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what is a financial instrument?
- a financial instrument includes the following:
- -Ownership interests in an entity(ex. stock)
- -Derivative contracts that create a right and obligation to transfer other financial instruments(ex stock options)
Financial instruments should be reported on the financial statements at the fair market value. Notice that, in the case of contract that creates an obligation, the instrument may be a liability rather than an asset.
what is a derivative?
- one special type of investment in known as a derivative and it creates contingent liabilties that are difficult to measure. A derivative is a contract whose value is based on an index of some sort. Examples include warrants, stocks, options, ect.
- All derivatives possess these following characteristics:
-Settlement in cash or equivalents
-Underlying and notion amount-the total value of derivative will be calculated by multiplying the index by a specific number of units specified in the contract such as units, pounds, ect.
-No net investment- at the time the derivative contract is entered there is no payment by either side in most cases.
how should derivatives be accounted for in general?
- when accounting for derivatives:
- -should be recognized in the financial statements as assets or liabilities.
-all derivatives are held at FV
-Gains/Losses resulting from speculation should be reported in I/S in Nonoperating section.
-G/L from hedge accounting varies a bit look to more questions.
what are and how do we account for Fair Value hedge?
- a fair value hedge is a bet against some property or inventory that we actually own as a company. So usually against inventory we carry we think price will go down they we hedge our bets. For Example,
- Inventory x
- Cash x
- Loss x
- Inventory x
*Gains/Losses go to income statement.
what are and how do we account for Cash Flow hedge?
a cash flow hedge is when you bet against an asset you do not own. Simply record the entry as so:
- Loss(AOCI) X
- Payable X
*The G/L would be sent to OCI
what is an embedded derivative and what is bifurcation?
an embedded derivative is a hybrid instrument that contains both a host instrument an an embedded derivative, if stood alone would meet the definition of derivative instrument. This is an example as such like a bond with detachable warrants. Bifurcation is the term used for when we spread the host and derivative apart. This happens with bonds with detachable warrants and we use the FMV Approach to bifurcate.
what does FASB 161 require?
- FASB 161 requires the following qualitative disclosures regarding:
- -how and why an entity uses derivative instruments
-how derivative instruments and related hedge items are accounted for under FASB 133 and its related interpretations
-how derivative instruments and related hedge items affect and entity's financial position, financial performance, and cash flows.
are cash flow hedges or fair value hedges accounted for differently under IFRS?
No. they are accounted for the same as GAAP under IFRS.