Suppose that a firm plans to purchase an asset at a future date. The forward price of the asset is $200,000. It hedges that purchase by buying a forward contract at a price of $205,000. During the hedging period, the forward contract incurs a paper loss of $15,000.
At the end of the hedge, the forward contract has lost an accumulated value of $20,000 and the asset is $20,000 cheaper.
Explain what accounting entries would be done and how the firm's earnings and balance sheet would be affected. What would be different if it were not an effective hedge?