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Question 2 (adapted from AC3102 final examination in December 2023)

Company Crown (“CROWN” or “the Company”) is a company incorporated in Singapore. The Company adopts 31 December as its accounting year-end, and prepares quarterly financial statements. The functional and presentation currency of the Company are the Singapore Dollars (“S$”). CROWN is a manufacturing company that requires raw materials of Ribbed Smoked Sheets (“RSS”) and industrial machinery.

As at 1 January 20×3, CROWN had 100,000 kg of RSS in inventory, which was carried at S$2.57 per kg in accordance with SFRS(I) 1–2: Inventories. Prices of RSS had been volatile in recent months. Of the inventory, 50,000 kg was used in production and charged to manufacturing expenses on 30 June 20×3.

In a plan to expand production capacity, on 1 January 20×3, CROWN entered into an agreement to buy a piece of machinery for United States Dollars (“US$”) 500,000, on cash terms, payable upon delivery on 30 June 20×3. On 30 June 20×3, the machine was duly delivered and paid for.

For working capital requirements, on 1 January 20×3, the Company borrowed S$1,000,000 from a bank at an interest rate based on a floating interest rate benchmark plus 25 basis points. The loan principal is repayable on 31 December 20×3 whilst interest on the loan is payable on a quarterly basis. The floating interest rate benchmark are reset quarterly and settlement of interest for a quarter is based on the rate at the beginning of that quarter. The loan liability is accounted for on the basis of amortised cost.

In planning to hedge financial risks that the Company was exposed to, CROWN contracted the following derivative instruments on 1 January 20×3.

The Company entered into a futures contract to sell 100,000 kg of RSS at S$2.80 per kg on 30 June 20×3. The prices of RSS were as follows:

The Company also entered into a forward foreign exchange contract to buy US$500,000 at forward exchange rate of US$1.00 = S$1.3505 on 31 August 20×3. The foreign exchange rates of US$ to S$ were as follows:

On 1 January 20×3, CROWN entered into an interest rate swap of a notional amount of S$1,000,000 with maturity date 31 December 20×3. In the swap arrangement, CROWN shall pay interest at a fixed rate of 1.00% per quarter in exchange for the counterparty paying interest at an interest rate based on the same floating interest rate benchmark as the working capital borrowing described above plus 25 basis points. Rates for the floating rate benchmark are reset quarterly and settlement of interest under the swap for a quarter is based on the rate at the beginning of that quarter. The floating interest rates and the fair value of the swap (calculated based on certain assumptions relating to its yield curve) are as follows:

CROWN wishes to apply hedge accounting where hedges can be designated to meet the requirements for hedge accounting under SFRS(I) 9: Financial Instruments. Where permitted to apply hedge accounting, the Company will document that it shall designate changes in fair value of hedging instruments based on their forward rates to hedge changes in fair value/cash flow of hedged items based on their spot rates. Where applicable, in applying hedge accounting 6 / 9 for hedges of firm commitment for foreign exchange risk, the Company would apply fair value hedge as an accounting policy choice. Ignore

Ignore (i) margin deposit on futures contracts,

(ii) time value of money as it is not expected to be significant and

(iii) tax effects, if any, arising from the above transactions and events.

Required:

(a) From the above-mentioned transactions and events,

(i) describe and identify all financial risks that Company Crown was exposed to during the financial year 20×3; and

(ii) for each risk identified, designate* an appropriate hedge, using financial derivative financial instruments that Company Crown had contracted for, that qualifies for hedge accounting under SFRS(I) 9: Financial Instruments.

Designate means:

(1) describe and state the hedged item, hedging instrument and type of hedge based on SFRS(I) 9; or
(2) explain, if no appropriate hedge can be so designated for the risk identified.

(b) Prepare journal entries to record all the above-mentioned transactions and events for the quarter ending:

(i) 31 March 20×3; and

(ii) 30 June 20×3.

(for an account line item in the statement of comprehensive income, indicate clearly whether it shall be accounted for in “profit or loss” or “other comprehensive income”).

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