FAC 3702 FASSET CLASS 3 SEPTEMBEROCTOBER 2018 Important

FAC 3702 FASSET CLASS 3 SEPTEMBER/OCTOBER 2018

Important FASSET Information • Have you signed and to submitted your contract? • Sign the attendance register • Complete the evaluation/feedback form

Agenda for Today Class 3 • Non-current assets held for sale – IFRS 5 • The effects of changes in foreign exchange rates – IAS 21, IAS 32, IFRS 7 and IFRS 9

IFRS 5 - NCAHFS OBJECTIVE: Assets that meet the criteria to be classified as held for sale to be measured at the lower of carrying amount and fair values less cost to sell {such assets will no longer be depreciated}. Assets that meet the criteria to be classified as held for sale to be presented separately on the face of the statement of financial position and the results of discontinued operations to be presented separately in the statement of comprehensive income.

IFRS 5 - NCAHFS WHAT IS IT? Classify a non-current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. Such assets and liabilities shall be remeasured to the lower of carrying amount and fair value less costs to sell and carried as current items on the face of the statement of financial position.

IFRS 5 - NCAHFS

IFRS 5 - NCAHFS CRITERIA TO QUALIFY AS HELD FOR SALE: IFRS 5 makes it clear that items should only be classified as held for sale once they have met all the criteria! • Available for immediate sale in its current condition subject only to terms that are usual and customary for sale of such assets AND its sale must be highly probable. • For the sale to be highly probable: o Management must be committed to a plan to sell the asset, AND o An active program to locate a buyer and complete the plan must be initiated. • Asset must be actively marketed for sale at a price that is reasonable. • The sale should be expected to qualify for recognition as completed sale within one year from date of classification. • Actions required to complete the plan should indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

Extension of the period required to complete a sale IFRS 5 Appendix B (Application supplement) WHAT: An extension of the period required to complete a sale beyond one year. CRITERIA: If the delay is caused by events or circumstances beyond the entity's control AND If there is sufficient evidence that the entity remains committed to its plan to sell the asset (or disposal group). IMPACT: Still classify an asset (or disposal group) as held for sale.

Other matters to consider with regard to classification as held for sale Sale transactions include exchanges of non-current assets for other noncurrent assets when the exchange has commercial substance in accordance with IAS 16 Property, plant and equipment. When an entity acquires a non-current asset (or disposal group) exclusively with a view to its subsequent disposal, it shall classify the non-current asset (or disposal group) as held for sale at the acquisition date, only if the oneyear or a permitted extended period requirement is met AND It is highly probable that any other criteria above that are not met at acquisition date will be met within a short period following the acquisition (usually limited to three months).

The criteria is met after the reporting period If the criteria is met after authorisation of the financial statements for issue: shall not classify a non-current asset (or disposal group) as held for sale in those financial statements when issued. If the criteria is met after year-end but before the authorisation of the financial statements for issue, the entity shall disclose the following information by way of a note: (a) a description of the non-current asset (or disposal group); (b) a description of the facts and circumstances of the sale, or leading to the expected disposal, and the expected manner and timing of that disposal; (c) if applicable, the reporting segment in which the non-current asset (or disposal group) is presented in accordance with IFRS 8 Operating segments.

IFRS 5 - NCAHFS EXAMPLES: Ø Disposal group Ø Discontinued operation INCLUDES: All recognised non-current assets and disposal groups except for: Ø Assets carried at Fair Value (FV) with changes in FV recognised in P/L for example financial assets (IFRS 9); non-current assets accounted for using Fair Value model in IAS 40 (Investment property) Ø Assets with difficulty in determining fair value for example deferred tax assets in IAS 12 These assets will be carried at values determined by applying their applicable standard.

IFRS 5 – Initial Measurement The carrying amount of a non-current asset (or all the assets and liabilities in a disposal group) shall, immediately before the initial classification as held for sale, be measured in accordance with the applicable IFRSs. An entity shall measure a non-current asset (or disposal group) classified as held for sale at the lower of its carrying amount (at the moment of reclassification) and fair value less costs to sell – this adjustment is an impairment loss. (IFRS 5. 15) If it falls outside the scope of IFRS 5 the individual item shall instead be carried at the value determined by applying the relevant standard relating to that asset. For example IAS 40

IFRS 5 – Initial Measurement for a Disposal Group STEP 1: Determine the carrying amount of all the individual assets in the disposal group at date of classification by applying the IFRSs applicable to them. STEP 2: Determine the fair value less costs to sell of the disposal group. Note: CGT is excluded specifically per the definition of costs to sell. STEP 3: Determine the lower of carrying amount and fair value less costs to sell. Measure the disposal group held for sale at the lower of the two figures calculated. STEP 4: Calculate the impairment loss (Carrying amount less figure calculated in step 3) STEP 5: Allocate the impairment loss to non-current assets within the scope of the measurement requirements of IFRS 5 If outside the scope carried at their values determined by applying their applicable standards.

