Fair value hedge of an Unrecognized firm commitment

A firm commitment is a binding agreement to sell or purchase a specified quantity of resources at a specified
price on a specified future date or dates.

When an unrecognized firm commitment is designated as a hedged item, the subsequent cumulative change in
the fair value of the firm commitment is recognized as an asset or liability with a corresponding gain or loss
recognized in profit or loss. The changes in the fair value of the hedging instrument are also recognized in profit
or loss.

The initial carrying amount of the asset or liability that results from the entity meeting the firm commitment is
adjusted to include the cumulative change in the fair value of the firm commitment that was recognized in the
statement of financial position.

Problem 5: Fair value hedge of a firm sale commitment

On December 15, 20x1, ABC Co. received a sale order from a Japanese firm in the amount of 1,000,000 yens.
The goods are to be delivered on January 15, 20x1. ABC Co. was concerned about the fluctuation in the
Japanese yen, so on this date, ABC Co. entered into a 30-day forward contract to sell 1,000,000 yens for
19470,000 to a bank at the forward rate of 0.47.

Relevant rates are shown below:

Dec. 15, 20x1 Dec. 31, 20x1 Jan. 15, 20x1
Spot rate P0.48 P0.49 P0.46
Forward rate P0.47 P0.485 P0.46

Notes:
Hedged item:
⮚ Unlike in "Probelm 1" where ABC Co. hedged a recognized asset (a receivable from a sale transaction
that has already transcribed), in this illustration ABC Co. is hedging a firm commitment (a receivable from
a committed sale transaction that is yet to transcribe in the future).

Hedging instrument:
⮚ The forward contract is accounted for similar to the previous illustrations.

The entries on December 15, 20x1 are as follows:

Hedged item – Hedging instrument –

Firm Sale commitment Forward contract (Derivative)

Dec. 15, 20x1 Dec. 15, 20x1

NO ENTRY NO ENTRY

Dec. 31, 20x1 Dec. 31, 20x1

Firm commitment (asset) 15,000 Loss on forward contract 15,000

Gain on firm commitment 15,000 Forward contract (liability) 15,000

Jan.15, 20x2 Jan.15, 20x2

Cash (foreign currency) 460,000 Cash (local currency 470,000

Loss on firm commitment. 25,000 Forward contract (liability 15,000

Sales 470,000 Gain on forward contract 25,000

Firm commitment (asset) 15,000 Cash (foreign currency) 460,000

Alternative journal entries: Simple entries

In all of the previous illustrations, the journal entries made on settlement date are compound
entries. This is to simplify the illustrations. However, there might be a chance that you will find it
simpler to use simple entries.

The simple entries on January 15, 20x2 would' have been as follows:
Hedged item – Hedging instrument –

Firm sale commitment Forward contract

Jan. 15,20x2 Jan. 15, 20x2

Loss on firm commitment. 25,000 Firm commitment 25, 000

Firm commitment 25, 000 Gain on Firm commitment 25,

000

to recognize the change in the fair value

to recognize the change in the fair value of the
firm commitment of the forward contract during the period

Cash (foreign currency) 460,000 Cash local currency 470,000

Firm commitment. 10,000 Gain on forward contract 10,000

Sales 470,000 Cash (foreign currency) 460,000

to record the actual sale transaction and to to record the remittance of 1M yens to the
derecognize the firm commitment bank in exchange for the pre-agreed sale price
of P470,000.

Variation: Net cash settlement

If the forward contract is settled net, the entries on January 15, 20x would be as follows:
 Hedge item – Hedging instrument –

Firm sale commitment Forward contract (Derivative)

Jan. 15, 20x2 Jan. 15, 20x2

Cash (foreign currency) 460,000 Cash (local currency 10,000

Loss on firm commitment. 25,000 Forward contract (liability 15,000

Sales 470,000 Gain on forward contract 25,000

Firm commitment (asset) 15,000