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MATERIAL 14: FOREIGN CURRENCY TRANSACTIONS WITH ANDWITHOUT HEDGING TRANSACTIONSFOREIGN CURRENCY WITHOUT HEDGINGI - Importing TransactionsOn December 1, 2009, Petra Corporation, ordered equipment FOB shipping point from an American Company for US $ 10, 000. The equipment was shipped and invoiced to P...

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MATERIAL 14: FOREIGN CURRENCY TRANSACTIONS WITH AND WITHOUT HEDGING TRANSACTIONS

FOREIGN CURRENCY WITHOUT HEDGING I - Importing Transactions On December 1, 2009, Petra Corporation, ordered equipment FOB shipping point from an American Company for US $ 10, 000. The equipment was shipped and invoiced to Petra on December 16, 2009. Petra paid the invoice on January 15, 2010. Relevant spot rates for US dollars on the respective dates are as follows:

1-Dec-09 16-Dec-09 31-Dec-09 15-Jan-10

Buying Spot Rate P 48.50 P 48.90 P 49.50 P 50.00

Selling Spot Rate P 49.00 P 50.00 P 51.00 P 50.50

Required: 1. Prepare all the entries on Petra Corporation’s books to record the above transactions. 2. Determine the following: a. Foreign Exchange gain or loss on: a.1 December 16, 2009 a.2 December 31, 2009 a.3 January 15, 2010 3. On December 31, 2009: b.1 Accounts payable b.2 Equipment

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II – Exporting Transactions Conrada Exports Corporation, sold merchandise – metal crafts to a Canadian Corporation for a 10, 000 Canadian dollars. Pertinent information on the exchange conversion rates related to this transaction were as follows:

11/16/2009 - receipt of order 12/16/2009 - date of shipment 12/31/2009 - balance sheet date 01/15/2010 - date of collection Required:

Buying Spot Rate P 51.50 P 52.50 P 53.50 P 53.00

Selling Spot Rate P 52.00 P 53.00 P 53.75 P 54.00

1. Prepare all the entries on Conrada Corporation’s books to record the above transactions. 2. Determine the following: a. Foreign Exchange gain or loss on: a.1 December 16, 2009 a.2 December 31, 2009 a.3 January 15, 2010 3. On December 31, 2009: b.1 Accounts receivable b.2 Sales III – Import Ashar, a Philippine Corporation, bought inventory items from a foreign supplier in US on November 5, 2009 for US $ 100, 000, when the spot rate was P41.00. At Ashar’s December 31, 2009 year-end, the spot rate was P 40.50. On January 15, 2010, Ashar bought US $ 100, 000 at the spot rate of P 40.90 and paid the invoice. How much should Ashar report in its income statements for 2009 and 2010 as foreign exchange transaction gain or (loss)? 2009

2010

2009

2010

a.

P (50, 000) P 40, 000

c.

P0

P 10, 000

b.

P 50, 000

d.

P 10, 000

P0

P (40, 000)

IV – Importing and Exporting 2

Bon-Bon Corporation had the following foreign currency transactions during 2009:  Merchandise was purchased from a foreign supplier on January 20, 2009 for the Philippine peso equivalent of P 90, 000. The invoice was paid on March 20, 2009 at the Philippine peso equivalent of P 96, 000.  On July 1, 2009, Bon-Bon borrowed from foreign corporation with a Philippine Peso equivalent of P 500, 000 evidenced by a note that was payable in the lender’s local currency on July 1, 2010. On December 31, 2009, the Philippine peso equivalents of the principal amount and accrued interest were P 520,000 and P 26, 000, respectively. Interest on the note is 10% per annum. In Bon-Bon’s 2009 income statement, what amount should be included as foreign exchange loss? a. P 0 b. P 6, 000

c. d.

P 21, 000 P 27, 000

V – Export On September 1, 2009, Rosan Corporation received an order for equipment from a foreign customer for 300, 000 local currency units (LCU) when the Philippine peso equivalent was P 96, 000. Rosan shipped the equipment on October 15, 2009, and billed the customer for 300, 000 LCU when the Philippine peso equivalent was P 100,000. Rosan received the customer’s remittance in full amount on November 16, 2009, and sold the 300, 000 LCU for P 105, 000. In its income statement for the year ended December 31, 2009, Rosan should report a foreign exchange transaction gain of: a. P 0 b. P 4, 000

c. d.