IFRS 5 – Subsequent Measurement Assets or disposal groups classified as held for sale will have to be remeasured to its fair value less costs to sell if a year-end occurs between the date of initial classification as held for sale and the final date of disposal. Outside Scope Inside Scope Remeasured in accordance with applicable Standards before the fair value less costs to sell of the disposal group is remeasured Remeasured to the "new" fair value less costs to sell, resulting in a further impairment loss or a reversal of a previous impairment loss

Example- Disposal group containing both items included and excluded (extract from question 3, tutorial letter 102) Investment Prop-Invest Ltd is a property investment company situated in Johannesburg, with property investments in Gauteng and the Western Cape. The property company has a 30 June year-end. A property was purchased on 28 February 20. 10 for R 2 800 000 (land: R 1 000; building: R 1 800 000) with the intention to earn rental income from it. On 31 March 20. 10, Prop-Invest Ltd entered into a five (5) year operating lease contract with Mrs. Ndlovu, who uses the property for residential purposes. However, the return on the investment in properties located in the Western Cape did not meet management’s expectations and subsequently the board of directors decided to sell all properties located in the Western Cape and rather reinvest in Gauteng. IFRS 5 criteria?

Example- Continued (extract from question 3, tutorial letter 102) On 31 January 20. 11 a detailed formal plan of disposal was approved, publicly announced and at a stage of completion where no realistic possibility of withdrawal existed. IFRS 5 Management expects that a binding sales agreement for the property will be concluded by criteria 30 September 20. 11. The property will be sold for cash. The property is marketed by an estate agent at a price that is reasonable in relation to its current fair value. The commission payable to the estate agent on the sale of the property will amount to R 250 000. On 31 January 20. 11 the sale of the property located in the Struisbaai geographical area met all the requirements for classification as held for sale in terms of IFRS 5. The fair values of the Struisbaai property, on the respective dates, are as follows: 30 June 20. 10 R 31 January 20. 11 R 30 June 20. 11 R Land 1 050 000 1 056 000 1 061 000 Building 1 900 000 1 918 000 2 950 000 2 966 000 2 979 000

Example- Continued (extract from question 3, tutorial letter 102) Accounting policies: Investment property is accounted for using the fair value model. All the net replacement values and fair values of the properties were determined by Mr. Sharp, an independent sworn appraiser. Mr. Sharp has recent experience in the location and category of the property being valued. The net replacement values and the fair values were determined by reference to current market prices on an arm’s length basis of similar properties in the same area. The carrying amount of the investment property will be recovered through sale. REQUIRED: What will the notes to the Financial Statements look like at year-end 30 June 20. 11 for 1) Investment Property AND 2) Non-current assets held for sale

Example- Continued (extract from question 3, tutorial letter 102) ANSWER: PROP-INVEST LTD NOTES FOR THE YEAR ENDED 30 JUNE 20. 11 FV adjustment at the end of previous financial year CA at beginning of year Investment property- Land calculation Carrying Amount R Cost 28 February 20. 10 Fair value adjustment 30 June 20. 10 (1 050 000 – 1 000) Special rules for IAS 40! Carrying amount 30 June 20. 10 Not sold at y/e remeasure to FV using IAS Fair value adjustment 31 January 20. 11 40 principles (1 056 000 – 1 050 000) Transfer to NCAHFS* Fair value adjustment 30 June 20. 11 (1 061 000 – 1 056 000) Carrying amount 30 June 20. 11 Historical Carrying Amount R Fair Value Adjustment R 1 000 000 - 50 000 1 050 000 1 000 50 000 6 000 FV adjustment on date of transfer 6 000 1 056 000 1 000 56 000 5 000 - 5 000 1 061 000 000 61 000

Example- Continued (extract from question 3, tutorial letter 102) ANSWER: PROP-INVEST LTD NOTES FOR THE YEAR ENDED 30 JUNE 20. 11 Investment property- Building calculation Carrying Amount Investment property was R 1 800 000 transferred to NCAHFS is therefore 100 000 Fair value adjustment 30 NCAHFS! June 20. 10 debited with the FV (1 900 000 – 1 800 000) adjustment and NOT Carrying amount 30 June 20. 10 1 900 000 Investment Fair value adjustment 31 January 20. 11 Property with subsequent 10 000 (1 910 000 – 1 900 000) changes in FV after transfer Transfer to NCAHFS* 1 910 000 date Cost 28 February 20. 10 Fair value adjustment 30 June 20. 11 (1 918 000 – 1 910 000) Carrying amount 30 June 20. 11 Historical Carrying Amount R Fair Value Adjustment R 1 800 000 - - 100 000 1 800 000 100 000 - 10 000 1 800 000 110 000 8 000 - 8 000 1 918 000 1 800 000 118 000

