Vous êtes sur la page 1sur 57

CHAPTER 9

FOREIGN CURRENCY TRANSACTIONS AND


HEDGING FOREIGN EXCHANGE RISK
Chapter Outline
I.

In todays global economy, a great many companies deal in currencies other than their
reporting currencies.
A. Merchandise may be imported or exported with prices stated in a foreign currency.
B. For reporting purposes, foreign currency balances must be stated in terms of the
companys reporting currency by multiplying it by an exchange rate.
C. Accountants face two questions in restating foreign currency balances.
1. What is the appropriate exchange rate for restating foreign currency balances?
2. How are changes in the exchange rate accounted for?
D. Companies often engage in foreign currency hedging activities to avoid the adverse
impact of exchange rate changes.
E. Accountants must determine how to properly account for these hedging activities.

II.

Foreign exchange rates are determined in the foreign exchange market under a variety of
different currency arrangements.
A. Exchange rates can be expressed in terms of the number of U.S. dollars to purchase
one foreign currency unit (direct quotes) or the number of foreign currency units that
can be obtained with one U.S. dollar (indirect quotes).
B. Foreign currency trades can be executed on a spot or forward basis.
1. The spot rate is the price at which a foreign currency can be purchased or sold
today.
2. The forward rate is the price today at which foreign currency can be purchased or
sold sometime in the future.
3. Forward exchange contracts provide companies with the ability to lock in a price
today for purchasing or selling currency at a specific future date.
C. Foreign currency options provide the right but not the obligation to buy or sell foreign
currency in the future, and therefore are more flexible than forward contracts.

III. FASB Accounting Standards Codification Topic 830, Foreign Currency Matters (FASB ASC
830) prescribes accounting rules for foreign currency transactions.
A. Export sales denominated in foreign currency are reported in U.S. dollars at the spot
exchange rate at the date of the transaction. Subsequent changes in the exchange
rate until collection of the receivable are reflected through a restatement of the foreign
currency account receivable with an offsetting foreign exchange gain or loss reported
in income. This is known as a two-transaction perspective, accrual approach.
B. The two-transaction perspective, accrual approach also is used in accounting for
foreign currency payables. Receivables and payables denominated in foreign
currency create an exposure to foreign exchange risk; this is the risk that changes in
the exchange rate over time will result in a foreign exchange loss.
IV. FASB Accounting Standards Codification Topic 815, Derivatives and Hedging (FASB ASC
815) governs the accounting for derivative financial instruments and hedging activities
including the use of foreign currency forward contracts and foreign currency options.
A. The fundamental requirement is that all derivatives must be carried on the balance
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-1

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

B.

C.

D.

E.

F.

G.

sheet at their fair value. Derivatives are reported on the balance sheet as assets
when they have a positive fair value and as liabilities when they have a negative fair
value.
U.S. GAAP provides guidance for hedges of the following sources of foreign exchange
risk:
1. foreign currency denominated assets and liabilities.
2. unrecognized foreign currency firm commitments.
3. forecasted foreign denominated currency transactions.
4. net investments in foreign operations (covered in Chapter 10).
Companies prefer to account for hedges in such a way that the gain or loss from the
hedge is recognized in net income in the same period as the loss or gain on the risk
being hedged. This approach is known as hedge accounting. Hedge accounting for
foreign currency derivatives may be applied only if three conditions are satisfied:
1. the derivative is used to hedge either a cash flow exposure or fair value exposure
to foreign exchange risk,
2. the derivative is highly effective in offsetting changes in the cash flows or fair value
related to the hedged item, and
3. the derivative is properly documented as a hedge.
Hedge accounting is allowed for hedges of two different types of exposure: cash flow
exposure and fair value exposure. Hedges of (1) foreign currency denominated
assets and liabilities, (2) foreign currency firm commitments, and (3) forecasted foreign
currency transactions can be designated as cash flow hedges. Hedges of (1) and (2)
also can be designated as fair value hedges. Accounting procedures differ for the two
types of hedges.
For cash flow hedges of foreign currency denominated assets and liabilities, at each
balance sheet date:
1. The hedged asset or liability is adjusted to fair value based on changes in the spot
exchange rate, and a foreign exchange gain or loss is recognized in net income.
2. The derivative hedging instrument is adjusted to fair value (resulting in an asset or
liability reported on the balance sheet), with the counterpart recognized as a
change in Accumulated Other Comprehensive Income (AOCI).
3. An amount equal to the foreign exchange gain or loss on the hedged asset or
liability is then transferred from AOCI to net income; the net effect is to offset any
gain or loss on the hedged asset or liability.
4. An additional amount is removed from AOCI and recognized in net income to
reflect (a) the current periods amortization of the original discount or premium on
the forward contract (if a forward contract is the hedging instrument) or (b) the
change in the time value of the option (if an option is the hedging instrument).
For fair value hedges of foreign currency denominated assets and liabilities, at each
balance sheet date:
1. The hedged asset or liability is adjusted to fair value based on changes in the spot
exchange rate, and a foreign exchange gain or loss is recognized in net income.
2. The derivative hedging instrument is adjusted to fair value (resulting in an asset or
liability reported on the balance sheet), with the counterpart recognized as a gain
or loss in net income.
Under fair value hedge accounting for hedges of foreign currency firm commitments:
1. the gain or loss on the hedging instrument is recognized currently in net income,
and
2. the change in fair value of the firm commitment is also recognized currently in net
income.
This accounting treatment requires (1) measuring the fair value of the firm

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-2

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

commitment, (2) recognizing the change in fair value in net income, and (3) reporting
the firm commitment on the balance sheet as an asset or liability. A decision must be
made whether to measure the fair value of the firm commitment through reference to
(a) changes in the spot exchange rate or (b) changes in the forward rate.
H. Cash flow hedge accounting is allowed for hedges of forecasted foreign currency
transactions. For hedge accounting to apply, the forecasted transaction must be
probable (likely to occur). The accounting for a hedge of a forecasted transaction
differs from the accounting for a hedge of a foreign currency firm commitment in two
ways:
1. Unlike the accounting for a firm commitment, there is no recognition of the
forecasted transaction or gains and losses on the forecasted transaction.
2. The hedging instrument (forward contract or option) is reported at fair value, but
because there is no gain or loss on the forecasted transaction to offset against,
changes in the fair value of the hedging instrument are not reported as gains and
losses in net income. Instead they are reported in other comprehensive income.
On the projected date of the forecasted transaction, the cumulative change in the
fair value of the hedging instrument is transferred from other comprehensive
income (balance sheet) to net income (income statement).
V.

IFRS is very similar to U.S. GAAP with respect to the accounting for foreign currency
transactions and hedging of foreign exchange risk.
A. IAS 21 requires the use of a two-transaction perspective in accounting for foreign
currency transactions with unrealized foreign exchange gains and losses accrued in
net income in the period of exchange rate change.
B. IAS 39 allows hedge accounting for foreign currency hedges of recognized assets and
liabilities, firm commitments, and forecasted transactions when documentation
requirements and effectiveness tests are met. Hedges are designated as cash flow or
fair value hedges.
C. One difference between IFRS and U.S. GAAP relates to the type of financial
instrument that can be designated as a foreign currency cash flow hedge. Under U.S.
GAAP, only derivative financial instruments can be used as a cash flow hedge,
whereas IFRS also allows non-derivative financial instruments, such as foreign
currency loans, to be designated as hedging instruments in a foreign currency cash
flow hedge.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-3

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Answer to Discussion Question: Do We Have a Gain or What?


This case demonstrates the differing kinds of information provided through application of
current accounting rules for foreign currency transactions and derivative financial instruments.
The Ahnuld Corporation could have received $200,000 from its export sale to Tcheckia if it had
required immediate payment. Instead, Ahnuld allows its customer six months to pay. Given
the future exchange rate of $1.70, Ahnuld would have received only $170,000 if it had not
entered into the forward contract. This would have resulted in a decrease in cash inflow of
$30,000. In accordance with current accounting standards, the decrease in the value of the
tcheck receivable is recognized as a foreign exchange loss of $30,000. This loss represents
the cost of extending credit to the foreign customer if the tcheck receivable is left unhedged.
However, rather than leaving the tcheck receivable unhedged, Ahnuld sells tchecks forward at
a price of $180,000. Because the future spot rate turns out to be only $1.70, the forward
contract provides a benefit, increasing the amount of cash received from the export sale by
$10,000. In accordance with current accounting standards, the change in the fair value of the
forward contract (from zero initially to $10,000 at maturity) is recognized as a gain on the
forward contract of $10,000. This gain reflects the cash flow benefit from having entered into
the forward contract, and is the appropriate basis for evaluating the performance of the foreign
exchange risk manager. (Students should be reminded that the forward contract will not
always improve cash inflow. For example, if the future spot rate were $1.85, the forward
contract would result in $5,000 less cash inflow than if the transaction were left unhedged.)
The net impact on income resulting from the fluctuation in the value of the tcheck is a loss of
$20,000. Clearly, Ahnuld forgoes $20,000 in cash inflow by allowing the customer time to pay
for the purchase, and the net loss reported in income correctly measures this. The $20,000
loss is useful to management in assessing whether the sale to Tcheckia generated an
adequate profit margin, but it is not useful in assessing the performance of the foreign
exchange risk manager. The net loss must be decomposed into its component parts to fairly
evaluate the risk managers performance.
Gains and losses on forward contracts designated as fair value hedges of foreign currency
assets and liabilities are relevant measures for evaluating the performance of foreign
exchange risk managers. (The same is not true for cash flow hedges. For this type of hedge,
performance should be evaluated by considering the net gain or loss on the forward contract
plus or minus the forward contract premium or discount.)

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-4

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Answers to Questions
1.

Under the two-transaction perspective, an export sale (import purchase) and the
subsequent collection (payment) of cash are treated as two separate transactions to be
accounted for separately. The idea is that management has made two decisions: (1) to
make the export sale (import purchase), and (2) to extend credit in foreign currency to the
foreign customer (obtain credit from the foreign supplier). The income effect from each of
these decisions should be reported separately.

2.

Foreign currency receivables resulting from export sales are revalued at the end of
accounting periods using the current spot rate. An increase in the value of a receivable
will be offset by reporting a foreign exchange gain in net income, and a decrease will be
offset by a foreign exchange loss. Foreign exchange gains and losses are accrued even
though they have not yet been realized.

3.

