Advanced ing Test Bank Chapter 07 Susan Hamlen 4p1p4w

TEST BANK CHAPTER 7 Foreign Currency Transactions and Hedging MULTIPLE CHOICE 1.

Topic: Valuation of forward contracts LO 3 A U.S. company invests in a forward purchase contract for 100,000,000 yen with a purchase price of $0.009/yen, for delivery in 45 days. The spot rate at the time the contract is initiated is $0.0085/yen. At the end of the ing year, the forward contract is still outstanding. The year-end spot rate is $0.0088/yen. The year-end forward rate for delivery at the contract date is $0.0092/yen. How is the forward contract reported on the U.S. company’s balance sheet? a. b. c. d.

$20,000 asset $20,000 liability $30,000 asset $30,000 liability

ANS: a ($0.0092 - $0.009) x 100,000,000 = $20,000 2.

Topic: Cash flow hedge LO 6 On August 1, a U.S. company enters into a forward contract, in which it agrees to buy 1,000,000 euros from a bank at a rate of $1.115 on December 1. Changes in the value of the forward contract will be reported in other comprehensive income on the balance sheet in which one of the following situations? a. b. c. d.

The U.S. company has receivables denominated in euros, with payment to be received on December 1. The U.S. company sold merchandise to a customer in Belgium on August 1, and expects payment of 1,000,000 euros on December 1. The U.S. company plans to sell merchandise to a customer in Belgium on August 1, with payment of 1,000,000 euros expected on December 1. The U.S. company plans to purchase merchandise from a supplier in Belgium, with payment of 1,000,000 euros expected to be paid on December 1.

ANS: d

Test Bank, Chapter 7

©Cambridge Business Publishers, 2010 1

Use the following information on the U.S. dollar value of the euro to answer questions 3 – 7 below:

October 30, 2010 December 31, 2010 April 30, 2011

Spot rate $ 1.25 1.28 1.26

Forward rate for April 30, 2011 delivery $ 1.30 1.32 1.26

On October 30, 2010, a company enters a forward contract to sell €100,000 on April 30, 2011. The company’s ing year ends December 31. 3.

Topic: Hedge of export transaction LO 4 The forward contract hedges an outstanding €100,000 receivable due on April 30. What is the net effect on income in 2010 and 2011? a. b. c. d.

2010 $1,000 gain $1,000 loss $3,000 gain $2,000 loss

2011 $4,000 gain $4,000 gain $6,000 gain $6,000 gain

ANS: a 2010: Gain on receivable, ($1.28 - $1.25) x €100,000 Loss on forward, ($1.32 - $1.30) x €100,000 Net gain

= $3,000 = $2,000 $1,000

2011: Loss on receivable, ($1.28 - $1.26) x €100,000 Gain on forward, ($1.32 - $1.26) x €100,000 Net gain

= $2,000 = $6,000 $4,000

©Cambridge Business Publishers, 2010 2 Edition

Advanced ing, 1st

4.

Topic: Hedge of firm commitment LO 5 The forward contract hedges a sales order for €100,000, received October 30. The sale was made and the €100,000 collected on April 30, 2011. Sales revenue recorded on April 30 is: a. b. c. d.

$126,000 $122,000 $130,000 $124,000

ANS: c (€100,000 x $1.26) + ($1.30 - $1.26) x €100,000 = $130,000 5.

Topic: Hedge of firm commitment LO 5 The forward contract hedges a sales order for €100,000, received October 30. The sale was made and the €100,000 collected on April 30, 2011. The net effect on 2010 income is: a. b. c. d.

No effect $2,000 loss $3,000 gain $1,000 gain

ANS: a The gain on the firm commitment and loss on the forward contract are ($1.32 - $1.30) x €100,000 = $2,000, and they offset for a zero effect on 2010 income.



6.

Topic: Hedge of forecasted transaction LO 6 The forward contract hedges a forecasted sale for €100,000, expected at the end of April 2011. The net effect on 2010 income is: a. b. c. d.

No effect $2,000 loss $3,000 gain $1,000 gain

ANS: a The loss on the forward contract is reported in other comprehensive income. 7.

Topic: Hedge of forecasted transaction LO 6 The forward contract hedges a forecasted sale for €100,000, expected at the end of April 2011. The sale takes place on April 30, 2011, €100,000 is collected, and the forward contract is closed. Which statement is true, concerning the sale on April 30, 2011? a. b. c. d.

The $1,000 total loss on the forward contract is reclassified from other comprehensive income as an adjustment to sales revenue. The $4,000 total gain on the forward contract is reclassified from other comprehensive income as an adjustment to sales revenue. The 2011 $6,000 gain on the forward contract is recognized as a hedging gain on the 2011 income statement. The 2010 $2,000 loss on the forward contract is recognized as a hedging loss on the 2010 income statement.

ANS: b The total gain on the forward contract is ($1.30 - $1.26) x €100,000 = $4,000. Changes in the value of the forward are reported in other comprehensive income until the hedged forecasted transaction is reported in income. In this case, the forecasted transaction results in sales revenue, reported in 2011.


Advanced ing, 1st

8.

Topic: Export transaction LO 2 On May 20, 2012, when the spot rate is $1.30/€, a company sells merchandise to a customer in Italy. The spot rate is $1.31/€ on June 30, the company’s year-end. Payment of €100,000 is received on July 30, 2012, when the spot rate is $1.28/€. What is the effect on fiscal 2012 and 2013 income? a. b. c. d.

Fiscal 2012 $1,000 exchange loss $1,000 exchange gain No effect No effect

Fiscal 2013 $3,000 exchange gain $3,000 exchange loss $2,000 exchange loss $2,000 exchange gain

ANS: b Fiscal 2012 exchange gain = ($1.31 - $1.30) x €100,000 = $1,000 Fiscal 2013 exchange loss = ($1.31 - $1.28) x €100,000 = $3,000 9.

Topic: Import transaction LO 2 On May 20, 2012, when the spot rate is $1.30/€, a company purchases merchandise from a supplier in Italy. The spot rate is $1.31/€ on June 30, the company’s year-end. Payment of €100,000 is made on July 30, 2012, when the spot rate is $1.28/€. What is the effect on fiscal 2012 and 2013 income? a. b. c. d.

Fiscal 2012 $1,000 exchange loss $1,000 exchange gain No effect No effect

Fiscal 2013 $3,000 exchange gain $3,000 exchange loss $2,000 exchange loss $2,000 exchange gain

ANS: a Fiscal 2012 exchange loss = ($1.31 – $1.30) x €100,000 = $1,000 Fiscal 2013 exchange gain = ($1.31 – $1.28) x €100,000 = $3,000



Data for questions 10 and 11 are as follows: On September 8, the Sealy Company purchased cotton at an invoice price of €20,000, when the exchange rate was $1.32/€. Payment was to be made on November 8. On November 8, Sealy purchased the €20,000 for $1.30/€, and paid the invoice. 10.

Topic: Import transaction LO 2 The cotton should be valued in Sealy's inventory at: a. b. c. d.

$20,000 $25,600 $26,000 $26,400

ANS: d €20,000

11.

x $1.32 = $26,400

Topic: Import transaction LO 2 The exchange gain or loss recognized by Sealy as a result of this transaction is: a. b. c. d.

No gain or loss $400 gain $400 loss $1,667 gain

ANS: b €20,000 x ($1.32 - $1.30) = $400 gain


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Data for questions 12 and 13 are as follows: On June 5, Teneco Corporation sold merchandise at an invoice price of €100,000, when the exchange rate was $1.36/€. Payment was to be received on August 16. On August 16, the customer paid the €100,000. The exchange rate on that date was $1.39/€. 12.

Topic: Export transaction LO 2 The sale should be reported on Teneco's books at: a. b. c. d.

$136,000 $139,000 $ 73,530 $ 71,942

ANS: a €100,000 x $1.36 = $136,000 13.

Topic: Export transaction LO 2 The exchange gain or loss recognized by Teneco as a result of this transaction is: a. b. c. d.

-0$3,000 gain $3,000 loss $3,919 loss

ANS: b €100,000 x ($1.39 - 1.36) = $3,000 gain



14.

Topic: Analysis of foreign currency risks LO 3 A U.S. exporter has made a sale to a customer in another country. The customer is obligated to remit payment in his local currency in 90 days. The direct spot rate is now $1.54. The 90-day forward rate is $1.60. At which spot rate at the time the customer remits payment would the company have been better off not hedging the export transaction with a forward contract? a. b. c. d.