Example- Continued (extract from question 3, tutorial letter 102) ANSWER: PROP-INVEST LTD NOTES FOR THE YEAR ENDED 30 JUNE 20. 11 The property will at year-end be disclosed as NCAHFS. 2. 2. Investment property Land R Carrying amount beginning of year Carrying amount end of the year Total R 1 050 000 1 900 000 2 950 000 6 000 10 000 16 000 (1 056 000) (1 910 000) (2 966 000) Fair value adjustment Transfer to non-current asset held for sale Building R 0 0 0 The valuation was performed on 31 January 20. 11. The fair values were determined by an independent sworn appraiser. Remember to first revalue IP (FV model) in order to transfer to FV of the property to NCAHFS (FV adjustment on reclassification date).

Example- Continued (extract from question 3, tutorial letter 102) ANSWER: PROP-INVEST LTD 1. Reason for sale NOTES FOR THE YEAR ENDED 30 JUNE 20. 11 2. 3. Non-current asset held for sale The board of directors decided to sell the Struisbaai property since the property investment did not meet expectations. A formal plan of disposal was approved and publicly announced on 31 January 20. 11. On 30 June 20. 11 the sales plan was at a stage of completion where no realistic possibility of withdrawal existed. Management expects that a binding sales agreement will be concluded by 30 September 20. 11. The property will be sold for cash. 3. Manner of sale Non-current asset held for sale consist of the following: 2. Anticipated date of sale R 4. List items included in Investment property – Struisbaai 2 979 000 this classification The valuation was performed on 31 January 20. 11. The fair values were determined by an independent sworn appraiser. Investment property at fair value falls outside the scope of IFRS 5. Continue to measure the investment property in accordance with IAS 40 even though it has been transferred. (@ FV )

IFRS 5 – Initial Measurement Example- Question 14 extract from TUT 102 Machinery IFRS 5 criteria Khona Ltd purchased a machine which was immediately available for use, as intended by management, on 1 September 20. 10 for R 2 400 000. The machine has an estimated useful life of 650 000 units, with a residual value of R 250 000. However, due to the fact that the machine did not meet its expected production capacity, the directors decided to dispose of it. A detailed formal disposal plan was publicly announced and on 30 April 20. 13 the disposal was at a stage of completion where no realistic possibility of withdrawal existed. A binding sales agreement for the machine was concluded and management expects the sale to be completed on 20 December 20. 13. The machine will be sold for cash. From acquisition date until 31 October 20. 12, the machine had produced a total of 185 000 units. During the current financial year until 30 April 20. 13, the machine had produced 70 000 units. On 30 April 20. 13 the machine’s fair value less costs to sell, was determined to be R 1 200 000. On 31 October 20. 13, the fair value less costs to sell of the machine increased to R 1 300 000 due to an unprecedented demand for this type of machinery.

IFRS 5 – Initial Measurement Example- Question 14 extract from TUT 102 Additional information: It is the accounting policy of Khona Ltd to account for machinery using the cost model. Depreciation on machinery is provided for according to the units of production method. A tax allowance on machinery, according to section 12 C of the Income Tax Act, allowing a 40% deduction in the first year of use, with a 20% deduction per year in the following three years.

IFRS 5 – Initial Measurement Example- Question 14 extract from TUT 102 Current financial year Details on a Timeline: 1 Sept 2010 Purchased 1 Nov 2012 Beginning of year Cost = R 2 400 000 Useful life= 650 000 units Res. Value= R 250 000 185 000 units produced 30 April 2013 Transfer to NCAHFS 31 Oct 2013 Year-end FV – cost to sell = R 1 200 000 FV – cost to sell = R 1 300 000 70 000 units produced

ANSWER: Calculations - Machinery Carrying amount R Cost 1 September 20. 10 2 400 000 Accumulated Depreciation ((2 400 000 - 250 000) / 650 000) x 185 000) (611 923) Carrying amount 31 October 20. 12 1 788 077 Depreciation ((2 400 000 - 250 000) / 650 000) x 70 000) (231 538) Transfer to Non-current assets held for sale 1 556 539 Impairment loss (1 788 077 – 231 538 = 1 556 539 – 1 200 000) (356 539) Reversal of impairment loss (1 300 000 – 1 200 000) Carrying amount 31 October 20. 13 On initial classification to NCAHFS 100 000 1 300 000 Subsequent measurement at Y/E