Foreign exchange gains and losses are created by two factors: having foreign currency
exposures (foreign currency receivables and payables) and changes in exchange rates.
Appreciation of the foreign currency will generate foreign exchange gains on receivables
and foreign exchange losses on payables. Depreciation of the foreign currency will
generate foreign exchange losses on receivables and foreign exchange gains on
payables.

4.

Hedging is the process of eliminating exposure to foreign exchange risk so as to avoid


potential losses from fluctuations in exchange rates. In addition to avoiding possible
losses, companies hedge foreign currency transactions and commitments to introduce an
element of certainty into the future cash flows resulting from foreign currency activities.
Hedging involves establishing a price today at which foreign currency can be sold or
purchased at a future date.

5.

A party to a foreign currency forward contract is obligated to deliver one currency in


exchange for another at a specified future date, whereas the owner of a foreign currency
option can choose whether to exercise the option and exchange one currency for another
or not.

6.

Hedges of foreign currency denominated assets and liabilities are not entered into until a
foreign currency transaction (import purchase or export sale) has taken place. Hedges of
firm commitments are made when a purchase order is placed or a sales order is received,
before a transaction has taken place. Hedges of forecasted transactions are made at the
time a future foreign currency purchase or sale can be anticipated, even before an order
has been placed or received.

7.

Foreign currency options have an advantage over forward contracts in that the holder of
the option can choose not to exercise if the future spot rate turns out to be more
advantageous. Forward contracts, on the other hand, can lock a company into an
unnecessary loss (or a reduced gain). The disadvantage associated with foreign currency
options is that a premium must be paid up front even though the option might never be
exercised.

8.

An enterprise is required to recognize all derivative financial instruments as assets or


liabilities on the balance sheet and measure them at fair value.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-5

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

9.

The fair value of a foreign currency forward contract is determined by reference to


changes in the forward rate over the life of the contract, discounted to the present value.
Three pieces of information are needed to determine the fair value of a forward contract at
any point in time during its life: (a) the contracted forward rate when the forward contract
is entered into, (b) the current forward rate for a contract that matures on the same date
as the forward contract entered into, and (c) a discount rate; typically, the companys
incremental borrowing rate.
The manner in which the fair value of a foreign currency option is determined depends on
whether the option is traded on an exchange or has been acquired in the over the counter
market. The fair value of an exchange-traded foreign currency option is its current market
price quoted on the exchange. For over the counter options, fair value can be determined
by obtaining a price quote from an option dealer (such as a bank). If dealer price quotes
are unavailable, the company can estimate the value of an option using the modified
Black-Scholes option pricing model. Regardless of who does the calculation, principles
similar to those in the Black-Scholes pricing model will be used in determining the value of
the option.

10. Hedge accounting is defined as recognition of gains and losses on the hedging instrument
in the same period as the recognition of gains and losses on the underlying hedged asset
or liability (or firm commitment).
11. For hedge accounting to apply, the forecasted transaction must be probable (likely to
occur), the hedge must be highly effective in offsetting fluctuations in the cash flow
associated with the foreign currency risk, and the hedging relationship must be properly
documented.
12. In both cases, (1) sales revenue (or the cost of the item purchased) is determined using
the spot rate at the date of sale (or purchase), and (2) the hedged asset or liability is
adjusted to fair value based on changes in the spot exchange rate with a foreign
exchange gain or loss recognized in net income.
For a cash flow hedge, the derivative hedging instrument is adjusted to fair value
(resulting in an asset or liability reported on the balance sheet), with the counterpart
recognized as a change in Accumulated Other Comprehensive Income (AOCI). An
amount equal to the foreign exchange gain or loss on the hedged asset or liability is then
transferred from AOCI to net income; the net effect is to offset any gain or loss on the
hedged asset or liability. An additional amount is removed from AOCI and recognized in
net income to reflect (a) the current periods amortization of the original discount or
premium on the forward contract (if a forward contract is the hedging instrument) or (b) the
change in the time value of the option (if an option is the hedging instrument).
For a fair value hedge, the derivative hedging instrument is adjusted to fair value (resulting
in an asset or liability reported on the balance sheet), with the counterpart recognized as a
gain or loss in net income. The discount or premium on a forward contract is not allocated
to net income. The change in the time value of an option is not recognized in net income.
13. For a fair value hedge of a foreign currency asset or liability (1) sales revenue (cost of
purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the
hedged asset or liability is adjusted to fair value based on changes in the spot exchange
rate with a foreign exchange gain or loss recognized in net income. The forward contract
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-6

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

is adjusted to fair value based on changes in the forward rate (resulting in an asset or
liability reported on the balance sheet), with the counterpart recognized as a gain or loss
in net income. The foreign exchange gain (loss) and the forward contract loss (gain) are
likely to be of different amounts resulting in a net gain or loss reported in net income.
For a fair value hedge of a firm commitment, there is no hedged asset or liability to
account for. The forward contract is adjusted to fair value based on changes in the forward
rate (resulting in an asset or liability reported on the balance sheet), with a gain or loss
recognized in net income. The firm commitment is also adjusted to fair value based on
changes in the forward rate (resulting in a liability or asset reported on the balance sheet),
and a gain or loss on firm commitment is recognized in net income. The firm commitment
gain (loss) offsets the forward contract loss (gain) resulting in zero impact on net income.
Sales revenue (cost of purchases) is recognized at the spot rate at the date of sale
(purchase). The firm commitment account is closed as an adjustment to net income in the
period in which the hedged item affects net income.
14. For a cash flow hedge of a foreign currency asset or liability (1) sales revenue (cost of
purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the
hedged asset or liability is adjusted to fair value based on changes in the spot exchange
rate with a foreign exchange gain or loss recognized in net income. The forward contract
is adjusted to fair value (resulting in an asset or liability reported on the balance sheet),
with the counterpart recognized as a change in Accumulated Other Comprehensive
Income (AOCI). An amount equal to the foreign exchange gain or loss on the hedged
asset or liability is then transferred from AOCI to net income; the net effect is to offset any
gain or loss on the hedged asset or liability. An additional amount is removed from AOCI
and recognized in net income to reflect the current periods allocation of the discount or
premium on the forward contract.
For a hedge of a forecasted transaction, the forward contract is adjusted to fair value
(resulting in an asset or liability reported on the balance sheet), with the counterpart
recognized as a change in Accumulated Other Comprehensive Income (AOCI). Because
there is no foreign currency asset or liability, there is no transfer from AOCI to net income
to offset any gain or loss on the asset or liability. The current periods allocation of the
forward contract discount or premium is recognized in net income with the counterpart
reflected in AOCI. Sales revenue (cost of purchases) is recognized at the spot rate at the
date of sale (purchase). The amount accumulated in AOCI related to the hedge is closed
as an adjustment to net income in the period in which the forecasted transaction was
anticipated to occur.
15. In accounting for a fair value hedge, the change in the fair value of the foreign currency
option is reported as a gain or loss in net income. In accounting for a cash flow hedge,
the change in the entire fair value of the option is first reported in other comprehensive
income, and then the change in the time value of the option is reported as an expense in
net income.
16. The accounting for a foreign currency borrowing involves keeping track of two foreign
currency payablesthe note payable and interest payable. As both the face value of the
borrowing and accrued interest represent foreign currency liabilities, both are exposed to
foreign exchange risk and can give rise to foreign currency gains and losses.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-7

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Answers to Problems
1. C (Foreign exchange gain/loss on foreign currency transaction)
An import purchase causes a foreign currency payable to be carried on
the books. If the foreign currency depreciates, the dollar value of the
foreign currency payable decreases, yielding a foreign exchange gain.
2. D (Method of accounting for foreign currency transactions)
Current accounting standards require a two-transaction perspective,
accrual approach.
3. B (Foreign exchange gain/loss on foreign currency transaction)
Foreign exchange gains related to foreign currency import purchases are
treated as a component of income before income taxes. If there is no
foreign exchange gain in operating income, then the purchase must have
been denominated in U.S. dollars or there was no change in the value of
the foreign currency from October 1 to December 1, 2013.
4. C

(Calculate foreign exchange gain/loss on foreign currency transaction)


The dollar value of the LCU receivable has decreased from $110,000 at
December 31, 2013 to $95,000 at February 15, 2014. This decrease of
$15,000 should be reported as a foreign exchange loss in 2014.

5. D

(Calculate foreign exchange gain/loss on foreign currency borrowing)


The increase in the dollar value of the euro note payable represents a
foreign exchange loss. In this case a $25,000 loss would have been
accrued in 2013 and a $10,000 loss will be reported in 2014.

6. D

(Foreign exchange gain/loss on foreign currency transaction)


A foreign currency receivable will generate a foreign exchange gain when
the foreign currency increases in dollar value. A foreign currency payable
will generate a foreign exchange gain when the foreign currency
decreases in dollar value. Hence, the correct combination is franc
(increase) and peso (decrease).

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-8

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

7. D

(Calculate foreign exchange gain/loss)


The merchandise purchase results in a foreign exchange loss of $8,000,
the difference between the U.S. dollar equivalent at the date of purchase
and at the date of settlement.
The increase in the dollar equivalent of the notes principal results in a
foreign exchange loss of $20,000.
The total foreign exchange loss is $28,000 ($8,000 + $20,000).

8. D

(Forward contract cash flow hedge of foreign currency denominated


asset/liability)
The Thai baht is selling at a premium (forward rate exceeds spot rate).
The exporter will receive more dollars as a result of selling the baht
forward than if the baht had been received and converted into dollars on
April 1. Thus, the premium results in additional revenue for the exporter.

9. D

(Forward contract fair value hedge of foreign currency firm commitment)


The parts inventory will be recognized at the spot rate at the date of
receipt (FC100,000 x $.23 = $23,000).

10. D (Determine the fair value of a forward contract)


The forward contract must be reported on the December 31, 2013 balance
sheet as a liability. Barnum has locked-in to purchase ringgits at $0.042
per ringgit but could have locked-in to purchase ringgits at $0.037 per
ringgit if it had waited until December 31 to enter into the forward
contract. The forward contract must be reported at its fair value
discounted for two months at 12% [($.042 $.037) x 1,000,000 x .9803 =
$4,901.50].
11. C

(Calculate foreign exchange gain/loss on foreign currency transaction)


The 10 million won receivable has changed in dollar value from $35,000 at
12/1/13 to $33,000 at 12/31/13. The won receivable will be written down by
$2,000 and a foreign exchange loss will be reported in 2013 income.

