Vous êtes sur la page 1sur 94

Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

Chapter 07
Foreign Currency Transactions and Hedging Foreign Exchange Risk

Multiple Choice Questions

1. Pigskin Co., a U.S. corporation, sold inventory on credit to a British company on April 8,
2011. Pigskin received payment of 35,000 British pounds on May 8, 2011. The exchange rate
was 1 = $1.54 on April 8 and 1 = 1.43 on May 8. What amount of foreign exchange gain or
loss should be recognized? (round to the nearest dollar)
A. $10,500 loss
B. $10,500 gain
C. $1,750 loss
D. $3,850 loss
E. No gain or loss should be recognized.

Norton Co., a U.S. corporation, sold inventory on December 1, 2011, with payment of 10,000
British pounds to be received in sixty days. The pertinent exchange rates were as follows:

2. For what amount should Sales be credited on December 1?


A. $5,500.
B. $16,949.
C. $18,182.
D. $17,241.
E. $16,667.

3. What amount of foreign exchange gain or loss should be recorded on December 31?
A. $300 gain.
B. $300 loss.
C. $0.
D. $941 loss.
E. $941 gain.

7-1
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

4. What amount of foreign exchange gain or loss should be recorded on January 30?
A. $1,516 gain.
B. $1,516 loss.
C. $575 loss.
D. $500 loss.
E. $500 gain.

Brisco Bricks purchases raw material from its foreign supplier, Bolivian Clay, on May 8.
Payment of 2,000,000 foreign currency units (FC) is due in 30 days. May 31 is Brisco's fiscal
year-end. The pertinent exchange rates were as follows:

5. For what amount should Brisco's Accounts Payable be credited on May 8?


A. $2,500,000.
B. $2,440,000.
C. $1,600,000.
D. $1,639,344.
E. $1,666,667.

6. How much Foreign Exchange Gain or Loss should Brisco record on May 31?
A. $2,520,000 gain.
B. $20,000 gain.
C. $20,000 loss.
D. $80,000 gain.
E. $80,000 loss.

7-2
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

7. How much US $ will it cost Brisco to finally pay the payable on June 7?
A. $1,666,667.
B. $2,440,000.
C. $2,520,000.
D. $2,500,000.
E. $2,400,000.

8. On June 1, CamCo received a signed agreement to sell inventory for 500,000. The sale
would take place in 90 days. CamCo immediately signed a 90-day forward contract to sell the
yen as soon as they are received. The spot rate on June 1 was 1 =$.004167, and the 90-day
forward rate was 1 = $.00427. At what amount would CamCo record the Forward Contract
on June 1?
A. $2,083.
B. $0.
C. $2,110.
D. $2,532.
E. $2,135.

9. Belsen purchased inventory on December 1, 2010. Payment of 200,000 stickles was to be


made in sixty days. Also on December 1, Belsen signed a contract to purchase 200,000 in
sixty days. The spot rate was 1 = .35714, and the 60-day forward rate was 1 = $.38462. On
December 31, the spot rate was 1 = .34483 and the 30-day forward rate was 1 = .38168.
Assume an annual interest rate of 12% and a fair value hedge. The present value for one
month at 12% is .9901.
In the journal entry to record the establishment of a forward exchange contract, at what
amount should the Forward Contract account be recorded on December 1?
A. $71,428.
B. $76,924.
C. $588.
D. $582.
E. $0, since there is no cost, there is no value for the contract at this date.

7-3
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

10. Meisner Co. ordered parts costing 100,000 for a foreign supplier on May 12 when the
spot rate was $.24 per stickle. A one-month forward contract was signed on that date to
purchase 100,000 at a forward rate of $.25 per stickle. On June 12, when the parts were
received and payment was made, the spot rate was $.28 per stickle. At what amount should
inventory be reported?
A. $0.
B. $28,000.
C. $24,000.
D. $25,000.
E. $2,000.

Car Corp. (a U.S.-based company) sold parts to a Korean customer on December 16, 2011,
with payment of 10 million Korean won to be received on January 15, 2012. The following
exchange rates applied:

11. Assuming a forward contract was not entered into, what would be the net impact on Car
Corp.'s 2011 income statement related to this transaction?
A. $500 (gain).
B. $500 (loss).
C. $200 (gain).
D. $200 (loss).
E. $ - 0 -

7-4
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

12. Assuming a forward contract was entered into, the foreign currency was originally sold in
the foreign currency market on December 16, 2011 at a
A. forward contract discount $600.
B. forward contract premium $600.
C. forward contract discount $980.
D. forward discount premium $980.
E. There is no premium or discount because the fair value of the contract is zero.

13. Assuming a forward contract was entered into, at what amount should the forward
contract be recorded at December 31, 2011? Assume an annual interest rate of 12% and a fair
value hedge. The present value for one month at 12% is .9901.
A. $200.
B. $295.
C. $495.
D. $500.
E. $9,300.

14. Assuming a forward contract was entered into, how would the forward contract be
reflected on Car's December 31, 2011 balance sheet?
A. Forward contract (asset).
B. Forward contract (liability).
C. Foreign currency (asset).
D. Foreign currency (liability).
E. Foreign exchange (liability).

15. Assuming a forward contract was entered into, what would be the net impact on Car
Corp.'s 2011 income statement related to this transaction? Assume an annual interest rate of
12% and a fair value hedge. The present value for one month at 12% is .9901.
A. $700 (gain).
B. $700 (loss).
C. $300 (gain).
D. $300 (loss).
E. $295 (gain).

7-5
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

16. Assuming a forward contract was entered into on December 16, what would be the net
impact on Car Corp.'s 2012 income statement related to this transaction?
A. $500 (gain).
B. $305 (gain).
C. $300 (gain).
D. $300 (loss).
E. $0.

17. Mills Inc. had a receivable from a foreign customer that is due in the local currency of the
customer (stickles). On December 31, 2010, this receivable for 200,000 was correctly
included in Mills' balance sheet at $132,000. When the receivable was collected on February
15, 2011, the U.S. dollar equivalent was $144,000. In Mills' 2011 consolidated income
statement, how much should have been reported as a foreign exchange gain?
A. $0.
B. $36,000.
C. $48,000.
D. $10,000.
E. $12,000.

18. A spot rate may be defined as


A. The price a foreign currency can be purchased or sold today.
B. The price today at which a foreign currency can be purchased or sold in the future.
C. The forecasted future value of a foreign currency.
D. The U.S. dollar value of a foreign currency.
E. The Euro value of a foreign currency.

19. The forward rate may be defined as


A. The price a foreign currency can be purchased or sold today.
B. The price today at which a foreign currency can be purchased or sold in the future.
C. The forecasted future value of a foreign currency.
D. The U.S. dollar value of a foreign currency.
E. The Euro value of a foreign currency.

7-6
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

20. Which statement is true regarding a foreign currency option?


A. A foreign currency option gives the holder the obligation to buy or sell foreign currency in
the future.
B. A foreign currency option gives the holder the obligation only sell foreign currency in the
future.
C. A foreign currency option gives the holder the obligation to only buy foreign currency in
the future.
D. A foreign currency option gives the holder the right but not the obligation to buy or sell
foreign currency in the future.
E. A foreign currency option gives the holder the obligation to buy or sell foreign currency in
the future at the spot rate on the future date.

21. A U.S. company sells merchandise to a foreign company denominated in U.S. dollars.
Which of the following statements is true?
A. If the foreign currency appreciates, a foreign exchange gain will result.
B. If the foreign currency depreciates, a foreign exchange gain will result.
C. No foreign exchange gain or loss will result.
D. If the foreign currency appreciates, a foreign exchange loss will result.
E. If the foreign currency depreciates, a foreign exchange loss will result.

22. A U.S. company sells merchandise to a foreign company denominated in the foreign
currency. Which of the following statements is true?
A. If the foreign currency appreciates, a foreign exchange gain will result.
B. If the foreign currency depreciates, a foreign exchange gain will result.
C. No foreign exchange gain or loss will result.
D. If the foreign currency appreciates, a foreign exchange loss will result.
E. Any gain or loss will be included in comprehensive income.

23. A U.S. company buys merchandise from a foreign company denominated in U.S. dollars.
Which of the following statements is true?
A. If the foreign currency appreciates, a foreign exchange gain will result.
B. If the foreign currency depreciates, a foreign exchange gain will result.
C. No foreign exchange gain or loss will result.
D. If the foreign currency appreciates, a foreign exchange loss will result.
E. Any gain or loss will be included in comprehensive income.

7-7
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

24. A U.S. company buys merchandise from a foreign company denominated in the foreign
currency. Which of the following statements is true?
A. If the foreign currency appreciates, a foreign exchange gain will result.
B. If the foreign currency depreciates, a foreign exchange loss will result.
C. No foreign exchange gain or loss will result.
D. If the foreign currency appreciates, a foreign exchange loss will result.
E. Any gain or loss will be included in comprehensive income.

