DJP wrote: ↑10 Jan 2022, 15:44
Yes, but also changes in time value are to be recorded in OCI and taken to P&L either linearly or when the hedged item affects P&L -- this is the so-called "cost of hedging" approach which was introduced by IFRS 9
So let’s say we do hedge Accounting and I have a call option 20k$ and I buy it for a premium for 1k$.
First I have to book the premium to p&l. DR option CR cost
If there is no change in value then I don’t have to do anything for monthly closing. If we do cash flow hedging and the price rises or falls, I will book the difference in my OCI like „normal“ hedge accounting. Whenever the option expires or I use it, the effect will be booked and the OCI recycled, right?
So let’s say we do hedge Accounting and I have a call option 20k$ and I buy it for a premium for 1k$.
First I have to book the premium but it has to be neutral to success. DR option CR cash
If there is no change in value then I don’t have to do anything for monthly closing.
If we do cash flow hedging and the price rises or falls, I will book the difference in my OCI like „normal“ hedge accounting. Whenever the option expires or I use it, the effect will be booked and the OCI recycled, right?
If we use Fair Value hedging and the price sinks my booking would be
DR Option CR cost of material , in addition to that I have to do an impairment to my inventories
price rises
DR other operating expenses CR Option, because I can't go over acquisition cost
That´s for the monthly valuation, but what will happen if we don't use the option? If we use it than the settlement will go to cost of material like in "normal" hedge accounting". Both in a rising and falling price scenario, right?
Before we get into specifics, what do you mean by "I have a call option 20k$, and I buy it for a premium for 1k$"? If what you mean is that the value of the option is 20k$ at the time you buy it, then that's the option's premium. Premium = option's price. I just want to make sure that you understand the terminology.
When you say "if we don't use the option" I am assuming that you are asking what happens if the option ends out of the money, i.e. without any value. If you don't apply hedge accounting, you just book the fair value changes through P&L. There will always be some fair value changes, if not only because of passage of time.
with a $20K call option, I mean the fixed selling price. The $1k is the premium paid.
We are using Hedge Accounting with a cash flow macro hedge at the moment. We would now like to expand our hedge accounting to include the unsold portfolio and add options to it. I am not sure if we could use another cash flow hedge for that or if a fair value hedge is the better option for that.
Yes, we are hedging future purchases. It’s a macro hedge so we hedge our order intake with the cash flow hedge. We would like to use options for the unsold stock. To eliminate any price risk.
Ok, so for your highly probale forecast sales you will apply cash flow hedge accounting and the entries are as you've suggested (you book the FV gains or losses of the options in OCI and release it once you recognise the sale).
For the remaining inventory you will have a fair value hedge. If the inventory value goes down, you need to write it down to its NRV through P&L. Conversely, your option will be in the money and its gain will be booked in P&L as well. But because you are applying hedge accounting, you can book the write down loss and the derivative's gain in the same line item in the P&L. If the inventory value goes up, your option will be out of the money. I think what you are asking is how to deal with the initial premium you have paid for the option. That depends on how you have designated the option in this hedging relationship. If you have designated the option in its entirety, you will keep booking changes in the option's fair value through P&L. Even if the option is out of the money, the initial premium will eventually go down to nil due to the passage of time (you just don't know how much it will go to P&L every month because that depends on the market value of the option at each reporting date). But if you have designated only the intrinsic value of the option, then you will treat the initial premium as a "cost of hedging". What this means is that you will amortise the initial premium to P&L in a systematic way (e.g. straigh line).
Yes, that's understandable. This means that I always have an effect on the P&L with the option. (if the option is not equal to the start value) If we say that I have a call option for 4k on the reporting date. Then the entry would be DR options to cost of materials CR. At the same time, the NRV would be booked in the opposite direction. In the case of a settlement, could I also post the effects to the cost of materials?
What do you mean by "cost of materials"? Do you mean cost of goods sold? If so, that is not correct. If the price of inventory goes down, you can book the gain on the option on the same line item in P&L where you book the NRV write down. If subsequently the price goes up, you will reverse the write down and the loss on the option will also go on the same line. If the price of inventory goes above its cost, you don't book anything in inventory, but your option will also be out of the money at that point, so no gain to be booked. The fair value change due to the passage of time goes through P&L in a separate line item.
What do you mean by "in case of of a settlement"? Do you mean a scenario where your option counterparty chooses to close his position by settling the option? In any case, a settlement is just a balance sheet movement: DR Cash; CR Option asset
by cost of material i mean the p&l position. In the cash flow hedge, the derivatives are settled before the due date and the resulting effects are acquisition costs and therefore influence the moving average.
so if i understand correctly, the option is ‘never’ drawn but only the price change of the own material is absorbed.
so what happens when the option expires. how is it booked then? Is it booked by the P&L?
I don't understand what you mean by "the option is ‘never’ drawn but only the price change of the own material is absorbed."
In any case, let's focus on what happens to the option's value as you approach the expiry date. There are two scenarios:
1 - The option ends in the money: any value change up to this date will have been recognised in P&L. On the last day of the option, you will have a positive balance that your counterparty needs to pay you. The option will then be settled and thus derecognised -- DR Cash, CR Derivative asset
2 - The option ends out of the money: any value change up to this date will also have been recognised in P&L. Because the option is out of the money, the option's value is simply time value (while the option is "alive", there is a chance that it can go into the money). But at the very last moment, if the option is still out of the money, there will be no value left; all value changes will have been recognised in P&L until the option's value is nil.
Yes, with the option we have the possibility to buy or sell at a certain price. But if we recognise the fair value of the option in the p&l, then we have not exercised the option at that time.
1. purchase of the option
DR Option asset; CR Cash
2. valuation at the end of the month
Price decline
NRV booked and same line Fair value option
Price increase
No NRV booked and fair value other P&L position
3. Pulling the option
DR Cash; CR Option asset
4. letting the option expire
P&L?; CR Option asset
our options will also have a due date. There is also the option of double protection. For example, we buy a put option with a strike price of 13000 and sell a put option with a strike price of 11000. The options are due at t+2. If the price were now to fall to 12000 at t+1. Then the first option would have a fair value of +1000 and the second option a fair value of -1000. Due to the price drop, I would form an NRV and show the +1000 on the same line in the nrv. What would happen to the -1000?
