© 2006 KPMG — Worldbank Wien March 2006— 1 Turning knowledge into value Case Studies...

© 2006 KPMG — Worldbank Wien March 2006— 1

Turning knowledge

intovalue

Case Studies Appliaction of IAS 32/39

Reinhard Klemmer, PartnerKPMG DTG Berlin


Case Studies Equity versus Liability Classification

Impairment of Loans and Receivables

Derecognition Examples

Hedge Accounting Examples


Case Study 1 – Participation Rights

Facts (1) Financial Instrument

Bank issues a Participation Right, volume Euro 75 Mio. Bearer is an Insurance Company

Interest Interest is 7,07% p.a. based on the notional amount of the

issuance



Facts (2) Interest Payments

Payments yearly in arreas No interest is paid if a P&L loss is caused or increased by the

payment Unpaid amounts of prior years will be paid if and when sufficient

funds are available and no P&L loss will be caused Subordination and rights of the holder of the instrument in case of

liquidation of the issuer Subordination of the rights with respect to all other rights in the

company that are (a) not equity and (b) are not also subordinated No rights to participate in liqidation proceeds in case of liquidation

of the Bank



Facts (3) Redemption

Maturity is limited to 10 years In case of early redemption by the issuer, redemption amount

is book value of the issuer Redemption amount is limited to the nominal value of the

participation right Termination

No termination rights for the holder of the instrument Termination option of the Bank



Question Equity or Liability according to IAS 32?



Assessment (1) Interest payments

Issuer is obligated to pay interest No obligation in case of P&L loss

- Specific rules for Banks may allow for the set up of reserves under local rules (home country GAAP) (i.e. § 340f-g HGB, IAS 30.50)

- Payments are at the discretion of the issuer Result

- Interest payments are equity



Assessment (2) Redemption obligation

Contractual redemption right/obligation- Participationb right with stated maturity

- Redemption of the issuance against payment at the maturity date Payments in case of liquidation of the issuer

- No effect on equity classification (IAS 32.25(b)) Result

- Due to stated maturity, the instrument is a Puttable Instrument according to IAS 32.18(b)

- Nominal amount of the issuance is a liability



Assessment (3) Termination rights

Regular termination rights- Termination right of the holder is contractually excluded

- Termination rights of the issuer in this case not relevant for classification Exceptional termination rights

- Both parties do not have any exceptional termination rights Result

- The existing termination rights do not preclude equity classification



Assessment (4) Settlement in own shares of the issuer

No settlement rights/options in own shares of the issuer are part of the contract

Result- Criteria for classification as equity due to settlement in own shares is not

relvant/met in this case



Result Participation right is a Compound Instrument according to

IAS 32.28, IAS 32.AG37 Interest payments are at the discretion of the Bank (issuer),

therefore qualification as equity The nominal amount of the Participation Right qualifies as a

Puttable Instrument, therefore classification as a liability Split Accounting according to IAS 32.31



Example Nominal amount 1,000 Present value of nominal amount at current marekt rate 800 Fair Value of the coupon 200 (residual of 1000-800) Equity: 200 Liability: 800 Cash: 1000 Note: in subsequent periods, the issuer has to record interest

expense for the 800 and no expense for the 200!


Case Study 2: Redeemable preference shares with fixed dividends

Facts:

Company A issues preference shares which are redeemable for cash after 5 years at the notional amount and which bear a 5% fixed dividend each year subject to the following restrictions: Alternative 1: Dividends will be paid only subject to the availability

of distributable profits Alternative 2: Dividends will be paid only if a dividend is paid in respect of

A’s ordinary shares

Is the instrument a debt instrument, an equity instrument or a compound instrument ?

If it is a compound instrument how are the components measured ?