$1.52 $1.54 $1.59 $1.62

ANS: d Any rate above $1.60 leads to higher U.S. dollar value of payment received than under the forward contract. 15.

Topic: Foreign currency options LO 3 A company invests $200 in a foreign exchange option with the following : The company may purchase 1,000,000 zloty at a price of $.25/zloty on December 20, 2014. Which statement is true? a. b. c. d.

If the spot price for zloty is $.36 on December 20, the company will gain $359,800 on the option. If the spot price for zloty is $.24 on December 20, the company will lose $200 on the option. If the spot price for zloty is $.27 on December 20, the company will lose $20,200 on the option. If the spot price for zloty is $.30 on December 20, the company will gain $24,800 on the option.

ANS: b The option gives the holder the option to buy 1,000,000 zloty for $250,000. At a spot price of $.24/zloty, the option has no value and the holder loses its $200 investment.


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16.

Topic: Hedge of import transaction LO 4 A U.S. import company purchases boomerangs from an Australian supplier on October 1, 2013 for 100,000 Australian dollars (A$), payable February 1, 2014. On October 1, 2013, the company enters into a forward contract to hedge the foreign currency risk resulting from this purchase. Exchange rates are as follows:

October 1, 2013 December 31, 2013 February 1, 2014

Spot rate $0.89 0.88 0.82

Forward rate for 2/1 delivery $0.85 0.84 0.82

For the import company, what is the income statement effect of the above information? a. b. c. d.

No effect in 2013, $4,000 gain in 2014 $1,000 gain in 2013, $6,000 gain in 2014 $1,000 loss in 2013, $6,000 loss in 2014 No effect in 2013, $4,000 loss in 2014

ANS: a 2013: forward contract: ($.85 - $.84) x A$100,000 = payable: ($.89 - $.88) x A$100,000 = 2014: forward contract: ($.84 - $.82) x A$100,000 = payable: ($.88 - $.82) x A$100,000 =


$1,000 loss 1,000 gain -0$2,000 loss 6,000 gain $4,000 gain


17.

Topic: Hedge of firm commitment LO 5 ABC Corporation issues a purchase order for 1,000,000 semiconductors to a foreign supplier. The agreed upon total price is FC1,200,000, and the current spot rate is $1/FC. Suppose a forward contract is taken out when the purchase order is issued, at a rate of $0.95/FC, for delivery when the semiconductors are received. If the spot rate rises to $1.05 when the semiconductors are received and paid for by ABC, at what value will the semiconductors be reported on ABC’s books? a. b. c. d.

$1,020,000 $1,140,000 $1,200,000 $1,260,000

ANS: b $1.05 x FC1,200,000 = ($1.05 - $.95) x FC1,200,000 =

$1,260,000 (120,000) $1,140,000

Use the following information to answer questions 18 and 19 below. A U.S. company purchases a 60-day certificate of deposit from an Italian bank on October 15. The certificate has a face value of €1,000,000, costs $1,200,000 (the spot rate is $1.20/€), and pays interest at an annual rate of 6 percent. On December 14, the certificate of deposit matures and the company receives principal and interest of €1,010,000. The spot rate on December 14 is $1.18/€. The average spot rate for the period October 15 – December 14 is $1.19/€. 18.

Topic: Foreign currency lending LO 2 The exchange gain or loss on this investment is: a. b. c. d.

$20,200 gain $20,200 loss $20,000 gain $20,000 loss

ANS: d €1,000,000 x ($1.20 - $1.18) = $20,000 loss


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19.

Topic: Foreign currency lending LO 2 Interest income on the investment is reported at: a. b. c. d.

$0 $11,800 $11,900 $12,000

ANS: b €10,000

x $1.18 = $11,800

Use the following information to answer questions 20 – 22 below: A U.S. company anticipates that it will purchase merchandise for €10,000,000 at the end of July, and pay for it at the end of September. On March 1, it enters a forward contract to buy €10,000,000 on September 30. The forward contract qualifies as a cash flow hedge. The company’s ing year ends December 31. The company actually purchases the merchandise on July 30 and closes the forward contract and pays for the merchandise on September 30. It still holds the merchandise at the end of the year. Exchange rates are as follows: Forward rate for 9/30 delivery March 1 July 30 September 30


Spot rate $1.40 1.42 1.43

$1.41 1.415 1.43


20.

Topic: Hedge of forecasted transaction LO 6 The merchandise is reported on the year-end balance sheet at: a. b. c. d.

$14,100,000 $14,150,000 $14,200,000 $14,300,000

ANS: c Changes in the value of the forward contract remain in other comprehensive income until the merchandise is sold. The merchandise is reported at the spot rate at the date of purchase, $1.42. 21.

Topic: Hedge of forecasted transaction LO 6 What is the net effect on income for the year? a. b. c. d.

No effect $100 loss $100 gain $50 gain

ANS: a Changes in the value of the forward are reported in other comprehensive income. The $100 loss on the payable is exactly offset by a reclassification of $100 out of other comprehensive income, so there is no net effect on income.


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22.

Topic: Hedge of forecasted transaction LO 6 When the merchandise is sold, what amount is reported for cost of goods sold? a. b. c. d.

$14,100,000 $14,150,000 $14,200,000 $14,300,000

ANS: a At the end of the year, other comprehensive income has a credit balance of $100. When the merchandise is sold, it is reclassified as a reduction in cost of goods sold; $14,100,000 = $14,200,000 - $100,000. Journal entries related to questions 20 – 22 (in thousands): July 30 Inventory

14,200 s payable

14,200

Investment in forward

50 Other comprehensive income

September 30 Exchange loss

50 100

s payable

100



Other comprehensive income

150 100

Exchange gain

100

s payable

14,300 Cash Investment in forward

When merchandise is sold: Cost of goods sold Other comprehensive income

14,100 100 Inventory


14,100 200

14,200


Use the following information on the U.S. dollar value of the euro to answer questions 23 – 25:

November 30, 2011 December 31, 2011 March 20, 2012 23.

Spot rate $ 1.30 1.33 1.35

Forward rate for March 20, 2012 delivery $ 1.29 1.31 1.35

Topic: Speculative forward purchase contract LO 7 On November 30, 2011, a U.S. company, with a December 31 year-end, enters a forward purchase contract for €100,000 to be delivered on March 20, 2012. The forward contract does not qualify as a hedge. The company closes the contract at its expiration date. Which statement is true? a. b. c. d.

No gain or loss is reported until the forward is closed on March 20 A gain of $2,000 is reported in 2012 A gain of $4,000 is reported in 2012 A gain of $6,000 is reported in 2012

ANS: c The change in value of the forward is reported in income as the forward rate changes. For 2012, the gain is ($1.35 - $1.31) x €100,000 = $4,000. 24.

Topic: Speculative forward sale contract LO 7 On November 30, 2011, a U.S. company, with a December 31 year-end, enters a forward sale contract for €100,000 to be delivered on March 20, 2012. The forward contract does not qualify as a hedge. The company closes the forward contract on December 31. Which statement is true? a. b. c. d.

No gain or loss is reported A loss of $1,000 is reported in 2011 A loss of $3,000 is reported in 2011 A loss of $2,000 is reported in 2011

ANS: d The change in value of the forward is reported in income as the forward rate changes. For 2011, the loss is ($1.31 - $1.29) x €100,000 = $2,000


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25.

Topic: IFRS for hedge of a forecasted purchase LO 8 On November 30, 2011, a U.S. company, with a December 31 year-end, enters a forward purchase contract for €100,000 to be delivered on March 20, 2012. The contract hedges a forecasted purchase of equipment. The forward is closed and the equipment purchased on March 20. If the company follows IFRS and reports gains and losses on hedges of forecasted transactions as basis adjustments, total depreciation expense over the life of the equipment is: a. b. c. d.

$129,000 $130,000 $131,000 $135,000

ANS: a The equipment is recorded at the spot rate of $1.35 x €100,000 = $135,000, adjusted for the $6,000 [= $1.35 - $1.29) x €100,000] gain on the forward contract. 26.

Topic: Exchange rates LO 1 The value of the euro changes from $1.39 to $1.43. Which statement is true concerning changes in the value of the euro in relation to the U.S. dollar? a. b. c. d.

Each U.S. dollar can be exchanged for more euros. Each euro can be exchanged for fewer U.S. dollars. The U.S. dollar has strengthened with respect to the euro. A $10 product can be purchased with fewer euros.

