Chapter 25 Acctg FOR Derivatives & Hedging Transactions PART 2 AFAR PART 2 PDF

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Chapter 25Accounting for Derivatives and HedgingTransactions (Part 2)PROBLEM 25-1: THEORY1. D 6. C2. A 7. B3. A 8. C4. D 9. C5. A 10. BPROBLEM 25-2: THEORY1. A 6. B2. E 7. D3. D 8. A4. A 9. B5. A 10. DPROBLEM 25-3: THEORY1. B 6. D2. B 7. A3. B 8. B4. B 9. C5. C 10. CPROBLEM 25-4: THEORY & CO...

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Chapter 25 Accounting for Derivatives and Hedging Transactions (Part 2)

PROBLEM 25-1: THEORY 1. D 6.

C

2.

A

7.

B

3.

A

8.

C

4.

D

9.

C

5.

A

10.

B

6.

B

PROBLEM 25-2: THEORY 1. A 2.

E

7.

D

3.

D

8.

A

4.

A

9.

B

5.

A

10.

D

6.

D

PROBLEM 25-3: THEORY 1. B 2.

B

7.

A

3.

B

8.

B

4.

B

9.

C

5.

C

10.

C

PROBLEM 25-4: THEORY & COMPUTATIONAL 1.

C

2.

D

3.

A

4.

D

1

5.

Solution: Hedged item – None

Forward contract (Derivative) Dec. 15, 20x1 No entry Dec. 31, 20x1 Forward contract (asset)……30K Gain on forward contract…..30K [ (48 - 45) x 10,000] to record the value of the derivative

There is gain because if Puppy Co. purchases $10,000 using the forward contract, the purchase price is ₱ 450,000; while if Puppy Co. purchases $10,000 in the market, the purchase price is ₱480,000.

Variation 1: Gross settlement – Compound entry Hedged item – None Forward contract (Derivative) Jan. 15, 20x2 Cash – foreign currency...460K ($10,000 x ₱46 spot rate)

Loss on forward contract….20K Forward contract (asset). 30K Cash – local currency… 450K to record the purchase of $10,000 from the bank in exchange at the pre-agreed purchase price of ₱450,000

Variation 2: Net settlement Hedged item – None

Forward contract (Derivative) Jan. 15, 20x2 Cash – local currency…… 10K [(46 – 45) x 10,000]

Loss on forward contract…20K Forward contract (asset)….30K to record the net cash settlement of the forward contract

6.

Solution: Hedged item – Accounts payable

Hedging instrument – Forward contract (Derivative) Dec. 15, 20x1

Dec. 15, 20x1 Machine………………..4.1M

No entry

(100K FCU x ₱41 spot rate)

Accounts payable………..4.1M

2

Dec. 31, 20x1 Forward contract (asset)...300K

Dec. 31, 20x1 FOREX loss………....300K Accounts payable……300K

[(₱43 - ₱40) x 100K]

Gain on forward contract….300K

[( ₱44 - ₱41) x 100K FCU]

to record the value of the derivative

to adjust accounts payable for the increase in spot rate

Variation 1: Gross settlement – Compound entry Hedged item – Hedging instrument – Accounts payable Forward contract (Derivative) Jan. 15, 20x2 Cash – foreign currency

Jan. 15, 20x2 Accounts payable……….4.4M Cash – foreign currency 4.2M (100,000 x 42) FOREX gain…………… 200K

4.2M

(100K x ₱42spot rate)

Loss on forward contract .. 100K Cash – local currency… 4M (100K x ₱40 agreed rate)

Forward contract (asset) 300K

to record the payment of 100,000 FCU to the supplier

to record the purchase of 100,000 FCU at the pre-agreed price of ₱4,000,000 (100,000 x ₱40)

Variation 2: Net settlement Hedged item – Accounts payable

Forward contract (Derivative)

Jan. 15, 20x2 Accounts payable……….4.4M Cash – foreign currency 4.2M (100,000 x 42) FOREX gain…………… 200K

Jan. 15, 20x2 Cash – local currency… 200K

to record the payment of 100,000 FCU to the supplier

to record the net cash settlement of the forward contract

7.