12. B (Forward contract fair value hedge of foreign currency denominated


asset/liability)
The nominal value of the forward contract on December 31, 2013 is a
positive $2,000, the difference between the amount to be received from the
forward contract actually entered into, $34,000 ($.0034 x 10 million), and
the amount that could be received by entering into a forward contract on
December 31, 2013 that matures on March 31, 2014, $32,000 ($.0032 x 10
million). The fair value of the forward contract is the present value of
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-9

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

$2,000 discounted for three months ($2,000 x .9706 = $1,941.20). On


December 31, 2013, MNC Corp. will recognize a $1,941.20 gain on the
forward contract and a foreign exchange loss of $2,000 on the won
receivable. The net impact on 2013 income is $58.80.
13. A (Forward contract cash flow hedge of forecasted foreign currency
transaction)
The krona is selling at a premium in the forward market, causing Pimlico
to pay more dollars to acquire kroner than if the kroner were purchased at
the spot rate on March 1. Therefore, the premium results in an expense of
$10,000 [($.12 $.10) x 500,000].
The Adjustment to Net Income is the amount accumulated in Accumulated
Other Comprehensive Income (AOCI) as a result of recognizing the
Premium Expense and the fair value of the forward contract. The journal
entries would be as follows:
3/1

no journal entries

6/1

Premium Expense
AOCI
AOCI
Forward Contract
Foreign Currency
Forward Contract
Cash
AOCI
Adjustment to Net Income

$10,000
$10,000
$2,500
$2,500
$57,500
2,500
$60,000
$7,500
$7,500

14. C (Option cash flow hedge of forecasted foreign currency transaction)


This is a cash flow hedge of a forecasted transaction. The original cost of
the option is recognized as an Option Expense over the life of the option.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-10

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

15-17. (Option fair value hedge of a foreign currency firm commitment)


The easiest way to solve problems 15 and 16 is to prepare journal entries
for the option fair value hedge and the firm commitment. The journal
entries are as follows:
9/1/13
Foreign Currency Option
Cash

$2,000
$2,000

12/31/13
Foreign Currency Option
Gain on Foreign Currency Option

$300
$300

Loss on Firm Commitment


Firm Commitment
[($.79 $.80) x 100,000 = $1,000 x .9803 = $980.30]
Net impact on 2013 net income:
Gain on Foreign Currency Option
Loss on Firm Commitment
3/1/14
Foreign Currency Option
Gain on Foreign Currency Option

$980.30
$980.30

$300.00
(980.30)
$(680.30)
$700
$700

Loss on Firm Commitment


$2,019.70
Firm Commitment
[($.77 $.80) x 100,000 = $3,000 $980.30 = $2,019.70]
Foreign Currency (C$)
Sales

$77,000

Cash
Foreign Currency (C$)
Foreign Currency Option

$80,000

Firm Commitment
Adjustment to Net Income

$3,000

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$2,019.70

$77,000
$77,000
3,000
$3,000

The McGraw-Hill Companies, Inc., 2013


9-11

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

15-17. (continued)
Net impact on 2014 net income:
Gain on Foreign Currency Option
Loss on Firm Commitment
Sales
Adjustment to Net Income

700.00
(2,019.70)
77,000.00
3,000.00
$78,680.30

15. B
16. D
17. B Net cash inflow with option ($80,000 $2,000)
Cash inflow without option (at spot rate of $.77)
Net increase in cash inflow

$78,000
77,000
$ 1,000

18-20. (Forward contract fair value hedge of a foreign currency firm commitment)
The easiest way to solve problems 18 and 19 is to prepare journal entries
for the forward contract fair value hedge of a firm commitment. The journal
entries are as follows:
3/1

no journal entries

3/31

Forward Contract
Gain on Forward Contract
($1,250 $0)

$1,250

Loss on Firm Commitment


Firm Commitment

$1,250

$1,250

$1,250

Net impact on first quarter net income is $0.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-12

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

18-20. (continued)
4/30

Loss on Forward Contract


Forward Contract
[Fair value of Forward Contract is
($.120 $.118) x 500,000 = $1,000;
$1,000 $1,250 = $250]

$250

Firm Commitment
Gain on Firm Commitment

$250

$250

$250

Foreign Currency (pesos)


Sales [500,000 pesos x $.118]

$59,000

Cash [500,000 x $.120]


Foreign Currency (pesos)
Forward Contract

$60,000

Firm Commitment
Adjustment to Net Income

$1,000

$59,000
$59,000
1,000
$1,000

Net impact on second quarter net income is: Sales $59,000 Loss on
Forward Contract $250 + Gain on Firm Commitment $250 + Adjustment to
Net Income $1,000 = $60,000.
18. A
19. C
20. B Cash inflow with forward contract [500,000 pesos x $.12]
$60,000
Cash inflow without forward contract [500,000 pesos x $.118] 59,000
Net increase in cash flow from forward contract
$ 1,000

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-13

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

21-22. (Option cash flow hedge of a forecasted foreign currency transaction)


The easiest way to solve problems 21 and 22 is to prepare journal entries
for the option cash flow hedge of a forecasted transaction. The journal
entries are as follows:
11/1/13
Foreign Currency Option
Cash

$1,500
$1,500

12/31/13
Option Expense
$400
Foreign Currency Option
$400
(The option has no intrinsic value at 12/31/13 so the entire change in fair
value is due to a change in time value; $1,500 $1,100 = $400 decrease
in time value. The decrease in time value of the option is recognized as
an expense in net income.)
Option Expense decreases net income by $400.
2/1/14
Option Expense
$1,100
Foreign Currency Option
900
Accumulated Other Comprehensive Income (AOCI)
(Record expense for the decrease in time value of the
option; $1,100 $0 = $1,100; and write-up option to fair
value ($.40 $.41) x 200,000 = $2,000 $1,100 = $900.)
Foreign Currency (BRL) [200,000 x $.41]
Cash [200,000 x $.40]
Foreign Currency Option

$82,000

Parts Inventory
Foreign Currency (BRL)

$82,000

$80,000
2,000
$82,000

Accumulated Other Comprehensive Income (AOCI)


Adjustment to Net Income

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$2,000

$2,000
$2,000

The McGraw-Hill Companies, Inc., 2013


9-14

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

21-22. (continued)
Net impact on 2014 net income:
Option Expense
$ (1,100)
Cost-of-Goods-Sold
(82,000)
Adjustment to Net Income
2,000
Decrease in Net Income $ (81,100)
21. B
22. C
23. (10 minutes) (Foreign currency payable -- import purchase)
a. The decrease in the dollar value of the LCU payable from November 1
(60,000 x .345 = $20,700) to December 31 (60,000 x .333 = $19,980) is
recorded as a $720 foreign exchange gain in 2013.
b. The increase in the dollar value of the LCU payable from December 31
($19,980) to January 15 (60,000 x .359 = $21,540) is recorded as a $1,560
foreign exchange loss in 2014.
24. (10 minutes) (Foreign currency receivable export sale)
a. The ostra receivable decreases in dollar value from (50,000 x $1.05)
$52,500 at December 20 to $51,000 (50,000 x $1.02) at December 31,
resulting in a foreign exchange loss of $1,500 in 2013.
b. The further decrease in dollar value of the ostra receivable from $51,000 at
December 31 to $49,000 (50,000 x $.98) at January 10 results in an
additional $2,000 foreign exchange loss in 2014.
25. (10 minutes) (Foreign currency receivable export sale)
9/15
9/30

10/15

Accounts Receivable (FCU) [100,000 x $.40]


Sales

$40,000
$40,000

Accounts Receivable (FCU)


Foreign Exchange Gain
[100,000 x ($.42 $.40)]

$2,000

Foreign Exchange Loss


Accounts Receivable (FCU)
[100,000 x ($.37 $.42)]

$5,000

Cash
Accounts Receivable (FCU)

$37,000

$2,000

$5,000
$37,000

26. (10 minutes) (Foreign currency payable -- import purchase)


12/1/13

Inventory

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$52,800
The McGraw-Hill Companies, Inc., 2013
9-15

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Accounts Payable (LCU) [60,000 x $.88]

$52,800

12/31/13 Accounts Payable (LCU) [60,000 x ($.82 $.88)] $3,600


Foreign Exchange Gain

$3,600

1/28/14

Foreign Exchange Loss


$4,800
Accounts Payable (LCU) [60,000 x ($.90 $.82)]
Accounts Payable (LCU)
Cash

$4,800

$54,000
$54,000

27. (15 minutes) (Determine U.S. dollar balance for foreign currency transactions)
Inventory and Cost of Goods Sold are reported at the spot rate at the date the
inventory was purchased. Sales are reported at the spot rate at the date of
sale. Accounts Receivable and Accounts Payable are reported at the spot rate
at the balance sheet date. Cash is reported at the spot rate when collected
and the spot rate when paid.
a. Inventory [50,000 pesos x 40% x $.17]......................................................$3,400
b. COGS [50,000 pesos x 60% x $.17]............................................................$5,100
c. Sales [45,000 pesos x $.18]........................................................................$8,100
d. Accounts Receivable [45,000 40,000 = 5,000 pesos x $.21].................$1,050
e. Accounts Payable [(50,000 30,000 pesos) x $.21].................................$4,200
f. Cash [(40,000 x $.19) (30,000 x $.20)].....................................................$1,600

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-16

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

28. (25 minutes) (Prepare journal entries for foreign currency transactions)
2/1/13
4/1/13

6/1/13
8/1/13

Equipment
Accounts Payable (L) [40,000 x $.44]

$17,600

Accounts Payable (L)


Foreign Exchange Loss
Cash [40,000 x $.45]

$17,600
400

Inventory
Accounts Payable (L) [30,000 x $.47]

$14,100

Accounts Receivable (L) [40,000 x $.48]


Sales

$19,200

$18,000

Cost-of-Goods Sold
Inventory [$14,100 x 70%]
10/1/13

$17,600

$14,100
$19,200
$9,870
$9,870

Cash [30,000 x $.49]


Accounts Receivable (L) [$19,200 x 3/4]

$14,700
$14,400

Foreign Exchange Gain


11/1/13

300

Accounts Payable (L) [$14,100 x 2/3]


Foreign Exchange Loss [20,000 x ($.50 $.47)]
Cash [20,000 x $.50]

$9,400
600
$10,000

12/31/13 Foreign Exchange Loss


Accounts Payable (L) [10,000 x ($.52 $.47)]

$500

Accounts Receivable (L) [10,000 x ($.52 $.48)]


Foreign Exchange Gain

$400

2/1/14

3/1/14

$500
$400

Cash [10,000 x $.54]


Accounts Receivable (L) [10,000 x $.52]
Foreign Exchange Gain

$5,400

Accounts Payable (L) [10,000 x $.52]


Foreign Exchange Loss
Cash [10,000 x $.55]

$5,200
300

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$5,200
200

$5,500

The McGraw-Hill Companies, Inc., 2013


9-17

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

29. (20 minutes) (Determine income effect of foreign currency payable import
purchase)
a.

Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (December 1, 2013), the liability had a dollar value of
$70,400 (AL 160,000 x $.44). On December 31, 2013, the dollar value has
risen to $76,800 (AL 160,000 x $.48). The increase in the dollar value of
the liability creates a foreign exchange loss of $6,400 ($76,800 $70,400)
in 2013.
By March 1, 2014, when the liability is paid, the dollar value has dropped
to $72,000 (AL 160,000 x $.45) creating a foreign exchange gain of $4,800
($72,000 $76,800) to be reported in 2014.

b. Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (September 1, 2013), the liability had a dollar value of
$73,600 (AL 160,000 x $.46). On December 1, 2013, when the liability is
paid, the dollar value has decreased to $70,400 (AL 160,000 x $.44). The
drop in the dollar value of the liability creates a foreign exchange gain of
$3,200 ($70,400 $73,600) in 2013.
c.

Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (September 1, 2013), the liability had a dollar value of
$73,600 (AL 160,000 x $.46). On December 31, 2013, the dollar value has
risen to $76,800 (AL 160,000 x $.48). The increase in the dollar value of
the liability creates a foreign exchange loss of $3,200 ($76,800 $73,600)
in 2013.
By March 1, 2014, when the liability is paid, the dollar value has dropped
to $72,000 (AL 160,000 x $.45) creating a foreign exchange gain of $4,800
($72,000 $76,800) to be reported in 2014.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-18

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

30. (30 minutes) (Foreign currency borrowing)


a.

9/30/13

Cash
$100,000
Note payable (dudek) [1,000,000 x $.10]
(To record the note and conversion of 1 million
dudeks into $ at the spot rate.)

12/31/13 Interest Expense


$525
Interest Payable (dudek)
[1,000,000 x 2% x 3/12 = 5,000 dudeks x
$.105 spot rate]
(To accrue interest for the period 9/30 12/31/13.)
Foreign Exchange Loss
Note Payable (dudek) [1 m x ($.105 $.10)]
(To revalue the note payable at the spot rate of
$.105 and record a foreign exchange loss.)

$5,000

9/30/14

$1,800
525

Interest Expense [15,000 dudeks x $.12]


Interest Payable (dudek)
Foreign Exchange Loss [5,000 dudeks x
($.12 $.105)]
Cash [20,000 dudeks x $.12]
(To record the first annual interest payment,
record interest expense for the period 1/1 9/30/14,
and record a foreign exchange loss on the
interest payable accrued at 12/31/13.)

$525

$5,000

75

12/31/14 Interest Expense


$625
Interest Payable (dudek) [5,000 dudeks x $.125]
(To accrue interest for the period 9/30 12/31/14.)
Foreign Exchange Loss
$20,000
Note Payable (dudek) [1 m x ($.125 $.105)]
(To revalue the note payable at the spot rate of
$.125 and record a foreign exchange loss.)

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$100,000

$2,400

$625

$20,000

The McGraw-Hill Companies, Inc., 2013


9-19

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

30. (continued)
9/30/15

Interest Expense [15,000 dudeks x $.15]


Interest Payable (dudek)
Foreign Exchange Loss [5,000 dudeks x
($.15 $.125)]
Cash [20,000 dudeks x $.15]
(To record the second annual interest payment,
record interest expense for the period 1/1 9/30/15,
and record a foreign exchange loss on the interest
payable accrued at 12/31/14.)
Note Payable (dudek)
Foreign Exchange Loss
Cash [1 m dudeks x $.15]
(To record payment of the 1 million dudek note.)

$2,250
625
125
$3,000

$125,000
25,000
$150,000

b. The effective cost of borrowing can be determined by considering the total


interest expense and foreign exchange losses related to the loan and
comparing this with the amount borrowed:
2013
Interest expense
Foreign exchange loss
Total
2014
Interest expense
Foreign exchange losses
Total
2015
Interest expense
Foreign exchange losses
Total

$525
5,000
$5,525 / $100,000 = 5.525% for 3 months =
= 22.1% for 12 months
$2,425
20,075
$22,500 / $100,000 = 22.5% for 12 months
$2,250
25,125
$27,375 / $100,000 = 27.38% for 9 months
= 36.5% for 12 months

= 36.5% for 12 months


Because of appreciation in the value of the dudek, the effective annual
borrowing costs range from 22.1% 36.5%.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-20

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

30.

(continued)
The net cash flow from this borrowing is:
Cash outflows:
Interest ($2,400 + $3,000)
Principal
Cash inflow:
Borrowing
Net cash outflow

$5,400
150,000
$155,400
(100,000)
$ 55,400

Ignoring compounding, this results in an effective borrowing cost of


approximately 27.7% per year [($55,400 / $100,000) or 55.4% over two years / 2
years = 27.7% per year].
31. (40 minutes) (Forward contract hedge of foreign currency receivable)
a. Cash Flow Hedge
12/1/13

Accounts Receivable (K) [20,000 x $2.00]


Sales

$40,000
$40,000

No entry for the forward contract.


12/31/13 Accounts Receivable (K)
Foreign Exchange Gain
[20,000 x ($2.10-$2.00)]

$2,000
$2,000

AOCI
$2,450.75
Forward Contract
$2,450.75
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
Loss on Forward Contract
AOCI

$2,000
$2,000

AOCI
$500
Premium revenue
[20,000 x ($2.075 $2.00) = $1,500 x 1/3 = $500]

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$500

The McGraw-Hill Companies, Inc., 2013


9-21

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

31. (continued)
Impact on 2013 income:
Sales
Foreign Exchange Gain
Loss on Forward Contract
Premium Revenue
Total
3/1/14

$40,000
2,000
(2,000)
500
$40,500

Accounts Receivable (K)


Foreign Exchange Gain
[20,000 x ($2.25 $2.10)]

$3,000
$3,000

AOCI
$1,049.25
Forward Contract
$1,049.25
[20,000 x ($2.25 $2.075) = $3,500 2,450.75] = $1,049.25
Loss on Forward Contract
AOCI

$3,000

AOCI
Premium revenue
[$1,500 x 2/3 = $1,000]

$1,000

$3,000
$1,000

Foreign Currency (K) [20,000 x $2.25]


Accounts Receivable (K)

$45,000

Cash [20,000 x $2.075]


Forward Contract
Foreign Currency (K)

$41,500
3,500

Impact on 2014 income:


Foreign Exchange Gain
Loss on Forward Contract
Premium revenue
Total

$45,000

$45,000

$3,000
(3,000)
1,000
$1,000

Impact on net income over both periods: $40,500 + $1,000 = $(41,500); equal
to cash inflow.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-22

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

31. (continued)
b. Fair Value Hedge
12/1/13 Accounts Receivable (K) [20,000 x $2.00]
Sales

$40,000
$40,000

No entry for the forward contract.


12/31/13 Accounts Receivable (K)
Foreign Exchange Gain
[20,000 x ($2.10 $2.00)]

$2,000
$2,000

Loss on Forward Contract


$2,450.75
Forward Contract
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
Impact on 2013 income:
Sales
Foreign Exchange Gain
Loss on Forward Contract
Total
3/1/14

$2,450.75

$40,000.00
2,000.00
(2,450.75)
$39,549.25

Accounts Receivable (K)


Foreign Exchange Gain
[20,000 x ($2.25 $2.10)]

$3,000
$3,000

Loss on Forward Contract


$1,049.25
Forward Contract
$1,049.25
[20,000 x (2.25 $2.075) = $3,500 2,450.75 = $1,049.25]
Foreign Currency (K) [20,000 x $2.25]
Accounts Receivable (K)

$45,000

Cash [20,000 x $2.075]


Forward Contract
Foreign Currency (K)

$41,500
3,500

Impact on 2014 income:


Foreign Exchange Gain
Loss on Forward Contract
Total

$45,000

$45,000

$3,000.00
(1,049.25)
$1,950.75

Impact on net income over both periods: $39,549.25 + $1,950.75 = $41,500;


equal to cash inflow.
32. (40 minutes) (Forward contract hedge of foreign currency payable)
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-23

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

a. Cash Flow Hedge


12/1/13Parts Inventory (COGS)
Accounts Payable (K)
[20,000 x $2.00]

$40,000
$40,000

No entry for the forward contract.


12/31/13 Foreign Exchange Loss
Accounts Payable (K)
[20,000 x ($2.10 $2.00)]

$2,000
$2,000

Forward Contract
$2,450.75
AOCI
$2,450.75
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
AOCI
Gain on Forward Contract

$2,000
$2,000

Premium Expense
$500
AOCI
[20,000 x ($2.075 $2.00) = $1,500 x 1/3 = $500]
Impact on 2013 income:
Parts inventory (COGS)
Foreign Exchange Loss
Gain on Forward Contract
Premium Expense
Total

$500

$(40,000)
(2,000)
2,000
(500)
$(40,500)

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-24

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

32. (continued)
3/1/14

Foreign Exchange Loss


Accounts Payable (K)
[20,000 x ($2.25 $2.10)]

$3,000
$3,000

Forward Contract
$1,049.25
AOCI
$1,049.25
[20,000 x ($2.25 $2.075) = $3,500 2,450.75 = $1,049.25]
AOCI
Gain on Forward Contract

$3,000

Premium Expense
AOCI
[$1,500 x 2/3 = $1,000]

$1,000

$3,000
$1,000

Foreign Currency (K) [20,000 x $2.25]


Cash
Forward Contract

$45,000

Accounts Payable (K)


Foreign Currency (K)

$45,000

Impact on 2014 income:


Foreign Exchange Loss
Gain on Forward Contract
Premium expense
Total

$41,500
3,500
$45,000

$(3,000)
3,000
(1,000)
$(1,000)

Impact on net income over both periods: $(40,500) + $(1,000) = $(41,500);


equal to cash outflow.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-25

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

32. (continued)
b. Fair Value Hedge
12/1/13Parts inventory (COGS)
Accounts Payable (K)
[20,000 x $2.00]

$40,000
$40,000

No entry for the forward contract.


