Page 155 - Microsoft Word - 00 P1 IW Prelims.docx
P. 155
Financial instruments
Hedge accounting
8.1 The problem of derivatives
As seen already, derivatives are used to manage risks, such as
changes in fair values or variability in cash flows.
Derivatives are a financial instrument. They are classified to be measured at fair
value through profit or loss. This can introduce volatility into the statement of profit
or loss.
Example 3
On 1 November 20X1, an entity committed to purchase an asset in dinars in
6 months’ time. To mitigate currency risk exposure the entity took out a
forward contract to buy dinars in 6 months’ time.
By the reporting date of 31 December 20X1, the dollar had weakened against
the dinar. The derivative contract had increased in value to $100,000.
Future purchases are not accounted for. However, at the reporting date, the
entity must revalue the derivative to fair value and record the gain in profit or
loss:
Dr Derivative $100,000
Cr Profit or loss $100,000
The derivative has introduced volatility into profit or loss.
Hedge accounting is an optional set of rules which, if applied, could have
reduced or eliminated this volatility.
149
