December 20×3. On 31 December 20×2. the forward exchange contact to buy Ftls,f 15.000.000 was duly settled and the specialised machine was acquired at its quoted price.

The machine is estimated to have a useful life of 25 years with no residual value. The machine was commissioned for operations on 1 January 20×3. Assume that all transactions were made and settled in cash. Ignore time value of money as it was not expected to be significant and ignore tax effects. arising from the above transactions and events.

(a) Prepare the relevant journal entries for all the transactions and events for the financial year ended 31 December 20×1.31 December 20×2 and 31 December 20×3. For gains or losses items. indicate clearly whether they are to be accounted for in “Profit or Loss” or “Other Comprehensive Income”. For reversal of reserve accounts. indicate clearly whether they are reclassification adjustment affecting “Other Comprehensive Income- or direct transfer to a balance sheet account.

(b) In respect of the planned acquisition of the specialized machine. discuss potential risks and economic consequences that may arise from the hedging transaction if the quoted price of the specialized machine on 31 December 20×2 are separately

(i) K.113.000.000. or

(ii) R3416.000.000.

Question; Oyl Li Refinery Ltd (-the Company’) has inventory of 10.000 barrels of jet fuel earned at a cost of $1.000.000. The current market value of jet fuel is S110 per banel. The market price of the jet fuel is largely determined by the market price of crude oil. There is market for crude oil futures. but there is no market for jet fuel futures.

The Company is concerned with a potential fall in the price of crude oil and consequently the price of jet thel. To hedge against this risk. the company sells crude oil futtues contracts with a total notional quantity of 10,000 barrels at S60 per barrel on 1 April 20xS. The contract matures on 30 June 20×2. Ignore margin deposit on the futures.

The company has designated the crude oil futures contracts as a cash flow hedge of the anticipated sale of 10.000 barrels of jet fuel on 30 June 20×13. Past experience has proven that there is a very high correlation between the market price of crude oil and the market price of jet fuel.

Therefore, the company expects that the fazes contracts to be an effective hedge of the anticipated sale and that the other conditions for hedge accounting are met. For the purpose of assessing hedge effectiveness. the entire change in the fair value of the futures contract is compared with the change in the expected cash flows from the sale of jet fuel based on spot rates.

Regard (a) Explain why the hedge may not be a perfect hedge (b) Show all the relevant journal entries for the hedging relationship and the sale of the
(c) Assume that Oyl Li Refinery Ltd decides to use the futures contracts (based on forwarding rates) to hedge the fair value of its jet fuel inventory (based on spot rates). Show all the relevant journal entries.

(d) Assume that Oil Li Refinery Ltd has entered into the futures contracts to hedge its jet fuel inventory. However, the company has decided not to apply hedge accounting. Show the all the relevant journal mime*

(e) Assume that Oyl Ls Refinery Ltd has not entered into the futures contracts to hedge HS jet fuel inventory. Show all the relevant journal entries.

f. Compare and explain the accounting consequences of. (s) applying cash flow hedge accounting 6

applying fair value hedge accounting (lid) not applying hedge accounting.

(g) Compare and explain the economic consequence of: (0 hedging (ii) no hedging.

Question 3 (adapted from Exam:nation Semester 1 .41 2020′ 2021! Co. P, with functional currency Singapore dollars (SS), acquired a controlling interest of 80% of Co. S on 1 January 20×7 with consideration of S$8.000.000. The functional currency of Co S was United States dollars (USS) On I January 20×7.

the share capital and retained earnings of Co. S were USS3.000.000 (comprising 3.000.000 shares) and USS2.800,000 respectively. the tau value of non-controlling interests was 551.800.000. and the fair value and book value of inventory were USS1.200.000 and USS1.100.000 respectively. The inventor). was subsequently sold on 31 December 20:

In order to hedge the investment in Co S. on 1 July 20x S. Co P entered into a foreign exchange option transaction to sell LTSS5.500.000 and buy SS at a strike price of USS1 00 to SS1 367″ The option matured on 31 December 20×9. The time value of the option was SS 10.000 on 1 July 20×3. and SS7.000 on 31 December 20×3 Co P had designated the foreign exchange option as a hedge of its net investment in Co. S at the group level with the appropriate documentation. and had complied with the relevant hedge accounting requirements

The financial year-end for both Co P and Co. S was 31 December. The accounting policy of CoP is to state non-controlling interests at acquisition-date at fair value in its consolidated financial statements and to state investment in the subsidiary at a cost in its separate financial statements

Required: Prepare the following in accordance with SFRS(I) 10 Consolidated Financial Statements and SFRS(f) 1-21 Effects of Changes in Foreign Exchange Rates (round up your answers to the nearest SS):

(a) arthscmancjAllasag Consolidation journal entries for the preparation of consolidated financial statements of Co. P for the financial year 20×8. For fair value gains and losses in relation to hedge transactions, indicate separately whether they relate to intrinsic value or time value. Also, indicate clearly whether they are to be accounted for in “profit or loss” or “other comprehensive income-.

(b) For the disposal of Co. Sin 20×9: (ignore the hedge transactions in part (a)) (i) journal entries in the separate financial statements of Co. P for the financial year 20×9. consolidation ‘journal entries