ANS: d 27.

Topic: Exchange rates LO 1 Informal markets contracting for future delivery of foreign currencies are called: a. b. c. d.

Spot markets Forward markets Futures markets Direct markets

ANS: b



28.

Topic: Forward sale hedging foreign currency receivable LO 4 A U.S. company has euro-denominated receivables that it hedges with a forward sale of euros. The euro weakens against the U.S. dollar. Which statement is true? a. b. c. d.

The gain on the receivables and the loss on the forward are reported on the income statement. The gain on the receivables and the loss on the forward are reported in other comprehensive income. The loss on the receivables and the gain on the forward are reported on the income statement. The loss on the receivables and the gain on the forward are reported in other comprehensive income.

ANS: c 29.

Topic: Forward purchase hedging foreign currency payable LO 4 A U.S. company has payables to suppliers denominated in euros, and hedges these payables with foreign currency forward purchase contracts. The euro strengthens against the U.S. dollar. Which statement is true? a. b. c. d.

The gain on the payables and the loss on the forward are reported on the income statement. The gain on the payables and the loss on the forward are reported in other comprehensive income. The loss on the payables and the gain on the forward are reported on the income statement. The loss on the payables and the gain on the forward are reported in other comprehensive income.

ANS: c


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30.

Topic: Forward sale hedging forecasted transaction LO 6 A U.S. company sells its products to customers in Japan, priced in yen. It hedges a forecasted sale to a Japanese customer with a forward sale of yen. Changes in the value of the hedge investment are: a. b. c. d.

Reported in other comprehensive income until the products are produced Reported as adjustments to selling and istrative expenses when the products are sold Reported in income as the changes occur Reported in other comprehensive income until the products are sold

ANS: d 31.

Topic: Special hedge ing, cash flow hedges LO 3, 6 Changes in the market value of forward foreign currency contracts used to hedge forecasted sales of merchandise to customers are: a. b. c. d.

Reported on the income statement if the forwards qualify for special hedge ing and in other comprehensive income if they don’t qualify. Reported as a direct adjustment to retained earnings if they qualify for special hedge ing and on the income statement if they don’t qualify. Reported in other comprehensive income if they qualify for special hedge ing and on the income statement if they don’t qualify. Not reported if they qualify for special hedge ing and reported on the income statement if they don’t qualify.

ANS: c



32.

Topic: Cash flow hedges LO 3, 6 Which one of the following is a cash flow hedge for a U.S. company? a. b. c. d.

A hedge of euro-denominated receivables A hedge of a planned purchase of inventory, denominated in pesos A hedge of a sales order from a customer in the U.K., denominated in pounds A hedge of payables denominated in U.S. dollars

ANS: b 33.

Topic: Identification of hedge investments LO 3 Which of the following is not a hedge investment? a. b. c. d.

A U.S. company issues a purchase order to a supplier in Mexico who requires payment in pesos, and invests in a put option in pesos. A U.S. company has debt denominated in euros, and invests in a forward purchase of euros. A U.S. company’s customers owe it several million pesos from credit sales, and the company invests in a forward sale of pesos. A U.S. company invests in corporate bonds denominated in euros and enters a put option in euros.

ANS: a 34.

Topic: Identification of hedge investments LO 3 You are a U.S. investor and you expect that the value of the euro, in U.S. dollar , will increase. Which of the following investments would you make? a. b. c. d.

Short position in euro futures. Put option in euros. Borrow from a bank in Italy, payment denominated in euros. Forward purchase of euros.

ANS: d


Advanced ing, 1st

35.

Topic: Derivatives disclosures LO 7 SFAS 161, effective at the end of 2008, provides that: a. b. c. d.

Hedges reported as assets be combined with hedges reported as liabilities. All hedged items be carried at market value. Additional footnote disclosures detail hedging gains and losses by hedge type. Hedging gains and losses be separately displayed on the income statement and not combined with other s.

ANS: c 36.

Topic: Identification of hedge investments LO 3 Which of the following is the real hedge? a. b. c. d.

A call option in euros, used to hedge a forecasted sale to a customer, denominated in euros A call option in euros, used to hedge an investment in securities, denominated in euros A put option in euros, used to hedge a receivable denominated in euros A forward sale in euros, used to hedge debt denominated in euros

ANS: c 37.

Topic: Hedge ing LO 3 On August 1, a U.S. company enters into a forward contract, in which it agrees to buy 1,000,000 euros from a bank at a rate of $1.45 on December 1. Changes in the value of the forward contract will be reported on the income statement in which one of the following situations? a. b. c. d.

The U.S. company uses the forward contract to hedge a loan denominated in euros. The U.S. company uses the forward contract to hedge a forecasted purchase of merchandise from a French supplier. The U.S. company uses the forward contract to hedge a planned purchase of commodities from an Italian supplier. The U.S. company uses the forward contract to hedge an expected acquisition of commodities from a Belgian company.

ANS: a



38.

Topic: Hedging financial risk LO 1, 3 Which statement below best describes the process of hedging using financial derivatives? a. b. c. d.

You have inside information that the $/yen rate is going to rise, so you invest in a financial derivative that allows you to gain if the $/yen rate rises. You have inside information that the $/euro rate is going to fall, so you invest in a financial derivative that allows you to gain if the $/euro rate falls. As part of your normal business transactions, you are exposed to financial risk. You invest in financial derivatives to increase potential gains from financial risk. As part of your normal business transactions, you are exposed to financial risk. You invest in financial derivatives to reduce that risk.

ANS: d 39.

Topic: Hedging financial risk LO 1, 3 A U.S. manufacturing company imports parts from a supplier in . The company is required to pay the supplier in euros. Which investment will hedge the manufacturing company's foreign exchange risk? a. b. c. d.

Call option in euros Short position in euros Forward sale of euros Borrowing from a German bank

ANS: a 40.

Topic: Valuation of forward contracts LO 3 How are investments in financial derivatives valued on the balance sheet? a. b. c. d.

Market value Cost Lower of cost or market value Not reported

ANS: a


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41.

Topic: Valuation of forward contracts LO 3 On December 1, a U.S. company agrees to buy euros on February 1 at a contract price of $1.40. The company did not pay anything for this contract. The exchange rate for euros declines to $1.38 (U.S. dollar strengthens) between December 1 and December 31, when the company’s reporting year ends. How is this contract reported on the company’s yearend balance sheet? a. b. c. d.

In the asset section In the liability section As a contra asset The contract is not reported on the balance sheet

ANS: b 42.

Topic: Hedges of firm commitments LO 5 On July 10, 2012, a U.S. company with a December 31 year-end enters a forward contract that locks in the selling price of won, for delivery on August 15. The forward contract hedges a firm commitment to sell merchandise to a customer in Korea, with payment denominated in won. The sale is made on August 1, 2012 and payment is received from the customer on August 15. Where is the value of the firm commitment to sell reported in the year-end financial statements for 2012? a. b. c. d.

Asset or liability on the balance sheet Increase or decrease in other comprehensive income Adjustment to sales revenue Adjustment to cost of goods sold

ANS: c



43.

Topic: Foreign currency borrowing LO 2 The XYZ Company borrows 100,000,000 euros by issuing bonds to German investors when the spot rate is $1.25/€. The interest rate is 10 percent per annum. When XYZ s for this loan, which of the following will not be true? a. b. c. d.

A decrease in the exchange rate will generate an exchange gain on the bonds payable If the spot rate rises to $1.35/€ one year hence, when the interest payment is accrued, the interest expense will be recorded at $13,500,000 If XYZ desires to hedge these bonds, it will have to purchase euros forward The bonds payable will be carried at $125,000,000 until they mature

ANS: d 44.

Topic: Foreign currency borrowing LO 2 Interest expense on a loan denominated in another currency is translated at: a. b. c. d.

The average spot rate for the period the interest covers The spot rate when the loan was made The spot rate when the interest is recorded The forward rate for delivery when the interest must be paid

ANS: c 45.

Topic: Hedging strategy LO 3 U.S. manufacturers that sell to customers in other countries, priced in the currency of the customer’s country, often adjust their hedging strategy depending on which way they believe foreign currency rates are headed. Which statement best represents the adjustment they make, if the U.S. dollar is expected to weaken? a. b. c. d.

Reduce the percentage of receivables hedged Reduce the percentage of payables hedged Increase the percentage of receivables hedged Increase the percentage of payables hedged

ANS: a


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46.