25. U.S. GAAP provides guidance for hedges of all the following sources of foreign exchange
risk except
A. Recognized foreign currency denominated assets and liabilities.
B. Unrecognized foreign currency firm commitments.
C. Forecasted foreign currency denominated transactions.
D. Net investment in foreign operations.
E. Deferred foreign currency gains and losses.

26. All of the following data may be needed to determine the fair value of a forward contract
at any point in time except
A. The forward rate when the forward contract was entered into.
B. The current forward rate for a contract that matures on the same date as the forward
contract entered into.
C. The future spot rate.
D. A discount rate.
E. The company's incremental borrowing rate.

27. A forward contract may be used for which of the following?


1) A fair value hedge of an asset.
2) A cash flow hedge of an asset.
3) A fair value hedge of a liability.
4) A cash flow hedge of a liability.
A. 1 and 3
B. 2 and 4
C. 1 and 2
D. 1, 3, and 4
E. 1, 2, 3, and 4

7-8
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

28. A company has a discount on a forward contract for a foreign currency denominated asset.
How is the discount recognized over the life of the contract under fair value hedge
accounting?
A. As a debit to discount expense.
B. As a debit to amortization expense.
C. As a debit to accumulated other comprehensive income.
D. As a debit impact on net income, as a result of the hedge.
E. As a decreases to sales.

29. Which of the following statements is true concerning hedge accounting?


A. Hedges of foreign currency firm commitments are used for future sales only.
B. Hedges of foreign currency firm commitments are used for future purchases only.
C. Hedges of foreign currency firm commitments are used for current sales or purchases.
D. Hedges of foreign currency firm commitments are used for future sales or purchases.
E. Hedges of foreign currency firm commitments are speculative in nature.

30. All of the following hedges are used for future purchase/sale transactions except
A. Forward contracts used as a fair value hedge of a firm commitment.
B. Options used as a fair value hedge of a firm commitment.
C. Option contract cash flow hedge of a forecasted transaction.
D. Forward contract cash flow hedges of a forecasted transaction.
E. Forward contracts used to hedge a foreign currency denominated liability.

On December 1, 2011, Keenan Company, a U.S. firm, sold merchandise to Velez Company of
Canada for 150,000 Canadian dollars (CAD). Collection of the receivable is due on February
1, 2012. Keenan purchased a foreign currency put option with a strike price of $.97 (U.S.) on
December 1, 2011. This foreign currency option is designated as a cash flow hedge. Relevant
exchange rates follow:

7-9
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

31. Compute the fair value of the foreign currency option at December 1, 2011.
A. $6,000.
B. $4,500.
C. $3,000.
D. $7,500.
E. $1,500.

32. Compute the fair value of the foreign currency option at December 31, 2011.
A. $6,000.
B. $4,500.
C. $3,000.
D. $7,500.
E. $1,500.

33. Compute the fair value of the foreign currency option at February 1, 2012.
A. $6,000.
B. $4,500.
C. $3,000.
D. $7,500.
E. $1,500.

34. Compute the U.S. dollars received on February 1, 2012.


A. $138,000.
B. $136,500.
C. $145,500.
D. $141,000.
E. $142,500.

7-10
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

35. Which of the following approaches is used in the United States in accounting for foreign
currency transactions?
A. One-transaction perspective; defer foreign exchange gains and losses.
B. Two-transaction perspective; accrue foreign exchange gains and losses.
C. Three-transaction perspective; defer foreign exchange gains and losses.
D. One-transaction perspective; accrue foreign exchange gains and losses.
E. Two-transaction perspective; defer foreign exchange gains and losses.

36. When a U.S. company purchases parts from a foreign company, which of the following
will result in zero foreign exchange gain or loss?
A. The transaction is denominated in U.S. dollars.
B. The option strike price to sell foreign currency is less than the spot rate of the currency.
C. The option strike price to buy foreign currency is less than the spot rate of the currency.
D. The foreign currency appreciated in value relative to the U.S. dollar.
E. The foreign currency depreciated in value relative to the U.S. dollar.

37. Alpha, Inc., a U.S. company, had a receivable from a customer that was denominated in
Mexican pesos. On December 31, 2010, this receivable for 75,000 pesos was correctly
included in Alpha's balance sheet at $8,000. The receivable was collected on March 2, 2011,
when the U.S. equivalent was $6,900. How much foreign exchange gain or loss will Alpha
record on the income statement for the year ended December 31, 2011?
A. $1,100 loss.
B. $1,100 gain.
C. $6,900 loss.
D. $6,900 gain.
E. $8,000 gain.

On April 1, 2010, Shannon Company, a U.S. company, borrowed 100,000 euros from a
foreign bank by signing an interest-bearing note due April 1, 2011. The dollar value of the
loan was as follows:

7-11
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

38. How much foreign exchange gain or loss should be included in Shannon's 2010 income
statement?
A. $3,000 gain.
B. $3,000 loss.
C. $6,000 gain.
D. $6,000 loss.
E. $7,000 gain.

39. How much foreign exchange gain or loss should be included in Shannon's 2011 income
statement?
A. $1,000 gain.
B. $1,000 loss.
C. $2,000 gain.
D. $2,000 loss.
E. $8,000 loss.

40. Angela, Inc., a U.S. company, had a euro receivable from exports to Spain and a British
pound payable resulting from imports from England. Angela recorded foreign exchange gain
related to both its euro receivable and pound payable. Did the foreign currencies increase or
decrease in dollar value from the date of the transaction to the settlement date?

A. A above
B. B above
C. C above
D. D above
E. E above

7-12
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

41. Frankfurter Company, a U.S. company, had a ruble receivable from exports to Russia and
a euro payable resulting from imports from Italy. Frankfurter recorded foreign exchange loss
related to both its ruble receivable and euro payable. Did the foreign currencies increase or
decrease in dollar value from the date of the transaction to the settlement date?

A. A above
B. B above
C. C above
D. D above
E. E above

Parker Corp., a U.S. company, had the following foreign currency transactions during 2011:
(1.) Purchased merchandise from a foreign supplier on July 5, 2011 for the U.S. dollar
equivalent of $80,000 and paid the invoice on August 3, 2011 at the U.S. dollar equivalent of
$82,000.
(2.) On October 1, 2011 borrowed the U.S. dollar equivalent of $872,000 evidenced by a non-
interest-bearing note payable in euros on October 1, 2011. The U.S. dollar equivalent of the
note amount was $860,000 on December 31, 2011, and $881,000 on October 1, 2012.

42. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2011?
A. $2,000 loss.
B. $2,000 gain.
C. $10,000 gain.
D. $14,000 loss.
E. $14,000 gain.

7-13
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

43. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2012?
A. $9,000 loss.
B. $9,000 gain.
C. $11,000 loss.
D. $21,000 loss.
E. $21,000 gain.

Winston Corp., a U.S. company, had the following foreign currency transactions during 2011:
(1.) Purchased merchandise from a foreign supplier on July 16, 2011 for the U.S. dollar
equivalent of $47,000 and paid the invoice on August 3, 2011 at the U.S. dollar equivalent of
$54,000.
(2.) On October 15, 2011 borrowed the U.S. dollar equivalent of $315,000 evidenced by a
non-interest-bearing note payable in euros on October 15, 2011. The U.S. dollar equivalent of
the note amount was $295,000 on December 31, 2011, and $299,000 on October 15, 2012.

44. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2011?
A. $9,000 loss.
B. $9,000 gain.
C. $11,000 loss.
D. $13,000 gain.
E. $14,000 gain.

45. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2012?
A. $1,000 loss.
B. $1,000 gain.
C. $2,000 loss.
D. $4,000 gain.
E. $4,000 loss.

7-14
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

46. Williams, Inc., a U.S. company, has a Japanese yen account receivable resulting from an
export sale on March 1 to a customer in Japan. The exporter signed a forward contract on
March 1 to sell yen and designated it as a cash flow hedge of a recognized receivable. The
spot rate was $.0094, and the forward rate was $.0095. Which of the following did the U.S.
exporter report in net income?
A. Discount revenue.
B. Premium revenue.
C. Discount expense.
D. Premium expense.
E. Both a discount revenue and a premium expense.

47. Larson Company, a U.S. company, has an India rupee account receivable resulting from
an export sale on September 7 to a customer in India. Larson signed a forward contract on
September 7 to sell rupees and designated it as a cash flow hedge of a recognized receivable.
The spot rate was $.023, and the forward rate was $.021. Which of the following did the U.S.
exporter report in net income?
A. Discount revenue.
B. Premium revenue.
C. Discount expense.
D. Premium expense.
E. Both a discount revenue and a premium expense.

