 Hello and welcome to the session. This is Professor Farhad and the session would look at the fair value hedge under IFRS 9. In the prior session we looked at the cash flow hedge. So matter of fact, I'm going to be using the same example that I illustrated for the cash value hedge except I'm going to be assuming we're going to be treating this position as a fair value hedge. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1500 plus accounting, auditing and tax lecture. If you like my lecture, please like them. Press on the like button. This is important for me. Put them in playlists. Share them. Let the world know about them. If they're benefiting you, it means they might benefit other people. This is my Instagram account. Please follow me on Instagram as I'm trying to grow my following and this is my Gumroad account and I do have a website. I do recommend if you're studying for an exam to use studypal.co. It's an artificial intelligence driven study body platform that matches you if you're studying for your CPA, CFA or any other exam for that matter with the study body or groups. You can find study bodies and groups in 85 countries and 2500 cities. This is the link. I strongly suggest to use them. So let's go back and talk about the fair value accounting under fair value accounting because remember, we have to account for our hedges at fair value. Once we have a fair value, it means we have to determine either the profit or the loss to determine where they go. And remember, we have two type of fair value hedging. We have if you are a gambler or a speculator, any profit or loss goes on the income statement. Now, if you have a hedging position and that's to protect your asset or protect your liabilities or protect your cash flow, here you have to decide whether you're going to designate this hedge as a fair value hedge or as a cash flow hedge. Now, we talked about those in the prior session explaining what this cash flow hedge means, what does fair value hedge mean. This is basically a review. In the prior session, we looked at the cash flow hedge. In this session, we will see how we account for fair value hedge. And to be more specific, here are the steps for fair value hedge. This is what we're going to be working today. The hedged asset or liability is adjusted to fair value, according to the spot rate. And any income or loss is recognized in that income. The derivative hedging instrument is adjusted to fair value also as an asset or liability with the counterpart recognize as a gain or a loss and net income. This is the fair value hedge. The cash flow hedge had four steps. It was much, much more involved. You will notice the fair value hedge is simpler. It's much simpler than the cash flow hedge. Then we're going to be looking at the same example this way. If you're interested, look in the description or in this playlist and you will find the cash flow hedge. We're going to be working with the same example. Epstein co-shipped goods to a Spanish customer on December 1st year, one with the payment to be received March 1st. Assume December 31st, the spot rate is $1.50. Remember, this is, we already went through this example. So in case I'm going a little bit fast, it's because of this. And by December 31st, the euro appreciated the $1.51. So here's the entry that we make on the date of the sale. On the date of the sale, we booked the receivable and we booked the sale at the spot rate, which is $1.50. Why? Because we're going to be receiving 1 million euros. $1.50 is the rate. So our account receivable is $1.5 million. $1.5 million. So record the sale at the spot rate. Now, on December 31st, the euro appreciated. It became $1.51. We had a gain of $10,000. So we increased the receivable $10,000 and we increased the, we increase our gain by $10,000, the foreign currency gain. And this goes on the income statement. This is to adjust the USD value of the euro receivable. Then on March 1st, the exchange rate was $1.48. At this point, we have a loss because it went, it was $1.51. December 31st went down to $1.38. We lost three pennies times a million. We have a loss of $30,000. Therefore, we debit for an exchange loss, which is other income or expense and credit the receivable, reduce the receivable to $1,480. Now the receivable is $1,480. We received the cash $1,480. Then we removed the receivable for $1,480. So notice in this example, we did not use any protection by a forward contract or any option or any other method. So we did not hedge. So this is what happened. As a result, simply put, if you look at it, we're supposed to receive $1.5 million. We received $1,480. So the net loss is $20,000. Now we're going to enter into a contract to protect this, to protect this possession. However, we're going to enter into a hedge contract and assume it's a fair value hedge. So assume on December 31st, the three-year forward rate is $1.48, 1.485. And we