(A)ALB purchased 10,000 units of widget inventory three months ago for $100,000. Since that time, the widgets have increased in value to $150,000. Because ALB carries its inventory at the lower of cost or market, ALB has not recognized the $50,000 appreciation in this inventory. To hedge the fair value of these 10,000 units of widget inventory, ALB purchases a put option to sell 10,000 widgets at a price of $15 each. ALB measures effectiveness using the option’s intrinsic value.
A1.If, as of the next reporting date (i.e., one month later), the intrinsic value of the option has increased by $20,000 and the fair value of the inventory has declined by $20,000, at what amount would ALB carry this inventory on its books?
A2.Could an entity decide to exclude the premium of an interest rate futures or forward contract from its assessment of hedge effectiveness?
(B)At inception of a hedging relationship, on January 1, 20X1, an entity formally documented that the hedging relationship is expected to be highly effective in achieving offsetting changes in fair value attributable to the hedged risk during the period that the hedge is designated. The entity also documented that its established policy for the range of what is considered highly effective is 80 to 125 percent. Assume the changes in fair value of the derivative hedging instrument and the hedged item attributable to the hedged risk during the three months ended March 31, 20X1 were $(50,000) and $45,000, respectively.
B1. Because the hedging relationship was highly effective during the three months ended March 31, 20X1 in achieving offsetting changes in fair value attributable to the hedged risk (i.e., $45,000/$50,000 = 90 percent effective) is the entity required to record in earnings the $5,000 which represents the loss on the derivative hedging instrument in excess of the gain on the hedged item?