48. Primo Inc., a U.S. company, ordered parts costing 100,000 rupee from a foreign supplier
on July 7 when the spot rate was $.025 per rupee. A one-month forward contract was signed
on that date to purchase 100,000 rupee at a rate of $.027. The forward contract is properly
designated as a fair value hedge of the 100,000 rupee firm commitment. On August 7, when
the parts are received, the spot rate is $.028. At what amount should the parts inventory be
carried on Primo's books?
A. $2,000.
B. $2,100.
C. $2,500.
D. $2,700.
E. $2,800.

7-15
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

49. Lawrence Company, a U.S. company, ordered parts costing 1,000,000 Thailand bahts
from a foreign supplier on July 7 when the spot rate was $.025 per baht. A one-month forward
contract was signed on that date to purchase 1,000,000 bahts at a rate of $.027. The forward
contract is properly designated as a fair value hedge of the 1,000,000 baht firm commitment.
On August 7, when the parts are received, the spot rate is $.028. What is the amount of
accounts payable that will be paid at this date?
A. $20,000.
B. $20,100.
C. $25,000.
D. $27,000.
E. $28,000.

50. On December 1, 2011, Joseph Company, a U.S. company, entered into a three-month
forward contract to purchase 50,000 pesos on March 1, 2012, as a fair value hedge of a
foreign currency denominated account payable. The following U.S. dollar per peso exchange
rates apply:

Joseph's incremental borrowing rate is 12 percent. The present value factor for two months at
an annual interest rate of 12 percent is .9803. Which of the following is included in Joseph's
December 31, 2011 balance sheet for the forward contract?
A. $5,146.58 asset.
B. $5,146.58 liability.
C. $500 liability.
D. $490.15 asset.
E. $490.15 liability.

7-16
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

51. On April 1, Quality Corporation, a U.S. company, expects to sell merchandise to a French
customer in three months, denominating the transaction in euros. On April 1, the spot rate is
$1.41 per euro, and Quality enters into a three-month forward contract cash flow hedge to sell
400,000 euros at a rate of $1.36. At the end of three months, the spot rate is $1.37 per euro,
and Quality delivers the merchandise, collecting 400,000 euros. What are the effects on net
income from these transactions?
A. $8,000 Discount Expense plus a $12,000 negative Adjustment to Net Income when the
merchandise is delivered.
B. $8,000 Discount Expense plus a $12,000 positive Adjustment to Net Income when the
merchandise is delivered.
C. $8,000 Discount Expense plus a $20,000 negative Adjustment to Net Income when the
merchandise is delivered.
D. $8,000 Discount Expense plus a $20,000 positive Adjustment to Net Income when the
merchandise is delivered.
E. $8,000 Discount Expense plus an $8,000 positive Adjustment to Net Income when the
merchandise is delivered.

Woolsey Corporation, a U.S. company, expects to sell goods to a British customer at a price
of 250,000 pounds, with delivery and payment to be made on October 24. On July 24,
Woolsey purchased a three-month put option for 250,000 British pounds and designated this
option as a cash flow hedge of a forecasted foreign currency transaction expected to be
completed in late October. The following exchange rates apply:

52. What amount will Woolsey include as an option expense in net income for the period July
24 to October 24?
A. $4,000.
B. $5,000.
C. $10,000.
D. $12,000.
E. $14,000.

7-17
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

53. What amount will Woolsey include as Adjustment to Net Income for the period ended
October 31?
A. $6,000 positive.
B. $6,000 negative.
C. $10,000 positive.
D. $10,000 negative.
E. $14,000 positive.

54. Atherton, Inc., a U.S. company, expects to order goods from a foreign supplier at a price
of 100,000 lira, with delivery and payment to be made on April 17. On January 17, Atherton
purchased a three-month call option on 100,000 lira and designated this option as a cash flow
hedge of a forecasted foreign currency transaction. The following exchange rates apply:

What amount will Atherton include as an option expense in net income for the period January
17 to April 17?
A. $4,000
B. $4,260
C. $4,340
D. $5,000
E. $5,260

On May 1, 2011, Mosby Company received an order to sell a machine to a customer in


Canada at a price of 2,000,000 Mexican pesos. The machine was shipped and payment was
received on March 1, 2012. On May 1, 2011, Mosby purchased a put option giving it the right
to sell 2,000,000 pesos on March 1, 2012 at a price of $190,000. Mosby properly designates
the option as a fair value hedge of the peso firm commitment. The option cost $3,000 and had
a fair value of $3,200 on December 31, 2011. The following spot exchange rates apply:

Mosby's incremental borrowing rate is 12 percent, and the present value factor for two months
at a 12 percent annual rate is .9803.

7-18
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

55. What was the impact on Mosby's 2011 net income as a result of this fair value hedge of a
firm commitment?
A. $1,760.60 decrease.
B. $1,960.60 decrease.
C. $1,000.00 decrease.
D. $1,760.60 increase.
E. $1,960.60 increase.

56. What was the impact on Mosby's 2012 net income as a result of this fair value hedge of a
firm commitment?
A. $1,800.00 decrease.
B. $2,500 increase.
C. $2,500 decrease.
D. $188,760.60 increase.
E. $188,760.60 decrease.

57. What was the overall result of having entered into this hedge of exposure to foreign
exchange risk?
A. $0
B. $9,000 net loss on the option.
C. $9,000 net gain on the option.
D. $2,000 net gain on the option.
E. $2,000 net loss.

7-19
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

On March 1, 2011, Mattie Company received an order to sell a machine to a customer in


England at a price of 200,000 British pounds. The machine was shipped and payment was
received on March 1, 2012. On March 1, 2011, Mattie purchased a put option giving it the
right to sell 200,000 British pounds on March 1, 2012 at a price of $380,000. Mattie properly
designates the option as a fair hedge of the pound firm commitment. The option cost $2,000
and had a fair value of $2,200 on December 31, 2011. The following spot exchange rates
apply:

Mattie's incremental borrowing rate is 12 percent, and the present value factor for two months
at a 12 percent annual rate is .9803.

58. What was the net impact on Mattie's 2011 income as a result of this fair value hedge of a
firm commitment?
A. $1,800.00 decrease.
B. $1,760.60 decrease.
C. $2,240.40 decrease.
D. $1,660.40 increase.
E. $2,240.60 increase.

59. What was the net impact on Mattie's 2012 income as a result of this fair value hedge of a
firm commitment?
A. $379,760.60 decrease.
B. $8,360.60 increase.
C. $8,360.60 decrease.
D. $4,390.40 decrease.
E. $379,760.60 increase.

7-20
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

60. What was the net increase or decrease in cash flow from having purchased the foreign
currency option to hedge this exposure to foreign exchange risk?
A. $0
B. $10,000 increase.
C. $10,000 decrease.
D. $20,000 increase.
E. $20,000 decrease.

On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British
supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle
pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per
pound. The option is considered to be a cash flow hedge of a forecasted foreign currency
transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot
exchange rates apply:

61. What journal entry should Eagle prepare on October 1, 2011?

A. A above.
B. B above.
C. C above.
D. D above.
E. E above.

7-21
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

62. What journal entry should Eagle prepare on December 31, 2011?

A. A above.
B. B above.
C. C above.
D. D above.
E. E above.

63. What is the amount of option expense for 2012 from these transactions?
A. $1,000.
B. $1,600.
C. $2,500.
D. $2,600.
E. $0.

64. What is the amount of Adjustment to Accumulated Other Comprehensive Income for 2012
from these transactions?
A. $1,000.
B. $1,600.
C. $1,800.
D. $2,000.
E. $2,600.

7-22
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

65. What is the amount of Cost of Goods Sold for 2012 as a result of these transactions?
A. $200,000.
B. $195,000.
C. $201,000.
D. $202,600.
E. $203,000.

66. What is the 2012 effect on net income as a result of these transactions?
A. $195,000
B. $201,600
C. $201,000
D. $202,600
E. $203,000

Essay Questions

67. Yelton Co. just sold inventory for 80,000 euros, which Yelton will collect in sixty days.
Briefly describe a hedging transaction Yelton could engage in to reduce its risk of unfavorable
exchange rates.

68. Where can you find exchange rates between the U.S. dollar and most foreign currencies?

7-23
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

69. What is meant by the spot rate?

70. How is the fair value of a Forward Contract determined by U.S. GAAP?

71. What is the major assumption underlying the one-transaction perspective?

72. What is the purpose of a hedge of foreign exchange risk?

7-24
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

73. How does a foreign currency forward contract differ from a foreign currency option?

74. What factors create a foreign exchange gain?

75. What happens when a U.S. company purchases goods denominated in a foreign currency
and the foreign currency depreciates?