Case Study 2: Redeemable preference shares with fixed dividends

Result: Alternative 1: Dividends will be paid only subject to the

availability of distributable profits: as both parts of the instrument are an obligation to surrender cash, the whole instrument is classified as a liability

Alternative 2: Dividends will be paid only if a dividend is paid in respect of A’s ordinary shares: Split accounting: Dividend right is equity, nominal amount is a liability (note: liability book value is the present value of the redemption amount using market interest rates for similar liabilities of the issuer)


Case Study 3: Redeemable preference shares with option of issuer to settle in cash

Facts:

A issues preference shares which are redeemable after 5 years for ordinary shares (one ordinary share for each preference share) and bear no fixed dividend (but preference shareholders will receive same dividend as ordinary shareholders)

A has an option to settle the instrument either through issuing one ordinary share of A for each preference share or by making a cash payment equal to the fair value of the shares at redemption




Case Study 3: Redeemable preference shares with option of issuer to settle in cash

Solution:

A issues preference shares which are redeemable after 5 years for ordinary shares (one ordinary share for each preference share) and bear no fixed dividend (but preference shareholders will receive same dividend as ordinary shareholders)

Dividend is an equity instrument (same distribution as for ordinary shares).

A has an option to settle the instrument either through issuing one ordinary share of A for each preference share or by making a cash payment equal to the fair value of the shares at redemption

A is not obliged to settle in cash or another financial instrument, therefore the whole instrument is an equity instrument


Case Study 4: Convertible bond with option of issuer to settle in cash

Facts:

A issues a convertible bond which bears 5% fixed interest and is repayable after 5 years at the notional amount, unless converted at the holders option into a fixed number of shares (one ordinary share for each CU 100 notional amount)

If the holder exercised its option and the bond is converted into shares, the issuer has an option to settle the instrument either through issuing one ordinary share for each CU 100 notional amount or by making a cash payment equal to the fair value of the shares at redemption




Case Study 4: Convertible bond with option of issuer to settle in cash

Solution:

A typical convertible bond would be classified as a compound instrument.

In this case, both elements meet the definition of a liability (IAS 39.26) because the conversion option gives one party a cash settlement option. In contrast to Case Study 3, the derivative component changes the classification from equity to liability.


Case Study 5: Mandatorily convertible bond with option of issuer to settle in cash

Facts:

A issues a mandatorily convertible bond which bears 5% fixed interest and is automatically converted into a fixed number of shares (one ordinary share for each CU 100 notional amount) at maturity in 5 years time

The issuer has an option to settle the instrument either through issuing one ordinary share for each CU 100 notional amount or by making a cash payment equal to the fair value of the shares at redemption




Case Study 5: Mandatorily convertible bond with option of issuer to settle in cash

Solution:

The instrument consists of 3 components:

• a non derivative settlement option of the issuer (does not qualify for derivative as Fair Value is always 0)

• a liability component, the present value of the interest payments and

• an equity component representing the prepaid forward sale of the entity’s own equity instruments (IAS 39 IG B9) with no obligation to deliver a variable number of its own equity instrument (IAS 32.16(b)(i))


Case Study 6: Preference Shares without fixed redemption date

Facts:

A issues preference shares which are redeemable at the option of the issuer at a fixed redemption price of € 100 per share plus any accrued unpaid dividends

There is no fixed redemption date, i.e. the holder does not have any right to demand repayment at a certain date

Payment of dividends is at the discretion of the issuer. However, payment of dividends is required in case that the parent company of A pays dividends on its ordinary shares




Case Study 6: Preference Shares without fixed redemption date

Solution:

In general, IAS 32.AG25 states that an option of the issuer to redeem the instrument for cash does not satisfy the definition of a liability, because there is no present obligation

Because dividend payments are contingent, the key question is whether the payment is beyond the control of the issuer

In this case, dividend payment is in the control of the parent company, nit the issuer, therefore, the dividend payments are classified as a liability

Note: As the dividend payments are all the payments required, the whole instrument is classified as a liability. In addition, the instrument may qualify as equity on the level of the parent/consolidated financial statements


Case Study 7: Perpetual bond with contingent step-up interest

Facts:A issues a perpetual bond, providing the holder with a contractual right to receive interest payments at fixed dates extending into the indefinite future with no right to receive a return of principal