12/31/13

Foreign Exchange Loss


Accounts Payable (K)
[20,000 x ($2.10 $2.00)]

$2,000
$2,000

Forward Contract
$2,450.75
Gain on Forward Contract
$2,450.75
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
Impact on 2013 income:
Parts inventory (COGS)
Foreign Exchange Loss
Gain on Forward Contract
Total
3/1/14

$(40,000.00)
(2,000.00)
2,450.75
$(39,549.25)

Foreign Exchange Loss


Accounts Payable (K)
[20,000 x ($2.25 $2.10)]

$3,000
$3,000

Forward Contract
$1,049.25
Gain on Forward Contract
$1,049.25
[20,000 x ($2.25 $2.075) = $3,500 2,450.75 = $1,049.25]
Foreign Currency (K) [20,000 x $2.25]
Cash
Forward Contract

$45,000

Accounts Payable (K)


Foreign Currency (K)

$45,000

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$41,500
3,500
$45,000

The McGraw-Hill Companies, Inc., 2013


9-26

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

32. (continued)
Impact on 2014 income:
Foreign Exchange Loss
Gain on Forward Contract
Total

$(3,000.00)
1,049.25
$(1,950.75)

Impact on net income over both periods: $(39,549.25) + $(1,950.75) =


$(41,500.00); equal to cash outflow.
33. (30 minutes) (Option hedge of foreign currency receivable)
a. Cash Flow Hedge
6/1

Accounts Receivable (P)


Sales [$.045 x 1,000,000 pesos]

$45,000
$45,000

Foreign Currency Option


$2,000
Cash
$2,000
6/30

Accounts Receivable (P)


Foreign Exchange Gain
[($.048 $.045) x 1,000,000]

$3,000
$3,000

AOCI
Foreign Currency Option
[($.0018 $.0020) x 1,000,000]

$200
$200

Loss on Foreign Currency Option


AOCI

$3,000
$3,000

Option Expense
AOCI
Date
6/1
6/30
9/1

Fair Value
$2,000
$1,800
$1,000

Intrinsic Value
$0
$0
$1,000

$200
$200
Time Value
$2,000
$1,800
$0

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

Change in Time Value

$ 200
$1,800

The McGraw-Hill Companies, Inc., 2013


9-27

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

33. (continued)
9/1

Foreign Exchange Loss


Accounts Receivable (P)
[($.044 $.048) x 1,000,000]

$4,000
$4,000

AOCI
Foreign Currency Option
[$1,800 $1,000]

$800
$800

AOCI
Gain on Foreign Currency Option

$4,000
$4,000

Option Expense
$1,800
AOCI
(Change in time value of option is recognized as expense)
Foreign Currency (P)
Accounts Receivable (P)

$44,000

Cash
Foreign Currency (P)
Foreign Currency Option

$45,000

$1,800

$44,000
$44,000
$1,000

Impact on Net Income over the Two Accounting Periods:


Sales
$45,000
Foreign currency option expense
(2,000)
Impact on net income
$43,000 = Net cash inflow
b. Fair Value Hedge
6/1

6/30

Accounts Receivable (P)


Sales [$.045 x 1,000,000]

$45,000
$45,000

Foreign Currency Option


Cash

$2,000

Accounts Receivable (P)


Foreign Exchange Gain
[($.048 $.045) x 1,000,000]

$3,000

Loss on Foreign Currency Option


Foreign Currency Option

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$2,000
$3,000
$200
$200

The McGraw-Hill Companies, Inc., 2013


9-28

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

33. (continued)
9/1

Foreign Exchange Loss


Accounts Receivable (P)
[($.044 $.048) x 1,000,000]

$4,000
$4,000

Loss on Foreign Currency Option


Foreign Currency Option

$800
$800

Foreign Currency (P)


Accounts Receivable (P)

$44,000

Cash
Foreign Currency (P)
Foreign Currency Option

$45,000

$44,000
$44,000
$1,000

Impact on Net Income over the Two Accounting Periods:


Sales
$45,000
Foreign Exchange Gain
3,000
Foreign Exchange Loss
(4,000)
Loss on Foreign Currency Option
(1,000)
Impact on net income
$43,000
=
Net cash inflow
minutes) (Option hedge of foreign currency payable)

34.

(30

a. Cash Flow Hedge


6/1

6/30

Date
6/1

Inventory [$.085 x 1,000,000]


Accounts Payable (M)

$85,000
$85,000

Foreign Currency Option


Cash

$2,000

Foreign Exchange Loss


Accounts Payable (M)
[($.088 .085) x 1,000,000]

$3,000

Foreign Currency Option


AOCI
[$4,000 $2,000]

$2,000

AOCI
Gain on Foreign Currency Option

$3,000

Option Expense
AOCI

$1,000*

Fair Value
$2,000

Intrinsic Value
$0

$2,000
$3,000

$2,000

$3,000
$1,000

Time Value
$2,000

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

Change in Time Value


-

The McGraw-Hill Companies, Inc., 2013


9-29

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

6/30
9/1

$4,000
$5,000

$3,000
$5,000

$1,000
$0

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

-$1,000*
-$1,000**

The McGraw-Hill Companies, Inc., 2013


9-30

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

34. (continued)
9/1

Foreign Exchange Loss


Accounts Payable (M)
[($.09 $.088) x 1,000,000]

$2,000

Foreign Currency Option


AOCI
[$5,000 $4,000]

$1,000

AOCI
Gain on Foreign Currency Option

$2,000

Option Expense
AOCI

$1,000**

$2,000

$1,000

$2,000

$1,000

Foreign Currency (M)


Cash
Foreign Currency Option

$90,000

Accounts Payable (M)


Foreign Currency (M)

$90,000

Impact on net income:


Option Expense

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$85,000
$5,000
$90,000
($2,000)

The McGraw-Hill Companies, Inc., 2013


9-31

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

34.

(continued)

b. Fair Value Hedge


6/1

6/30

9/1

Inventory
Accounts Payable (M)
[$.085 x 1,000,000]

$85,000

Foreign Currency Option


Cash

$2,000

Foreign Exchange Loss


Accounts Payable (M)
[($.088 $.085) x 1,000,000]

$3,000

Foreign Currency Option


Gain on Foreign Currency Option
[$4,000 $2,000]

$2,000

Foreign Exchange Loss


Accounts Payable (M)
[($.09 $.088) x 1,000,000]

$2,000

Foreign Currency Option


Gain on Foreign Currency Option
[$5,000 $4,000]

$1,000

$85,000

$2,000
$3,000

$2,000

$2,000

$1,000

Foreign Currency (M)


Cash
Foreign Currency Option

$90,000

Accounts Payable (M)


Foreign Currency (M)

$90,000

Impact on net income:


Foreign Exchange Loss
Gain on Foreign Currency Option
Impact on net income

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$85,000
5,000
$90,000
($5,000)
3,000
($2,000)

The McGraw-Hill Companies, Inc., 2013


9-32

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

35. (30 minutes) (Forward contract cash flow hedge of foreign currency
denominated asset)

Date
11/01/13
12/31/13
4/30/14

Account Receivable (FCU) Forward


SpotU.S. DollarChange in U.S.Rate to
RateValue Dollar Value
4/30/14
Fair Value
$.53
$53,000
$.52
$.50
$50,000
-$3,000
$.48
$.49
$49,000
-$1,000
$.49

Forward Contract
Change in
Fair Value
$0
$3,8441
+$3,844
$3,0002
- $ 844

($52,000 $48,000) x .961 = $3,844; where .961 is the present value factor for four
months at an annual interest rate of 12% (1% per month) calculated as 1/1.01 4.
2
$52,000 $49,000 = $3,000.
1

2013 Journal Entries


11/01/13 Accounts Receivable (FCU)
Sales

$53,000
$53,000

There is no entry for the forward contract.


12/31/13 Foreign Exchange Loss
Accounts Receivable (FCU)

$3,000
$3,000

AOCI
Gain on Forward Contract

$3,000

Forward Contract
AOCI

$3,844

$3,000
$3,844

Discount expense
AOCI
[100,000 x ($.53 $.52) = $1,000 x 2/6 = $333.33]

$333.33
$333.33

The impact on net income for the year 2013 is:


Sales
Foreign Exchange Loss
Gain on Forward Contract
Net Gain (Loss)
Discount Expense
Impact on net income

$53,000.00
(3,000.00)
3,000.00

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

0.00
(333.33)
$52,666.67

The McGraw-Hill Companies, Inc., 2013


9-33

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

35. (continued)
2014 Journal Entries
4/30/14

Foreign Exchange Loss


Accounts Receivable (FCU)

$1,000

AOCI
Gain on Forward Contract

$1,000

$1,000
$1,000

AOCI
Forward Contract

$844
$844

Discount expense
AOCI

$666.67

Foreign Currency (FCU)


Accounts Receivable (FCU)

$49,000

Cash
Foreign Currency (FCU)
Forward Contract

$52,000

$666.67
$49,000
$49,000
3,000

The impact on net income for the year 2014 is:


Foreign Exchange Loss
Gain on Forward Contract
Net Gain (Loss)
Discount Expense
Impact on net income

$(1,000.00)
1,000.00

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

0.00
(666.67)
$(666.67)

The McGraw-Hill Companies, Inc., 2013


9-34

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

36. (30 minutes) (Forward contract fair value hedge of net foreign currency
denominated asset)
Account Receivable (Payable) (mongs) Forward
Change in U.S.
Rate to
Date
U.S. Dollar Value
Dollar Value
1/31/14
11/30/13 $265,000 ($159,000)
$.52
12/31/13 $250,000 ($150,000) -$15,000 (-$9,000)
$.48
1/31/14 $245,000 ($147,000) -$ 5,000 (-$3,000)
$.49

Forward Contract
Change in
Fair Value
Fair Value
$0
$7,9211
+$7,921
$6,0002
- $1,921

($104,000 $96,000) x .9901 = $7,921; where .9901 is the present value factor for one
month at an annual interest rate of 12% (1% per month) calculated as 1/1.01.
2
$104,000 $98,000 = $6,000.
1

2013 Journal Entries


11/30

Accounts Receivable (mongs)


Sales
[$.53 x 500,000 mongs]

$265,000

Inventory
Accounts Payable
[$.53 x 300,000 mongs]

$159,000

$265,000

$159,000

There is no formal entry for the forward contract.