signed a contract with First National Bank to deliver 1 million euros in three months in exchange for 1,485. So what we did, we don't want to wait and be surprised on March 1st. We went to First National Bank and we told them we'd like to buy this forward contract. And notice it's at a discount. Now the first thing I want to tell you is we ignore the discount. We don't amortize the discount under the fair value. So under the fair value, we don't worry about the discount, which is easier. Like in the cash flow hedge, we had to amortize the discount. On December 31st, no cash change hand, which is entered into a contract. Now Exkimo, the same thing as the cash flow hedge, they have to account for the foreign currency transaction and the related forward contract simultaneously but separately. So we're going to have a receivable and we're going to have a sale. Also, we're going to have a hedging instrument and those are accounted for separately. So let's go ahead and start to book the transaction, assuming we have a fair value hedge. So first, we're going to go ahead and debit receivable 1.5 million, credit sales 1.5 million. Now assume that the company decide not to designate the forward contract as a cash flow, like the prior example, but instead we're going to treat it as a fair value hedge. What does that mean? It means in this case, gains and losses of the forward contract is taken directly to net income and there's no amortization of the original discount. So now all the gains and losses will go into net income versus the cash flow hedge. They went to the balance sheet, then eventually they were recycled. There's no formal entry for the forward contract. Basically, what we do is basically a memorandum would be prepared, designating the forward contract as a hedge of the risk of the change and the fair value of the foreign currency receivable, resulting from the change in the US dollar euro exchange rate. And we have to document this. Remember, for to be considered hedged accounting, we have to document all of this. Remember the documentation in this memorandum is very important from a theoretical perspective. Now let's go ahead and start to look at what happened on December 31st. Remember December 31st, the euro went up the dollar fifty one. So the euro was dollar fifty one. So what do we have of the euro is dollar fifty one? Our receivable went up by 10,000. We have to adjust the receivable and we have to book the gain. That's the first thing we have to do. Now remember, we have a gain on the receivable, but we have a hedging instrument. The hedging instrument work exactly the opposite of the hedging. So if we have a gain on the receivable, we're going to have a loss on the hedging instrument because we waited too long. Therefore, we're going to have a loss of 10,783. And we're going to this is a loss and this loss goes to the income statement. And we're going to have a forward contract, which is a liability, a liability, liability. Now, why do we why do we have a loss of 10,738? Because if we were waited until December 31st, we could have got a better deal on our forward contract, but we did not wait. Therefore, we have a loss of 10,783 to record the forward contract as a liability. So we have to put a liability and to put the loss on the income statement. Okay, so notice, we have a gain of 10,000 loss of 10,783. They both go on the income statement and they cancel each other out. And overall, we have a loss of 783. Simply put, now, if you don't know where the 10,783 coming from look at the prior prior session, basically what happened is for this 10,000, 10,783 is it's actually it's an $11,000 loss, but it's discounted to 10,783. I just look at the prior recording. I don't want to go over this. I just want to make sure you you understand it. So this is the loss. Okay. Now, so again, on year one net income, this is the net loss. So on the income statement, we recorded a sale of 1.5 million on December 1st, then we as a result, we have a loss from the hedging position. The loss is 783 overall. The impact on net income from this transaction is positive 1,499,217. On the balance sheet, we will have a receivable of 1,510. It was originally 1.5. Then we added the $10,000 with the foreign currency exchange. Then we had a liability. We had to book a liability forward contract and retained earning is this much as a result of this transaction went up this much, which is net income. Now, what I suggest you do is to keep track of all these accounts, keep track of the receivable, keep track of the liability because you're going to see how they're going to be removed by by by March 1st, once we do have the once we receive the money. So so let's go to March 1st. On March 1st, the rate is $1.48 the rate is $1.48 as a result, our receivable did bad went down 30,000 because the rate was $1.51. It went down to $1.48. So we lost three pennies times 1 million. It's