P 5, 000 P 9, 000

VI – Lending On July 1, 2009, Vir Company lent P 120,000 to a foreign supplier, evidenced by an interest-bearing note due on July 1, 2010. The note is denominated in the currency of the borrower and was equivalent to 840, 000 local currency units (LCU) on that rate. The note principal was appropriately included at P 140,000 in the receivable section of Vir’s December 31, 2009 balance sheet. The note principal was repaid to Vir on July 1, 2010 due date when the exchange rate was 8 LCU to P 1. In its income statement for the year ended, December 31, 2010, what amount should Vir include as a foreign currency transaction gain or loss? 3

a. P 0 b. P 15, 000 loss

c. d.

P 15, 000 gain P 35, 000 loss

VII – Import and Export During July 1, 2009, Petron Corporation had the following transactions with foreign businesses: Date Vendor A:

Nature of Transaction

Billing Currency

Exchange Rate (Direct)

Rupee

P .82 P .83 P .78

Syrian pound

P .95 P .90 P .91

Imported merchandise costing 100, 000 Rupees from Pakistan wholesaler 1-Jul-09 10-Jul-09 31-Jul-09 Custome r A: 15-Jul-09 20-Jul-09 30-Jul-09

Paid 40% of amount owed Paid remaining amount owed

Sold merchandise for 50, 000 pound to Syrian wholesaler Received 20% payment Received the remaining amount owed

1. What is the capitalized cost of inventory purchase from the Pakistan wholesaler? a. P 0 c. P 82, 000 b. P 78, 000 d. P 83, 000 2. What is the foreign exchange gain or loss on July 10, 2009 transaction arising from the Pakistan wholesaler? a. P 1, 000 loss c. P 400 gain b. P 1, 000 gain

d.

P 400 loss

3. What is the foreign exchange gain or loss on July 31, 2009 transaction arising from the Pakistan wholesaler? a. P 4, 000 gain c. P 2, 400 loss b. P 4, 000 loss d. P 2, 400 gain 4. What is the reportable sales amount in the income statement in 2009? a. P 38, 000 c. P 45, 500 b. P 45, 000 d. P 47, 500 5. What is the foreign exchange gain or loss on July 20, 2009 transaction arising from the Syrian wholesaler? a. P 500 gain c. P 2, 500 gain b. P 500 loss d. P 2, 500 loss

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6. What is the foreign exchange gain or loss on July 30, 2009 transaction arising from the Syrian wholesaler? a. P 1, 600 loss c. P 2, 000 gain b. P 1, 600 gain d. P 2, 000 loss FOREIGN CURRENCY WITH HEDGING The spot rates and forward rates for US $ on March 1, 2008, at various times are as follows: Dates

Spot Rate

Forward rates (for 2/1/2009)

March 1, 2008

P 55.00

P 56.00 (11 months)

December 31, 2008

P 55.60

P 56.50 (1 month)

February 1, 2009

P 55.10

 The firm’s fiscal year-end is December 31.  On March 1, 2008, the Philippine firm entered into a forward contract to buy us $10, 000 on February 1, 2009 for P 56.00  For simplicity and focus on the main points of accounting for hedges, interest was not considered noteworthy, thereby assume that the effects of discounting are insignificant – thus, we ignore discounting or present value. VIII - Hedging an Exposed Liability (“Undesignated Hedges” or Hedges does not require Hedge Accounting) A. On March 1, 2008 (date of transaction), a Philippine firm purchased inventory for US $10, 000 payable on February 1, 2009 (settlement date). 1. The fair value (or nominal value) of the forward contract on March 1, 2008 should be: a. P 0 c. P 560, 000 b. P 550, 000 d. P 565, 000 2. What is the notional value of the US $ 10, 000 forward contract? a. P 0 c. P 560, 000 b. P 550, 000 d. P 565, 000 3. The December 31, 2008 profit and loss statement, foreign exchange gain or loss due to hedged item (purchase of inventory) amounted to: a. P 6, 000 gain c. P 5, 000 loss b. P 6, 000 loss d. P 5, 000 gain 4. The December 31, 2008 profit and loss statement, foreign exchange gain or loss due to hedging instrument (forward contract) amounted to: a. P 6, 000 gain b. P 6, 000 loss

c. d.