The terms of the perpetual bonds are as follows: Payment of interest is contingent on the payment of dividends on preference

shares that have also been issued by A. Interest accrues if no payment is made in a particular year After years 10, 20, 30, etc. the issuer has a right to repay bond Interest is fixed at a rate for 10 years based on market interest rate After each 10 years: The interest rate is adjusted to the then current market

interest rate for 10 year fixed rate debt + 100 basis points

Is the instrument a debt instrument, an equity instrument or a compound instrument ? If it is a compound instrument how are the components measured ?


Case Study 7: Perpetual bond with contingent step-up interest

Solution:

Perpetual bonds with a fixed market-based interest rate are classified as liabilities in their entirety (present value of future interest payments)

In this case, interest payments are contingent on payments of dividends to preference shares

Therefore, the entire classification of the instrument is dependent on the classification of the preference shares


Overview: Impairment of Financial Assets carried at Amortized Cost

financial assets that are

individually significant *

financial assets that are

not individually significant

individually

individually collectively

Hinweis liegt vor

Assessment of objective Evidence of Impairment

(Trigger Events)

Assessment of Impairment

Impairment

Hinweis liegt nicht vor

Impairment individually collectively

Impairment liegt vor Kein Impairment

collectively

* Includes Assets that are individually significant and Assets that are already impaired


Loans and receivables:evaluation of impairment on a portfolio basis

Future cash flows Estimated cash flows Historic loss experience Changes in related observable

data

Discount rate Weighted average of the

original effective interest rate, which reflects estimated cash flows with no double counting or elimination of risk

Losses incurred but not reported At each year end the present value of the estimated cash flows is

re-calculated and impairment loss recognised for the difference between this amount and the carrying value of the portfolio, but the estimated cash flows take into account incurred losses, not expected future losses

When loans are identified as individually impaired they are removed from the portfolio


Incurred loss defines impairment loss Historic loss rate is determined by dividing charge-offs for a period (e.g. a year or a quarter) by the average portfolio (loan) balance in the pool during the same periodLoss confirmation period (‘emergence period’) is the average lag between incurrence of loss and confirmation of loss datesIncurrence loss date is the date on which objective evidence of impairment occurs on an individual asset basisConfirmation loss date is the date on which objective evidence of impairment is identified on an individual asset basis

Incurred

loss =

Historic

loss X

rate

Loss

confirmation X

period

Loan’s

balance of

portfolio

Loans and receivables - measurement of incurred losses on a portfolio basis


Impairment of available-for-sale equity securities

Additional indicators of impairment for equity securities Adverse effects of changes in technological, market, economic

or legal environment, in which the entity operates Significant or prolonged decline in the fair value of an

investment in the equity instrument

Impairment loss can not be reversed through profit or loss as long as the asset continues to be recognised

Equity instruments


Example of Impairment under IAS 39 AfS Equity Securities

Impairment - Example

31.12.2004 31.12.2005 31.12.2006 31.12.2007 31.12.2008

Fair Value 100 105 95 70 75

Fair Value Change - +5 -10 -25 +5

Fair Value Change cumulated - +5 -5 -30 -25

Impairment - no no yes no

Amount recognized in equity - +5 -5 0 +5

P&L (Impairment) - 0 0 -30 0

Cost Basis 100 100 100 70 70


Impairment of available-for-sale debt securities

Indicators of impairment for debt securities (similar to those for loans and receivables) Significant financial difficulty of the issuer Bankruptcy or financial reorganisation of the issuer Disappearance of an active market for the bonds concerned Measurable decrease in the estimated future cash flows

