Just a quickie here - Nolan Corporation (Nolan) is a successful and publicly-traded U.S. company that has operated for many years. It manufactures various sporting goods and in recent years, established three subsidiary companies, Soccer Inc. (Soccer), Hockey Inc. (Hockey), and Lacrosse Inc. (Lacrosse). Soccer and Hockey are located in the U.S. and Lacrosse is located in Canada. To protect itself from a multitude of business and financial risks, Nolan uses derivatives to manage its risks. It has engaged in several different hedges during the year, including a net investment hedge of a foreign subsidiary, a cash flow hedge, and a fair value hedge. With respect to a hedge undertaken in the Lacrosse subsidiary that utilizes a put option to protect one of its equity investments, which of the following best describes the accounting treatment for the hedge under U.S. GAAP? A) Unrealized gains and losses from the derivative are recognized in the income statement. B) Unrealized gains and losses from the derivative bypass the income statement and are reported in shareholders’ equity as part of other comprehensive income. C) Realized and unrealized gains and losses from the derivative are recognized in the income statement. Your answer: C was incorrect. The correct answer was A) Unrealized gains and losses from the derivative are recognized in the income statement. Lacrosse is not using the derivative to speculate. Therefore the unrealized and realized gains would NOT be recognized in the income statement. Since Lacrosse is using the derivative for hedging purposes, the gain or loss recognition depends on the type of hedge. By using the put option to hedge exposure to changes in the value of the equity investment, this is clearly an example of a fair value hedge. A fair value hedge requires unrealized gains and losses from the derivative to be recognized in the income statement. (Study Session 7, LOS 25.c) Why is C not correct? I don’t get it.
wierd. aren’t fair value hedge unrealized gains / losses reported in OCI? cpk, get on this. EDIT - my bad. cash flow hedges go on the OCI. nvm.
I think you are correct. It should be unrealized and not realized which NY marked. CPK pls help.
I don’t have the book with me, but in my notes, I have it written that when the accumulated realized g/l from the hedge is reflected in earnings, only then should it go on the IS. I realize this is a bit vague, so I’ll wait for others to pull from the text.
Fair value hedges flow through the IS (both realized and unrealized gains/losses) - not sure where the confusion is. A hedge designated as “far value” will generally cancel out with the asset it’s “protecting”, assuming it’s an appropriate hedge.
can someone post all 3 hedges and their entry to IS/BS under GAAP and IFRS
Enjoy… Purpose Recognition Fair value hedge Offset exposure to changes in fair value of an asset or liability. Gains and losses are recognized in the income statement. Cash flow hedge Offset exposure to variable cash flows from anticipated transactions. Gains and losses are reported in equity. The gains and losses are eventually recognized in the income statement once the anticipated transaction affects earnings. Net investment hedge of a foreign subsidiary Offset exposure from an existing investment in a foreign subsidiary. Gains and losses are recognized in equity along with translation gains and losses.
skillionaire Wrote: ------------------------------------------------------- > Fair value hedges flow through the IS (both > realized and unrealized gains/losses) - not sure > where the confusion is. > > A hedge designated as “far value” will generally > cancel out with the asset it’s “protecting”, > assuming it’s an appropriate hedge. sure, but then why isn’t C correct?
Great question - I didn’t even read “C”. My only answer would be that there aren’t any realized gains yet, thereby precluding “C” from being a viable choice, but that seems to be somewhat of a cop out. However, that’s my final answer.
It would be good to confirm whether its just unrealized G/L that flow into the IS in a FV hedge, or realized G/L as well.
in the absence of any further info I’m happy to declare this another incorrect question by Schweser
agreed that c seems to make more sense- could it be that the only reason you would realize a gain / loss is in order to offset value changes in the asset- so perhaps the realized gain and the asset value change are reported together off of the income statement- while the fluctuation in the value of your hedge is reported on the income statement?
I went for C, too and got it incorrect in QBank…