3.4 Excluded Components of a Derivative
As discussed in Section 2.5.2.1.2.1, an entity
may exclude components of a derivative’s fair value (and the resulting changes in
the fair value of the excluded components) from its assessment of hedge
effectiveness. An entity’s decision to either include or exclude components of fair
value from the assessment of hedge effectiveness does not affect the basis
adjustments to the hedged item in a qualifying fair value hedging relationship
because such adjustments are determined independently from the changes in the fair
values of the different components of the hedging instrument.
If an entity excludes components of the derivative’s fair value from the assessment
of hedge effectiveness and elects to recognize those amounts in earnings by using a
systematic and rational method over the life of the hedging instrument, any
difference between the change in fair value of those components and the amount
recognized in earnings should be recognized in OCI, even for a fair value hedging
relationship.
Example 3-13
Hedging Inventory — Excluding Time Value
MineAllMine owns and operates gold mines. As of July 1, 20X9,
MineAllMine has one ton of gold inventory and is concerned
about falling gold prices. The price of gold in the local
market is $1,400 per ounce, while the Chicago Mercantile
Exchange (CME) spot price is $1,320 per ounce. MineAllMine
purchases a financially settled put option on the CME with
the following terms:
|
Notional
|
32,000 ounces
|
|
Strike price
|
$1,320 per ounce
|
|
Expires
|
December 31, 20X9
|
|
Premium
|
$1,760,000
|
MineAllMine designates the put option as a fair value hedge
of its gold inventory for prices below $1,400 per ounce and
elects to exclude the option’s time value from its hedge
effectiveness assessment. Since this is a fair value hedging
relationship, MineAllMine must hedge the total change in the
inventory’s fair value, which is based on prices in the
gold’s current location (i.e., MineAllMine cannot hedge
solely for changes in the CME price).
MineAllMine will recognize the initial time value in a
systematic and rational basis over the life of the hedge.
Since the term of the put option is six months, use of the
systematic and rational method will result in the
recognition of $880,000 per quarter in cost of sales
provided that the hedging relationship is highly
effective.
The table below shows the CME spot prices of gold and the
fair values of the option components over the life of the
hedge.
The table below shows the local prices of gold and the fair
values of the inventory over the life of the hedge.
MineAllMine records the following journal entries over the
term of the hedging relationship:
July 1, 20X9
September 30, 20X9
December 31, 20X9