P 5, 000 loss P 5, 000 gain

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5. What is the net impact on Philippine firm’s December 31, 2008 income as a result of this hedged of an exposed liability? a. P 1, 000 loss c. P 9, 000 gain b. P 1, 000 gain d. P 9, 000 loss 6. The fair value (nominal value) of the forward contract on December 31, 2008 amounted to: a. P 6, 000 asset c. P 5, 000 asset b. P 6, 000 liability

d.

P 5, 000 liability

IX – Hedging an Unrecognized Foreign Currency Firm Commitment (Hedge Accounting Applies) B. On March 1, 2008, Philippine firm contracts to purchase equipment to a foreign customer located in Boston for US $ 10, 000. The equipment is to be delivered and the account is to be settled eleven months later on February 1, 2009. Thus, the transaction and the settlement date are both February 1, 2009. 7. The fair value (nominal value) of the forward contract on March 1, 2008 amounted to: a. P 0 c. P 560, 000 b. P 550, 000 d. P 565, 000 8. The December 31, 2008 profit and loss statement, foreign exchange gain or loss on hedged item/commitment amounted to: a. P 1, 000 loss c. P 5, 000 loss b. P 5, 000 gain d. P 9, 000 loss 9. The December 31, 2008 profit or loss statement, foreign exchange gain or loss on the hedging instrument (forward contract) amounted to: a. P 1, 000 loss c. P 5, 000 loss b. P 5, 000 gain d. P 9, 000 loss 10.The Firm Commitment account as shown in the December 31, 2008 balance sheet as: a. P 5, 000 asset c. P 5, 000 equity b. P 5, 000 liability d. None 11.What was the net impact on the Philippine firm’s December 31, 2008 income as a result of this fair value hedge of a firm commitment? a. P 9, 000 asset c. P 9, 000 equity b. P 9, 000 liability value hedge

d.

None, since it is a fair

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12.What is the amount of accounts payable that will be paid on February 1, 2009? a. P 550, 000 c. P 560, 000 b. P 551, 000 d. P 565, 000 13.What is the net increase or decrease in cash flow from having entered into this forward contract hedge? (NET METHOD) a. Zero b. P 9, 000 increase in cash flow c. P 9, 000 decrease in cash flow d. P 14, 000 increase in cash flow 14.The value of the equipment on February 1, 2009 if the firm commitment account will be adjusted to asset acquired: a. P 550, 000 c. P 560, 000 b. P 551, 000 d. P 565, 000 15.The value of the equipment on February 1,2 009 if the firm commitment account will be a separate adjustment to net income: a. P 550, 000 c. P 560, 000 b. P 551, 000 d. P 565, 000 X – Cash Flow Hedge: Forecasted Purchase Transaction C. On March 1, 2008, a Philippine firm estimates or forecasted the purchase of 5, 000 units of inventory from the United States. The purchase would probably occur on February 1, 2009 and require the payment of US $ 10, 000. It is anticipated that the inventory could be further processed and delivered to customers by early April 1, 2009. The company enters into a forward contract to purchase US $ 10,000 on February 1, 2009 for P 56. 16.The December 31, 2007 foreign exchange gain of forward contract amounted to: a. P 14, 000 currently in earnings b. P 5, 000 currently in earnings c. P 14, 000 other comprehensive income d. P 5, 000 other comprehensive income 17.On February 1, 2009, foreign currency exchange loss on forward contract amounted to: a. P 9, 000 other comprehensive income b. P 14, 000 currently in earnings c. P 5, 000 other comprehensive income d. P 9, 000 currently in earnings

