Seltec, a public limited company, processes and sells edible oils and uses several fi nancial instruments to spread the risk of fl uctuation in the price of the edible oils. The entity operates in an environment where the transactions are normally denominated in dollars. The functional currency of Seltec is the dollar.
(a) The entity uses forward and futures contracts to protect it against fl uctuation in the price of edible oils. Where forwards are used the company often takes delivery of the edible oil and sells it shortly afterwards. The contracts are constructed with future delivery in mind but the contracts also allow net settlement in cash as an alternative. The net settlement is based on the change in the price of the oil since the start of the contract. Seltec uses the proceeds of a net settlement to purchase a different type of oil or purchase from a different supplier. Where futures are used these sometimes relate to edible oils of a different type and market than those of Seltec’s own inventory of edible oil. The company intends to apply hedge accounting to these contracts in order to protect itself from earnings volatility. Seltec has also entered into a long-term arrangement to buy oil from a foreign entity whose currency is the dinar. The commitment stipulates that the fi xed purchase price will be denominated in pounds sterling.
Seltec is unsure as to the nature of derivatives and hedge accounting techniques and has asked your advice on how the above fi nancial instruments should be dealt with in the fi nancial statements. (14 marks)
(b) Seltec has decided to enter the retail market and has recently purchased two well-known brand names in the edible oil industry. One of the brand names has been in existence for many years and has a good reputation for quality. The other brand name is named after a famous fi lm star who has been actively promoting the edible oil as being a healthier option than other brands of oil. This type of oil has only been on the market for a short time. Seltec is fi nding it diffi cult to estimate the useful life of the brands and therefore intends to treat the brands as having indefi nite lives.
In order to sell the oil, Seltec has purchased two limited liability companies from a company that owns several retail outlets. Each entity owns retail outlets in several shopping complexes. The only assets of each entity are the retail outlets. There is no operational activity and at present the entities have no employees.
Seltec is unclear as to how the purchase of the brands and the entities should be accounted for. (9 marks)
Required:
Discuss the accounting principles involved in accounting for the above transactions and how the above transactions should be treated in the fi nancial statements of Seltec.
Professional marks will be awarded in this question for clarity and quality of discussion. (2 marks)
The mark allocation is shown against each of the two parts above.