Topic: Hedge ing LO 3 Two major goals of SFAS 133 are: a. b. c. d.

Disclose the fair values of derivatives investments in the footnotes of the financial statements, and report hedged assets and liabilities at fair value on the balance sheet. Report the fair values of derivatives investments on the balance sheet, and report hedged assets and liabilities at fair value on the balance sheet. Report the fair values of derivatives investments on the balance sheet, and match gains and losses on hedge investments and hedged assets and liabilities on the same income statement. Report hedged assets and liabilities at fair value on the balance sheet, and match gains and losses on hedge investments and hedged assets and liabilities on the same income statement.

ANS: c 47.

Topic: Hedge of forecasted transaction LO 6 A U.S. company hedges an anticipated sale of merchandise to a foreign customer. When are gains and losses on the hedge investment reported on the income statement? a. b. c. d.

When the customer pays for the merchandise When the anticipated sale becomes a firm commitment When the hedge investment is determined to be an effective hedge When the merchandise is sold

ANS: d 48.

Topic: Speculative investments LO 7 A U.S. company enters a forward purchase contract that does not qualify as a hedge investment. When are gains and losses on the hedge investment reported on the income statement? a. b. c. d.

When the forward contract changes in market value When the forward contract is closed When the forward contract is determined to be an effective hedge When the merchandise is sold

ANS: a



49.

Topic: Hedge of foreign-currency-denominated payable LO 4 A U.S. company has entered into a forward purchase contract to hedge a reported foreign currency obligation. If the U.S. dollar weakens against the foreign currency: a. b. c. d.

The forward contract appears as a current asset on the company’s balance sheet. The forward contract’s reported value exactly offsets the reported foreign currency obligation, with no net balance sheet disclosure. The gain on the forward contract adds to other comprehensive income. The gain on the foreign currency obligation adds to other comprehensive income.

ANS: a 50.

Topic: IFRS for foreign currency hedging LO 8 IFRS allows which reporting practice, not allowed under U.S. GAAP? a. b. c. d.

Reporting foreign currency derivative positions at cost rather than at market value Reporting gains and losses on cash flow hedges as adjustments to the carrying value of related asset acquisitions Reporting gains and losses on firm commitment hedges as adjustments to the carrying value of related asset acquisitions Reporting foreign currency derivative positions at market rather than at cost

ANS: b


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PROBLEMS 1.

Topic: Fair value hedge of receivables and payables, cash flow hedge of forecasted transaction LO 4, 6 Use the following exchange rates for the Canadian dollar to answer the three questions below concerning a U.S. company’s foreign exchange activities. The company’s ing year ends December 31.

October 31, 2010 December 31, 2010 March 31, 2011

Spot rate $ 0.82 0.85 0.83


Required Answer the following questions. a.

The company sells merchandise to a Canadian customer for C$100,000 on October 31, 2010, and receives payment from the customer, in Canadian dollars, on March 31, 2011. What are the following balances? i. Sales revenue for 2010 ii. s receivable, December 31, 2010 iii. Exchange gain or loss for 2011

b.

The company sells merchandise to a Canadian customer for C$100,000 on October 31, 2010, and receives payment from the customer, in Canadian dollars, on March 31, 2011. On October 31, 2010 it enters a forward contract to lock in the selling price of Canadian dollars, for March 31, 2011 delivery. On March 31, 2011, it delivers the Canadian dollars and closes the forward contract. What are the balances? i. Investment in forward , December 31, 2010 ii. Amount of U.S. dollars received March 31, 2011

c.

The company enters a forward contract on October 31, 2010 to hedge a forecasted purchase of merchandise for C$100,000 on March 31, 2011. On March 31 it takes delivery of the merchandise, closes the forward and pays for the merchandise. It sells the merchandise in May. What are the balances? i. Investment in forward, December 31, 2010 ii. Cost of goods sold on May sale



ANS:

2.

a.

i. ii. iii.

C$100,000 x $.82 = $82,000 C$100,000 x $.85 = $85,000 C$100,000 x ($.85 - $.83) = $2,000 loss

b.

i. ii.

C$100,000 x ($.81 - $.86) = $5,000 liability C$100,000 x $.81 = $81,000

c.

i. ii.

C$100,000 x ($.81 - $.86) = $5,000 asset $83,000 – ($.83 - $.81)(C$100,000) = $81,000

Topic: Unhedged foreign currency transactions, hedges of firm commitments LO 2, 4, 5 A U.S. company buys merchandise from suppliers in the U.K., and pays for the merchandise in pounds sterling. Its ing year ends December 31. Use the following information on $/£ to answer the questions below.

October 1, 2012 November 1, 2012 December 31, 2012 March 1, 2013

Spot rate $1.29 1.30 1.35 1.37

Forward rate for delivery March 1, 2013 $1.28 1.32 1.34 1.37

Required Answer the following questions: a.

The U.S. company takes delivery of merchandise costing £1,000,000 on November 1, 2012. The company pays for the merchandise, in pounds, on March 1, 2013. No hedging is involved. The company sells the merchandise on June 1, 2013. What amounts will appear on the financial statements of the U.S. company for: i. s payable, December 31, 2012 balance sheet ii. Exchange gain or loss, 2012 income statement iii. Cost of goods sold, 2013 income statement

b.

Assume the same facts as in a. above, but the U.S. company issues a purchase order on October 1, 2012 before taking delivery on November 1. On October 1 the company also enters a forward contract to hedge its FX risk, for delivery of pounds on March 1, 2013. What amounts will appear on the financial statements of the U.S. company for: i. Investment in forward contract, December 31, 2012 balance sheet ii.

Cost of goods sold, 2013 income statement


Advanced ing, 1st

ANS:

3.

a.

i. ii. iii.

£1,000,000 x $1.35 = $1,350,000 £1,000,000 x ($1.30 - $1.35) = $50,000 loss £1,000,000 x $1.30 = $1,300,000

b.

i. ii.

£1,000,000 x ($1.28 - $1.34) = $60,000 asset £1,000,000 x $1.30 – [£1,000,000 x ($1.28 - $1.32)] = $1,260,000

Topic: Unhedged foreign currency transactions, hedges of import and forecasted transactions LO 2, 4, 6 Following are exchange rates for the euro (U.S. $/€) . Import Express is a U.S. company whose ing year ends on December 31.

November 30, 2010 December 31, 2010 May 31, 2011

Spot rate $ 1.25 1.28 1.26

Forward rate for May 31, 2011 delivery $ 1.30 1.32 1.26

Required Answer the following questions. a.

On November 30, 2010, Import Express takes delivery of merchandise on credit from an Italian supplier for €1,000. It pays for the merchandise on May 31, 2011. It sells the inventory to a U.S. customer during 2011. What are the correct amounts that will appear on Import Express’ financial statements for each of the following items? i. s payable, December 31, 2010 balance sheet ii. Cost of goods sold, 2011 income statement iii. Foreign exchange loss, 2010 income statement

b.

On November 30, 2010, Import Express takes delivery of merchandise on credit from an Italian supplier for €1,000. On the same day, it agrees to buy €1,000 (forward purchase) for delivery on May 31, 2011. Import Express closes the forward on May 31 and pays for the merchandise. It sells the inventory to a U.S. customer during 2011. What are the correct amounts that will appear on Import Express’ financial statements for each of the following items? i. Investment in forward contract, December 31, 2010 (asset) ii. Loss on forward contract, 2011 Gain on s payable, 2011



c.

On November 30, 2010, Import Express forecasts that it will need to buy merchandise for €1,000 from an Italian supplier at the end of May, 2011. It plans to pay for the merchandise as soon as it is delivered. On November 30, 2010, Import Express agrees to buy €1,000 (forward purchase) for delivery on May 31, 2011. The forward contract qualifies as a cash flow hedge of the forecasted purchase of merchandise. The merchandise is actually delivered on May 31, 2011. Import Express closes the forward and immediately pays the supplier. The merchandise is subsequently sold to a U.S. customer later in 2011. Make the journal entries necessary to record these events: i. December 31, 2010: Adjust the investment in forward contract. ii. May 31, 2011: (1) Adjust the investment in forward contract. (2) Close out the forward contract. (3) Take delivery of the merchandise and pay for it. iii. Record cost of sales for 2011.

ANS: a.

Entries (not required):

11/30 Inventory

1,250 s payable

12/31 Exchange loss

1,250 30

s payable 5/31 s payable

30 20

Exchange gain s payable

20 1,260

Cash i. ii. ii.