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18.At what amount the inventory (purchase) is carried on the Philippine firm’s books on February 1, 2009 if the exchange differential will be a separate adjustment to net income? a. P 550, 000 c. P 560, 000 b. P 551, 000 d. P 565, 000 19.Suppose that in April 2009, the inventory was sold for P 600, 000, what would be the gross profit assuming any adjustments (if any) regarding exchange differential will be thru Cost of Goods Sold account: a. P 58, 000 c. P 40, 000 b. P 41, 000 d. P 31, 000 20.Suppose that premium or discount is allowed to be recognized by the firm, what amount does Philippine firm report in net income as a result of this cash flow hedge of a forecasted transaction/ the effects on net income from these transactions? a. P 10, 000 Discount Expense plus a P 9,000 negative Adjustment to Net Income when the merchandise is received. b. P 10, 000 Discount Expense plus a P 9,000 positive Adjustment to Net Income when the merchandise is received. c. P 10, 000 Premium Expense plus a P 9,000 negative Adjustment to Net Income when the merchandise is received. d. P 10, 000 Premium Expense plus a P 9,000 positive Adjustment to Net Income when the merchandise is received. XI - Speculation D. A Philippine firm entering into speculative purposes in anticipation for a gain, enters into a contract on March 1, 2008 to acquire U $ 10, 000 on February 1, 2009, a currency in which the company has no receivables, payables or commitments. 21.The December 31, 2008 profit and loss statement, foreign exchange gain or loss due to hedging instrument (forward contract) amounted to: a. P 14, 000 loss c. P 5, 000 loss b. P 5, 000 gain d. P 14, 000 gain 22.On February 1, 2009, foreign exchange gains or loss on forward contract amounted to: a. P 14, 000 loss c. P 5, 000 loss b. P 5, 000 gain d. P 14, 000 gain XII – With Present Value: Hedging an Exposed Liability Stark, Inc. placed an order for inventory costing 500,000 foreign currency (FC) with a foreign vendor on April 15 when the spot rate was 1 FC = P 0.683. Stark received the goods on May 1 when the spot rate was 1 FC = P 0.687. Also, on May 8

1, Stark entered into 90-day forward contract to purchase 500,000 FC at a forward rate of 1 FC = P 0.693. Payment was made to the foreign vendor on August 1 when the spot rate was 1 FC = P 0.696. Stark has a June 30 year-end. In that date, the spot rate was 1 FC = P 0.691, and the forward rate on the contract was 1 FC = P 0.695. Changes in the current value of the forward contract are measured as the present value of the changes in the forward rates over time. The relevant discount rate is 6%. 1. The foreign exchange gain on hedging instrument (forward contract) on June 30 amounted to: a. P 2, 000 c. P 995 b. P 1, 000 d. Zero 2. The net income effect on June 30 amounted to: a. P 2, 000

c.

P 1, 005

b. P 1, 000

d.

P 995

3. The foreign exchange gain due to hedging instrument (forward contract) on August 1 amounted to: a. P 2, 500 c. P 1, 500 b. P 2, 000 d. P 505 XIII – Call Option Contracts: Hedging an Exposed Liability On December 31, 2008, Optix Company paid cash to purchase 90-day “at-themoney” call option for 500, 000 Thailand baht. The option’s purpose is to protect an exposed liability of 500 000 Thailand baht relating to an inventory purchase receive on December 1, 2008 and to be paid on March 1, 2009. 12/1/200 12/31/200 3/1/200 8 8 9 Spot rate (market price) Strike price (exercise price) Fair value of call option

P 1.20

P 1.28

P 1.27

P 1.20

P 1.20

P 3, 000

P 42, 000

P 1.20 P 35, 000

1. The notional amount of the option should be: a. 500, 000 Thailand baht c. P 35, 000 b. P 3, 000 d. P 42, 000 2. The fair value of the call option on December 1, 2008? a. P 0 c. P 35, 000 b. P 3, 000 d. P 42, 000 9

