BANK PENALTY FOR CANCELLATION OF FORWARD CONTRACT ACCOUNTING

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Amit purohit (Querist)
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08 February 2021 Bank have imposed cancellation charges on forward contract to us. what is the accounting treatment of it. Our forward contract comes under cash flow hedge.

Aashok Kumar Sharma

Aashok Kumar Sharma

(Expert)
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06 July 2024 When a bank imposes cancellation charges on a forward contract and the forward contract comes under a cash flow hedge, the accounting treatment involves recognizing these charges in the financial statements according to the relevant accounting standards (such as IFRS 9 or AS 30/31 for Indian Accounting Standards). Here’s how you can handle it:

### Accounting Treatment Steps:

1. **Identify the Nature of the Charges**:
- Cancellation charges are typically recognized as an expense.

2. **Determine the Timing of Recognition**:
- These charges should be recognized in the period they are incurred, which is the period when the forward contract is canceled.

3. **Journal Entry for Cancellation Charges**:
- Debit: Cancellation Charges (Expense)
- Credit: Bank/Cash

### Example Journal Entry:

```
Cancellation Charges Expense A/c Dr
To Bank/Cash A/c
```

### Cash Flow Hedge Accounting:

For cash flow hedges, changes in the fair value of the hedging instrument that are considered effective hedges are recognized in other comprehensive income (OCI). When the hedging instrument is canceled, the following steps should be taken:

1. **Remove the Hedging Instrument from the Books**:
- Debit: Hedging Reserve (OCI) if any deferred gain/loss exists
- Credit: Forward Contract Liability/Asset

2. **Recognize the Cancellation Charges**:
- Debit: Cancellation Charges (Expense)
- Credit: Bank/Cash

### Complete Example:

Assume you had a forward contract with a fair value adjustment in OCI and now you incur cancellation charges.

1. **Remove Hedging Instrument**:
```
Hedging Reserve (OCI) A/c Dr
To Forward Contract Asset/Liability A/c
```

2. **Recognize Cancellation Charges**:
```
Cancellation Charges Expense A/c Dr
To Bank/Cash A/c
```

### Relevant Accounting Standards:

1. **IFRS 9 (Financial Instruments)**:
- Hedging instruments are initially recognized at fair value.
- Effective portion of changes in fair value of hedging instruments in a cash flow hedge are recognized in OCI.
- Ineffective portion and cancellation costs are recognized in profit or loss.

2. **Indian Accounting Standards (Ind AS 109)**:
- Similar to IFRS 9, hedge accounting principles and recognition in OCI and profit or loss are followed.

### Practical Considerations:

- **Documentation**: Ensure all the related documents, such as the original contract, cancellation notice, and bank statement showing the charges, are well-documented.
- **Disclosure**: In the financial statements, disclose the nature and financial impact of the cancellation charges, especially in the notes section detailing the hedge accounting policies and impacts.

### Summary:

- Recognize cancellation charges as an expense when incurred.
- Adjust the hedging reserve in OCI if applicable.
- Follow relevant accounting standards for correct treatment and disclosure.

Consult with your financial advisor or auditor to ensure compliance with specific accounting policies applicable to your situation.

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