1,260

s payable, December 31, 2010 balance sheet $1,280 Cost of goods sold, 2011 income statement $1,250 Exchange loss, 2010 income statement $ 30


Advanced ing, 1st

b.

Entries (not required):

11/30 Inventory

1,250 s payable

12/31 Exchange loss

1,250 30

s payable Investment in forward

30 20

Exchange gain 5/31 s payable

20 20

Exchange gain Exchange loss

20 60

Investment in forward Foreign currency Investment in forward

60 1,260 40

Cash s payable

1,300 1,260

Foreign currency i. ii.


1,260

Investment in forward contract, December 31, 2010 (asset) $20 Loss on forward contract, 2011 $60 Gain on s payable, 2011 $20


c.

i.



ii. (1) Other comprehensive income

20 60


60

(2) Foreign currency Investment in forward

1,260 40 Cash

1,300

(3) Inventory

1,260 Foreign currency

1,260

iii. Cost of goods sold

1,300 Other comprehensive income Inventory


40 1,260

Advanced ing, 1st

4.

Topic: Forward purchase, cash flow hedge that becomes a fair value hedge LO 4, 5, 6 Use the following information on exchange rates for the euro to answer the question below.

October 1, 2011 December 31, 2011 January 31, 2012 March 31, 2012 April 30, 2012

Spot rate $1.45 1.50 1.52 1.56 1.60

Forward rate for 4/30/12 delivery $1.48 1.53 1.55 1.58 1.60

On October 1, 2011, a U.S. company forecasts that it will take delivery of merchandise from a supplier in Portugal for €10,000,000 around the end of March, 2012, with payment expected to be made, in euros, about one month later. The company closes its books on December 31. The following events occur: 1. 2. 3. 4. 5. 6.

October 1, 2011: The company enters a forward purchase agreement for delivery of €10,000,000 on April 30, 2012. This position qualifies as a hedge of the forecasted transaction described above. No initial investment is required. December 31, 2011: The company closes its books. January 31, 2012: The company issues a purchase order to the supplier for €10,000,000 in merchandise, to be delivered March 31, 2012. March 31, 2012: The company takes delivery of the merchandise. April 30, 2012: The company closes the forward contract and pays the supplier €10,000,000. May 15, 2012: The company sells the merchandise to a U.S. customer for $22,500,000.

Required Prepare the journal entries to record the above events on the indicated dates.



ANS: December 31, 2011: End of year adjusting entry: Investment in forward Other comprehensive income January 31, 2012: Adjust the investment: Investment in forward Other comprehensive income

500,000 500,000 200,000 200,000

March 31, 2012:

Adjust for the period January 31 - March 31, and take delivery of the merchandise. Investment in forward 300,000 Other comprehensive income 300,000 Exchange loss

300,000 Firm commitment


300,000 300,000

Exchange gain Inventory Firm commitment

15,300,000 300,000 s payable


300,000

15,600,000

Advanced ing, 1st

April 30, 2012:

Adjust for the period March 31 to April 30, close the forward contract and pay the supplier. Investment in forward 200,000 Other comprehensive income 200,000 Exchange loss

400,000 s payable

400,000


400,000 Exchange gain

400,000

Foreign currency

16,000,000 Investment in forward Cash

s payable

1,200,000 14,800,000 16,000,000

Foreign currency Cost of goods sold Other comprehensive income

14,800,000 500,000 Inventory


16,000,000

15,300,000


5.

Topic: Hedge of firm commitment LO 5 Following is information on $/€ exchange rates:

March 1, 2012 June 30, 2012 August 15, 2012

Spot rate $1.50 1.60 1.65

Forward rate for delivery August 15, 2012 $1.55 1.62 1.65

A U.S. company buys from suppliers in , and pays the suppliers in euros. The U.S. company’s ing year ends June 30. On March 1, 2012, the company sends a purchase order to a German supplier for €1,000,000 in merchandise, payable in euros, delivery to take place August 15, 2012. On the same day the company enters into a forward contract for delivery of €1,000,000 on August 15. The forward qualifies as a hedge of a firm commitment. On August 15, the company closes the forward contract, takes delivery of the merchandise, and pays the supplier. The company sells the merchandise to its customers on August 31, 2012. Required What amounts will appear on the financial statements of the U.S. company for: a. b.

Investment in forward contract, June 30, 2012 balance sheet Cost of goods sold, fiscal 2013 income statement

ANS: a. b.

€1,000,000 x ($1.62 - $1.55) = $70,000 Value of firm commitment = €1,000,000 x ($1.65 - $1.55) = $100,000 credit Currency paid = $1,650,000 - firm commitment offset $100,000 = $1,550,000


Advanced ing, 1st

6.

Topic: Hedge of firm commitment LO 5 On November 1, 2012, a U.S. company issues a purchase order to buy merchandise for €1,000,000. The company expects to take delivery of the merchandise on January 10, 2008, and will pay the supplier on March 1, 2013. To hedge its FX risk, on November 1, 2012 the company invests in a forward contract for delivery of €1,000,000 on March 1, 2013. The company sells the merchandise to a U.S. customer for $2,000,000 in cash on April 1, 2013. Assume the forward contract qualifies as a fair value hedge of the firm commitment to buy merchandise. Exchange rates for the euro ($/€) are below.

November 1, 2012 December 31, 2012 January 10, 2013 March 1, 2013

Spot rate $ 1.40 1.41 1.44 1.45

Forward rate for March 1, 2013 delivery $1.42 1.43 1.435 1.45

Required For each date below, prepare the necessary journal entries to record the events and/or adjustments needed. a. b. c. d.

December 31, 2012 (end of year closing) January 10, 2013 (takes delivery of merchandise) March 1, 2013 (closes the forward and pays the bill) April 1, 2013 (sells the merchandise to a U.S. customer). Assume the company uses the perpetual inventory method.



ANS: a. December 31, 2012 Investment in forward

10,000 Exchange gain

Exchange loss

10,000 10,000

Firm commitment

10,000

Rate changes from $1.42 to $1.43. b. January 10, 2013 Investment in forward

5,000 Exchange gain

Exchange loss

5,000 5,000

Firm commitment Rate changes from $1.43 to $1.435. Inventory Firm commitment

5,000 1,425,000 15,000

s payable c. March 1, 2013 Exchange loss

1,440,000 10,000

s payable

10,000

Rate changes from $1.44 to $1.45. Investment in forward

15,000

Exchange gain Rate changes from $1.435 to $1.45. Foreign currency

15,000 1,450,000

Cash Investment in forward s payable

1,420,000 30,000 1,450,000

Foreign currency d. April 1, 2013 Cash

1,450,000 2,000,000

Sales revenue Cost of goods sold

1,425,000 Inventory


2,000,000 1,425,000

Advanced ing, 1st

7.

Topic: Import and export transactions LO 2 Following is information on $/€ exchange rates: November 1, 2013 December 31, 2013 February 15, 2014 March 1, 2014

Spot rate $1.42 1.38 1.36 1.35

Required Answer the following questions: a.

A U.S. company sells merchandise to customers in euro countries, with payment to be received in euros. Sales totaling €1,000,000 occur on November 1, 2013. Payment is made on March 1, 2014. The U.S. company’s ing year ends December 31. What amounts will appear on the financial statements of the U.S. company for: i. Sales revenue, 2013 income statement ii. s receivable, 12/31/13 balance sheet iii. Exchange gain or loss, 2013 income statement

b.

A U.S. company buys merchandise from suppliers in euro countries, payable in euros. Purchases of €1,000,000 are made on November 1, 2013. The U.S. company pays the suppliers on February 15, 2014. The U.S. company sells the merchandise to its customers on March 1, 2014. The U.S. company’s ing year ends December 31. What amounts will appear on the financial statements of the U.S. company for: i. s payable, 12/31/13 balance sheet ii. Exchange gain or loss, 2014 income statement iii. Cost of goods sold, 2014 income statement

ANS: a.

i. ii. iii.

€1,000,000 x $1.42 = $1,420,000 €1,000,000 x $1.38 = $1,380,000 €1,000,000 x ($1.38 - $1.42) = $40,000 loss

b.

i. ii. iii.

€1,000,000 x $1.38 = $1,380,000 €1,000,000 x ($1.38 - $1.36) = $20,000 gain €1,000,000 x $1.42 = $1,420,000



8.

