Forward contracts are financial instruments used to hedge against future price fluctuations or to lock in prices for a future date. The accounting for forward contracts involves recognizing the contract at its inception and subsequently accounting for any changes in its fair value.
Scenario:
A company enters into a forward contract to purchase 1,000 units of a commodity at ₹200 per unit. The current market price is ₹190 per unit. The delivery date is six months from the contract date.
Journal Entries for Forward Contracts:
1. Inception of the Forward Contract:
No entry is required at inception if no premium is paid.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| (No entry required at inception if no premium is paid) |
2. Adjusting Entry for Changes in Fair Value:
Assuming the forward contract is marked-to-market at the end of the accounting period and the market price has increased to ₹210 per unit.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Forward Contract Asset A/c | 10,000 | |
| To Unrealized Gain on Forward Contract A/c | 10,000 | |
| (Being recognition of gain due to increase in fair value) |
Calculation:
- Fair value change: (₹210 - ₹200) * 1,000 units = ₹10,000
3. Settlement of the Forward Contract:
On the settlement date, the company receives the commodity and pays the contracted amount. Assume the market price on the delivery date is ₹220 per unit.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Commodity Inventory A/c | 220,000 | |
| To Cash/Bank A/c | 200,000 | |
| To Forward Contract Asset A/c | 20,000 | |
| (Being receipt of commodity and settlement of forward contract) |
Calculation:
- Cash payment: ₹200 * 1,000 units = ₹200,000
- Fair value adjustment: (₹220 - ₹200) * 1,000 units = ₹20,000
Example with Different Details:
1. Inception of the Forward Contract:
Company enters into a forward contract to sell 500 units of a commodity at ₹300 per unit. The current market price is ₹310 per unit. The delivery date is three months from the contract date.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| (No entry required at inception if no premium is received) |
2. Adjusting Entry for Changes in Fair Value:
Assuming the forward contract is marked-to-market at the end of the accounting period, and the market price has decreased to ₹290 per unit.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Unrealized Loss on Forward Contract A/c | 10,000 | |
| To Forward Contract Liability A/c | 10,000 | |
| (Being recognition of loss due to decrease in fair value) |
Calculation:
- Fair value change: (₹300 - ₹290) * 500 units = ₹5,000
3. Settlement of the Forward Contract:
On the settlement date, the company delivers the commodity and receives the contracted amount. Assume the market price on the delivery date is ₹295 per unit.
Particulars | Debit (₹) | **Credit (₹
Certainly! Here are the journal entries for the forward contract without the date column, presented in a clear format:
Scenario:
A company enters into a forward contract to purchase 1,000 units of a commodity at ₹200 per unit. The current market price is ₹190 per unit. The delivery date is six months from the contract date.
Journal Entries for Forward Contracts:
1. Inception of the Forward Contract:
No entry is required at inception if no premium is paid.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| (No entry required at inception if no premium is paid) |
2. Adjusting Entry for Changes in Fair Value:
Assuming the forward contract is marked-to-market at the end of the accounting period and the market price has increased to ₹210 per unit.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Forward Contract Asset A/c | 10,000 | |
| To Unrealized Gain on Forward Contract A/c | 10,000 | |
| (Being recognition of gain due to increase in fair value) |
Calculation:
- Fair value change: (₹210 - ₹200) * 1,000 units = ₹10,000
3. Settlement of the Forward Contract:
On the settlement date, the company receives the commodity and pays the contracted amount. Assume the market price on the delivery date is ₹220 per unit.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Commodity Inventory A/c | 220,000 | |
| To Cash/Bank A/c | 200,000 | |
| To Forward Contract Asset A/c | 20,000 | |
| (Being receipt of commodity and settlement of forward contract) |
Calculation:
- Cash payment: ₹200 * 1,000 units = ₹200,000
- Fair value adjustment: (₹220 - ₹200) * 1,000 units = ₹20,000
Example with Different Details:
1. Inception of the Forward Contract:
Company enters into a forward contract to sell 500 units of a commodity at ₹300 per unit. The current market price is ₹310 per unit. The delivery date is three months from the contract date.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| (No entry required at inception if no premium is received) |
2. Adjusting Entry for Changes in Fair Value:
Assuming the forward contract is marked-to-market at the end of the accounting period, and the market price has decreased to ₹290 per unit.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Unrealized Loss on Forward Contract A/c | 5,000 | |
| To Forward Contract Liability A/c | 5,000 | |
| (Being recognition of loss due to decrease in fair value) |
Calculation:
- Fair value change: (₹300 - ₹290) * 500 units = ₹5,000
3. Settlement of the Forward Contract:
On the settlement date, the company delivers the commodity and receives the contracted amount. Assume the market price on the delivery date is ₹295 per unit.
| Particulars | Debit (₹) | Credit (₹) |
|---|---|---|
| Cash/Bank A/c | 150,000 | |
| To Commodity Inventory A/c | 147,500 | |
| To Forward Contract Liability A/c | 2,500 | |
| (Being delivery of commodity and settlement of forward contract) |
Calculation:
- Cash receipt: ₹300 * 500 units = ₹150,000
- Fair value adjustment: (₹295 - ₹300) * 500 units = -₹2,500
Summary:
Accounting for forward contracts involves recognizing changes in fair value and recording the final settlement. This ensures that the company's financial statements accurately reflect the economic impact of such contracts.