IFRS 5 – Initial Measurement Example- Question 14 extract from TUT 102 ANSWER: Disclosure – Machinery: Property, plant and equipment note Machinery R Carrying amount at beginning of year 1 788 077 Cost 2 400 000 Accumulated depreciation (611 923) Depreciation (231 538) Transfer to Non-current asset held for Sale (1 788 077 – 231 538) Carrying amount at end of year (1 556 539) - Cost / gross carrying amount - Accumulated depreciation Carrying amount of machinery on date of reclassification

IFRS 5 – Initial Measurement Example- Question 14 extract from TUT 102 Reason for sale, date of sale, manner of sale Item Impairment loss on initial classification: Amount & Where included Reversal of impairment loss on subsequent measurement: Amount + Where included

IFRS 5 – Impairment Losses Example: Question 2 in TUT 102 Vino Ltd is a company which produces and sells wine. The wine is produced in the Western Cape and bottled at their plant in Gauteng. The company has a 31 March year-end. On 31 October 20. 10, the directors decided to sell the Gauteng bottling plant and all of its assets. On that date they approved a detailed formal plan of disposal. On 31 December 20. 10, the approved formal sales plan was at a stage of completion where no realistic possibility of withdrawal existed and all the requirements to classify the Gauteng bottling plant as held for sale were met. Management expects that a binding sales agreement for all the assets will be concluded by 1 May 20. 11, and the assets will be sold for cash. Criteria of IFRS 5 were met = Transfer to NCAHFS

IFRS 5 – Impairment Losses Example: Question 2 in TUT 102 Details of the bottling plant’s assets are as follows: Machinery with an original cost price of R 8 000 was acquired on 1 July 20. 05. The machinery is used specifically in the bottling process. It has a residual value of R 80 000 and an expected useful life of 15 years. The machinery was available for use, as intended by management, on acquisition date. The carrying amount of the machinery on 1 April 20. 10 amounted to R 5 492 000. The carrying amount of inventory on 31 December 20. 10 and 31 March 20. 11 amounted to R 650 000 and R 625 000 respectively. The net realisable value of the inventory amounted to R 550 000 on 31 December 20. 10 and R 525 000 on 31 March 20. 11. Vino Ltd developed a customised software package to be used in the bottling plant. The software package met all the criteria for the recognition as an intangible asset. The software was used to operate the machinery. The software was developed at a cost price of R 860 000. It was estimated that the software will have an expected useful life of 20 years. The software was available for use, as intended by management, on 30 September 20. 07 and was brought into use on the same date. The carrying amount on 1 April 20. 10 amounted to R 752 500.

IFRS 5 – Impairment Losses Example: Question 2 in TUT 102 No provision for depreciation or amortisation has been made for the current financial year. The fair value less costs to sell of the bottling plant, on the respective dates, is as follows: 31 October 20. 10 R 6 400 000 31 December 20. 10 R 6 250 000 31 March 20. 11 R 6 225 000 Additional information • A pre-tax discount rate of 15% is considered to be appropriate. Initial measurement Subsequent measurement 2. It is the accounting policy of Vino Ltd to account for intangible assets using the cost model. 3. Depreciation and amortisation is provided for in accordance with the straight-line method over the expected useful life of the assets. Required: Calculate the impairment loss on the disposal group and disclose it in the NCAHFS note

IFRS 5 – Impairment Losses Example: Question 2 in TUT 102 ANSWER (Calculations Disposal Group): Step 1: Determine the carrying amount of all the individual assets in the disposal group at 31 December 20. 10. Period from 1 April 20. 10 until 31 December 20. 10 R MACHINERY Carrying amount on 1 April 20. 10 SOFTWARE PACKAGE INVENTORY 5 492 000 Depreciation [(8 000 – 80 000) / 15 x 9/12] (396 000) Carrying amount on 31 December 20. 10 5 096 000 Carrying amount on 1 April 20. 10 752 500 Amortisation [860 000/20 x 9/12] (32 250) Carrying amount on 31 December 20. 10 720 250 Carrying amount on 31 December 20. 10 650 000 Write down to net realisable value (650 000 – 550 000) Net realisable value on 31 December 20. 10 Carrying value of disposal group on 31 December 20. 10 (100 000) 550 000 6 366 250 Total CA of all assets included in disposal group on reclassification date

IFRS 5 – Impairment Losses Example: Question 2 in TUT 102 ANSWER (Calculations Disposal Group): Step 2: Determine the fair value less cost to sell the disposal group at 31 December 20. 10. Fair value less cost to sell (given) R 6 250 000 Step 3: Determine the lower of carrying amount and fair value less cost to sell at 31 December 20. 10. Measure the disposal group at fair value less cost to sell Fair value less cost to sell (given) R 6 250 000 Step 4: Calculate impairment loss suffered at 31 December 20. 10. Carrying amount less fair value less cost to sell R 116 250 Total impairment loss of disposal group (R 6 366 250 – R 6 250 000) on initial classification = Should now be allocated to all the non-current assets within the group