Impairment loss can be reversed through profit or loss if the increase

can be objectively related to an event occurring after the loss was

recognised

Debt instruments


Example of Impairment under IAS 39 AfS Debt Securities


31.12.2004 31.12.2005 31.12.2006 31.12.2007 31.12.2008

Fair Value 100 105 95 70 90

Fair Value Change - +5 -10 -25 +20

Fair Value Change cumulated - +5 -5 -30 -10

Impairment - no no yes no

Amount recognized in equity - +5 -5 0 0

P&L (Impairment) - 0 0 -30 +20

Cost Basis 100 100 100 100 100


Amortised cost (1)

Definition Amount at which the financial asset or liability was measured at

initial recognition minus principal repayments, plus or minus the cumulative amortisation of any difference between that initial amount and the maturity amount minus impairment


Derecognition

AmortisationFinancial Liabilities

Derecognition

Impairment

Amortisation

P&L impact

Financial Assets

Amortised Cost (2)


Facts:Bank is granting a loan to a company as of 1.1.2002 in an amount of € 50 Mio. The loan is paid out at 98 % of the nominal amount. Maturity of the loan is at 31. December 2006. Interest rate is set at 10 % to be paid annually in arreas.

The effective interest rate is r = 10,53482 % (internal rate of return) and can be calcualted as follows:

49,000,000 = 5,000,000

(1+r) +

5,000,000 (1+r)2

+5,000,000

(1+r)3 +

5,000,000 (1+r)4

+55,000,000

(1+r)5

Amortised cost (effective interest rate) (1/4)


Date Carrying amount

Interest expense Coupon Carrying amount

(1.1.) (10,53482 %) (31.12.)

2002 49,000,000 5,162,063 (5,000,000) 49,162,063

2003 49,162,063 5,179,136 (5,000,000) 49,341,199

2004 49,341,199 5,198,008 (5,000,000) 49,539,207

2005 49,539,207 5,218,868 (5,000,000) 49,758,075

2006 49,758,075 5,241,925 (55,000,000) 0

26,000,000 75,000,000



Book entries as of 1.1.2002 for the borrowers books

50,000,000Loan, nominal amount

1,000,000Loan, Discount

49,000,000Cash, Bank

CreditDebit



Book entries as of 31. 12. 2002 for the borrowers books

5,162,063Interest expense

162,063Loan, accretion amount

5,000,000Cash/liabilities to Banks

CreditDebit



Example of Impairment under IAS 39 (1)

31.12.2004: Granting a loan of 10.000 € at 4%; Maturity 4 years, interest payable annually


31.12.2004 31.12.2005 31.12.2006 31.12.2007 31.12.2008

Contractual Cash Flows -10.000 +400 +400 +400 +10.400

Expected Cash Flows

Amortized Cost

./. Impairment

Carrying Value Loan

Interest Income

Carrying Value Loan

Interest Income

Carrying Value Loan

Interest Income

Carrying Value Loan



31.12.2005: Loss Event Expectation: Repayment of Loan 50%; no interest payments

31.12.2004 31.12.2005 31.12.2006 31.12.2007 31.12.2008


Expected Cash Flows -10.000 +5.000

Amortized Cost 10.400

./. Impariment 5.955

Carrying Value Loan 4.445

Interest Income 178


Interest Income 185


Interest Income 192


Impairment – Example (2)


31.12.2004 31.12.2005 31.12.2006 31.12.2007 31.12.2008


Expected Cash Flows -10.000 +2.500

Amortized Cost 10.400 10.400

./. Impairment 5.955 8.090


Interest Income 178


Interest Income 93


Interest Income 97




31.12.2006: Change in Expectations New Expectation: Repayment of Loan 25%; no interest payments

Additional Impairment Loss of

EUR 2.135




Impairment on Portfolio-Basis effective interest rate = 8%, PD = 2% (probability of default, one year), LGD = 60% (loss given default based on contractual cash flows)Period (t) 1 2 3 4Contractual Cash Flows (CF) of the loanj portfolio 905.762 905.762 905.762 905.762original effective interest rate 8,00% 8,00% 8,00% 8,00%discount factor for the loan portfolio 0,925926 0,857339 0,793832 0,735030