76. What happens when a U.S. company purchases goods denominated in a foreign currency
and the foreign currency appreciates?

7-25
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

77. What happens when a U.S. company sells goods denominated in a foreign currency and
the foreign currency depreciates?

78. What happens when a U.S. company sells goods denominated in a foreign currency and
the foreign currency appreciates?

79. Gaw Produce Co. purchased inventory from a Japanese company on December 18, 2011.
Payment of 4,000,000 yen () was due on January 18, 2012. Exchange rates between the
dollar and the yen were as follows:

Required:
Prepare all journal entries for Gaw Produce Co. in connection with the purchase and
payment.

7-26
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

80. Old Colonial Corp. (a U.S. company) made a sale to a foreign customer on September 15,
2011, for 100,000 stickles. Payment was received on October 15, 2011. The following
exchange rates applied:

Required:
Prepare all journal entries for Old Colonial Corp. in connection with this sale assuming that
the company closes its books on September 30 to prepare interim financial statements.

Coyote Corp. (a U.S. company in Texas) had the following series of transactions in a foreign
country during 2011:

The appropriate exchange rates during 2011 were as follows:

7-27
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

81. Prepare all journal entries in U.S. dollars along with any December 31, 2011 adjusting
entries. Coyote uses a perpetual inventory system.

82. What amount will Coyote Corp. report in its 2011 balance sheet for Inventory?

83. What amount will Coyote Corp. report in its 2011 income statement for Cost of goods
sold?

84. What amount will Coyote Corp. report in its 2011 income statement for Sales?

7-28
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

85. What amount will Coyote Corp. report in its 2011 balance sheet for Accounts receivable?

86. What amount will Coyote Corp. report in its 2011 balance sheet for Accounts payable?

87. The beginning balance of cash was 50,000 pesos on January 1, 2011, translated at 1 peso
= $.18. What amount will Coyote Corp. report in its 2011 balance sheet for Cash?

7-29
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

On November 10, 2011, King Co. sold inventory to a customer in a foreign country. King
agreed to accept 96,000 local currency units (LCU) in full payment for this inventory.
Payment was to be made on February 1, 2012. On December 1, 2011, King entered into a
forward exchange contract wherein 96,000 LCU would be delivered to a currency broker in
two months. The two month forward exchange rate on that date was 1 LCU = $.30. Any
contract discount or premium is amortized using the straight-line method. The spot rates and
forward rates on various dates were as follows:

The company's borrowing rate is 12%. The present value factor for one month is .9901.

88. (A.) Assume this hedge is designated as a cash flow hedge. Prepare the journal entries
relating to the transaction and the forward contract.
(B.) Compute the effect on 2011 net income.
(C.) Compute the effect on 2012 net income.

89. (A.) Assume this hedge is designated as a fair value hedge. Prepare the journal entries
relating to the transaction and the forward contract.
(B.) Compute the effect on 2011 net income.
(C.) Compute the effect on 2012 net income.

7-30
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

On October 1, 2011, Jarvis Co. sold inventory to a customer in a foreign country,


denominated in 100,000 local currency units (LCU). Collection is expected in four months.
On October 1, 2011, a forward exchange contract was acquired whereby Jarvis Co. was to pay
100,000 LCU in four months (on February 1, 2012) and receive $78,000 in U.S. dollars. The
spot and forward rates for the LCU were as follows:

The company's borrowing rate is 12%. The present value factor for one month is .9901.
Any discount or premium on the contract is amortized using the straight-line method.

90. Assuming this is a cash flow hedge, prepare journal entries for this sales transaction and
forward contract.

91. Assuming this is a fair value hedge, prepare journal entries for this sales transaction and
forward contract.

7-31
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

92. On October 31, 2010, Darling Company negotiated a two-year 100,000 franc loan from a
foreign bank at an interest rate of 3 percent per year. Interest payments are made annually on
October 31, and the principal will be repaid on October 31, 2012. Darling prepares U.S.-dollar
financial statements and has a December 31 year-end. Prepare all journal entries related to this
foreign currency borrowing assuming the following:

7-32
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

Matching Questions

93. For each of the following situations, select the best answer concerning accounting for
foreign currency transactions:
(G) Results in a foreign exchange gain.
(L) Results in a foreign exchange loss.
(N) No foreign exchange gain or loss.

1. No foreign
exchange gain or Export sale by a U.S. company denominated in
loss dollars, foreign currency of buyer appreciates. ____
2. No foreign Export sale by a U.S. company denominated in
exchange gain or foreign currency, foreign currency of buyer
loss appreciates. ____
3. Results in a Import purchase by a U.S. company denominated
foreign exchange in foreign currency, foreign currency of buyer
loss appreciates. ____
4. Results in a
foreign exchange Import purchase by a U.S. company denominated
loss in dollars, foreign currency of buyer appreciates. ____
5. Results in a Import purchase by a U.S. company denominated
foreign exchange in foreign currency, foreign currency of buyer
gain depreciates. ____
6. No foreign
exchange gain or Import purchase by a U.S. company denominated
loss in dollars, foreign currency of buyer depreciates. ____
7. No foreign
exchange gain or Export sale by a U.S. company denominated in
loss dollars, foreign currency of buyer depreciates. ____
8. Results in a Export sale by a U.S. company denominated in
foreign exchange foreign currency, foreign currency of buyer
gain depreciates. ____

7-33
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

Chapter 07 Foreign Currency Transactions and Hedging Foreign Exchange Risk


Answer Key

Multiple Choice Questions

1. Pigskin Co., a U.S. corporation, sold inventory on credit to a British company on April 8,
2011. Pigskin received payment of 35,000 British pounds on May 8, 2011. The exchange rate
was 1 = $1.54 on April 8 and 1 = 1.43 on May 8. What amount of foreign exchange gain or
loss should be recognized? (round to the nearest dollar)
A. $10,500 loss
B. $10,500 gain
C. $1,750 loss
D. $3,850 loss
E. No gain or loss should be recognized.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

Norton Co., a U.S. corporation, sold inventory on December 1, 2011, with payment of 10,000
British pounds to be received in sixty days. The pertinent exchange rates were as follows:

7-34
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

2. For what amount should Sales be credited on December 1?


A. $5,500.
B. $16,949.
C. $18,182.
D. $17,241.
E. $16,667.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Easy
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-35
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

3. What amount of foreign exchange gain or loss should be recorded on December 31?
A. $300 gain.
B. $300 loss.
C. $0.
D. $941 loss.
E. $941 gain.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

4. What amount of foreign exchange gain or loss should be recorded on January 30?
A. $1,516 gain.
B. $1,516 loss.
C. $575 loss.
D. $500 loss.
E. $500 gain.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

Brisco Bricks purchases raw material from its foreign supplier, Bolivian Clay, on May 8.
Payment of 2,000,000 foreign currency units (FC) is due in 30 days. May 31 is Brisco's fiscal
year-end. The pertinent exchange rates were as follows:

7-36
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

5. For what amount should Brisco's Accounts Payable be credited on May 8?


A. $2,500,000.
B. $2,440,000.
C. $1,600,000.
D. $1,639,344.
E. $1,666,667.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Easy
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

6. How much Foreign Exchange Gain or Loss should Brisco record on May 31?
A. $2,520,000 gain.
B. $20,000 gain.
C. $20,000 loss.
D. $80,000 gain.
E. $80,000 loss.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7. How much US $ will it cost Brisco to finally pay the payable on June 7?
A. $1,666,667.
B. $2,440,000.
C. $2,520,000.
D. $2,500,000.
E. $2,400,000.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-37
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

8. On June 1, CamCo received a signed agreement to sell inventory for 500,000. The sale
would take place in 90 days. CamCo immediately signed a 90-day forward contract to sell the
yen as soon as they are received. The spot rate on June 1 was 1 =$.004167, and the 90-day
forward rate was 1 = $.00427. At what amount would CamCo record the Forward Contract
on June 1?
A. $2,083.
B. $0.
C. $2,110.
D. $2,532.
E. $2,135.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-03 Understand how foreign currency forward contracts and foreign currency options can be used to hedge foreign
exchange risk.
Learning Objective: 07-05 Account for forward contracts and options used as hedges of foreign currency firm commitments.