we have a loss of 30,000. So first, we have to adjust the receivable the fair value. Then we're going to record again. On the contract on the forward contract, we have again, if we have a loss on the receivable, the hedging instrument work the opposite way, we have a gain. Now notice we have a gain of 15,783. Now again, both of these, the loss of 30,000 and the gain of 15,783. They basically they go on the income statement and they cancel each other out. Okay, and notice we reduce our forward contract, which is the which is the liability the liability that we created created earlier. So on the that's why I told you to keep track of the liability. Remember, we had the liability recorded in the prior in the prior of 10,000 the liability was 10,783. This was the liability value. Now we reduced it by 10,783. Therefore, we have in a sense, we have a net, a net, a net positive net positive in the liability, which is a debit, which is basically technically a gain. Then we settle the transaction settling the transaction, it means we're going to get cash 1,485. Why 1,485? Because we signed the contract with the bank that they're going to give us the rate 1.485. Okay, therefore, this is how much cash we receive. Now, we credit the receivable 1,480. Again, you can first you could break this into two transactions that foreign currency, but basically this debit and credit foreign currency can be eliminated. Cash is cash is 1,481,485. The receivable is 1,480. That's the balance in your receivable. And you have to eliminate the forward contract of 5,000. Simply put, this 5,000 is your gain is your net gain on this transaction is your net gain on this transaction. Simply put, it's the same thing as the cash flow hedge that we work earlier, the gain was 5,000. Except here, things went to the income statement up front. Okay, so foreign exchange loss in year two is 30,000. And the gain from the contract was 15,783. Because the value of the the value of the currency worked against us, the receivable went down. We had a gain on the forward contract of 15,783. So overall, we had the net loss in year two of 14,217. Now, this is year two loss, plus add year one loss 873. So we received $15,000 less. So we have losses in both years, total of 15,000. Simply put, we were supposed to receive $1.5 million. We only received $1,485,000. That's still better than if we did not hedge the position. If we did not hedge the position, if you look at the beginning of the session, we received cash $1,450,000 when we had no protection. When we had no protection, this is how much how much cash we received. Now we received $1,485,000. Well, we have $5,000 more. Okay. So it's good. So the hedging position worked for us overall, and we had a net gain of $5,000. Our goal was not to make a gain from this hedging position. Having a gain is good. But our goal is to make sure we receive $1,485,000 because the risk is if we don't hedge it, we would only receive maybe $1,400,000 if we did not hedge and the value of the currency worked against us. Now, we don't care if it went up. That's not our concern. We're not trying to make money on foreign currency. Okay. So under the fair value hedge, the original contract discount again is not amortized. Remember this income is the difference between the foreign exchange gain or loss of the receivable and the gain or loss on the forward contract that is, you know, $15,000 for year one and year two. Remember if your receivable goes down, the hedge goes up. If your receivable goes up, the hedge position goes down. That's what hedging is. They work against each other to cancel each other out. So the net impact on that income over two years is $15,000. I just showed you this here, which reflect the cost of extending credit to a Spanish customer. And that's part of extending credit. The net gain on the forward contract is $5,000. Okay. Remember, we had a loss of $10,783 in year one. We had a liability in year two at reverse. And we had a gain of $15,783. Remember, I told you had like a net positive liability. So the net is $5,000 net positive liability. I put this in quote, okay, that's an increase in cash flow. So simply put, this is how the fair value hedge work. So it's the accounting is different. And the company will have to decide whether this they're going to account for it as a cash, cash flow hedge or a fair value hedge. In the next session, we're going to be looking at different type of hedging. But basically, we're going to go into the foreign currency option, basically looking at to have a put option or a call option to hedge a recognized foreign currency, you know, maybe would look at a dominated asset. If you have any questions, any comments, please email me. If you happen to visit my website, please consider donating. If you're studying for your CPA exam, as always, study hard, it's worth it. Good luck and see you on the other side of success.