12/31

Foreign Exchange Loss


Accounts Receivable (mongs)

$15,000
$15,000

Accounts Payable (mongs)


Foreign Exchange Gain

$9,000

Forward Contract
Gain on Forward Contract

$7,921

$9,000
$7,921

The impact on net income for the year 2013 is:


Sales
Net Foreign Exchange Loss $ (6,000)
Gain on Forward Contract
7,921
Net Gain (Loss)
Impact on net income

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$265,000
1,921
$266,921

The McGraw-Hill Companies, Inc., 2013


9-35

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

36. (continued)
2014 Journal Entries
1/31

Foreign Exchange Loss


Accounts Receivable (mongs)

$5,000

Accounts Payable (mongs)


Foreign Exchange Gain

$3,000

Loss on Forward Contract


Forward Contract

$1,921

$5,000
$3,000
$1,921

Foreign Currency (mongs)


Accounts Receivable (mongs)

$245,000

Accounts Payable (mongs)


Foreign Currency (mongs)

$147,000

Cash
Foreign Currency (mongs)
Forward Contract

$104,000

$245,000
$147,000
$98,000
$6,000

The impact on net income for the year 2014 is:


Net Foreign Exchange Loss
Loss on Forward Contract
Impact on net income

$(2,000)
(1,921)
$(3,921)

The net effect on the balance sheet is an increase in cash of $104,000 and an
increase in inventory of $159,000 with a corresponding increase in retained
earnings of $263,000 ($266,921 $3,921).

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-36

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

37. (40 minutes) (Forward contract fair value hedge foreign currency receivable
and firm commitment (sale))
a. Foreign Currency Receivable
10/01

Accounts Receivable (LCU)


Sales (100,000 LCUs x $.69)

$69,000
$69,000

There is no formal entry for the forward contract.


12/31

Accounts Receivable (LCU)


Foreign Exchange Gain
[($.71 $.69) x 100,000]

$2,000
$2,000

Loss on Forward Contract


$8,910.90
Forward Contract
[($.74 $.65) x 100,000 = $ 9,000 x .9901 = $ 8,910.90]
1/31

Accounts Receivable (LCU)


Foreign Exchange Gain
[($.72 $.71) x 100,000]

$8,910.90

$1,000
$1,000

Forward Contract
$ 1,910.90
Gain on Forward Contract
$ 1,910.90
[($.72 $.65) x 100,000 = $ 7,000 loss 8,910.90 = $ 1,910.90 gain]
Foreign Currency (LCU)
Accounts Receivable (LCU)

$72,000

Cash
Forward Contract
Foreign Currency (LCU)

$65,000
$7,000

$72,000

$72,000

The impact on net income:


Sale
Foreign Exchange Gain
Loss on Forward Contract
Gain on Forward Contract
Impact on net income

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$69,000.00
3,000.00
(8,910.90)
1,910.90
$65,000.00 = Cash Inflow

The McGraw-Hill Companies, Inc., 2013


9-37

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

37. (continued)
b. Foreign Currency Firm Commitment (Sale)
10/01

There is no entry to record either the sales agreement or the


forward contract as both are executory contracts.

12/31

Loss on Forward Contract


Forward Contract

$8,910.90

Firm Commitment
Gain on Firm Commitment

$8,910.90

Forward Contract
Gain on Forward Contract

$1,910.90

Loss on Firm Commitment


Firm Commitment

$1,910.90

1/31

$8,910.90
$8,910.90
$1,910.90
$1,910.90

Foreign Currency (LCU)


Sales

$72,000

Cash
Forward Contract
Foreign Currency (LCU)

$65,000
$7,000

Adjustment to Net Income


Firm Commitment

$7,000

$72,000

$72,000
$7,000

Impact on Net Income:


Sales
Net Loss on Forward Contract
Net Gain on Firm Commitment
Adjustment to Net Income

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$72,000
(7,000)
7,000
(7,000)
$65,000 = Cash Inflow

The McGraw-Hill Companies, Inc., 2013


9-38

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

38. (30 minutes) (Forward contract fair value hedge of a foreign currency firm
commitment (purchase))
Forward
Date 10/31
8/1
9/30
10/31

Rate to
Fair Value
$.30
$.325
$.320 (spot)

Forward Contract
Fair Value
$0
$4,950.50 1
$4,0002

Firm Commitment

Change in
Fair Value
+ $4,950.50
$ 950.50

Change in
Fair Value
$0
$(4,950.50)1
$(4,000)2

$0
$4,950.50
+ $ 950.50

($65,000 $60,000) = $5,000 x .9901 = $4,950.5; where .9901 is the present value factor
for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.01.
2
($64,000 $60,000) = $4,000.

a. Journal entries
8/1

There is no entry to record either the purchase agreement or the


forward contract as both are executory contracts.

9/30

Forward Contract
Gain on Forward Contract

$4,950.50

Loss on Firm Commitment


Firm Commitment

$4,950.50

Loss on Forward Contract


Forward Contract

$950.50

Firm Commitment
Gain on Firm Commitment

$950.50

Foreign Currency (rupees)


Cash
Forward Contract

$64,000

Inventories (Cost-of-Goods-Sold)
Foreign Currency (rupees)

$64,000

10/31

Firm Commitment
Adjustment to Net Income

$4,950.50
$4,950.50
$950.50
$950.50
$60,000
4,000
$64,000
$4,000
$4,000

b. Assuming the inventory is sold in the fourth quarter, the net impact on net
income is negative $60,000:
Cost-of-Goods-Sold
Adjustment to Net Income
Net impact on net income

$(64,000)
4,000
$(60,000)

c. The net cash outflow is $60,000.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-39

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

39. (30 minutes) (Option fair value hedge of a foreign currency firm commitment
(sale))
Firm Commitment
Spot
Date Rate Fair Value

6/1
6/30
9/1

$1.00
$0.99
$0.97

Change in
Fair Value
for 9/1

$(4,901.50)1
$(15,000)2

$ 4,901.50
$10,098.50

Option

Option

Premium
Fair Value

Fair Value

Change in

$0.010
$0.016
$0.030

$5,000
$8,000
$15,000

+ $3,000
+ $7,000

$495,000 $500,000 = $(5,000) x .9803 = $(4,901.5), where .9803 is the present value
factor for two months at an annual interest rate of 12% (1% per month) calculated as
1/1.012.
2
$485,000 $500,000 = $(15,000).

a. Journal Entries
6/1

Foreign Currency Option


Cash

$5,000
$5,000

There is no entry to record the sales agreement


because it is an executory contract.
6/30

Loss on Firm Commitment


Firm Commitment
Foreign Currency Option
Gain on Foreign Currency Option

9/1

Loss on Firm Commitment


Firm Commitment
Foreign Currency Option
Gain on Foreign Currency Option

$4,901.50
$4,901.50
$3,000
$3,000
$10,098.50
$10,098.50
$7,000
$7,000

Foreign Currency (lek)


Sales

$485,000

Cash
Foreign Currency (lek)
Foreign Currency Option

$500,000

Firm Commitment
Adjustment to Net Income

$15,000

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$485,000
$485,000
15,000
$15,000

The McGraw-Hill Companies, Inc., 2013


9-40

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

39. (continued)
b. Impact on Net Income
The impact on net income for the second quarter is:
Loss on Firm Commitment
Gain on Foreign Currency Option
Impact on net income

$(4,901.50)
3,000.00
$(1,901.50)

The impact on net income for the third quarter is:


Sales
Loss on Firm Commitment
Gain on Foreign Currency option
Adjustment to Net Income
Impact on net income

$485,000.00
(10,098.50)
7,000.00
15,000.00
$496,901.50

The impact on net income over the second and third quarters is:
$495,000 ($496,901.50 $1,901.50)
c. Net Cash Inflow
The net cash inflow resulting from the sale is: $500,000 $5,000 = $495,000
40. (20 minutes) (Option fair value hedge of a foreign currency firm commitment
(purchase))
Firm Commitment
Spot
Date Rate Fair Value

11/20
$.20
a) 12/20 $.21
b) 12/20 $.18

$(500)1
$1,0002

Option

Change in
Premium
Fair Value
for 12/20 Fair Value

$500
+ $1,000

$.008
$.0103
$.0004

Option
Change in
Fair Value

$400
$500
$0

+ $100
$400

$10,000 $10,500 = $(500).


$10,000 $9,000 = $1,000.
3
The premium on 12/20 for an option that expires on that date is equal to the options
intrinsic value. Given the spot rate on 12/20 of $.21, a call option with a strike price of
$.20 has an intrinsic value of $.01 per pijio.
4
The premium on 12/20 for an option that expires on that date is equal to the options
intrinsic value. Given the spot rate on 12/20 of $.18, a call option with a strike price of
$.20 has no intrinsic value the premium on 12/20 is $.000.
2

a.

The option strike price ($.20) is less than the spot rate ($.21) on December 20,
the date the parts are to be paid for. Therefore, Big Arber will exercise its
option. The journal entries are as follows:

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-41

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

11/20

Foreign Currency Option


Cash

$400
$400

There is no entry to record the purchase agreement


because it is an executory contract.
12/20

Loss on Firm Commitment


Firm Commitment

$500

Foreign Currency Option


Gain on Foreign Currency Option

$100

$500
$100

Foreign Currency (pijio)


Cash
Foreign Currency Option

$10,500

Parts inventory
Foreign Currency (pijio)

$10,500

$10,000
500
$10,500

The following entry is made in the period when the inventory affects net
income through cost-of-goods-sold:
Firm Commitment
Adjustment to Net Income

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$500
$500

The McGraw-Hill Companies, Inc., 2013


9-42

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

40. (continued)
b. The option strike price ($.20) is greater than the spot rate ($.18) on December
20, the date the parts are to be paid for. Therefore, Big Arber will allow the
option to expire unexercised. Foreign currency will be acquired at the spot
rate on December 20. The journal entries are as follows:
11/20

Foreign Currency Option


Cash

$400
$400

There is no entry to record the purchase agreement


because it is an executory contract.
12/20

Firm Commitment
Gain on Firm Commitment
Loss on Foreign Currency Option
Foreign Currency Option

$1,000
$1,000
$400
$400

Foreign Currency (pijio)


Cash

$9,000

Parts Inventory
Foreign Currency (pijio)

$9,000

$9,000
$9,000

The following entry is made in the period when the inventory affects net
income through cost-of-goods-sold:
Adjustment to Net Income
Firm Commitment

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$1,000
$1,000

The McGraw-Hill Companies, Inc., 2013


9-43

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

41. (20 minutes) (Option cash flow hedge of a forecasted transaction)


a.
12/15/13 Foreign Currency Option
Cash [1 million marks x $.005]

$5,000
$5,000

No journal entry related to the forecasted


transaction.
12/31/13 Foreign Currency Option
AOCI
To recognize the increase in the value of
the foreign currency option with the counterpart
recorded in AOCI.