Topic: Hedges of export transactions LO 4 A U.S. company sells merchandise to a Greek customer on February 1, 2010 for €1,000,000. The customer pays the bill on May 1, 2010. To hedge foreign exchange risk, on February 1, 2010 the U.S. company enters a forward sale contract for €1,000,000 with a May 1 delivery date. On May 1 the company collects the €1,000,000 from the customer and closes the forward contract. Relevant rates are as follows: February 1, 2010 May 1, 2010

Spot $1.345 1.330

5/1 Forward $1.348 1.330

Required Make the journal entries to record the following transactions, including appropriate adjusting entries: a. b.

February 1 sale to the Greek customer. May 1 collection of the receivable and closing of the contract.

ANS: a. s receivable

1,345,000 Sales revenue

b. Exchange loss

1,345,000 15,000

s receivable Investment in forward

15,000 18,000

Exchange gain Foreign currency

18,000 1,330,000

s receivable Cash

1,348,000 Investment in forward Foreign currency


1,330,000 18,000 1,330,000

Advanced ing, 1st

9.

Topic: Hedge of firm commitment LO 5 On February 1, 2010, a U.S. company issues a purchase order to buy merchandise from a Greek supplier for €1,000,000. On February 1, 2010 the U.S. company enters a forward purchase contract for €1,000,000 with a July 1 delivery date. The forward qualifies as a hedge of the firm commitment to buy the merchandise. On May 1, 2010, the company takes delivery of the merchandise. On July 1, 2010, the company closes the forward and pays the bill. Relevant exchange rates are as follows:

February 1, 2010 May 1, 2010 July 1, 2010

7/1 forward rate $1.350 1.344 1.330

Spot rate $1.345 1.340 1.330

Required a. Make the journal entries to record the following transactions, including appropriate adjusting entries: i. May 1 delivery of merchandise. ii. July 1 closing of forward contract and payment of bill. b. Assume the U.S. company sells the merchandise to a U.S. customer for $1,600,000. What is the reported gross margin (sales revenue minus cost of goods sold) on the sale? ANS: a. i. Exchange loss

6,000 Investment in forward

Firm commitment

6,000 6,000

Exchange gain Inventory

1,346,000 Firm commitment s payable


6,000 6,000 1,340,000


ii. Exchange loss


s payable

14,000 10,000

Exchange gain

10,000

Foreign currency Investment in forward

1,330,000 20,000 Cash

1,350,000

s payable

1,330,000 Foreign currency

b. 10.

1,330,000

$1,600,000 - $1,346,000 = $254,000

Topic: Hedge of forecasted transaction LO 6 A U.S. corporation purchases merchandise from a German supplier on a regular basis. On November 8, 2012, the corporation purchased €100,000 for delivery on March 8, 2013, in anticipation of an expected purchase of merchandise for €100,000 at the beginning of March. The forward contract qualifies as a hedge of a forecasted transaction. The corporation took delivery of the merchandise, settled the forward contract, and paid the German supplier €100,000 on March 8, 2013. The merchandise was subsequently sold on April 10, 2013 to a U.S. customer for $200,000. The corporation’s ing year ends on December 31. Relevant exchange rates are as follows:

November 8, 2012 December 31, 2012 March 8, 2013 April 10, 2013

Spot rate 1.25 1.27 1.24 1.23

Forward rate for delivery March 8, 2013 1.26 1.28 1.24 N/A

Required a. Prepare the adjusting entry necessary to update the investment in forward at December 31, 2012. b. Prepare the entries necessary to take delivery of the merchandise and close the forward on March 8, 2013. c. Prepare the entry necessary to record cost of goods sold on April 10, 2013.


Advanced ing, 1st

ANS: a. Investment in forward

2,000 Other comprehensive income

b. Other comprehensive income

2,000 4,000

Investment in forward Foreign currency Investment in forward

4,000 124,000 2,000

Cash

126,000

Inventory


124,000

c. Cost of goods sold

126,000 Inventory Other comprehensive income


124,000 2,000


11.

Topic: Valuation of forward contracts, hedging entries LO 3, 4, 6 A U.S. company enters into the following forward contracts on October 15, 2011: 1. 2.

Agreement to sell 100,000,000 yen on January 15, 2012 at $0.0088 Agreement to buy 1,000,000 new shekels on February 15, 2012 at $0.221

Forward and spot rates for yen and shekels are as follows:

October 15, 2011 December 31,2011

Forward rate Spot rate for 1/15/12 for yen delivery of yen $ .0086 $ .0088 .0084 .0085

Forward rate Spot rate for 2/15/12 for new delivery of new shekels shekels $.220 $ .221 .222 .219

The company’s ing year ends December 31. Required a. How are the forward contracts valued on the company’s December 31, 2011 balance sheet? For each contract, specify the amount and whether it is a current asset or a current liability. b. Assume that the forward contract to sell yen is an effective hedge of a 100,000,000 yen forecasted sale to customers in Japan. Make the adjusting entry for this contract at December 31, 2011. c. Assume the forward contract to buy new shekels is an effective hedge of a 1,000,000 new shekel obligation currently on the company’s books. Make the adjusting entry for this contract at December 31, 2011. ANS: a.

Forward sale in yen: ($.0088 - $.0085) x 100,000,000 = $30,000 current asset Forward purchase in new shekels: ($.221 - $.219) x 1,000,000 = $2,000 current liability

b. Investment in forward

30,000 Other comprehensive income

c. Exchange loss



30,000

2,000

Advanced ing, 1st

12.

Topic: Hedge of firm commitment LO 5 On March 1, 2011, a U.S. company issued a purchase order to a supplier in the Cayman Islands for goods with a price of KYD 5,000,000. The goods will be delivered July 1, 2011, and payment will be made on September 1, 2011. On March 1, 2011, the company purchased KYD 5,000,000 for delivery September 1, 2011. The forward contract is an effective hedge of the firm commitment to purchase goods from the Cayman Islands. The goods are delivered as expected on July 1, and the company follows through on the forward contract and makes the payment to the supplier on September 1. The company’s ing year ends on December 31. Spot and forward rates are as follows ($/KYD): March 1, 2011 July 1, 2011 September 1, 2011

Spot Rate $1.22 1.21 1.19

Forward rate for delivery on September 1, 2011 $1.21 1.20 1.19

Required Answer the following questions regarding how the above information is reported on the company’s financial statements: a. b.

What is the net hedging gain or loss for 2011? Suppose the goods purchased from the Cayman Islands are sold to a U.S. customer for $8,000,000. What is the gross margin (sales revenue less cost of goods sold) on the sale? Show calculations clearly.

ANS: a.

Loss on forward: ($1.21 - $1.19) x 5,000,000 = Gain on firm commitment: ($1.21 - $1.20) x 5,000,000 = Gain on s payable: ($1.21 - $1.19) x 5,000,000 = Net

b.

Inventory is recorded as follows when the goods are delivered on July 1:

Inventory

$100,000 loss 50,000 gain 100,000 gain $ 50,000 gain

6,100,000 Firm commitment s payable

50,000 6,050,000

The gross margin on the sale is: Sales Cost of goods sold Gross margin


$8,000,000 6,100,000 $1,900,000


13.

Topic: Forward purchase, cash flow hedge that becomes a fair value hedge LO 4, 5, 6 A U.S. company purchases merchandise from a Hong Kong supplier on a regular basis. The following events occur:     

October 1, 2012: The company purchased $H1,000,000 for delivery on May 1, 2013, in anticipation of an expected payment of $H for a forecasted merchandise purchase. December 1, 2012: The company issued a purchase order for $H1,000,000 in merchandise from the supplier. March 1, 2013: The company took delivery of the merchandise. May 1, 2013: The company closed the forward contract and paid the supplier. May 31, 2013: The company sold the merchandise to a U.S. customer for $200,000.

The company’s ing year ends December 31. Exchange rates ($/H) are as follows:

October 1, 2012 December 1, 2012 December 31, 2012 March 1, 2013 May 1, 2013

Spot rate $0.125 0.127 0.128 0.131 0.132

Forward rate for delivery 5/1/13 $0.127 0.129 0.131 0.1315 0.132

Required Prepare the journal entries to record the above transactions, including necessary adjusting entries. Assume the hedge qualifies for special hedge ing.


