## Forward Exchange Contracts – Entered for Hedging
A forward exchange contract is an agreement to buy or sell a specified amount of foreign currency at a rate fixed today, for delivery at a future date.
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### When is it a Hedging Contract?
When the contract is entered to manage exchange risk on an existing / anticipated transaction:
- You import goods on credit and simultaneously enter a forward contract to buy the foreign currency at a locked-in rate.
- This protects you from adverse exchange rate movements.
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### Accounting Treatment
Compare: Forward Rate (rate locked in the contract) vs Spot Rate (today's rate)
- Forward Rate > Spot Rate → Premium (cost of hedging; it is a loss)
- Forward Rate < Spot Rate → Discount (gain from hedging)
Key Rule:
> The premium or discount at the inception of the forward contract is amortised (spread equally) over the life of the contract and charged/credited to P&L each period.
At each Balance Sheet date / period end, the exchange difference on the underlying transaction is also recognised in P&L as usual.
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### Journal Entry Pattern
Each period (amortisation of premium/discount):
```
If Premium (loss):
Dr Exchange Loss (P&L)
Cr Forward Contract Liability A/c
If Discount (gain):
Dr Forward Contract Asset A/c
Cr Exchange Gain (P&L)
```
### Example 1
Illus 4 CDR – Hedging Contract
Details:
- Forward Rate (rate fixed in contract) = ₹49.15/$
- Spot Rate on contract date = ₹48.85/$
- Premium = 49.15 − 48.85 = ₹0.30 per $
- Contract Amount = $1,00,000
- Total Premium (loss/cost of hedging) = 1,00,000 × 0.30 = ₹30,000
- Contract Period = 3 months
Amortisation per month = 30,000 ÷ 3 = ₹10,000 loss per month
Each month:
```
Dr Exchange Loss (P&L) 10,000
Cr Forward Contract A/c 10,000
```
Over 3 months, ₹30,000 total premium is charged to P&L in equal instalments.
### Example 2
Extra Example – Hedging a PPE Purchase
On 01.03.Y1: PPE purchased for $15,000; spot rate = ₹45/$
- Recorded at: 15,000 × 45 = ₹6,75,000
- Payment due after 3 months; forward contract entered to buy $ at ₹47/$.
Forward Rate = ₹47; Spot Rate = ₹45
Premium per $ = 47 − 45 = ₹2; Total Premium = 15,000 × 2 = ₹30,000 (loss)
Contract period = 3 months → Amortise ₹10,000 loss per month.
```
31.03.Y1 (1 month): Dr Exchange Loss 10,000
Cr Forward Contract 10,000
30.04.Y1 (2 months): Dr Exchange Loss 10,000
Cr Forward Contract 10,000
31.05.Y1 (3 months – payment): Dr Exchange Loss 10,000
Cr Forward Contract 10,000
On payment:
Dr Creditors A/c 6,75,000
Cr Bank A/c 7,05,000 (15,000 × ₹47 forward rate)
Cr Exchange Gain (P&L) [if spot moved favourably]
```
Note: PPE remains at ₹6,75,000 (original rate). The premium is expensed separately.