9. Belsen purchased inventory on December 1, 2010. Payment of 200,000 stickles was to be


made in sixty days. Also on December 1, Belsen signed a contract to purchase 200,000 in
sixty days. The spot rate was 1 = .35714, and the 60-day forward rate was 1 = $.38462. On
December 31, the spot rate was 1 = .34483 and the 30-day forward rate was 1 = .38168.
Assume an annual interest rate of 12% and a fair value hedge. The present value for one
month at 12% is .9901.
In the journal entry to record the establishment of a forward exchange contract, at what
amount should the Forward Contract account be recorded on December 1?
A. $71,428.
B. $76,924.
C. $588.
D. $582.
E. $0, since there is no cost, there is no value for the contract at this date.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Easy
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-38
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

10. Meisner Co. ordered parts costing 100,000 for a foreign supplier on May 12 when the
spot rate was $.24 per stickle. A one-month forward contract was signed on that date to
purchase 100,000 at a forward rate of $.25 per stickle. On June 12, when the parts were
received and payment was made, the spot rate was $.28 per stickle. At what amount should
inventory be reported?
A. $0.
B. $28,000.
C. $24,000.
D. $25,000.
E. $2,000.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

Car Corp. (a U.S.-based company) sold parts to a Korean customer on December 16, 2011,
with payment of 10 million Korean won to be received on January 15, 2012. The following
exchange rates applied:

7-39
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

11. Assuming a forward contract was not entered into, what would be the net impact on Car
Corp.'s 2011 income statement related to this transaction?
A. $500 (gain).
B. $500 (loss).
C. $200 (gain).
D. $200 (loss).
E. $ - 0 -

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

12. Assuming a forward contract was entered into, the foreign currency was originally sold in
the foreign currency market on December 16, 2011 at a
A. forward contract discount $600.
B. forward contract premium $600.
C. forward contract discount $980.
D. forward discount premium $980.
E. There is no premium or discount because the fair value of the contract is zero.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.

7-40
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

13. Assuming a forward contract was entered into, at what amount should the forward
contract be recorded at December 31, 2011? Assume an annual interest rate of 12% and a fair
value hedge. The present value for one month at 12% is .9901.
A. $200.
B. $295.
C. $495.
D. $500.
E. $9,300.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

14. Assuming a forward contract was entered into, how would the forward contract be
reflected on Car's December 31, 2011 balance sheet?
A. Forward contract (asset).
B. Forward contract (liability).
C. Foreign currency (asset).
D. Foreign currency (liability).
E. Foreign exchange (liability).

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Evaluation
Difficulty: Medium
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-41
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

15. Assuming a forward contract was entered into, what would be the net impact on Car
Corp.'s 2011 income statement related to this transaction? Assume an annual interest rate of
12% and a fair value hedge. The present value for one month at 12% is .9901.
A. $700 (gain).
B. $700 (loss).
C. $300 (gain).
D. $300 (loss).
E. $295 (gain).

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Hard
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

16. Assuming a forward contract was entered into on December 16, what would be the net
impact on Car Corp.'s 2012 income statement related to this transaction?
A. $500 (gain).
B. $305 (gain).
C. $300 (gain).
D. $300 (loss).
E. $0.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Hard
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-42
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

17. Mills Inc. had a receivable from a foreign customer that is due in the local currency of the
customer (stickles). On December 31, 2010, this receivable for 200,000 was correctly
included in Mills' balance sheet at $132,000. When the receivable was collected on February
15, 2011, the U.S. dollar equivalent was $144,000. In Mills' 2011 consolidated income
statement, how much should have been reported as a foreign exchange gain?
A. $0.
B. $36,000.
C. $48,000.
D. $10,000.
E. $12,000.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Easy
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

18. A spot rate may be defined as


A. The price a foreign currency can be purchased or sold today.
B. The price today at which a foreign currency can be purchased or sold in the future.
C. The forecasted future value of a foreign currency.
D. The U.S. dollar value of a foreign currency.
E. The Euro value of a foreign currency.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Easy
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.

7-43
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

19. The forward rate may be defined as


A. The price a foreign currency can be purchased or sold today.
B. The price today at which a foreign currency can be purchased or sold in the future.
C. The forecasted future value of a foreign currency.
D. The U.S. dollar value of a foreign currency.
E. The Euro value of a foreign currency.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Easy
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.

20. Which statement is true regarding a foreign currency option?


A. A foreign currency option gives the holder the obligation to buy or sell foreign currency in
the future.
B. A foreign currency option gives the holder the obligation only sell foreign currency in the
future.
C. A foreign currency option gives the holder the obligation to only buy foreign currency in
the future.
D. A foreign currency option gives the holder the right but not the obligation to buy or sell
foreign currency in the future.
E. A foreign currency option gives the holder the obligation to buy or sell foreign currency in
the future at the spot rate on the future date.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Easy
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.

7-44
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

21. A U.S. company sells merchandise to a foreign company denominated in U.S. dollars.
Which of the following statements is true?
A. If the foreign currency appreciates, a foreign exchange gain will result.
B. If the foreign currency depreciates, a foreign exchange gain will result.
C. No foreign exchange gain or loss will result.
D. If the foreign currency appreciates, a foreign exchange loss will result.
E. If the foreign currency depreciates, a foreign exchange loss will result.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Evaluation
Difficulty: Easy
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

22. A U.S. company sells merchandise to a foreign company denominated in the foreign
currency. Which of the following statements is true?
A. If the foreign currency appreciates, a foreign exchange gain will result.
B. If the foreign currency depreciates, a foreign exchange gain will result.
C. No foreign exchange gain or loss will result.
D. If the foreign currency appreciates, a foreign exchange loss will result.
E. Any gain or loss will be included in comprehensive income.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Evaluation
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-45
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

23. A U.S. company buys merchandise from a foreign company denominated in U.S. dollars.
Which of the following statements is true?
A. If the foreign currency appreciates, a foreign exchange gain will result.
B. If the foreign currency depreciates, a foreign exchange gain will result.
C. No foreign exchange gain or loss will result.
D. If the foreign currency appreciates, a foreign exchange loss will result.
E. Any gain or loss will be included in comprehensive income.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Evaluation
Difficulty: Easy
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

24. A U.S. company buys merchandise from a foreign company denominated in the foreign
currency. Which of the following statements is true?
A. If the foreign currency appreciates, a foreign exchange gain will result.
B. If the foreign currency depreciates, a foreign exchange loss will result.
C. No foreign exchange gain or loss will result.
D. If the foreign currency appreciates, a foreign exchange loss will result.
E. Any gain or loss will be included in comprehensive income.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Evaluation
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-46
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

25. U.S. GAAP provides guidance for hedges of all the following sources of foreign exchange
risk except
A. Recognized foreign currency denominated assets and liabilities.
B. Unrecognized foreign currency firm commitments.
C. Forecasted foreign currency denominated transactions.
D. Net investment in foreign operations.
E. Deferred foreign currency gains and losses.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Easy
Learning Objective: 07-03 Understand how foreign currency forward contracts and foreign currency options can be used to hedge foreign
exchange risk.

26. All of the following data may be needed to determine the fair value of a forward contract
at any point in time except
A. The forward rate when the forward contract was entered into.
B. The current forward rate for a contract that matures on the same date as the forward
contract entered into.
C. The future spot rate.
D. A discount rate.
E. The company's incremental borrowing rate.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Medium
Learning Objective: 07-03 Understand how foreign currency forward contracts and foreign currency options can be used to hedge foreign
exchange risk.

7-47
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

27. A forward contract may be used for which of the following?


1) A fair value hedge of an asset.
2) A cash flow hedge of an asset.
3) A fair value hedge of a liability.
4) A cash flow hedge of a liability.
A. 1 and 3
B. 2 and 4
C. 1 and 2
D. 1, 3, and 4
E. 1, 2, 3, and 4

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Easy
Learning Objective: 07-03 Understand how foreign currency forward contracts and foreign currency options can be used to hedge foreign
exchange risk.

28. A company has a discount on a forward contract for a foreign currency denominated asset.
How is the discount recognized over the life of the contract under fair value hedge
accounting?
A. As a debit to discount expense.
B. As a debit to amortization expense.
C. As a debit to accumulated other comprehensive income.
D. As a debit impact on net income, as a result of the hedge.
E. As a decreases to sales.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-48
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

29. Which of the following statements is true concerning hedge accounting?


A. Hedges of foreign currency firm commitments are used for future sales only.
B. Hedges of foreign currency firm commitments are used for future purchases only.
C. Hedges of foreign currency firm commitments are used for current sales or purchases.
D. Hedges of foreign currency firm commitments are used for future sales or purchases.
E. Hedges of foreign currency firm commitments are speculative in nature.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Medium
Learning Objective: 07-03 Understand how foreign currency forward contracts and foreign currency options can be used to hedge foreign
exchange risk.

30. All of the following hedges are used for future purchase/sale transactions except
A. Forward contracts used as a fair value hedge of a firm commitment.
B. Options used as a fair value hedge of a firm commitment.
C. Option contract cash flow hedge of a forecasted transaction.
D. Forward contract cash flow hedges of a forecasted transaction.
E. Forward contracts used to hedge a foreign currency denominated liability.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Medium
Learning Objective: 07-03 Understand how foreign currency forward contracts and foreign currency options can be used to hedge foreign
exchange risk.