[(42 – 40) x 100,000]

Loss on forward contract 100K Forward contract (asset)…300K

Solution:

Hedged item – Firm sale commitment

Hedging instrument – Forward contract (Derivative)

Dec. 15, 20x1 No entry

Dec. 15, 20x1 No entry

Dec. 31, 20x1 Loss on firm commitment 20K Firm commitment (liability) 20K

Dec. 31, 20x1 Forward contract (asset).. 20K Gain on forward contract.. 20K

[( ₱4 – ₱3.8) x 100K FCUs]

[( ₱4 – ₱3.8) x 100K FCUs]

to recognize the change in the fair value of the firm commitment

to recognize the change in the fair value of the forward contract

3

Variation 1: Gross settlement – Compound entry Jan. 15, 20x2 Cash (local currency)….....400K Cash (foreign currency)….360K Forward contract (asset)… 20K Gain on forward contract….20K

Jan. 15, 20x2 Cash (foreign currency)… 360K (100K FCUs x ₱3.6 spot rate)

Firm commitment (liability)..20K Loss on firm commitment... 20K Sales……………………..400K (100K FCUs x ₱4.00 forward rate)

to record the remittance of 100,000 FCUs to the bank in exchange for the preagreed sale price of ₱400,000

to record the actual sale transaction, to recognize the change in the fair value of the firm commitment, and to derecognize the firm commitment

Variation 2: Net settlement Jan. 15, 20x2 Cash (foreign currency)… 360K

Jan. 15, 20x2 Cash (local currency)….....40K (4 – 3.6) x 100,000 Forward contract (asset)… 20K Gain on forward contract….20K

(100K FCUs x ₱3.6 spot rate)

Firm commitment (liability)..20K Loss on firm commitment... 20K Sales……………………..400K (100K FCUs x ₱4.00 forward rate)

to record the net settlement of the forward contract

to record the actual sale transaction, to recognize the change in the fair value of the firm commitment, and to derecognize the firm commitment

8.

Solution:

Hedged item – Firm purchase commitment

Hedging instrument – Forward contract (Derivative)

Oct. 1, 20x1 No entry

Oct. 1, 20x1 No entry

Dec. 31, 20x1 Loss on firm commitment .. 3,882 Firm commitment (liability) 3,882

Dec. 31, 20x1 Forward contract (asset)... 3,882 Gain on forward contract 3,882

to recognize the change in the fair value of the firm commitment

to recognize the change in the fair value of the forward contract

(₱100 – ₱96) x 1,000 meters of yarn x PV of 1 @1%*, n=3 = 4,000 x 0.970590 = 3,882 * (12% ÷ 12 months) = 1% per month

Hedged item – Firm purchase commitment

Hedging instrument – Forward contract (Derivative) 4

Mar. 31, 20x2 Cash [(100 - 92) x 1,000]...8,000 Gain on forward contract (8,000 – 3,882)…. 4,118 Forward contract (asset)…3,882

Mar. 31, 20x2 Inventory (92 x 1,000). 92,000 Loss on firm commitment (8,000 – 3,882)………….. 4,118 Firm commitment (liability)………………….3,882 Cash ………………………100,000 (100 fixed contract price x 1,000) to record the actual purchase transaction and to derecognize the firm commitment

to net cash settlement of the forward contract.

9. Solution: Scenario (a):

Hedged item – Highly probable forecast transaction

Hedging instrument – Forward contract (Derivative)

Dec. 15, 20x1 No entry

Dec. 15, 20x1 No entry

Dec. 31, 20x1 No entry

Dec. 31, 20x1 Accumulated OCI… ……. 4K Forward contract (liability)… 4K [(100 –96) x 1,000 to recognize the change in the fair value of the forward contract

Jan. 15, 20x2 Inventory…………………..92K

Jan. 15, 20x2 Accumulated OCI… ……. 4K Forward contract (liability)… 4K

(1,000 x 92 current spot rate)

Cash …………………...……92K

[(96 - 92) x 1,000 to recognize the change in the fair value of the forward contract

to record the actual purchase transaction

Jan. 15, 20x2 Forward contract (liability)… 8K Cash ……………………….… 8K to record the net settlement of the forward contract.