PD 2,00% 2,00% 2,00% 2,00%LGD 60,00% 60,00% 60,00% 60,00%Expected Loss 10.869 10.869 10.869 10.869

expected future CF (t) 894.893 894.893 894.893 894.893

discounted expected future CF (t) 828.604 767.226 710.395 657.773PV of expected future CF 2.963.999Carrying Value (IFRS) 3.000.000Impairment (IFRS) 36.001


Case Study A: Measuring risks and rewards

Facts:

A sells 100 of short-term receivables to Bank B for 95

Historic (adjusted) default rates: expected credit losses are 5% range of losses between 4.5% - 6.5% with a confidence interval of

99.9%

A guarantees to reimburse B for losses exceeding 6.5%

Assume that credit risk is the only significant risk

Has A transferred substantially all risks and rewards?


Case Study A:Measuring risks and rewards

Analysis of credit risk:

The risk inherent in the transferred receivables is that actual credit losses will exceed expected credit losses of 5%.

The rewards inherent in the receivables is that actual credit losses will be less than expected credit losses of 5%.

This does not necessarily mean that A should derecognise the receivables since the other derecognition criteria (e.g. pass-through conditions) must also be met!

Consequently, A has transferred the substantially all risks and rewards in relation to credit risk!


Case Study B: Securitisation Transaction I

Subsidiary SPE 1(Purchase Vehicle)

SPE 2(Financing Vehicle)

Cash (par value)

Receivables1 Loan

Cash

Cash collateralfor 40% of first loss of 1.5 %

Parent Subordinated loan (second loss) for 9,5 % of notional amount of transferred receivables(required for AAA-rating)

External bondholders

Insurance Company Financial Guarantee /

Credit InsuranceCredit Insurance2 for 60% of notional amount of receivables Premium paid by parent

1Expected loss: 1.0 %Unexpected loss: 0.5 %Total risk: 1.5% (confidence interval 99.9%)

Assume that credit risk is the only significant risk inherent in the receivables

100%

Bonds/ CP

Cash

Pledge of credit insurance contract as collateral for 60% of first loss of 1.5%

2 The insurance contract was established at origination of the receivables and substantially prior to the transfer via a Master Credit Insurance Contract


Case Study B: Securitisation Transaction I

Questions:

Who consolidates SPE 1?

Can the group achieve derecognition?

If not, how can the structure be modified to achieve derecognition?


NEW

Case Study C: Securitisation Transaction II

Subsidiary SPE 1(Purchase Vehicle)

SPE 2(Financing Vehicle)

Cash (par value)

Receivables1 Loan

Cash

Cash collateralfor 40% of first loss of 1.5 %

Parent Subordinated loan (second loss) for 9,5 % of notional amount of transferred receivables(required for AAA-rating)

External bondholders

Insurance Company Financial Guarantee /

Credit Insurance

Credit Insurance2 for 60% of notional amount of receivables Premium paid by parent

100%

Bonds/ CP

Cash

Sale of credit insurance contract for issuance of financial guarantee

1 / 2 (see previous slide)

Financial Guarantee provided by 2 banks(2 x 30 % of 1.5 %)

(to avoid consolidation)

Pledge of credit insurance contract as collateral for 60% of first loss of 1.5%


HedgeAccountingCash Flow Hedges - Example (1/5)

A manufacturer of computers purchases various components in Asia. On 28.02.20X1 he signs a contract to purchase 1.000.000 parts from a foreign company, delivery 31.03.20X1The purchase price is 750.000.000 (foreign currency) due 30.04.20X1According to the purchasers risk management policy, forign exchange risk is hedged if the limit of 2.500.000 EURO is exceeded The purchaser is entering into a forward sale of 750.000.000 (foreign currency) for EURO at a rate of 102,46 as of 30.04.20X1Effectiveness of the hedge is given



