Derivatives and Hedge Accounting

[Pradeep Kaushik]

Dear All,

Please tell me, what is Derivatives and how we determine the loss or profit from derivatives.

Please also let me know that what is Hedge accouting.

Best Regards.

Pradeep kaushik

[Guest]

Derivative is a financial instrument, which dervies its value based on the existing price discouted to future date. Kinds of derivative are forwards, futures, swaps, options.

Hedge is a term that comes under Derivate. Hedge is a attempt to reduce risk.

Accounting in brief

Take a forward contract. It is a Derivate to hedge ur exchange rate risk.

Contract Details: Type: IMPORT, Currency: USD/INR, Value: USD 1,000,000/- Spot: 44.50, Premium: 0.45, Bank Margin: 0.05. Forward Rate: 45. Maturity Date: 31/05/2011

The premium of Rs. 4,50,000/- (0.45 * 1000000) and Margin of Rs. 500,000/- (0.05 * 1000000) is to be amortised over the period of the Contract.

If the contract is cancelled in between say 30/04/2011 at a profit of Rs. 100,000/-, the banker will pay ur profit only on 31/05/2011. Hence u need a pass an accrual entry on 30/04 and the receipt entry to be made on the due date of the contract.

AI Summary

Derivatives risk management: amortise forward contract costs and accrue early cancellation gains until contractual settlement. Derivatives such as forwards, futures, swaps and options derive value from underlying prices; when used as a hedge to reduce exchange risk, contract costs (premiums and bank margins) must be amortised over the contract term. If a forward contract is cancelled before maturity, any profit reported by the counterparty is typically settled only at the original maturity, requiring accrual of the profit on the cancellation date and recognition of the receipt at the contract due date.