On December 1, 2011, Keenan Company, a U.S. firm, sold merchandise to Velez Company of
Canada for 150,000 Canadian dollars (CAD). Collection of the receivable is due on February
1, 2012. Keenan purchased a foreign currency put option with a strike price of $.97 (U.S.) on
December 1, 2011. This foreign currency option is designated as a cash flow hedge. Relevant
exchange rates follow:

7-49
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

31. Compute the fair value of the foreign currency option at December 1, 2011.
A. $6,000.
B. $4,500.
C. $3,000.
D. $7,500.
E. $1,500.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

32. Compute the fair value of the foreign currency option at December 31, 2011.
A. $6,000.
B. $4,500.
C. $3,000.
D. $7,500.
E. $1,500.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

33. Compute the fair value of the foreign currency option at February 1, 2012.
A. $6,000.
B. $4,500.
C. $3,000.
D. $7,500.
E. $1,500.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-50
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

34. Compute the U.S. dollars received on February 1, 2012.


A. $138,000.
B. $136,500.
C. $145,500.
D. $141,000.
E. $142,500.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

35. Which of the following approaches is used in the United States in accounting for foreign
currency transactions?
A. One-transaction perspective; defer foreign exchange gains and losses.
B. Two-transaction perspective; accrue foreign exchange gains and losses.
C. Three-transaction perspective; defer foreign exchange gains and losses.
D. One-transaction perspective; accrue foreign exchange gains and losses.
E. Two-transaction perspective; defer foreign exchange gains and losses.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Easy
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.

7-51
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

36. When a U.S. company purchases parts from a foreign company, which of the following
will result in zero foreign exchange gain or loss?
A. The transaction is denominated in U.S. dollars.
B. The option strike price to sell foreign currency is less than the spot rate of the currency.
C. The option strike price to buy foreign currency is less than the spot rate of the currency.
D. The foreign currency appreciated in value relative to the U.S. dollar.
E. The foreign currency depreciated in value relative to the U.S. dollar.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

37. Alpha, Inc., a U.S. company, had a receivable from a customer that was denominated in
Mexican pesos. On December 31, 2010, this receivable for 75,000 pesos was correctly
included in Alpha's balance sheet at $8,000. The receivable was collected on March 2, 2011,
when the U.S. equivalent was $6,900. How much foreign exchange gain or loss will Alpha
record on the income statement for the year ended December 31, 2011?
A. $1,100 loss.
B. $1,100 gain.
C. $6,900 loss.
D. $6,900 gain.
E. $8,000 gain.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Easy
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-52
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

On April 1, 2010, Shannon Company, a U.S. company, borrowed 100,000 euros from a
foreign bank by signing an interest-bearing note due April 1, 2011. The dollar value of the
loan was as follows:

38. How much foreign exchange gain or loss should be included in Shannon's 2010 income
statement?
A. $3,000 gain.
B. $3,000 loss.
C. $6,000 gain.
D. $6,000 loss.
E. $7,000 gain.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-07 Prepare journal entries to account for foreign currency borrowings.

39. How much foreign exchange gain or loss should be included in Shannon's 2011 income
statement?
A. $1,000 gain.
B. $1,000 loss.
C. $2,000 gain.
D. $2,000 loss.
E. $8,000 loss.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-07 Prepare journal entries to account for foreign currency borrowings.

7-53
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

40. Angela, Inc., a U.S. company, had a euro receivable from exports to Spain and a British
pound payable resulting from imports from England. Angela recorded foreign exchange gain
related to both its euro receivable and pound payable. Did the foreign currencies increase or
decrease in dollar value from the date of the transaction to the settlement date?

A. A above
B. B above
C. C above
D. D above
E. E above

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-54
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

41. Frankfurter Company, a U.S. company, had a ruble receivable from exports to Russia and
a euro payable resulting from imports from Italy. Frankfurter recorded foreign exchange loss
related to both its ruble receivable and euro payable. Did the foreign currencies increase or
decrease in dollar value from the date of the transaction to the settlement date?

A. A above
B. B above
C. C above
D. D above
E. E above

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

Parker Corp., a U.S. company, had the following foreign currency transactions during 2011:
(1.) Purchased merchandise from a foreign supplier on July 5, 2011 for the U.S. dollar
equivalent of $80,000 and paid the invoice on August 3, 2011 at the U.S. dollar equivalent of
$82,000.
(2.) On October 1, 2011 borrowed the U.S. dollar equivalent of $872,000 evidenced by a non-
interest-bearing note payable in euros on October 1, 2011. The U.S. dollar equivalent of the
note amount was $860,000 on December 31, 2011, and $881,000 on October 1, 2012.

7-55
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

42. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2011?
A. $2,000 loss.
B. $2,000 gain.
C. $10,000 gain.
D. $14,000 loss.
E. $14,000 gain.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.
Learning Objective: 07-07 Prepare journal entries to account for foreign currency borrowings.

43. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2012?
A. $9,000 loss.
B. $9,000 gain.
C. $11,000 loss.
D. $21,000 loss.
E. $21,000 gain.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Easy
Learning Objective: 07-07 Prepare journal entries to account for foreign currency borrowings.

Winston Corp., a U.S. company, had the following foreign currency transactions during 2011:
(1.) Purchased merchandise from a foreign supplier on July 16, 2011 for the U.S. dollar
equivalent of $47,000 and paid the invoice on August 3, 2011 at the U.S. dollar equivalent of
$54,000.
(2.) On October 15, 2011 borrowed the U.S. dollar equivalent of $315,000 evidenced by a
non-interest-bearing note payable in euros on October 15, 2011. The U.S. dollar equivalent of
the note amount was $295,000 on December 31, 2011, and $299,000 on October 15, 2012.

7-56
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

44. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2011?
A. $9,000 loss.
B. $9,000 gain.
C. $11,000 loss.
D. $13,000 gain.
E. $14,000 gain.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.
Learning Objective: 07-07 Prepare journal entries to account for foreign currency borrowings.

45. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2012?
A. $1,000 loss.
B. $1,000 gain.
C. $2,000 loss.
D. $4,000 gain.
E. $4,000 loss.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Easy
Learning Objective: 07-07 Prepare journal entries to account for foreign currency borrowings.

7-57
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

46. Williams, Inc., a U.S. company, has a Japanese yen account receivable resulting from an
export sale on March 1 to a customer in Japan. The exporter signed a forward contract on
March 1 to sell yen and designated it as a cash flow hedge of a recognized receivable. The
spot rate was $.0094, and the forward rate was $.0095. Which of the following did the U.S.
exporter report in net income?
A. Discount revenue.
B. Premium revenue.
C. Discount expense.
D. Premium expense.
E. Both a discount revenue and a premium expense.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.

47. Larson Company, a U.S. company, has an India rupee account receivable resulting from
an export sale on September 7 to a customer in India. Larson signed a forward contract on
September 7 to sell rupees and designated it as a cash flow hedge of a recognized receivable.
The spot rate was $.023, and the forward rate was $.021. Which of the following did the U.S.
exporter report in net income?
A. Discount revenue.
B. Premium revenue.
C. Discount expense.
D. Premium expense.
E. Both a discount revenue and a premium expense.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-58
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

48. Primo Inc., a U.S. company, ordered parts costing 100,000 rupee from a foreign supplier
on July 7 when the spot rate was $.025 per rupee. A one-month forward contract was signed
on that date to purchase 100,000 rupee at a rate of $.027. The forward contract is properly
designated as a fair value hedge of the 100,000 rupee firm commitment. On August 7, when
the parts are received, the spot rate is $.028. At what amount should the parts inventory be
carried on Primo's books?
A. $2,000.
B. $2,100.
C. $2,500.
D. $2,700.
E. $2,800.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-05 Account for forward contracts and options used as hedges of foreign currency firm commitments.

49. Lawrence Company, a U.S. company, ordered parts costing 1,000,000 Thailand bahts
from a foreign supplier on July 7 when the spot rate was $.025 per baht. A one-month forward
contract was signed on that date to purchase 1,000,000 bahts at a rate of $.027. The forward
contract is properly designated as a fair value hedge of the 1,000,000 baht firm commitment.
On August 7, when the parts are received, the spot rate is $.028. What is the amount of
accounts payable that will be paid at this date?
A. $20,000.
B. $20,100.
C. $25,000.
D. $27,000.
E. $28,000.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-05 Account for forward contracts and options used as hedges of foreign currency firm commitments.