Feb. 14, 20x2 Cash…………………….360K Cost of goods sold………92K Inventory……………………..92K Sales………………………..360K

Feb. 14, 20x2 Cost of goods sold…………..8K Accumulated OCI… ……….. 8K

to record the sale of inventory

to reclassify accumulated losses on forward contract to profit or loss as an increase in cost of goods sold.

5

Scenario (b):

Hedged item – Highly probable forecast transaction

Hedging instrument – Forward contract (Derivative)

Dec. 15, 20x1 No entry

Dec. 15, 20x1 No entry

Dec. 31, 20x1 No entry

Dec. 31, 20x1 Accumulated OCI… ……. 4K Forward contract (liability)… 4K [(100 –96) x 1,000 to recognize the change in the fair value of the forward contract

Jan. 15, 20x2 Inventory…………………..92K

Jan. 15, 20x2 Accumulated OCI… ……. 4K Forward contract (liability)… 4K

(1,000 x 92 current spot rate)

Cash …………………...……92K

[(96 - 92) x 1,000

to record the actual purchase transaction

to recognize the change in the fair value of the forward contract

Jan. 15, 20x2 Inventory…………………...8K Accumulated OCI…………….8K

Jan. 15, 20x2 Forward contract (liability)… 8K Cash ……………………….… 8K

to remove the accumulated OCI and adjust it to the initial cost of the inventory

to record the net settlement of the forward contract.

Feb. 14, 20x2 Cash…………………….360K Cost of goods sold…… 100K Inventory……………………100K Sales………………………..360K

Feb. 14, 20x2 No entry

to record the sale of inventory

PROBLEM 25-5: MULTIPLE CHOICE: COMPUTATIONAL 1.

A Pinoy Corp. recognizes no net gain or net loss. By opening the letter of credit, Pinoy Corp. fixes its net exposure to exchange rate risk at ₱27.50.

2. A Solution: Contract rate 30-day futures rate on 12/31/01 Decrease Multiply by: No. of Swiss francs

0.70 0.65 0.05 50,000

6

Loss

2,500

3. B Current price (¥47,850,000 ÷ ¥115) Fixed amount of dollars to be received from the ¥47,850,000

$416,087 $435,000

Deficiency - Receipt

18,913

4. C Solution: Current price (¥47,850,000 ÷ ¥105) Fixed amount of dollars to be received from the ¥47,850,000

$455,714 $435,000

Excess – Payment

$(20,714)

5. B Solution: Current price (¥47,850,000 ÷ ¥115) Fixed amount of dollars to be received from the ¥47,850,000 Difference - Fair value

$416,087 $435,000 $18,91 3

PROBLEM 25-6: EXERCISES: COMPUTATIONAL 1. Solution: Hedged item – None Forward contract (Derivative) Dec. 15, 20x1 No entry Dec. 31, 20x1 Loss on forward contract…..30K [ (48 - 45) x 10,000]

Forward contract (liability)… 30K to record the value of the derivative

Jan. 15, 20x2 Forward contract (liability) .30K Gain on forward contract… 20K Cash – local currency…… 10K [(46 – 45) x 10,000] to record the net cash settlement of the forward contract

7

2.

Solution: Hedged item – Accounts receivable

Hedging instrument – Forward contract (Derivative) Dec. 15, 20x1

Dec. 15, 20x1 Accounts receivable…. 4.1M Sales………………..

No entry 4.1M

(100K FCU x ₱41 spot rate)

Dec. 31, 20x1 Accounts receivable…. 300K FOREX gain………....

Dec. 31, 20x1 Loss on forward contract….300K Forward contract (liability)... 300K

300K

[( ₱44 - ₱41) x 100K FCU]

[(₱43 - ₱40) x 100K]

Scenario A: Gross settlement – Compound entry Hedged item – Hedging instrument – Accounts payable Forward contract (Derivative) Jan. 15, 20x2 Cash – local currency…

Jan. 15, 20x2 Cash – foreign currency 4.2M (100,000 x 42) FOREX loss…………… 200K Accounts receivable…… 4.4M

4M

(100K x ₱40 agreed rate)

Forward contract (liability) 300K Cash – foreign currency 4.2M (100K x ₱42 spot rate)

Gain on forward contract . 100K

Scenario B: Net settlement Hedged item – Accounts payable

Forward contract (Derivative)

Jan. 15, 20x2 Cash – foreign currency 4.2M (100,000 x 42) FOREX loss…………… 200K Accounts receivable…… 4.4M

3.

