AAA Rubber Trading Ltd (the company) has 100,000 kg of Standard Malaysian Rubber (SMR) in its rubber inventory, at a cost of $2.00 per kg. The current market price of SMR is $2.40 per kg. There is a futures market for Ribbed Smoke Sheet (RSS) rubber, but there is no futures market for SMR.

The company is concerned with a potential fall in the value of its SMR inventory. To hedge this risk, on 1 April 20x8, the company sells RSS futures contract with a total notional quantity of 100,000 kg at $3.80 per kg. The contract matures on 30 June 20x8.

The company has designated the change in the futures price of RSS futures contract as a fair value hedge of the spot price of the value of the SMR inventory on 30 June 20x8. Past experience has proven that there is a very high correlation between the futures price of RSS and the spot price of SMR. Therefore, the company expects the RSS futures contract to be an effective hedge of the value of the SMR inventory. For the purpose of assessing the retrospective effectiveness of the hedge, the company has adopted the cumulative approach. Assume that all the other conditions for hedge accounting under FRS 39 Financial Instruments: Recognition and Measurement are met.

The spot prices of SMR and the futures prices of RSS futures contract for 30 June 20x8 delivery are as follows:

The futures contract is net settled on 30 June 20x8. The company sells all its SMR inventory on 1 July 20x8 at $2.50 per kg for cash.

The company prepares monthly financial statements, and adopts the Singapore Financial Reporting Standards including the hedge accounting provisions of FRS 39.

Required:

(a) Apply the appropriate hedge accounting provisions in FRS 39, prepare and account for all the relevant journal entries to record the transactions and events from 1 April 20x8 to 1 July 20x8, indicating clearly whether the gain/loss is recognised as profit or loss or as other comprehensive income. Ignore the margin deposit and the time value of money. (12 marks)

(b) Assume that the company decides not to apply hedge accounting. Apply the appropriate hedge accounting provisions in FRS 39, prepare and account for all the relevant journal entries to record the transactions and events from 1 April 20x8 to 1 July 20x8, indicating clearly whether the gain/loss is recognized as profit or loss or as other comprehensive income. Ignore the margin deposit and the time value of money. (8 marks)

(c) Based on (a) and (b) above, analyse and explain the accounting consequences of applying and not applying hedge accounting in this case. Support your answer with monthly profit or loss figures. (10 marks)

Spot price of SMR per kg 1 April 20x8 30 April 20x8 31 May 20x8 30 June 20x8 $2.40 $2.45 $2.47 $2.50 Futures price of RSS per kg for 30 June 20x8 delivery $3.80 $3.86 $3.88 $3.92 Spot price of SMR per kg 1 April 20x8 30 April 20x8 31 May 20x8 30 June 20x8 $2.40 $2.45 $2.47 $2.50 Futures price of RSS per kg for 30 June 20x8 delivery $3.80 $3.86 $3.88 $3.92