$3,000
$3,000

Option Expense
$1,000
AOCI
To recognize the decrease in the time value
of the option as expense.
[($.584 $.58) x 1,000,000 = $4,000 $3,000 = $1,000]
3/15/14

Foreign Currency Option


AOCI
To recognize the increase in the value of the
Foreign Currency Option with the counterpart
recorded in AOCI.
Option Expense
AOCI
To recognize the decrease in the time value of
the option as expense.
Foreign Currency (marks)
Cash
Foreign Currency Option
To record exercise of the foreign currency
option at the strike price of $.58 and close
out the foreign currency option account.

$2,000
$2,000

$4,000
$4,000

$590,000
$580,000
10,000

Parts Inventory
$590,000
Foreign Currency (marks)
To record the purchase of parts and payment
of 1 million marks to the supplier.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$1,000

$590,000

The McGraw-Hill Companies, Inc., 2013


9-44

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

41. (continued)
AOCI
Adjustment to Net Income
To transfer the amount accumulated in AOCI
as an adjustment to net income in the period
in which the forecasted transaction occurs.

$10,000
$10,000

b. Impact on net income: 2013 Option Expense

$(1,000)

2014 Cost-of-goods-sold
Option Expense
Adjustment to Net Income

$(590,000)
(4,000)
10,000
$(584,000)

The impact on net income over the two periods is $(585,000).


c. Net cash outflow for parts: $585,000 = ($5,000 + $580,000)
42. (60 minutes) (Unhedged foreign currency transaction; forward contract and
option hedge of foreign currency liability; forward contract and option hedge
of foreign currency firm commitment (purchase))
Part a. Foreign Currency Liability (Unhedged)
9/15
9/30
10/31

Inventory
Accounts Payable (euro)

$200,000

Foreign Exchange Loss


Accounts Payable (euro)

$10,000

Foreign Exchange Loss


Accounts Payable (euro)

$10,000

$200,000
$10,000
$10,000

Foreign Currency (euro)


Cash

$220,000

Accounts Payable (euro)


Foreign Currency (euro)

$220,000

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$220,000
$220,000

The McGraw-Hill Companies, Inc., 2013


9-45

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

42. (continued)
Part b. Forward Contract Fair Value Hedge of a Foreign Currency Liability
Spot
Date Rate Value
9/15
$1.00
9/30
$1.05
10/31
$1.10

Accounts Payable (C)


Forward
U.S. Dollar
Change in U.S.
Rate to
Dollar Value 10/31 Fair Value
$200,000
$1.06
$210,000
+$10,000
$1.09
$220,000
+$10,000
$1.10

Forward Contract
Change in
Fair Value
$0
$5,940.60 1
+$5,940.60
$8,000.00 2
+$2,059.40

($218,000 $212,000) x .9901 = $5,940.60; where .9901 is the present value factor for
one month at an annual interest rate of 12% (1% per month) calculated as 1/1.01.
2
$220,000 $212,000 = $8,000.

9/15

Inventory
Accounts Payable (euro)

$200,000
$200,000

There is no formal entry for the forward contract.


9/30

Foreign Exchange Loss


Accounts Payable (euro)
Forward Contract
Gain on Forward Contract

10/31

Foreign Exchange Loss


Accounts Payable (euro)

$10,000
$10,000
$5,940.60
$5,940.60
$10,000
$10,000

Forward Contract
Gain on Forward Contract

$2,059.40

Foreign Currency (euro)


Cash
Forward Contract

$220,000

Accounts Payable (euro)


Foreign Currency (euro)

$220,000

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-46

$2,059.40
$212,000
8,000
$220,000

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

42. (continued)
Part c. Forward Contract Fair Value Hedge of a Foreign Currency Firm
Commitment (Purchase)
9/15

There is no formal entry for the forward contract or the purchase order.

9/30

Forward Contract
Gain on Forward Contract

$5,940.60

Loss on Firm Commitment


Firm Commitment

$5,940.60

Forward Contract
Gain on Forward Contract

$2,059.40

Loss on Firm Commitment


Firm Commitment

$2,059.40

Foreign Currency (euro)


Cash
Forward Contract

$220,000

Inventory
Foreign Currency (euro)

$220,000

10/31

$5,940.60
$5,940.60
$2,059.40
$2,059.40
$212,000
8,000
$220,000

The following entry is made in the period when the inventory affects net income
through cost-of-goods-sold:
Firm Commitment
Adjustment to Net Income

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$8,000
$8,000

The McGraw-Hill Companies, Inc., 2013


9-47

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

42. (continued)
Part d. Option Cash Flow Hedge of a Foreign Currency Liability
The following schedule summarizes the changes in the components of the fair
value of the euro call option with a strike price of $1.00 for October 31.
Spot
Date
Rate
09/15 $1.00
09/30 $1.05
10/31 $1.10
1

Option
Fair
Premium
Value
$.035 $7,000
$.070 $14,000
$.100 $20,000

Change
in Fair
Value
+ $7,000
+ $6,000

Intrinsic
Value
$0
$10,0002
$20,000

Time
Value
$7,0001
$4,0002
$03

Change
in Time
Value
- $3,000
- $4,000

Because the strike price and spot rate are the same, the option has no intrinsic
value. Fair value is attributable solely to the time value of the option.
With a spot rate of $1.05 and a strike price of $1.00, the option has an intrinsic
value of $10,000. The remaining $4,000 of fair value is attributable to time value.
The time value of the option at maturity is zero.

9/15

Inventory
Accounts Payable (euro)
Foreign Currency Option
Cash

9/30

Foreign Exchange Loss


Accounts Payable (euro)
Foreign Currency Option
AOCI
AOCI
Gain on Foreign Currency Option
Option Expense
AOCI

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$200,000
$200,000
$7,000
$7,000
$10,000
$10,000
$7,000
$7,000
$10,000
$10,000
$3,000
$3,000

The McGraw-Hill Companies, Inc., 2013


9-48

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

42. (continued)
10/31

Foreign Exchange Loss


Accounts Payable (euro)
Foreign Currency Option
AOCI
AOCI
Gain on Foreign Currency Option
Option Expense
AOCI

$10,000
$10,000
$6,000
$6,000
$10,000
$10,000
$4,000
$4,000

Foreign Currency (euro)


Cash
Foreign Currency Option

$220,000

Accounts Payable (euro)


Foreign Currency (euro)

$220,000

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-49

$200,000
$20,000
$220,000

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

42. (continued)
Part e. Option Fair Value Hedge of a Foreign Currency Firm Commitment
(Purchase)
Firm Commitment

Option

Spot
Change in
Premium
Date Rate Fair Value
Fair Value
for 10/31
9/15
$1.00
$0
$.035
9/30
$1.05
$ (9,901)
$ (9,901)1
$.070
10/31
$1.10
$(20,000)
$(10,099)
$.100

Foreign Currency Option


Fair Value
$ 7,000
$14,000
$20,000

Change in
Fair Value
+$7,000
+$6,000

($210,000 $200,000) x .9901 = $(9,901), where .9901 is the present value factor for one
month at an annual interest rate of 12% (1% per month) calculated as 1/1.01.

9/15
9/30

10/31

Foreign Currency Option


Cash

$7,000

Foreign Currency Option


Gain on Foreign Currency Option

$7,000

Loss on Firm Commitment


Firm Commitment

$9,901

Foreign Currency Option


Gain on Foreign Currency Option

$6,000

Loss on Firm Commitment


Firm Commitment

$7,000
$7,000
$9,901
$6,000
$10,099
$10,099

Foreign Currency (euro)


Cash
Foreign Currency Option

$220,000

Inventory
Foreign Currency (euro)

$220,000

$200,000
20,000
$220,000

The following entry is made in the period when the inventory affects net income
through cost-of-goods-sold:
Firm Commitment
Adjustment to Net Income

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$20,000
$20,000

The McGraw-Hill Companies, Inc., 2013


9-50

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 9 Develop Your Skills


Research CaseInternational Flavors and Fragrances
The responses to this assignment might change over time as the company
changes its use of foreign currency derivatives or changes the manner in
which it discloses its foreign currency hedging activities in the annual report.
The following responses are based on IFFs 2010 annual report.
1. In 2010, IFF provided information in the annual report related to its
management of foreign exchange risk in the following locations:
a. Item 1A. Risk Factors. -- impact of currency fluctuation or devaluation
b. Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
c. Note 14. Financial Instruments. derivatives
2. IFF uses foreign currency forward contracts to reduce exposure to cash
flow volatility arising from foreign currency fluctuations associated with
intercompany loans, certain foreign currency receivables and payables
(hedges of foreign currency denominated assets and liabilities), and
anticipated purchases of raw materials used in operations (hedges of
forecasted transactions).
The company uses a Japanese Yen- U.S. Dollar swap to hedge monthly
sale and purchase transactions between the U.S. and Japan.
The company also uses forward contracts to hedge net investments in
foreign operations. (This topic is discussed in more detail in Chapter 10.)
3. In Item 7a., IFF indicates that the notional amount and maturity dates of
such (i.e., forward) contracts match those of the underlying transactions.
Toward the end of Note 14, the company also indicates that no
ineffectiveness was experienced in the above noted cash flow hedges
during the year ended December 31, 2010.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-51

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Accounting Standards CaseForecasted Transactions


Questions asked in the case are:
Is managements intent sufficient to assess that a forecasted transaction is
likely to occur?
If not, what additional evidence must be considered?
Source of guidance: FASB ASC 815-20-55-24 Derivatives and Hedging; HedgingGeneral; Implementation Guidance and Illustrations; Probability of a
Forecasted Transaction
ASC 815-20-55-24 states: An assessment of the likelihood that a forecasted
transaction will take place should not be based solely on management's intent
because intent is not verifiable. The transaction's probability should be
supported by observable facts and the attendant circumstances. Consideration
should be given to all of the following circumstances in assessing the likelihood
that a transaction will occur.
a. The frequency of similar past transactions
b. The financial and operational ability of the entity to carry out the transaction
c. Substantial commitments of resources to a particular activity (for example, a
manufacturing facility that can be used in the short run only to process a
particular type of commodity)
d. The extent of loss or disruption of operations that could result if the
transaction does not occur
e. The likelihood that transactions with substantially different characteristics
might be used to achieve the same business purpose (for example, an entity
that intends to raise cash may have several ways of doing so, ranging from a
short-term bank loan to a common stock offering).
The answers to the specific questions asked in the case are:
Managements intent is not sufficient to assess whether a forecasted
transaction is likely to occur.
Additional evidence listed in items a. e. in ASC 815-20-55-24 must be
considered in assessing that likelihood.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-52

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Excel CaseDetermine Foreign Exchange Gains and Losses


1., 2. and 3. Spreadsheet for the calculation of the foreign exchange gains
(losses) related to Import/Export Companys foreign currency
transactions for the year 2010.