3. What is the intrinsic value (IV) and time value (TV) of option on December 1, 2008? Intrinsic Value Time Value Intrinsic Value Time Value a. P 0 P 0 c. P 35, 000 P 0 b. P 2, 000 P 40, 000 d. P0 P 3, 000 4. What is the intrinsic value (IV) and time value (TV) of option on December 31, 2008? Intrinsic Value Time Value Intrinsic Value Time Value a. P 40, 000 P 2, 000 c. P 3, 000 P0 b. P 2, 000 P 40, 000 d. P0 P 3, 000 5. What is the intrinsic value (IV) and time value (TV) of option on March 1, 2009? Intrinsic Value Time Value Intrinsic Value Time Value a. P 42, 000 P 0 c. P 35, 000 P 0 b. P 40, 000 P 2, 000 d. P0 P 35, 000 6. The foreign exchange gain or loss on option contract (hedging instrument) on December 31, 2008 if changes in the time value will be included from the assessment of hedge effectiveness (non-split accounting) should be: a. P 1, 000 loss c. P 39, 000 gain b. P 1, 000 gain d. P 40, 000 gain 7. The foreign exchange gain or loss on option contract (hedging instrument) due to change in time value on December 31, 2008 if changes in the time value will be excluded from the assessment of hedge effectiveness (split accounting) should be: a. P 1, 000 loss c. P 39, 000 gain b. P 1, 000 gain d. P 40, 000 gain 8. The foreign exchange gain or loss on option contract (hedging instrument) due to change in intrinsic value on December 31, 2008 if changes in the time value will be excluded from the assessment of hedge effectiveness (split accounting) should be: a. P 1, 000 loss c. P 39, 000 gain b. P 1, 000 gain

d.

P 40, 000 gain

9. The December 31, 2008 foreign exchange gain or loss amounted to: a. P 0 c. P 1, 000 loss b. P 1, 000 gain d. P 40, 000 gain 10.The March 1, 2009 expiration date, foreign exchange gain or loss amounted to: a. P 0 c. P 2, 000 loss b. P 2, 000 gain d. P 5, 000 gain XIV – Put Option Contracts: Hedging a Foreign Currency Firm Commitment 10

On September 1, 2009, Jensen Company received an order to sell a machine to a customer in Japan at a price of 100, 000 yens. Jensen shipped the machine and received payment on March 1, 2010. On September 1, 2009, Jensen purchased a put option giving it the right to sell 100, 000 yens on March 1, 2010, at a price of P 80, 000. Jensen properly designated the option as a fair value hedge of the Japanese yen firm commitment. The option cost P 2, 000 and had a fair value of P 2, 300 on December 31, 2009. The fair value of the firm commitment was measured by referring to changes in the spot rate. The following spot exchange rates apply: Dates Sept. 1, 2009 Dec. 31, 2009 March. 01, 2010

Philippine Peso per Japanese Yen P 0.80 P 0.79 P 0.77

1. The notional amount of the put option should be: a. 100, 000 yens c. P 2, 300 b. P 80, 000 d. P 2, 000 2. The fair value (nominal value) of the put option on September 1, 2009? a. P 0 c. P 2, 300 b. P 2, 000 d. P 3, 000 3. What is the intrinsic value (IV) and time value (TV) of option on September 1, 2009? Intrinsic Value Time Value Intrinsic Value Time Value a. P 0 P 2, 300 c. P 2, 300 P 2, 000 b. P 2, 000 P0 d. P0 P 2, 000 4. What is the intrinsic value (IV) and time value (TV) of option on December 31, 2009? Intrinsic Value Time Value Intrinsic Value Time Value a. P 1, 000 P 1, 300 c. P 1, 300 P 1, 000 b. P 2, 300 P 1, 000 d. P0 P 2, 300 5. What is the intrinsic value (IV) and time value (TV) of option on March 1, 2010? Intrinsic Value Time Value Intrinsic Value Time Value a. P 3, 000 P0 c. P 2, 300 P0 b. P 0 P 3, 000 d. P 2, 000 P0 6. What was the net impact on Jensen Company’s 2009 income as a result of this fair value hedge of a firm commitment? a. P 0 b. P 680.30 decrease in income 11

c. P 300 increase in income d. P 980.30 increase in net income 7. What was the net impact on Jensen Company’s 2010 income as a result of this fair value hedge of a firm commitment? a. P 0 b. P 1, 319.70 decrease in income c. P 77, 980.30 increase in income d. P 78, 680.30 increase in net income 8. 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. P 0 b. P 1, 319.70 decrease in income c. P 77, 980.30 increase in income d. P 78, 680.30 increase in net income XV – Put Option Contracts: Hedging a Forecasted Transaction – Hedge Accounting Applies (Split Accounting: Exclude the time value element in assessing hedge effectiveness) On June 1, the company forecasted the purchase the purchase of 5, 000 units of inventory from a foreign vendor. The purchase would probably occur on September 1 and require the payment of 100, 000 forei...