Jan. 15, 20x2 Forward contract (liability) 300K Cash – local currency… 200K [(42 – 40) x 100,000]

Gain on forward contract . 100K

Solution:

Hedged item – Firm sale commitment

Hedging instrument – Forward contract (Derivative)

Dec. 15, 20x1 No entry

Dec. 15, 20x1 No entry

Dec. 31, 20x1

Dec. 31, 20x1

8

Firm commitment (asset) 20K

Loss on forward contract.. 20K Forward contract (liability).. 20K

[( ₱4 – ₱3.8) x 100K FCUs]

Gain on firm commitment

20K

[( ₱4 – ₱3.8) x 100K FCUs]

Scenario A: Gross settlement – Compound entry Jan. 15, 20x2 Equipment……………… 400K (100,000 x 4 forward rate) Firm commitment (asset).. 20K Cash (foreign currency)… 360K

Jan. 15, 20x2 Cash (foreign currency)….360K Forward contract (liability)… 20K Loss on forward contract…. 20K Cash (local currency)….....400K

(100K FCUs x ₱3.6 spot rate)

Gain on firm commitment... 20K

Scenario B: Net settlement Jan. 15, 20x2 Equipment……………… 400K (100,000 x 4 forward rate) Firm commitment (asset).. 20K Cash (foreign currency)… 360K

Jan. 15, 20x2 Forward contract (liability)… 20K Loss on forward contract…. 20K Cash (local currency)..... 40K

(100K FCUs x ₱3.6 spot rate)

Gain on firm commitment... 20K

4.

Solution:

Hedged item – Firm purchase commitment

Hedging instrument – Forward contract (Derivative)

Oct. 1, 20x1 No entry

Oct. 1, 20x1 No entry

Dec. 31, 20x1 Firm commitment (asset) 3,941 Gain on firm commitment .. 3,941

Dec. 31, 20x1 Loss on forward contract 3,941 Forward contract (liability)... 3,941

(₱100 – ₱96) x 1,000 meters of yarn x PV of 1 @0.5%*, n=3 = 4,000 x 0.985149 = 3,941 * (6% ÷ 12 months) = 0.5% per month

Hedged item – Firm purchase commitment

Hedging instrument – Forward contract (Derivative)

Mar. 31, 20x2

Mar. 31, 20x2

9

Cash………………… 100,000 (100 fixed contract price x 1,000) Sales (92 x 1,000). 92,000

Firm commitment (asset) 3,941 Gain on firm commitment 4,059

5.

Forward contract (liability)... 3,941 Loss on forward contract ….4,059 (8,000 – 3,941)…. Cash [(100 - 92) x 1,000]... 8,000

Solution:

Hedged item – Highly probable forecast transaction

Hedging instrument – Forward contract (Derivative)

Dec. 15, 20x1 No entry

Dec. 15, 20x1 No entry

Dec. 31, 20x1 No entry

Dec. 31, 20x1 Forward contract (asset)… 4K [(100 –96) x 1,000

Accumulated OCI… ……. Jan. 15, 20x2 Cash…………………..92K

Jan. 15, 20x2 Forward contract (asset)… 4K

(1,000 x 92 current spot rate)

[(96 - 92) x 1,000

Sales…………………...……92K

Accumulated OCI… …….

4K

4K

to record the actual purchase transaction

to recognize the change in the fair value of the forward contract

Jan. 15, 20x2 Accumulated OCI… ……….. 8K Sales…………………...…… 8K

Jan. 15, 20x2 Cash ………………………. 8K Forward contract (asset)… 8K

to reclassify accumulated losses on forward contract to profit or loss as an increase in sales

to record the net settlement of the forward contract.

10...