Foreign
Currency
Brazilian
real (BRL)
Swiss
franc
(CHF)
Swiss
franc
(CHF)
Euro
Euro
Chinese
yuan
(CNY)
South
Korean
won
(KRW)
Total Net
Foreign
Exchange
Gain
(Loss)

Type of
Transaction
Import
purchase
(payable)
Export sale
(receivable)
Import
purchase
(payable)
Export sale
(receivable)
Export sale
(receivable)
Import
purchase
(payable)
Import
purchase
(payable)

Amount in
Foreign
Currency

Transaction
Date

Exchange
Rate at
Transaction
Date

$ Value on
Transaction
Date

Settlement
Date

Exchange
Rate at
Settlemen
t Date

$ Value on
Settlement
Date

Foreign
Exchange
Gain
(Loss)

(87,000)

1/4/2010

0.577477

(50,240.50)

5/4/2010

0.57428

(49,962.36)

278.14

51,700

1/4/2010

0.967455

50,017.42

5/4/2010

0.913718

47,239.22

(2,778.20)

(55,000)

5/4/2010

0.913718

(50,254.49)

10/4/2010

1.02836

(56,559.80)

(6,305.31)

37,200

4/1/2010

1.3468

50,100.96

9/1/2010

1.28

47,616.00

(2,484.96)

37,200

4/1/2010

1.3468

50,100.96

10/1/2010

1.3726

51,060.72

959.76

(342,000)

1/4/2010

0.146471

(50,093.08)

10/4/2010

0.14945

(51,111.90)

(1,018.82)

(55,600,000)

1/4/2010

0.00086557

(48,125.69)

10/4/2010

0.0008892

(49,439.52)

(1,313.83)

(12,663.22)

Source of exchange rates: www.x-rates.com, Historical Lookup


Import/Export Company reported a net foreign exchange loss of $12,663.22 in
2010 income.
Possible discussion points for instructors: Note that all transactions had a $
value on transaction date of approximately $50,000. The size of the foreign
exchange gains and losses reported in the last column differs substantially
across transactions because of different rates and directions of change in the
exchange rates across the currencies in which Import/Export Company had
exposures. At one extreme, the large depreciation in value of the CHF from
1/4/10 to 5/4/10 coupled with an asset exposure resulted in a large foreign
exchange loss. The large appreciation in value of the CHF from 5/4/10 to
10/4/10 coupled with the CHF liability exposure also generated a large foreign
exchange loss. The depreciation in value of the Euro from 4/1/10 to 9/1/10
resulted in a foreign exchange loss on one of the companys Euro receivables;
the overall appreciation in value of the Euro from 4/1/10 to 10/1/10 resulted in a
foreign exchange gain on a second Euro receivable.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-53

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Analysis CaseCash Flow Hedge


1. Given the $6,000 total Premium Expense, the forward rate on 2/1/13 must
have been $1.06 [($1.06 $1.00 spot) x 100,000 euros = $6,000].
2. Given that the forward contract is reported as a liability of $1,980 ($2,000 x
.9901), the forward rate at 3/31/13 must have been $1.04 [($1.04 $1.06) x
100,000 euros = $2,000]. The fact that the forward contract is a liability
signals that the forward rate at 3/31 is less than the forward rate on 2/1.
3. Given that the cost of goods sold is $103,000, the spot rate on 5/1/13 must
have been $1.03. Linber must pay $1.06 per euro under the forward
contract, so the forward contract results in an economic loss of $3,000
[($1.06 $1.03) x 100,00 euros]. The negative adjustment to net income
reflects this economic loss.
4. The Premium Expense of $6,000 reflects the increase in cost for the parts
from the date the transaction was forecasted until the date of purchase. If
Linber had purchased 100,000 euros on 2/1/13 at the spot rate of $1.00, it
could have saved $6,000.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-54

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Internet CaseHistorical Exchange Rates


1. Spreadsheets for the calculation of the foreign exchange gains (losses)
related to Pier Ten Companys foreign currency account receivables.

Currency

Code

Indian rupee

INR

Philippine peso

PHP

Japanese yen

JPY

Malaysian ringgit

MYR

Foreign
Currency
Account
Receivabl
e
898,0
00
874,0
00
1,662,5
00
62,5
50

Exchange
Rate on
12/14/10

U.S. Dollar
Value on
12/14/10

0.0222781

$20,005.73

0.0228883

20,004.37

0.0120353

20,008.69

0.319881

20,008.56
$80,027.35

Currency

Code

Indian rupee

INR

Philippine peso

PHP

Japanese yen

JPY

Malaysian ringgit

MYR

Foreign
Currency
Account
Receivabl
e
898,0
00
874,0
00
1,662,5
00
62,5
50

Exchange
Rate on
12/31/10

U.S. Dollar
Value on
12/31/10

0.0223602

$20,079.46

0.0229194

20,031.56

27.19

0.0122982

20,445.76

437.07

0.3263

20,410.07

401.51

$80,966.85

Currency

Code

Indian rupee

INR

Philippine peso

PHP

Japanese yen

JPY

Malaysian ringgit

MYR

Foreign
Currency
Account
Receivabl
e
898,0
00
874,0
00
1,662,5
00
62,5
50

Foreign
Exchange
Gain (Loss)
on 12/31/10

Exchange
Rate on
1/14/11

U.S. Dollar
Value on
1/14/11

73.73

939.50

Foreign
Exchange
Gain (Loss)
on 1/14/11

0.0220214

$19,775.22

$ (304.24)

0.0225666

19,723.21

(308.35)

0.0120456

20,025.81

(419.95)

0.326938

20,449.97

39.90

$79,974.21

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

$ (992.64)

The McGraw-Hill Companies, Inc., 2013


9-55

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Currency

Code

Indian rupee

INR

Philippine peso

PHP

Japanese yen

JPY

Malaysian ringgit

MYR

Foreign
Currency
Account
Receivabl
e
898,0
00
874,0
00
1,662,5
00
62,5
50

U.S. Dollar
Value on
12/14/10

U.S. Dollar
Value on
1/14/11

Net Foreign
Exchange
Gain (Loss)

$20,005.73

$19,775.22

$ (230.51)

20,004.37

19,723.21

(281.16)

20,008.69

20,025.81

17.12

20,008.56

20,449.97

441.41

$80,027.35

$79,974.21

(53.14)

Source of exchange rates: www.x-rates.com, Historical Lookup


2. Pier Ten would have reported a net foreign exchange gain of $939.50 in
2010 and a net foreign exchange loss of $992.64 in 2011 related to these
foreign currency receivables. The transactions denominated in Indian
rupees and Philippine pesos resulted in a net foreign exchange loss of
$230.51 and $281.16, respectively. The PHP receivable would have been
the most important to hedge.
3. Assuming a strike price equal to the December 14, 2010 spot rate, the only
foreign currency transactions for which the purchase of a put option
costing $100 would have been beneficial are the transactions in Indian
rupees and Philippine pesos. Net cash inflow from the INR receivable
would have been $130.51 greater ($230.51 FX loss avoided less $100.00
cost of option) if a put option had been acquired and the net cash flow
from the PHP receivable would have been $181.16 greater ($281.16 FX loss
avoided less $100.00 cost of option) if a put option had been acquired.
Put options in JPY and MYR would have had no value at 1/14/11. The
purchase of JPY and MYR options would have resulted in a decrease in
net cash inflow to Pier Ten of $200.00 (the cost of the options).

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-56

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Communication CaseForward Contracts and Options


To: Mr. Dewey Nukem, CEO, Palmetto Bug Extermination Company (PBEC)
The primary advantage of using forward contracts to hedge foreign exchange
risk is that there is no cost to enter into them. The disadvantage is that the
company is obligated to exchange foreign currency for dollars at the
contracted forward rate. Depending upon the future spot rate, this may or
may not be advantageous for the company. In contrast, the primary
disadvantage of using foreign currency options to hedge foreign exchange
risk is that there is an up-front cost incurred to purchase them. The primary
advantage is that the company is not required to exchange foreign currency
for dollars at the option strike price if it is disadvantageous to do so. The
company can simply allow the option to expire unexercised and the only cost
is the initial premium that was paid to acquire the option.
Exporters sometimes use forward contracts to hedge export sales (import
purchases) when the foreign currency is selling at a forward premium
(discount) as this locks in premium revenue (discount revenue). The risk
associated with this strategy is that the customer may or may not pay on
time. If an exporter enters into a forward contract to sell foreign currency,
and the customer does not pay on time, the exporter will need to purchase
foreign currency at the spot rate to settle the forward contract. This is
essentially the same as speculation; a gain or loss could arise. In this case,
the exporter might be better off by purchasing a foreign currency put option.
The exporter can simply allow the option to exercise if it has not received
foreign currency from the customer by the expiration date.
Since PBEC is making import purchases, it has more control over the timing
of when it will need foreign currency. In that case, it should be safe to enter
into a forward contract to purchase foreign currency on the date when PBEC
plans to pay for its purchases. However, there is always the risk that the
supplier does not deliver on time, in which case the forward contract
provides PBEC with foreign currency for which it has no current use.
The bottom line is that there is no right or wrong answer to the question
which hedging instrument should be used to hedge the Swiss franc exposure
to foreign exchange risk. Both forward contracts and option have the
advantages and disadvantages.

McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e

The McGraw-Hill Companies, Inc., 2013


9-57

2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Vous aimerez peut-être aussi