Advanced ing, 1st

ANS: Adjusting entries at December 31, 2012: Investment in forward Other comprehensive income To record increase in value of forward contract ($.127 to $.131) Exchange loss

4,000 4,000 2,000

Firm commitment To record loss on firm commitment ($.129 to $.131)

2,000


2,000

Exchange gain 2,000 To reclassify other comprehensive income to income to match against loss on firm commitment. March 1, 2013 Investment in forward

500

Other comprehensive income To mark the forward to market ($.131 to $.1315)

500

Exchange loss

500

Firm commitment To mark the firm commitment to market ($.131 to $.1315)

500


500

Exchange gain 500 To reclassify other comprehensive income to income to match against firm commitment loss. Inventory Firm commitment

128,500 2,500

s payable To record delivery of merchandise, adjusted for firm commitment balance.


131,000


May 1, 2013 Investment in forward

500

Other comprehensive income To mark the forward to market ($.1315 to $.132) Exchange loss

500 1,000

s payable To mark s payable to market ($.131 to $.132)

1,000


1,000 Exchange gain 1,000 To reclassify other comprehensive income to income to match against s payable loss. Foreign currency

132,000 Investment in forward Cash

5,000 127,000

To close forward contract. s payable


132,000

To pay the supplier. May 31, 2013 Cost of goods sold Other comprehensive income

127,000 1,500

Inventory 128,500 Note: Remaining other comprehensive income balance is $4,000 - $2,000 + $500 - $500 + $500 - $1,000 = $1,500 gain.


Advanced ing, 1st

14.

Topic: Cash flow hedge ing versus regular ing LO 3, 6 Following is information on exchange rates for the euro: October 1, 2011 December 31, 2011 January 31, 2012 March 31, 2012 April 30, 2012

Spot rate $1.45 1.50 1.52 1.56 1.60

Forward rate for 4/30/12 delivery $1.48 1.53 1.55 1.58 1.60

On October 1, 2011, a U.S. company forecasts that it will buy merchandise from a supplier in Portugal for €10,000,000 around the end of March, 2012, with payment expected to be made, in euros, about one month later. The company closes its books on December 31. The following events occur: 1. 2. 3. 4. 5. 6.

October 1, 2011: The company enters a forward purchase agreement for delivery of €10,000,000 on April 30, 2012. No initial investment is required. December 31, 2011: The company closes its books. January 31, 2012: The company issues a purchase order to the supplier for €10,000,000 in merchandise, to be delivered March 31, 2012. March 31, 2012: The company takes delivery of the merchandise. April 30, 2012: The company closes the forward contract and pays the supplier €10,000,000. May 15, 2012: The company sells the merchandise to a U.S. customer for $22,500,000.

Required Fill in the schedule below, showing the amounts related to the above events that will be reported in the company’s annual reports for 2011 and 2012. Show related journal entries in the next schedule. Show liabilities and gains in parenthesis.



ANS:

title

Forward contract qualifies as a hedge of the forecasted transaction 2011

Investment in forward (balance sheet) Other comprehensive income (Balance sheet)

2012

$ 500,000 (500,000)

2011

2012

--

$ 500,000

--

--

--

--

(Gains) and losses (income statement)

--

--

Cost of goods sold (income statement)

--

$14,800,000


The forward contract does not qualify as a hedge

(500,000)

--

$ (200,000) (300,000) (200,000) 400,000 $ (300,000) $15,600,000

Advanced ing, 1st

Forward contract is a qualified hedge December 31 Investment in forward 500,000 OCI 500,000 January 31 Investment in forward OCI

200,000 200,000

March 31 Investment in forward 300,000 OCI 300,000 Exchange loss 300,000 Firm commitment 300,000 OCI 300,000 Gain 300,000 Inventory 15,300,000 Firm commitment 300,000 A/P 15,600,000 April 30 Investment in forward 200,000 OCI 200,000 Exchange loss 400,000 A/P 400,000 OCI 400,000 Exchange gain 400,000 Foreign currency 16,000,000 Cash 14,800,000 Investment in for. 1,200,000 A/P 16,000,000 Foreign currency 16,000,000 May 15 CGS OCI Inventory


14,800,000 500,000

Forward contract is not a qualified hedge Investment in forward Exchange gain

500,000

Investment in forward Exchange gain

200,000

Investment in forward Exchange gain --

300,000

500,000

200,000

300,000

-Inventory A/P 15,600,000

15,600,000

Investment in forward Exchange gain 200,000 Exchange loss A/P 400,000 --

200,000 400,000

Foreign currency Cash 14,800,000 Investment in for. A/P Foreign currency

16,000,000

CGS Inventory 15,600,000

15,600,000

1,200,000 16,000,000 16,000,000

15,300,000


15.

Topic: Cash flow hedge ing versus regular ing LO 3, 6 Following are exchange rates for the Canadian dollar.

October 31, 2011 December 31, 2011 March 31, 2012

Spot rate $ 0.80 0.84 0.82


A U.S. company enters a forward contract on October 31, 2011 to hedge a forecasted purchase of merchandise for C$1,000,000 on March 31, 2012. On March 31 it takes delivery of the merchandise, closes the forward and pays for the merchandise. It sells the merchandise in May. The company’s ing year ends December 31. Required What are the balances for the following s, assuming the forward contract qualifies as a hedge of the forecasted transaction for the period October 31, 2011 to March 31, 2012, and also if the forward contract does not qualify as a hedge? a. b. c. d.

Other comprehensive income balance, December 31, 2011 Gain/loss on forward contract, 2011 income statement Gain/loss on forward contract, 2012 income statement 2012 cost of goods sold

ANS: Qualifies as hedge Other comprehensive income, December 31, 2011 (gain) 2011 income statement gain on forward contract 2012 income statement loss on forward contract 2012 cost of goods sold


$ 50,000

Does not qualify $

0

0

50,000

0 810,000

40,000 820,000

Advanced ing, 1st

16.

Topic: Hedge of firm commitment, import transaction, speculation LO 2, 5, 7 Electronic Importers, a U.S. company, has the following outstanding balances as of December 31, 2011, its ing year-end. Forward purchase contract dated December 1, 2011 for 20,000,000 yen to hedge a firm commitment to purchase computer hardware for 20,000,000 yen in 90 days ending on March 1, 2012. payable for 70,000,000 yen for unpaid merchandise acquired on December 16, 2011 and due on January 15, 2012. Forward sale contract dated December 16, 2011 for 30,000,000 yen to speculate in exchange rate changes and due on January 15, 2012. Exchange rates quoted in the U.S. for Japanese yen are: Spot rate 90-day forward 60-day forward 30-day forward 15-day forward

12/1/11 $.00620 .00630 .00620 .00610 .00615

12/16/11 12/31/11 $.00610 $.00600 .00620 .00610 .00610 .00603 .00600 .00590 .00605 .00595

1/15/12 $.00593 .00600 .00590 .00580 .00585

3/1/12 $.00580 .00590 .00580 .00570 .00575

Required a. Calculate the gain or loss on Electronic Importers' 2011 income statement due to the above items. Specify the amount and whether it is a gain or loss. b. Calculate the balances at which the forward purchase contract and the forward sale contract would be reported in the December 31, 2011 balance sheet. c. At what amount (U.S. dollars) should the computer hardware be valued on March 1, 2012?



ANS: a.

Forward purchase contract: no income effect due to offsetting gain and loss on contract and firm commitment.

s payable 70,000,000 x ($.00610 - $.00600) = Forward sale 30,000,000 x ($.00600 - $.00595) =

b.

$7,000 gain 1,500 gain $8,500 gain

Forward purchase contract: ($.0063 - $.00603) x 20,000,000 = $5,400 current liability Forward sale contract: ($.006 - $.00595) x 30,000,000 = $1,500 current asset

c. ($.0058 x 20,000,000) = Plus firm commitment balance: ($.0063 - $.0058) x 20,000,000 Hardware balance, 3/1/12


$116,000 10,000 $126,000

Advanced ing, 1st

17.

Topic: Import transactions, hedge of firm commitment, hedge of forecasted transaction, speculation LO 2, 5, 6, 7 Each of the following situations is independent of the others. Acme Importers is a U.S. company with a December 31 year-end. Use the following information on exchange rates (US$/$Canadian) to answer each question.

September 1, 2012 October 1, 2012 December 31, 2012 February 1, 2013

Spot rate $.80 .78 .75 .69

Forward rate for delivery on 2/1/13 $.82 .79 .74 .69

Required For each situation, (1) make the journal entries necessary to record the events, including year-end adjustments, and (2) calculate the effect on Acme's income in the year 2012, and in the year 2013. Show the amounts and whether they are gains or losses. a. b.

c.

d.

e.

