Steel Maker Construction (SMC) is a Singapore company that uses iron ore to manufacture steel for construction purposes. SMC has the Singapore Dollar (S$) as its functional currency and presentation currency and a 31 December financial year-end.

On 1 January 20x8, SMC signed a non-cancellable contract with an American supplier, Ironman Inc., to buy 200,000 Dry Metric Tons of iron ore at US$0.80 (in United States Dollar) per Dry Metric Ton, for delivery on 30 June 20x8.

SMC is concerned with the foreign currency risk arising from the firm commitment to purchase iron ore. To hedge this risk, on 1 January 20x8, SMC entered into a forward exchange contract with a foreign exchange dealer to buy US$160,000 of United States Dollar on 30 June 20x8.

SMC has designated the change in the fair value of the forward exchange contract based on the forward rate as a hedge against the foreign exchange risk of the firm commitment to buy the iron ore based on the forward rate. Assume that SMC has decided to adopt the Singapore Financial Reporting Standards (International) (SFRS(I)) 1-39 Financial Instruments: Recognition and Measurement to account for the hedge, and assume that all the conditions for hedge accounting under SFRS(I) 1-39 are met.

The exchange rates between US$ and S$ were as follows:

On 30 June 20x8, SMC purchased the iron ore from Ironman Inc. and paid cash for the purchase. On the same date, SMC duly settled the forward exchange contract with the forward exchange dealer.

The company prepares quarterly financial statements.

Ignore the time value of money as it is deemed to be immaterial, and ignore the tax effects, if any, that arise from the above transactions and events.

Required:

(a) Assume that SMC decides to apply fair value hedge accounting under SFRS(I) 1-39. Illustrate the accounting for the companys hedging transactions by preparing all the relevant journal entries to record the transactions and events from 1 January 20x8 to 30 June 20x8 in accordance with the appropriate hedge accounting provisions in SFRS(I) 1-39. In your answer, indicate clearly whether the gain/loss is recognised as profit or loss or other comprehensive income. (8 marks)

(b) Assume that SMC decides to apply cash flow hedge accounting under SFRS(I) 1-39. SCM has adopted the policy of including the hedge reserve in the initial cost of the iron ore purchased. Illustrate the accounting for this situation by preparing all the relevant journal entries to record the transactions and events from 1 January 20x8 to 30 June 20x8 in accordance with the appropriate hedge accounting provisions in SFRS(I) 1-39. In your answer, indicate clearly whether the gain/loss is recognised as profit or loss or other comprehensive income. (8 marks)

(c) Assume that SMC decides not to apply hedge accounting. Illustrate the accounting for this situation by preparing all the relevant journal entries to record the transactions and events from 1 January 20x8 to 30 June 20x8. (4 marks)

(d) Assume that on 1 January 20x8, SMC did not enter into the forward exchange contract to hedge its foreign currency risk. Illustrate the accounting for this situation by preparing all the relevant journal entries to record the transactions and events from 1 January 20x8 to 30 June 20x8. (2 marks)

(e) Based on (a), (b), (c), and (d) above, analyse and explain (i) the economic consequences of hedging, and (ii) the accounting consequences of applying hedge accounting. Support your answer with figures. (8 marks)

1 January 20x8 31 March 20x8 30 June 20x8 Spot exchange rate US$1.00 = S$1.23 US$1.00 = S$1.27 US$1.00 = S$1.30 Forward exchange rate (delivery 30 June 20x8) US$1.00 = S$1.25 US$1.00 = S$1.28 US$1.00 = S$1.30 1 January 20x8 31 March 20x8 30 June 20x8 Spot exchange rate US$1.00 = S$1.23 US$1.00 = S$1.27 US$1.00 = S$1.30 Forward exchange rate (delivery 30 June 20x8) US$1.00 = S$1.25 US$1.00 = S$1.28 US$1.00 = S$1.30