IFRS 5 – Impairment Losses Example: Question 2 in TUT 102 ANSWER (Calculations Disposal Group): Total calculated impairment loss Step 5: Allocate the impairment loss to the assets Carrying amount on initial Classification R Machinery [5 096 000 / 5 816 250 x 116 250] = 101 854 Software package [720 250 / 5 816 250 x 116 250] = 14 396 5 096 000 + 720 250 Inventory = 5 816 250 Allocate only to non-current assets! Inventory = current Impairment loss Allocated R Carrying amount after impairment allocated R 5 096 000 101 854 4 994 146 720 250 14 396 705 854 550 000 nil 550 000 6 366 250 116 250 000 Total of FV less cost to sell on initial measurement as given in question

AT YEAR-END!! IFRS 5 – Impairment Losses Example: Question 2 in TUT 102 ANSWER (Disclosure): Why, When, How? 3. Non-current assets held for sale A decision to dispose of the assets of the Gauteng bottling plant was taken on 31 October 20. 10 after a formal detailed disposal plan for the assets of the bottling plant was approved. The plan regarding the once-off sale of the assets was at a stage of completion on 31 December 20. 10, where no realistic possibility of withdrawal existed. It is expected that the plan for the sale of the assets will be completed Total of FV less cost to sell on year-end as by 1 May 20. 11 for cash. The disposal group under discussion comprises: Final amounts after impairment loss allocated at year-end given in question Assets R Plant and equipment 4 994 146 Intangible assets 705 854 Inventory (550 000 – 25 000) 525 000 IAS 2 special rules. Writedown to NRV at Y/E 6 225 000 An impairment loss of R 116 250 was recognised upon initial classification of the disposal group as held for sale. The impairment loss was included under loss after tax on remeasurement on the face of the statement of profit or loss and other comprehensive income. Total impairment loss, where included?

IFRS 5 – Presentation and Disclosure – Continuing and Discontinued operations STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE Statement of P/L will be split to show YEAR ENDED 31 DECEMBER 20. 10 profit from continued operations and loss on discontinued operation CONTINUING OPERATIONS separately Revenue XXXX Cost of sales (XXX) Gross profit XXXX Other expenses (XXX) Finance costs (XX) Profit before tax XXX Income tax expense (XX) Profit for the year from continuing operations XXX

IFRS 5 – Presentation and Disclosure Non-current assets held for sale- Disclosure in SOCI STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20. 10 CONTINUING OPERATIONS Profit for the year from continuing operations XXX DISCONTINUED OPERATIONS Revenue XXX Expenses (XXX) Loss before tax (XXX) Income tax benefit XX Loss after tax XXX Loss after tax on measurement of non-current asset held for sale/disposal group (XX) Loss on measurement of non-current asset held for sale to fair value less costs to sell (XX) Income tax benefit X Loss for the year from discontinued operations (XX) PROFIT FOR THE YEAR XXXXXX

IFRS 5 – Non Current Assets to be Abandoned Won’t be classified as held for sale! Carrying amount will be recovered primarily through continuing use. An entity shall not account for a non-current asset that has been temporarily taken out of use as if it had been abandoned. (IFRS 5. 14)

IFRS 5 – Changes to a plan of sale Criteria for classification as held for sale are no longer met! Cease to classify the asset (or disposal group) as held for sale. (IFRS 5. 26) Measure at the lower of: (a) its carrying amount before the asset (or disposal group) was classified as held for sale, adjusted for any depreciation, amortisation or revaluations that would have been recognised had the asset (or disposal group) not been classified as held for sale, and (b) its recoverable amount at the date of the subsequent decision not to sell. (IFRS 5. 27)

IFRS 5 – Changes to a plan of sale Individual assets: The adjustment must be included in the same caption in the statement of comprehensive income used to present a gain or loss. PPE item or intangible asset that has been carried under the revaluation model per IAS 16 or IAS 38, the adjustment shall be treated as a revaluation increase or decrease. The asset no longer classified as held for sale should be reinstated at the lower of what its carrying amount would have been had it never been classified as held for sale and its recoverable amount. Disposal group: The remaining non-current assets of the group that individually still meet the criteria to be classified as held for sale shall be measured individually at the lower of their carrying amounts and fair values less costs to sell at that date. Any non-current assets that no longer meet the criteria shall cease to be classified as held for sale.

Questions?

FAC 3702 FASSET CLASS 3 SEPTEMBER/OCTOBER 2018 LEARNING UNIT 7

The Effects of Changes in Foreign Exchange Rates What is it? • Transactions in foreign currencies and/or foreign operations • Translate transactions into presentation currency (Rand) for incorporation into the financial statements. • The results of the foreign operations (branch) will be accounted for in the functional currency (rand).