(120.160)N/a104,1730. April

(211.070)105,51105,7831. March

---102,46102,7528. February

Fair Value of the forward contract in EURO

Forward rate for 30.04. 1 Euro = foreign currency

Spot rate

1 Euro = foreign currency

Date



31.03.20X1

28.02.20X1

Recording the purchase at the exchange rate of delivery date (750.000.000/105,78)

7.090.187Trade liabilities

7.090.187Inventory

Recording the Fair Value change of the derivative (forward contract)

211.070Derivative (liability)

211.070Equity valuation reserve

No book entry; Fair Value of forward contract is Zero

CreditDebit



211.070Inventory

30.04.20X1

211.070Equity valuation reserve

Recognition of Fair Value Change of the Forward contract

90.910FX gain (P&L)


FX loss recognition on liability

109.583Trade liability

109.583FX loss on trade liability

Recognition of the hedge transaction upon delivery of the goods

CreditDebit



7.199.770Trade liability


7.199.770Cash

Cash settlement of the Forward contract

120.060Cash

Settlemtent of the liability by cash transfer

CreditDebit


Fair Value Hedges – Example (1/13)

Global Tech Company (GTC) needs financing for the coming five years of EURO 100 million

As of 1.1.20X1 GTC issues a 5-year note for EURO 100 million

The note is bearing interest at a fixed rate of 6%, payable each 6 months

The note is issued at par



GTC´s risk management strategy requires the financing with variable rates

GTC enters into an interest rate Swap (IRSwap) with a 5-year term

Nominal amount: EURO 100 million

ÍRS: Payment of a variable rate based on LIBOR, receiving 6% fix

The variable rate for the first six months is 5,7%

Initial Fair Value of the IRSwap is zero

Management designates the IRS as a Fair Value hedge for the note issued and prepares the required documentation at inception of the hedge

The hedge is effective based on the interest rate based changes in Fiar Value of the IRS and the note issued



Issuance of the note for cash

100.000.000Note (liability)

100.000.000Cash

IRSwap is recorded at Fair Value of zero

1. January 20X1

CreditDebit



As of 30.06.20X1 interest rates increased

Variable rate for the next 6 months period increased from 5,7% to 6,7%

As a result, the Fair Value of the note decreases and the IRSwap has a negative Fair Value

Fair Value of the note decreases from 100.000.000 to 96.196.000

The Fair Value of the IRSwap is -3.804.000

Based on the Fair Value changes, Management assesses the hedge relationship to be effective



Recording of the change in Fair Value of the liability due to hedge accounting

3.804.000Change in Fair Value P&L

3.804.000Note (liability)

Recording the fixed interest payments at 6%

3.000.000Cash

3.000.000Interest expense

30. Juni 20X1

CreditDebit



Recording of the change in Fair Value of the IRSwap

Net interest expense is 2.850.000, the variable interest rate amount for a rate of 5,7 %

3.804.000IRSwap (libability)

3.804.000Fair Value Change of IRSwap P&L

IRSwap interest payments for 1.1.20X1 bis 30.6.20X1

150.000Interest income

150.000Cash

CreditDebit



As of 31.12.20X1 interest rates remain unchanged at 6,7%

Fair Value of the note is 96.563.000

Fair Value of the IRSwap is -3.437.000

Based on the Fair Value changes, Management assesses the hedge relationship to be effective



Change in Fair Value of the note attributable to the risk hedged

367.000Note (liability)

367.000Change in Fair Value P&L

Recording of the fixed interest payments at 6%

3.000.000Cash

3.000.000Interest expense

31. Dezember 20X1

CreditDebit



Recording of the change in Fair Value of the derivative

367.000Fair Value Change IRSwap P&L

367.000IRSwap (liability)

IRSwap interest payments from 30.6. to 31.12.20X1

350.000Cash

350.000Interest expense

CreditDebit



Interest expense is 3.350.000; this is the amount based on a rate of 6,7% for 6 months

the balance sheet as of 31.12.20X1:

