Exam 22: Derivatives and Related Accounting Issues

Jensen Company forecasts a need for 200,000 pounds of cotton in May.On April 11, the company acquires a call option to buy 200,000 pounds of cotton in May at a strike price of $0.3765 per pound for a premium of $814.Spot prices and options values at selected dates follow: ? ? April 11 April 30 May 3 Spot price per pound \ 0.3718 \ 0.3801 \ 0.3842 Fair value of option 814 1,137 1,689 Jensen Company settled the option on May 3 and purchased 200,000 pounds of cotton on May 17 at a spot price of $0.3840 per pound.During the last half of May and the beginning of June the cotton was used to produce cloth.One third of the cloth was sold in June.The change in the option's time value is excluded from the assessment of hedge effectiveness. ? Required: ? a.Prepare all journal entries necessary through June to record the above transactions and events.? ? b.What would the effect on earnings have been if the forecasted purchase were not hedged?

On May 1 of the current year, Orr Company purchases a call option on 15,000 bushels of corn with delivery in July for a premium of $1,200 and a strike price of $3.05 per bushel.The values of the option at the end of May and June are $1,125 and $1,007, respectively.The option is sold on July 7th for $1,133.Orr Company prepares monthly financial statements.

On August 1, an oil producer decided to hedge the fair value of its inventory by acquiring a futures contract to sell 100,000 barrels of oil on November 1 for $85.00 each.Price data follow: ? Spot Price Futures Price August 1 \ 84.00 \ 85.00 September 1 82.80 83.50 October 1 82.20 82.40 November 1 81.00 81.00 What is the current period change in time value that would be recognized in earnings as of October 1?

At the beginning of 20X5, a derivative loss associated with a forecasted purchase of equipment will plus the expected cost of the equipment is $211,000.The fair value of the equipment is $199,000.The equipment has a useful life of 5 years.

On May 11, McElroy Inc.purchased a call option on 5,000 bushels of wheat with delivery on August 31 for a premium of $750.The strike price is $1.85 per bushel.The values of the option at the end of May and June are $790 and $810, respectively.The option is sold on July 26 for $804.McElroy Inc.prepares quarterly and annual financial statements.Its year end is June 30.McElroy Inc.will

Which of the following is not true regarding using an option to hedge financial risks versus a forward contract?

A swap

A futures contract

Interest rate swaps

On February 1, Durham Company writes a forward contract to sell Rubright Company 3,000,000 yen at a specific, fixed price of $0.00875 per yen with delivery in 60 days.The spot rate at the end of the 60 days is $0.00913 per yen.The following is the forward rates information throughout the 60-day term. ? Assume the discount rate is 7%. Remaining Term of Contract Forward Rate Notional Amount 60 days \ 0.00875 3,000,000 30 days 0.00891 3,000,000 0 days 0.00913 3,000,000 ? Required: ? a.Compute the gain or loss for Rubright Company over the life of the contract.? ? b.Assume the contract is settled at the end of the 60 days, prepare the journal entries to account for this contract on Rubright's books.

On January 1, 20X3, Shuey Company borrowed $1,000,000 at a variable rate based on LIBOR + 1.5% for 10 years with interest payable semi-annually.Shuey anticipates that interest rates will rise and has also arranged to receive a variable rate based on LIBOR + 1.5% in exchange for the payment of a 10% rate of interest.LIBOR rates were as follows on the reset dates: ? LIBOR rate FV of swap January 1,203 8.5\% July 1,203 8.7\% \ 40,000 January 1,204 8.8\% \ 37,000 How much interest expense is recognized for the six months ended December 31, 20X3?

Both forward contracts and futures contracts provide for the receipt or payment of a specific amount of an asset at a specific price with delivery at a specified future point in time.Which combination of characteristics is true for a futures contract? ? Subject to Subject to margin call discounting A) No No B) No Yes C) Yes No D) Yes Yes

A critical characteristic of a derivative is that the instrument

Which of the following statements is true?

On June 30, 20X5, Adams Company had a $500,000, 7.4% fixed rate note due in 2 years.The note has been outstanding since May 26, 20X4 and the interest on the note is paid on June 30 and December 31 each year.The controller of Adams believed that interest rates would drop over the next two years, so he entered into a 2-year swap with Belmont National Bank to convert the fixed-rate note into a variable-rate note.According to the agreement, Adams Company will receive interest at a fixed rate of 7.4% and will pay a variable rate as determined by LIBOR.The LIBOR on June 30, 20X5 was 7.1%.The swap agreement calls for the variable rate to be reset each six months.The swap fair value on December 31, 20X5 was $6,300. Required: a.Present the journal entries, if any, to record the following events: 1.The entry to record the swap on June 30, 20X5. 2.The entries to record the semiannual interest payment on the debt and the settlement of the semiannual swap on December 31, 20X5. 3.The entries to record changes in fair value required by the above information on December 31, 20X5. b.Present a partial balance sheet and income statement for the fiscal year ended December 31, 20X5 to include accounts affected by the above information. Required: ​ a.Present the journal entries, if any, to record the following events: ​ ​ ​

The gains and losses from cash flow hedges are recorded in OCI until the impact of the hedged item in included in earnings.

Explain how a derivative instrument may be used to reduce or avoid the exposure to risk associated with other transactions.

A hedge to avoid the potential unfavorable effects of changing prices associated with all of the following would qualify for special fair value hedge accounting except:

Based on the relationship between the strike price and the current price, an option may be at-the-money, out-of-the-money or in-the-money.Which of the following statements is true?

On August 9, Jacobs Company buys 25 contracts on Nymex to receive December delivery of Brent Crude Oil.Each contract is in units of 1,000 bbls at a futures price of $24.85 per bbl.The initial margin on the contract is set at $25,000, with a maintenance margin of $19,000.The futures prices are as follows: ? ? Aug. 9 Aug. 10 Aug. 11 \ 24.85 \ 24.63 \ 24.56 Required: ? a.Journalize the entries for Jacobs Company for the first three days of the contract.? ? b.Why are forward prices discounted and future prices are not discounted?