Uncovered foreign currency transactions Initial Measurement: Principle: The spot rate on the transaction date is used for translation purposes. The date of the transaction is the date on which the transaction first qualifies for recognition in accordance with IASs. (IAS 21. 22) Application: Transaction date is when risks and rewards pass. For example- shipped FOB (Free on Board)

Covered transactions – FEC taken out What is it? Risk management to cover the entity against foreign currency fluctuations. Hedge accounting involves the following steps: Step 1: Identify the hedged item. Step 2: Identify a potential hedging instrument. Step 3: Determine if the qualifying criteria for hedge accounting have been met. Step 4: Account for the hedge transaction in terms of the appropriate hedge accounting model.

Hedged Item • Liability Creditor/ Supplier • External to the reporting entity. • Always use SPOT rate at transaction date. • Transaction date = date on which all risk and rewards are transferred When you become the owner Delivery, Shipped free on board (FOB) • Creditor- revalue outstanding balance (in foreign currency) at year-end and before payment at SPOT rate at date of payment/ year-end. • Must be reliably measured and the transaction highly probable

Hedging Instrument- FEC • • What is a FEC? Contract with bank Buy specified amount of foreign currency from the bank at a specified exchange rate. Example: $ 10 000 at R 7. 00 for $1 For hedge accounting purposes, only contracts with a party external to the reporting entity (i. e. external to the group or individual entity that is being reported on) can be designated as hedging instruments. Revalue- compare to other FEC forward rates Expire/ Settle- compare your FEC forward rate to SPOT at the day of payment to revalue your FEC before your payment journal. FEC Forward rates - increase to more than what yours is = gain - decrease to less than yours = loss 2 types of hedges – Fair value hedge – Cash flow hedge Will be specified in question information which one

Hedge Accounting 2 Types of hedges: i. Fair value hedge (FV hedge) which hedges the exposure to changes in fair value ii. Cash flow hedge (CF hedge) which hedges the exposure to variability in cash flows Determine if the FEC is taken out before or on/after transaction date. ü Before transaction date = cash flow hedge ü On/After transaction date = fair value hedge

Fair value hedge • Revalue = Fair value gain (P/L) = FEC Asset (SFP) OR Fair value loss (P/L) = FEC Liability (SFP) • Compare FEC Forward rates when revalue except when FEC expires, then compare FEC Forward rate to Spot on date of expiry/ payment of creditor. • On expiry: 1. Revalue FEC using FEC rate VS Spot rate 2. Revalue creditor at Spot rate 3. Write payment journal which is - Debit creditor = forex amount you pay @ Spot rate - Credit bank = FEC contract amount @ ORIGINAL FEC rate - Debit FEC liability and/ or Credit FEC asset to clear those accounts.

Fair value hedge Using fair value hedge accounting

Example - Fair value hedge Skhota Ltd is a manufacturing company situated in Rustenburg. The company has a 31 December reporting date. “Flame Hot” Formula On 1 June 2015, Skhota Ltd signed an agreement with an Australian company to acquire a formula at a cost of AUD 30 000 (Australian dollar), to manufacture charcoal with an increased heat retention ability. All the risks and rewards associated with the formula were transferred to Skhota Ltd on the date of the agreement and the formula was available for use as intended by management, on this date. The cost price of the formula is payable in full on 31 January 2016. The formula has an estimated useful life of 25 years and a residual value of Rnil was allocated to the formula. On 1 June 2015, Skhota Ltd took out a foreign exchange contract (FEC) for AUD 30 000 in order to hedge the foreign currency risk component of the transaction.

Example - Fair value hedge Skhota Ltd chooses to apply hedge accounting and on 1 June 2015, designated the FEC as the hedging instrument and the foreign currency risk component of the creditor that arises as a result of this transaction, as the hedged item. The hedge complied with all the requirements for hedge accounting. A hedge of the foreign currency risk component related to a foreign currency creditor, is accounted for as a fair value hedge. The following foreign exchange rates are applicable: Date Spot Rate 1 AUD = R Forward Rate for FEC 1 AUD = R FEC Period 1 June 2015 8, 25 8, 35 7 months 31 December 2015 8, 30 8, 37 1 month 31 January 2016 9, 00 REQUIRED: Prepare all the general journal entries (including cash transactions and amortisation) relevant to the dates indicated below, in the accounting records of Skhota Ltd, to correctly account for the purchased “Flame Hot” formula, the hedged item and the hedging instrument. • 1 June 2015 • 31 December 2015 • 31 January 2016