93.800.00093.800.000

3.437.000IRSwap

96.563.000note

(6.200.000)Equity/reserves93.800.000Cash

Equity and liabilitiesAssets



Statement of income and expense:• First 6 months at 5,7 % 2.850.000• Second 6 months at 6,7% 3.350.000 Total for the year 20X1 6.200.000



Termination of the hedge relationship As of 31.12.20X1 GTC terminates the IRSwap based on

their changed risk mamagement policy GTC terminates the IRSwap by paying 3.437.000 to the

counterparty of the IRS:

Termination of the IRSwap as of 31.12.20X1

3.437.000Cash

3.437.000IRSwap (liability)

CreditDebit



The carrying value of the note as per the balance sheet as of 31.12.20X1 is 96.563.000

This is based on a reduction of 3.437.000 due to the application of hedge accounting

After termination of the hedge relationship, the amount of 3.437.000 will be amortized into income/expense over the remaining maturity of the note, therby adjsuting the interest rate for that remaining period


Fair Value Hedge – Firm Commitment Example (1/10)

A car manufacturer purchases steel coils in Europe

He signs at 28.02.20X1 a contract to purchase 10.000t coils with a east european steel producer; delivery 31.08.20X1

The purchase price is 7.500.000 due 30.11.20X1

According to the risk management policy of the car manufacturer, all price risks above the limit of 2.500.000 have to be hedged

The car manufaturer purchases a put option for 10.000t od steel a t a strike price of €750/t

The premium paid for the option contract is 450.000

Effectiveness is assumed

What type of hedge relationship is this?



The car manufaturer entered into a firm commitment

The firm commitment is not recorded on the balance sheet

The Fair Value of inventory to be purchased is the hedged item

Therefore, Fair Value Hedging would be appropriate

Problem: Definition of Hedged Item

Solution: IAS 39.93-94



Option purchased for premium

450.000

Derivative (Premium paid)

450.000Cash

No book entry for firm commitment

1. March 20X1

CreditDebit



at 30.06.20X1 the price for steel decreased to 700/t

Fair Value of the Option increased by 500.000 to 950.000

Fair Value of the Firm Commitment is now negative, because the contract onerous for the car manufaturer at current steel prices at -500.000



Recording of the change in Fair Value of the Firm Commitment; for Hedge Accounting only, the Firm Commitment is recognized on the balance sheet

500.000Result from FV-Hedge

500.000Firm Commitment

Recording the change in Fair Value of the Option

500.000Derivative

500.000Valuation result

30. June 20X1

CreditDebit



at 31.8.20X1 the price of steel decreased to 650/t

The Option is exercised bs the car manufaturer and the company receives a payment of (750-650 x 10.000)= 1.000.000

Simultaneously, the steel coils are delivered against trade liability of 7.500.000

Inventory is valued at 6.500.000, the current market price



Valuation of the derivative at Fair Value (total 1.000.000)

50.000Derivative

50.000Valuation result

Recordig of the exercise payment for the Option

1.000.000Cash

1.000.000Gain from Derivative

31. August 20X1

CreditDebit



Valuation of inventory at current market

1.000.000Result from valuation of inventory

1.000.000Inventory

Recording of the delivery of steel coils

7.500.000Inventory

7.500.000Liability

CreditDebit



Derecognition of the firm commitment

500.000Firm Commitment

500.000Hedging result

Settlement of the Option

1.000.000Result Hedging

1.000.000Derivative

31. August 20X1

CreditDebit



Hedging result is a loss of 450.000, the premium paid for the option contract

Withour hegding, the loss would have been 1.000.000 due to the revaluation of inventory

7.500.0007.500.000

7.500.000Liability

450.000Capital

(450.000)Equity/Reserves1.000.000Cash

Equity and liabilitiesAssets

Inventory 6.500.000

Capital is based on the opening balance sheet (cash 450.000; capital 450.000)

© 2006 KPMG — Worldbank Wien March 2006— 1 Turning knowledge into value Case Studies...

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Transcript of © 2006 KPMG — Worldbank Wien March 2006— 1 Turning knowledge into value Case Studies...