7-59
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

50. On December 1, 2011, Joseph Company, a U.S. company, entered into a three-month
forward contract to purchase 50,000 pesos on March 1, 2012, as a fair value hedge of a
foreign currency denominated account payable. The following U.S. dollar per peso exchange
rates apply:

Joseph's incremental borrowing rate is 12 percent. The present value factor for two months at
an annual interest rate of 12 percent is .9803. Which of the following is included in Joseph's
December 31, 2011 balance sheet for the forward contract?
A. $5,146.58 asset.
B. $5,146.58 liability.
C. $500 liability.
D. $490.15 asset.
E. $490.15 liability.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-60
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

51. On April 1, Quality Corporation, a U.S. company, expects to sell merchandise to a French
customer in three months, denominating the transaction in euros. On April 1, the spot rate is
$1.41 per euro, and Quality enters into a three-month forward contract cash flow hedge to sell
400,000 euros at a rate of $1.36. At the end of three months, the spot rate is $1.37 per euro,
and Quality delivers the merchandise, collecting 400,000 euros. What are the effects on net
income from these transactions?
A. $8,000 Discount Expense plus a $12,000 negative Adjustment to Net Income when the
merchandise is delivered.
B. $8,000 Discount Expense plus a $12,000 positive Adjustment to Net Income when the
merchandise is delivered.
C. $8,000 Discount Expense plus a $20,000 negative Adjustment to Net Income when the
merchandise is delivered.
D. $8,000 Discount Expense plus a $20,000 positive Adjustment to Net Income when the
merchandise is delivered.
E. $8,000 Discount Expense plus an $8,000 positive Adjustment to Net Income when the
merchandise is delivered.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-06 Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

Woolsey Corporation, a U.S. company, expects to sell goods to a British customer at a price
of 250,000 pounds, with delivery and payment to be made on October 24. On July 24,
Woolsey purchased a three-month put option for 250,000 British pounds and designated this
option as a cash flow hedge of a forecasted foreign currency transaction expected to be
completed in late October. The following exchange rates apply:

7-61
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

52. What amount will Woolsey include as an option expense in net income for the period July
24 to October 24?
A. $4,000.
B. $5,000.
C. $10,000.
D. $12,000.
E. $14,000.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Easy

53. What amount will Woolsey include as Adjustment to Net Income for the period ended
October 31?
A. $6,000 positive.
B. $6,000 negative.
C. $10,000 positive.
D. $10,000 negative.
E. $14,000 positive.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-06 Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

7-62
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

54. Atherton, Inc., a U.S. company, expects to order goods from a foreign supplier at a price
of 100,000 lira, with delivery and payment to be made on April 17. On January 17, Atherton
purchased a three-month call option on 100,000 lira and designated this option as a cash flow
hedge of a forecasted foreign currency transaction. The following exchange rates apply:

What amount will Atherton include as an option expense in net income for the period January
17 to April 17?
A. $4,000
B. $4,260
C. $4,340
D. $5,000
E. $5,260

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Easy
Learning Objective: 07-06 Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

On May 1, 2011, Mosby Company received an order to sell a machine to a customer in


Canada at a price of 2,000,000 Mexican pesos. The machine was shipped and payment was
received on March 1, 2012. On May 1, 2011, Mosby purchased a put option giving it the right
to sell 2,000,000 pesos on March 1, 2012 at a price of $190,000. Mosby properly designates
the option as a fair value hedge of the peso firm commitment. The option cost $3,000 and had
a fair value of $3,200 on December 31, 2011. The following spot exchange rates apply:

Mosby's incremental borrowing rate is 12 percent, and the present value factor for two months
at a 12 percent annual rate is .9803.

7-63
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

55. What was the impact on Mosby's 2011 net income as a result of this fair value hedge of a
firm commitment?
A. $1,760.60 decrease.
B. $1,960.60 decrease.
C. $1,000.00 decrease.
D. $1,760.60 increase.
E. $1,960.60 increase.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Hard
Learning Objective: 07-05 Account for forward contracts and options used as hedges of foreign currency firm commitments.

56. What was the impact on Mosby's 2012 net income as a result of this fair value hedge of a
firm commitment?
A. $1,800.00 decrease.
B. $2,500 increase.
C. $2,500 decrease.
D. $188,760.60 increase.
E. $188,760.60 decrease.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Hard
Learning Objective: 07-05 Account for forward contracts and options used as hedges of foreign currency firm commitments.

7-64
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

57. What was the overall result of having entered into this hedge of exposure to foreign
exchange risk?
A. $0
B. $9,000 net loss on the option.
C. $9,000 net gain on the option.
D. $2,000 net gain on the option.
E. $2,000 net loss.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Hard
Learning Objective: 07-05 Account for forward contracts and options used as hedges of foreign currency firm commitments.

On March 1, 2011, Mattie Company received an order to sell a machine to a customer in


England at a price of 200,000 British pounds. The machine was shipped and payment was
received on March 1, 2012. On March 1, 2011, Mattie purchased a put option giving it the
right to sell 200,000 British pounds on March 1, 2012 at a price of $380,000. Mattie properly
designates the option as a fair hedge of the pound firm commitment. The option cost $2,000
and had a fair value of $2,200 on December 31, 2011. The following spot exchange rates
apply:

Mattie's incremental borrowing rate is 12 percent, and the present value factor for two months
at a 12 percent annual rate is .9803.

7-65
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

58. What was the net impact on Mattie's 2011 income as a result of this fair value hedge of a
firm commitment?
A. $1,800.00 decrease.
B. $1,760.60 decrease.
C. $2,240.40 decrease.
D. $1,660.40 increase.
E. $2,240.60 increase.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Hard
Learning Objective: 07-05 Account for forward contracts and options used as hedges of foreign currency firm commitments.

59. What was the net impact on Mattie's 2012 income as a result of this fair value hedge of a
firm commitment?
A. $379,760.60 decrease.
B. $8,360.60 increase.
C. $8,360.60 decrease.
D. $4,390.40 decrease.
E. $379,760.60 increase.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Hard
Learning Objective: 07-05 Account for forward contracts and options used as hedges of foreign currency firm commitments.

7-66
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

60. What was the net increase or decrease in cash flow from having purchased the foreign
currency option to hedge this exposure to foreign exchange risk?
A. $0
B. $10,000 increase.
C. $10,000 decrease.
D. $20,000 increase.
E. $20,000 decrease.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Hard
Learning Objective: 07-05 Account for forward contracts and options used as hedges of foreign currency firm commitments.

On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British
supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle
pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per
pound. The option is considered to be a cash flow hedge of a forecasted foreign currency
transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot
exchange rates apply:

7-67
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

61. What journal entry should Eagle prepare on October 1, 2011?

A. A above.
B. B above.
C. C above.
D. D above.
E. E above.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-06 Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

7-68
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

62. What journal entry should Eagle prepare on December 31, 2011?

A. A above.
B. B above.
C. C above.
D. D above.
E. E above.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-06 Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

63. What is the amount of option expense for 2012 from these transactions?
A. $1,000.
B. $1,600.
C. $2,500.
D. $2,600.
E. $0.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-06 Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

7-69
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

64. What is the amount of Adjustment to Accumulated Other Comprehensive Income for 2012
from these transactions?
A. $1,000.
B. $1,600.
C. $1,800.
D. $2,000.
E. $2,600.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-06 Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

65. What is the amount of Cost of Goods Sold for 2012 as a result of these transactions?
A. $200,000.
B. $195,000.
C. $201,000.
D. $202,600.
E. $203,000.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-06 Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

7-70
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

66. What is the 2012 effect on net income as a result of these transactions?
A. $195,000
B. $201,600
C. $201,000
D. $202,600
E. $203,000

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Hard
Learning Objective: 07-06 Account for forward contracts and options used as hedges of forecasted foreign currency transactions.

Essay Questions

67. Yelton Co. just sold inventory for 80,000 euros, which Yelton will collect in sixty days.
Briefly describe a hedging transaction Yelton could engage in to reduce its risk of unfavorable
exchange rates.

Yelton could sign a forward exchange contract to sell the euros in 60 days, after they are
received. Alternatively, Yelton could purchase an option to sell the euros in 60 days, after they
are received.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Easy
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.

7-71
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

68. Where can you find exchange rates between the U.S. dollar and most foreign currencies?

Foreign exchange rates are published in the Wall Street Journal, major U.S. newspapers, and
several Internet sites.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Easy
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.

69. What is meant by the spot rate?

The spot rate is the price at which a foreign currency can be purchased or sold today.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Easy
Learning Objective: 07-01 Understand concepts related to foreign currency; exchange rates; and foreign exchange risk.