Fair value hedge example: Oct 2016 Q 2 PART A 31 Dec 2014 prior year 1 June 2015 Order and Transaction date AUD 30 000 Take out FEC @ 8, 35 Ready for use- amortisation start Useful life = 25 years Rnil Residual value 31 Dec 2015 current year end Revalue! FEC= FEC rate Creditor = Spot 31 Jan 2016 Pay creditor and FEC expire AUD 30 000 Spot = 9, 00 Revalue creditor @ Spot Revalue FEC @ Spot Clear FEC Asset/ FEC Liabilities Fair value hedge accounting: FEC Asset (SFP) ; Fair value gain (P/L) OR FEC Liability (SFP) ; Fair value loss (P/L)

Remember! When you start your journals, have a thought process to follow! i. Work by date, finish all your journals for 1 date first before moving on to the next. ii. Remember to first complete your hedged item (such as revaluations) and then your hedging instrument BEFORE you do the settlement/ payment journal of your creditor- FEC asset/ liability clear to creditor. iii. Lastly do any depreciation/ amortisation journals Year-end! Remember to revalue at year-end if you haven’t settled by then! iv. Don’t use abbreviations and clearly distinguish between FEC Asset and FEC Liability. These descriptions count marks.

Solution : Transaction date journal 1 June 2015 Dr R J 1 Formula/ Intangible asset Cr R 247 500 Accounts payable/ Creditor (30 000 x 8, 25) Spot rate on transaction date 247 500

Solution: Year-end journals 1. Restate your FEC (Calculate gain/loss on FEC). Making a gain, paying less due to our specific contract. Fair value FEC asset (SFP) gain = FEC asset Use FEC rates Fair value gain / adjustment (P/L) 31 December 2015 J 2 Dr R Cr R 600 [30 000 x (8, 37 – 8, 35)] J 3 Foreign exchange difference / loss (P/L) Accounts payable / Creditor J 4 1 500 2. Restate creditor Adjust balance to spot rate [30 000 x (8, 30 – 8, 25)] at year-end. Creditor Amortisation 5 775 balance increases, Accumulated amortisation therefore FED loss (247 500 / 300 x 7) OR (247 500 / 25 x 7/12) 1 500 5 775

Solution: Payment and FEC Expires journals Restate creditor. Adjust balance to spot rate at settlement date. Creditor balance increases, therefore FED loss Foreign exchange difference / loss (P/L) 31 January 2016 J 5 Dr R 21 000 Accounts payable / Creditor J 6 J 7 Calculate gain on FEC. [30 000 x (9, 00 – 8, 30) FEC expires, use spot rate. We are paying less due FEC asset (SFP) 18 900 to our contract, making a Fair value adjustment / gain (P/L) gain, therefore FEC asset [30 000 x (9, 00 – 8, 37)] Accounts payable / Creditor (30 000 x 9, 00) Bank (30 000 x 8, 35) FEC asset Rate at which contract was signed Reversing the balance of your FEC account. (J 2 - R 600 + J 6 R 18 900 = R 19 500) Cr R 21 000 18 900 270 000 250 500 19 500

Cash flow hedge • • Revalue = FEC Asset or liability (SFP) with Cash flow hedge reserve (OCI) Compare FEC Forward rates when revalue except when FEC expires, then compare FEC Forward rate to Spot on date of expiry/ payment of creditor. • On delivery/ transaction date when risk and rewards are transferred and you are now the owner: – Revalue your FEC (FEC Forward rates) – Transfer your cash flow hedge reserve (OCI) to your asset to adjust your asset’s carrying amount. – Going forward, your cash flow hedge reserve (OCI) will now clear to your P/L account, fair value gain or loss • Payment or expiry of your FEC works the same way as with a fair value hedge Compare FEC forward rate to Spot rate. • Payment journal will be the same as with the fair value hedge.

Cash flow hedge

Cash flow hedge

Example – Cash flow hedge Question 5 in TUT 102 Choco. Coffee Ltd is a company situated on the North Coast of Kwazulu Natal. The company has a 31 December year-end. Roasting machine On 1 November 20. 10, Choco. Coffee Ltd placed an order for a coffee bean roasting machine from an Italian company for € 3 000. The invoice amount is payable on 30 June 20. 11. The order was shipped free on board (FOB) on 1 December 20. 10 and the machine was available for use, as intended by management, on 1 January 20. 11. The machine was brought into use on 1 January 20. 11. On 1 November 20. 10, Choco. Coffee Ltd took out a forward exchange contract (FEC) for the same amount as the purchase price of the roasting machine, to counter the exchange rate fluctuations. The FEC will expire on 30 June 20. 11.

