Exam 9: Foreign Currency Transactions and Hedging Foreign Exchange Risk

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: Date Spot Rate October 1, 2011 \ 2.00 December 31, 2011 \ 1.97 February 1,2012 \ 2.01 -What journal entry should Eagle prepare on December 31, 2011? A) Foreign Currency Option 200 Cash 200 B) Foreign Currency Option 200 Option Revenue 200 C) Foreign Currency Option 400 Option Revenue 400 D) Option Expense 200 Foreign Currency Option 200 E) Option Expense 400 Foreign Currency Option 400

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.

A U.S. company sells merchandise to a foreign company denominated in U.S. dollars. Which of the following statements is true?

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. -What amount should be included as a foreign exchange gain or loss from the two transactions for 2011?

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: Date Spot Rate Option Premium December 1,2011 \ .97 \ .05 December 31,2011 \ .95 \ .04 February 1,2012 \ .94 \ .03 -Compute the fair value of the foreign currency option at December 31, 2011.

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) Increase Decrease B) Decrease Decrease C) Decrease Increase D) No change Decrease E) Increase Increase

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. -(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.

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: Date Spot Rate October 1, 2011 \ 2.00 December 31, 2011 \ 1.97 February 1,2012 \ 2.01 -What is the amount of Cost of Goods Sold for 2012 as a result of these transactions?

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: May 8 Spot rate: \ 1.25 May 31 Spot rate: \ 1.26 Jun. 7 Spot rate: \ 1.20 -How much US $ will it cost Brisco to finally pay the payable on June 7?

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

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?

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: May 8 Spot rate: \ 1.25 May 31 Spot rate: \ 1.26 Jun. 7 Spot rate: \ 1.20 -For what amount should Brisco's Accounts Payable be credited on May 8?

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

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)

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: Date Spot Rate Option Premium December 1,2011 \ .97 \ .05 December 31,2011 \ .95 \ .04 February 1,2012 \ .94 \ .03 -Compute the fair value of the foreign currency option at December 1, 2011.

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: Date Spot Rate March 1, 2011 \ 1.90 December 31, 2011 \ 1.89 March 1, 2012 \ 1.84 Mattie's incremental borrowing rate is 12 percent, and the present value factor for two months at a 12 percent annual rate is .9803. -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?

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: Date Spot Rate March 1, 2011 \ 1.90 December 31, 2011 \ 1.89 March 1, 2012 \ 1.84 Mattie's incremental borrowing rate is 12 percent, and the present value factor for two months at a 12 percent annual rate is .9803. -What was the net impact on Mattie's 2012 income as a result of this fair value hedge of a firm commitment?

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: Date Spot Rate March 1, 2011 \ 1.90 December 31, 2011 \ 1.89 March 1, 2012 \ 1.84 Mattie's incremental borrowing rate is 12 percent, and the present value factor for two months at a 12 percent annual rate is .9803. -What was the net impact on Mattie's 2011 income as a result of this fair value hedge of a firm commitment?

Coyote Corp. (a U.S. company in Texas) had the following series of transactions in a foreign country during 2011: Mar. 1 Bought inventory costing 60,000 pesos on credit. May 1 Sold 60\% of the inventory for 54,000 pesos on credit. Aug. 1 Collected 48,000 pesos from customers Sept. 1 Paid 36,000 pesos to creditors The appropriate exchange rates during 2011 were as follows: Exchange Date Rate March 1, 2011 \ .20=1 peso May 1, 2011 \ .22=1 peso August 1,2011 \ .23=1 peso September 1,2011 \ .24=1 peso December 31,2011 \ .25=1 peso -What amount will Coyote Corp. report in its 2011 balance sheet for Inventory?

Which of the following approaches is used in the United States in accounting for foreign currency transactions?