On September 1, 2012 Acme Importers agrees to buy merchandise from Montreal Suppliers. Delivery will take place on October 1, 2012, and Acme will pay Montreal Suppliers C$5,000 on February 1, 2013. On September 1, 2012, Acme Importers makes a firm commitment to buy merchandise from Montreal Suppliers. Delivery will take place on October 1, 2012, and Acme will pay Montreal Suppliers C$5,000 on February 1, 2013. On October 1, 2012, Acme enters into a forward purchase contract with ABC Exchange Dealers for the purchase of C$5,000, to be delivered February 1, 2013. On September 1, 2012, Acme Importers makes a firm commitment to buy merchandise from Montreal Suppliers. Delivery will take place on October 1, 2012, and Acme will pay Montreal Suppliers C$5,000 on February 1, 2013. On September 1, 2012, Acme enters into a forward purchase contract with ABC Exchange Dealers for the purchase of C$5,000, to be delivered February 1, 2013. The merchandise remains in Acme's inventory as of December 31, 2013. The CFO at Acme Importers believes that the U.S. dollar will continue to strengthen with respect to the Canadian dollar. On October 1, 2012, he enters into a speculative forward sale contract with ABC Exchange Dealers for delivery of C$5,000 on February 1, 2013. On September 1, 2012, Acme Importers forecasts that it will buy merchandise from a Canadian supplier. Delivery and payment of C$5,000 is expected to take place on October 1, 2012. On September 1, 2012, Acme enters into a forward purchase contract with ABC Exchange Dealers for the purchase of C$5,000 for $0.76, to be delivered October 1, 2012. The merchandise purchase occurs as forecasted, and the merchandise remains in Acme’s inventory as of December 31, 2013.



ANS: 1a. 10/1

Merchandise

3,900 s payable

3,900

(5,000 x $.78) 12/31 10/1

s payable

150 Exchange gain

150

[($.78 - $.75) x 5,000] 2/1

s payable

300 Exchange gain

300

[($.75 - $.69) x 5,000] 2/1

s payable

3,450 Cash

3,450

(5,000 x $.69) b. 10/1

Merchandise

3,900 s payable

12/31

3,900

s payable

150 Exchange gain

12/31

150

Exchange loss

250 Investment in forward

250

[($.79 - $.74) x 5,000] 2/1

s payable

300 Exchange gain

2/1

300

Exchange loss


250

[($.74 - $.69) x 5,000] 2/1


3,450 500 Cash

2/1

s payable



3,950 3,450

Advanced ing, 1st

c. 10/1

Exchange loss


150

[($.82 - $.79) x 5,000] 10/1

Firm commitment

150 Exchange gain

10/1

150

Merchandise

3,900 s payable

10/1

Merchandise

3,900 150

Firm commitment 12/31

Exchange loss

150 250

Investment in forward 12/31

s payable

250 150

Exchange gain 2/1

150

Exchange loss


s payable

250 300

2/1 Exchange gain 2/1 2/1

300

Foreign currency

3,450


500 Cash

3,950

s payable

3,450

2/1 Foreign currency


3,450


d. 12/31


250 Exchange gain

250

[($.79 - $.74) x 5,000] 2/1


250 Exchange gain

250

[($.74 - $.69) x 5,000] 2/1

Foreign currency

3,450 Cash

3,450

Cash

3,950

2/1 Foreign currency Investment in forward e. 10/1


3,450 500 100


100

[($.78-.76) x 5,000] 10/1

Foreign currency

3,900 Investment in forward Cash

Merchandise

100 3,800 3,900

10/1 Foreign currency 2. (a) (b) (c) (d) (e)

3,900

Income effects:

2012 $150 gain 100 loss 100 loss 250 gain -0-


2013 $300 gain 50 gain 50 gain 250 gain -0-

Advanced ing, 1st

18.

Topic: Borrowing in foreign currency LO 2 A U.S. company purchases a 60-day certificate of deposit from a German bank on October 15. The certificate has a face value of €10,000,000, costs $13,800,000 (the spot rate is $1.38/€ on October 15), and pays interest at an annual rate of 8 percent. On December 14, the certificate of deposit matures and the company receives principal and interest due to it. The spot rate on December 14 is $1.40/€. The average spot rate for the period October 15 - December 14 is $1.39/€. Required Prepare all necessary journal entries to record the above events on the U.S. company's books. ANS: 10/15 Temporary investments

13,800,000 Cash

12/14 Temporary investments

13,800,000 200,000

Exchange gain $200,000 = ($1.40 - $1.38) x €10,000,000. Foreign currency Temporary investments Interest income $186,667 = (10,000,000 x 8% x 2/12) x $1.40


200,000 14,186,667 14,000,000 186,667


19.

Topic: Speculation in forward contracts LO 7 On November 1, 2013, a U.S. company thinks the exchange rate for the euro will fall, so it enters into a forward contract in the amount of €1,000,000, for delivery on March 15, 2014. This is a speculative contract. The company’s ing year ends December 31. The company closes the contract on February 1, 2014. Exchange rates are as follows ($/ €):

November 1, 2013 December 31, 2013 February 1, 2014 March 15, 2014

Spot rate $ 1.42 1.46 1.47 1.50

Forward rate for March 15, 2014 delivery $ 1.43 1.45 1.48 1.50

Required a. Does the company enter a forward purchase or a forward sale contract? Explain. b. Prepare the journal entries necessary on December 31, 2013 and February 1, 2014 to record the above events. ANS: a.

A forward sale locks in the selling price. If the rate falls, as the company expects, it will gain by buying euros at the lower price and selling at the higher contract price.

b. December 31, 2013 Loss

20,000 Investment in forward To adjust the forward contract to fair value; $20,000 = ($1.45 - $1.43) x €1,000,000.

20,000

February 1, 2014 Loss

30,000 Investment in forward To adjust the forward contract to fair value; $30,000 = ($1.48 - $1.45) x €1,000,000.

30,000

The company closes the forward by entering a forward purchase for delivery on March 15, 2014, at $1.48/€. So the company sells at $1.43 and buys at $1.48, for a net cash outflow of ($1.48 - $1.43) x €1,000,000 = $50,000. Investment in forward Cash To close the forward contract on February 1, 2014.


50,000 50,000

Advanced ing, 1st

20.

Topic: IFRS for hedging forecasted transactions LO 8 On February 15, 2011, an Italian company, with a June 30 year-end, enters a forward purchase contract for $1,000,000 to be delivered on August 1, 2011. The contract hedges a forecasted purchase of equipment. The forward is closed and the equipment purchased on August 1. The equipment has a 2-year life, and is straight-line depreciated. Following is information on exchange rates (€/$):

February 15, 2011 June 30, 2011 August 1, 2011

Spot rate €0.80 0.74 0.72

Forward rate for August 1, 2011 delivery €0.81 0.76 0.72

The company follows IFRS and uses the basis adjustment approach to reporting cash flow hedges. Required Prepare the journal entries to record the following events: a. b. c. d.

June 30, 2011 adjusting entry August 1, 2011 adjusting entries and transactions June 30, 2012 adjusting entry for the equipment If the company followed U.S. GAAP, how would the June 30, 2012 entry differ?



ANS: a. June 30, 2011 Other comprehensive income

50,000

Investment in forward 50,000 To adjust the forward contract to fair value; €50,000 = (€.81 - €.76) x $1,000,000. b. August 1, 2011 Other comprehensive income

40,000 Investment in forward 40,000 To adjust the forward contract to fair value; €40,000 = (€.76 - €.72) x $1,000,000.


720,000 90,000 Cash

810,000

To close the forward contract. Equipment


720,000

To purchase the equipment. Equipment

90,000

Other comprehensive income To adjust the equipment for the accumulated loss on the forward.

90,000

c. June 30, 2012 Depreciation expense

371,250 Equipment, net 371,250 To record depreciation expense for fiscal 2012; €371,250 = (€810,000/2) x 11/12.

d. June 30, 2012 Depreciation expense

330,000

Equipment, net 330,000 To record depreciation expense for fiscal 2012; €330,000 = (€720,000/2) x 11/12. Depreciation expense

41,250

Other comprehensive income 41,250 To reclassify other comprehensive income as an adjustment of depreciation expense for fiscal 2012; €41,250 = (€90,000/2) x 11/12.


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