Example – Cash flow hedge Question 5 in TUT 102 Choco. Coffee Ltd chose to apply cash flow hedge accounting and on 1 November 20. 10, designated the FEC as the hedging instrument and any foreign currency creditor that arises as a result of this transaction, as the hedged item. The hedge complied with all the requirements for hedge accounting and the hedge was considered to be highly effective at all times during the period. From transaction date the hedge is used as a hedge against variability in fair value. The useful life of the machine was estimated to be 10 years with a residual value of R 5 000. The residual value and remaining useful life of the machine remained unchanged. The following dates and exchange rates are applicable: Date Spot rate € 1 = R Forward rate for FEC period € 1 = R 1 November 20. 10 10, 21 10, 30 8 months 1 December 20. 10 10, 03 10, 15 7 months 31 December 20. 10 10, 36 10, 42 6 months 30 June 20. 11 10, 29

Example – Cash flow hedge Question 5 in TUT 102 It is the accounting policy of the company to account for property, plant and equipment using the revaluation model on the net replacement value basis. The roasting machine will be revalued for the first time during the 20. 12 financial year It is the accounting policy of the company to provide for depreciation according to the straightline method over the assets’ estimated useful lives. Depreciation for the year is calculated on the most recent revalued amounts. REQUIRED: Prepare all the relevant journal entries (cash transactions included) in the accounting records of Choco. Coffee Ltd, to correctly account for the roasting machine purchased, the hedged item, the hedging instrument and foreign currency creditor. Prepare only the journal entries relevant to the following dates: • 1 December 20. 10 • 30 June 20. 11

Cash flow hedge example - Timeline 1 Nov 2010 1 Dec 2010 31 Dec 2010 = 1 Jan 2011 30 June 2011 Order date EUR 3 000 Take out FEC @ 10, 30 No Journal entries! Shipped FOB = Transaction date! Transfer CFHR (OCI) to asset Year-end Revalue! FEC= FEC rate Creditor = Spot Available for use = depreciation starts! Useful life = 10 years Residual value = R 5000 Pay creditor and FEC expires EUR 3 000 Spot = 10, 29 Cash flow hedge accounting: Cash flow hedge reserve (OCI) until transaction date. Fair value hedge accounting from transaction date: Fair value Gain/Loss to P/L FEC rate up = gain FEC rate down = loss Revalue creditor @ Spot Revalue FEC @ Spot Clear the FEC Assets/ FEC Liabilities account Account for payment

Solution : Transaction date journal 1 December 2010 J 1 Machine @ Spot rate on transaction date Dr R Cr R 30 090 Accounts payable/ Creditor 30 090 (3 000 x 10, 03) J 2 Cash flow hedge reserve (OCI) 450 FEC liability 450 [3 000 x (10, 30 – 10, 15)] J 3 Machine 450 Cash flow hedge reserve (OCI) Account for gain and loss on FEC from contract date until transaction date. Compare FEC to FEC rate. According to the contract rate, the company is paying more than he would have if he signed a contract now. Company is making a loss, therefore FEC liability. 450 Cash flow hedge accounting: Transfer the balance of the CFHR account to the purchased asset on transaction date.

Solution: Year-end journals 31 December 2010 J 4 Dr R Foreign exchange difference / loss (P/L) Cr R 990 Accounts payable / Creditors 990 [3 000 x (10, 36 – 10, 03) J 5 FEC asset Fair value gain (P/L) [3 000 x (10, 42 – 10, 15)] Restate the creditor to balance outstanding on yearend (using spot rate on yearend) 810 Calculate the gain/loss on the FEC for the period transaction date until yearend. Company choose fair value hedge accounting. Fair value gain/loss account will be used. New FEC rate is more than the FEC rate on transaction date, thus paying less, making a gain.

Solution: Payment and FEC Expires journals 30 June 2011 Restating the creditor to spot rate on payment date Dr R Cr R J 6 Accounts payable / Creditors J 7 Foreign exchange difference / profit (P/L) Calculate the gain/loss on the [3 000 x (10, 36 – 10, 29)] FEC from year-end until Fair value loss (P/L) settlement date. Company is 390 paying more (10, 42 compared FEC liability to 10, 29), making a loss. [3 000 x (10, 42 – 10, 29)] J 8 FEC liability (450 + 390) (reversing J 2 + J 7) 210 840 Accounts payable / Creditors (3 000 x 10, 29) 30 870 Original contract rate Bank (3 000 x 10, 30) for FEC asset (reversing J 5) Reversing the balance in your FEC general ledger accounts 210 390 @ Spot rate 30 900 810

Remember 1. No journal entries on order date unless you paid a deposit (hedged item). 2. No journal entry for FEC on date that you entered into that FEC. 3. Identify the type of hedge, identify the type of hedge accounting used! 4. Show all your calculations in your journals. 5. Use full journal descriptions, no abbreviations (FEC or Forex) Account for the relevant transactions at each significant date. REMEMBER to account for the hedge item and hedge instrument. 6. Remember to include in your solution the dates of the transactions.

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