70. How is the fair value of a Forward Contract determined by U.S. GAAP?

The fair value of a Forward Contract is determined by comparing the difference between the
contracted forward rate and the currently available forward rate for contracts expiring on the
same date. On the initial date of the contract, this would result in a fair value of $0. As time
passes, the currently available forward rate will likely fluctuate relative to the "fixed"
contracted forward rate, creating a difference that must be accounted for as a gain or loss on
the forward contract. A contract with a net gain over its life is recorded on the balance sheet as
a Forward Contract Asset. A contract with a net loss over its life is recorded on the balance
sheet as a Forward Contract Liability.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Hard
Learning Objective: 07-03 Understand how foreign currency forward contracts and foreign currency options can be used to hedge foreign
exchange risk.

7-72
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

71. What is the major assumption underlying the one-transaction perspective?

The one-transaction perspective assumes that an export sale is not complete until the foreign
currency receivable has been collected and converted into U.S. dollars.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Knowledge
Difficulty: Easy
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

72. What is the purpose of a hedge of foreign exchange risk?

Hedge of foreign exchange risk is a strategy to limit exposure to the effect of unfavorable
changes in the value of foreign currencies that are caused by 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 by establishing a price today at which foreign currency can be sold
or purchased at a future date.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Medium
Learning Objective: 07-03 Understand how foreign currency forward contracts and foreign currency options can be used to hedge foreign
exchange risk.

7-73
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

73. How does a foreign currency forward contract differ from a foreign currency option?

A foreign currency forward contract obligates the parties to deliver one currency in exchange
for another at a specified future date. On the other hand, the owner of a foreign currency
option can choose whether to exercise the option and exchange one currency for another or
not.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

74. What factors create a foreign exchange gain?

Foreign exchange gains and losses are created by two factors: having foreign currency
exposures (foreign currency receivables and payables) and changes in exchange rates.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

75. What happens when a U.S. company purchases goods denominated in a foreign currency
and the foreign currency depreciates?

The event results in a foreign exchange gain.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-74
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

76. What happens when a U.S. company purchases goods denominated in a foreign currency
and the foreign currency appreciates?

The event results in a foreign exchange loss.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

77. What happens when a U.S. company sells goods denominated in a foreign currency and
the foreign currency depreciates?

The event results in a foreign exchange loss.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

78. What happens when a U.S. company sells goods denominated in a foreign currency and
the foreign currency appreciates?

The event results in a foreign exchange gain.

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-75
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

79. Gaw Produce Co. purchased inventory from a Japanese company on December 18, 2011.
Payment of 4,000,000 yen () was due on January 18, 2012. Exchange rates between the
dollar and the yen were as follows:

Required:
Prepare all journal entries for Gaw Produce Co. in connection with the purchase and
payment.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-76
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

80. Old Colonial Corp. (a U.S. company) made a sale to a foreign customer on September 15,
2011, for 100,000 stickles. Payment was received on October 15, 2011. The following
exchange rates applied:

Required:
Prepare all journal entries for Old Colonial Corp. in connection with this sale assuming that
the company closes its books on September 30 to prepare interim financial statements.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-77
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

Coyote Corp. (a U.S. company in Texas) had the following series of transactions in a foreign
country during 2011:

The appropriate exchange rates during 2011 were as follows:

7-78
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

81. Prepare all journal entries in U.S. dollars along with any December 31, 2011 adjusting
entries. Coyote uses a perpetual inventory system.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-79
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

82. What amount will Coyote Corp. report in its 2011 balance sheet for Inventory?

Inventory (60,000 pesos x $.20 x 40%): $4,800

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

83. What amount will Coyote Corp. report in its 2011 income statement for Cost of goods
sold?

Cost of goods sold (60,000 pesos x $.20 x 60%): $7,200

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

84. What amount will Coyote Corp. report in its 2011 income statement for Sales?

Sales (54,000 pesos x $.22): $11,880

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-80
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

85. What amount will Coyote Corp. report in its 2011 balance sheet for Accounts receivable?

Accounts receivable ((54,000-48,000 pesos) x $.25): $1,500

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

86. What amount will Coyote Corp. report in its 2011 balance sheet for Accounts payable?

Accounts payable ((60,000-36,000 pesos) x $.25): $6,000

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

87. The beginning balance of cash was 50,000 pesos on January 1, 2011, translated at 1 peso
= $.18. What amount will Coyote Corp. report in its 2011 balance sheet for Cash?

Cash (50,000pesos x $.18) + (48,000 pesos x $.23) - (36,000 pesos x $.24): $11,400

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Analysis
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-81
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

On November 10, 2011, King Co. sold inventory to a customer in a foreign country. King
agreed to accept 96,000 local currency units (LCU) in full payment for this inventory.
Payment was to be made on February 1, 2012. On December 1, 2011, King entered into a
forward exchange contract wherein 96,000 LCU would be delivered to a currency broker in
two months. The two month forward exchange rate on that date was 1 LCU = $.30. Any
contract discount or premium is amortized using the straight-line method. The spot rates and
forward rates on various dates were as follows:

The company's borrowing rate is 12%. The present value factor for one month is .9901.

7-82
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

88. (A.) Assume this hedge is designated as a cash flow hedge. Prepare the journal entries
relating to the transaction and the forward contract.
(B.) Compute the effect on 2011 net income.
(C.) Compute the effect on 2012 net income.

7-83
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

1
[(.30 - .28) 96,000] x .9901 = 1,901
2
[(.30 - .27) 96,000] = 2,880 - 1,901 = 979

7-84
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Hard
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-85
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

89. (A.) Assume this hedge is designated as a fair value hedge. Prepare the journal entries
relating to the transaction and the forward contract.
(B.) Compute the effect on 2011 net income.
(C.) Compute the effect on 2012 net income.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Hard
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-86
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

On October 1, 2011, Jarvis Co. sold inventory to a customer in a foreign country,


denominated in 100,000 local currency units (LCU). Collection is expected in four months.
On October 1, 2011, a forward exchange contract was acquired whereby Jarvis Co. was to pay
100,000 LCU in four months (on February 1, 2012) and receive $78,000 in U.S. dollars. The
spot and forward rates for the LCU were as follows:

The company's borrowing rate is 12%. The present value factor for one month is .9901.
Any discount or premium on the contract is amortized using the straight-line method.

7-87
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

90. Assuming this is a cash flow hedge, prepare journal entries for this sales transaction and
forward contract.

7-88
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

1
[(.80 - .78) 100,000] x .9901 = 1,980
2
[(.78 - .86) 100,000] - 1,980 = 6,020

7-89
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Hard
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

91. Assuming this is a fair value hedge, prepare journal entries for this sales transaction and
forward contract.

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Hard
Learning Objective: 07-04 Account for forward contracts and options used as hedges of foreign currency denominated assets and liabilities.

7-90
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

92. On October 31, 2010, Darling Company negotiated a two-year 100,000 franc loan from a
foreign bank at an interest rate of 3 percent per year. Interest payments are made annually on
October 31, and the principal will be repaid on October 31, 2012. Darling prepares U.S.-dollar
financial statements and has a December 31 year-end. Prepare all journal entries related to this
foreign currency borrowing assuming the following:

7-91
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

In US dollars:

7-92
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

AACSB: Analytic
AACSB: Diversity
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Application
Difficulty: Hard
Learning Objective: 07-07 Prepare journal entries to account for foreign currency borrowings.

7-93
Chapter 07 - Foreign Currency Transactions and Hedging Foreign Exchange Risk

Matching Questions

93. For each of the following situations, select the best answer concerning accounting for
foreign currency transactions:
(G) Results in a foreign exchange gain.
(L) Results in a foreign exchange loss.
(N) No foreign exchange gain or loss.

1. No foreign Export sale by a U.S. company denominated in


exchange gain or loss dollars, foreign currency of buyer appreciates. 1
2. No foreign Export sale by a U.S. company denominated in
exchange gain or loss foreign currency, foreign currency of buyer appreciates. 5
3. Results in a foreign Import purchase by a U.S. company denominated in
exchange loss foreign currency, foreign currency of buyer appreciates. 3
4. Results in a foreign Import purchase by a U.S. company denominated in
exchange loss dollars, foreign currency of buyer appreciates. 1
5. Results in a foreign Import purchase by a U.S. company denominated in
exchange gain foreign currency, foreign currency of buyer depreciates. 5
6. No foreign Import purchase by a U.S. company denominated in
exchange gain or loss dollars, foreign currency of buyer depreciates. 1
7. No foreign Export sale by a U.S. company denominated in
exchange gain or loss dollars, foreign currency of buyer depreciates. 1
8. Results in a foreign Export sale by a U.S. company denominated in
exchange gain foreign currency, foreign currency of buyer depreciates. 3

AACSB: Diversity
AACSB: Reflective thinking
AICPA BB: Global
AICPA FN: Measurement
Bloom's: Comprehension
Difficulty: Medium
Learning Objective: 07-02 Account for foreign currency transactions using the two-transaction perspective; accrual approach.

7-94