Deck 13: Accounting for Derivatives and Hedging Activities

Question 1

Barnes Company entered into a forward contract during the current year to hedge the risk of a material supply cost increase.Based on the current market,at year-end the present value of the estimated amount they will have to pay in ten months is $750,000.What entry would be recorded at year-end closing,assuming that no amount was recorded for this contract until this time?

A)
B)
C)
D)

Answer 1

D

Question 2

Cirtus Corporation,a U.S.corporation,placed an order for inventory from a Mexican supplier on September 18 when the spot rate was $0.0840 = 1 peso.The invoice price will be denominated in pesos.At that time,they entered into a 30-day forward contract (designated as a fair value hedge of the firm commitment to purchase)to purchase 860,000 pesos at a forward rate of $0.0810.On October 18 when the inventory was received,the spot rate was $0.0890.At what amount should the inventory be carried on Cirtus' books?

A)$69,660
B)$72,240
C)$76,540
D)$860,000

Answer 2

A
Explanation: A)Inventory = 860,000 × .081 = $69,660

Question 3

A highly-effective hedge of an existing asset or liability that is reported on the balance sheet would be recorded using

A)Modified Cash Basis Accounting.
B)Critical Term Hedge Analysis.
C)Fair Value Hedge Accounting.
D)Hedge of Net Investment in Foreign Subsidiary.

Answer 3

C

Question 4

A fair value hedge differs from a cash flow hedge because a fair value hedge

A)cannot be used for firm purchase or sales commitments.
B)is not recorded unless it is a highly-effective hedge.
C)records gains or losses in the value of the derivative directly to earnings of the company.
D)defers the gains or losses in the value of the derivative using Other Comprehensive Income.

Question 5

If a financial instrument is classified as a cash flow hedge,then

A)its gains or losses are reported in the income statement if a fiscal year-end occurs before the settlement date.
B)it is classified as a held-to-maturity asset.
C)it does not require a notional amount.
D)its gains or losses are reported in the balance sheet if a fiscal year-end occurs before the settlement date.

Question 6

The purchase price of an option contract is typically recorded as

A)an expense.
B)an asset.
C)an amortized cost.
D)a component of shareholders equity.

Question 7

A forward contract used as a cash flow hedge will be recorded as an asset if

A)the holder is expecting to receive a payment as a result of the contract.
B)the holder is accounting for the hedged instrument as a fair value hedge.
C)the holder is hedging the net investment in a foreign entity.
D)the holder is using the alternate accounting method and deferring all gains or losses from the hedge.

Question 8

Use the following information to answer the question(s)below.
On November 2,2011,Bellamy Corporation sells product to their Danish customer.At the same time,Bellamy signed a forward contract to sell 200,000 Danish krone in ninety days to hedge the account receivable at $0.1905,the 90-day forward rate.The receivable is expected to be collected in ninety days.Assume the forward contract will be settled net and this is a fair value hedge.The related exchange rates are shown below:

Assuming a present value factor of 1 for simplicity,what is the fair value of this forward contract on December 31?

A)$160 asset
B)$160 liability
C)$140 asset
D)$140 liability

Question 9

When a cash flow hedge is appropriate,the effective portion of the gain or loss on the derivative is

A)deferred using other comprehensive income.
B)recognized immediately at the time the agreement is made.
C)recognized over time,amortized over the period of the agreement.
D)recognized over time,offset by the fluctuation in the value of the hedged asset or liability.

Question 10

Which of the following hedging strategies would a business most likely use?

A)An importer will want to hedge his foreign denominated accounts receivable and will purchase forward contracts to hedge an exposed net asset position.
B)An importer will want to hedge his foreign denominated accounts payable and will purchase forward contracts to hedge an exposed net liability position.
C)An exporter will want to hedge his foreign denominated accounts receivable and will purchase forward contracts to hedge an exposed net liability position.
D)An exporter will want to hedge his foreign denominated accounts payable and will purchase forward contracts to hedge an exposed net liability position.

Question 11

Which of the following is not an approach appropriate for hedge accounting?

A)Cash Flow Hedge Accounting
B)Critical Term Hedge Accounting
C)Fair Value Hedge Accounting
D)Hedge of Net Investment in Foreign Subsidiary

Question 12

When preparing their year-end financial statements,the Warner Company includes a footnote regarding their hedging activities during the year.Which of the following is not required to be disclosed?

A)How hedge effectiveness is determined and assessed
B)The specific types of risks being hedged,and how they are being hedged
C)Alternative hedging options declined
D)The net gain or loss reported for the period for fair value hedges and where in the financial statements it is reported

Question 13

Use the following information to answer the question(s)below.
On November 2,2011,Bellamy Corporation sells product to their Danish customer.At the same time,Bellamy signed a forward contract to sell 200,000 Danish krone in ninety days to hedge the account receivable at $0.1905,the 90-day forward rate.The receivable is expected to be collected in ninety days.Assume the forward contract will be settled net and this is a fair value hedge.The related exchange rates are shown below:

Assuming a present value factor of 1 for simplicity,what is the fair value of this forward contract on January 31?

A)$-0-
B)$ 60 asset
C)$160 liability
D)$200 liability

Question 14

On May 1,2011,Listing Corporation receives inventory items from their Bulgarian supplier.At the same time,Listing signed a forward contract to purchase 75,000 Bulgarian lev in sixty days to hedge the inventory purchase at $0.738,the 60-day forward rate.Payment for the inventory will be due in sixty days in Bulgarian lev.Assume the forward contract will be settled net and this qualifies as a fair value hedge.The related exchange rates are shown below: Assuming a present value factor of 1 for simplicity,what is the fair value of this forward contract on May 31?

A)$150 asset
B)$150 liability
C)$375 asset
D)$375 liability

Question 15

International accounting standards differ from U.S.Generally Accepted Accounting Principles in that International standards

A)require that firm sale or purchase commitments are accounted for as fair value hedges.
B)require that firm sale or purchase commitments are accounted for as cash flow hedges.
C)state that firm sale or purchase commitments may not be treated as a hedged transaction.
D)permit firm sale or purchase commitments to be accounted for as either fair value hedges or cash flow hedges.

Question 16

Use the following information to answer the question(s)below.
On November 2,2011,Bellamy Corporation sells product to their Danish customer.At the same time,Bellamy signed a forward contract to sell 200,000 Danish krone in ninety days to hedge the account receivable at $0.1905,the 90-day forward rate.The receivable is expected to be collected in ninety days.Assume the forward contract will be settled net and this is a fair value hedge.The related exchange rates are shown below:

Assuming a present value factor of 1 for simplicity,what is the fair value of this forward contract on November 2?

A)$-0-
B)$100 asset
C)$100 liability
D)$38,100 asset

Question 17

Use the following information to answer the question(s)below.
On December 1,2011,Thomas Company,a U.S.corporation,purchases inventory from a vendor in Italy for 400,000 euros.Payment is due in 90 days.To hedge the transaction,Thomas signs a forward contract to buy 400,000 euros in 90 days at $1.3670.Thomas uses a discount rate of 6% (present value factor for 30 days = .9950;60 days = .9901;90 days = .9851).Assume the forward contract will be settled net and this is a cash flow hedge.Currency exchange rates are shown below:

What is the fair value of the forward contract at February 29?

A)$-0-
B)$1,654.97 asset
C)$1,654.97 liability
D)$1,680 asset

Question 18

Use the following information to answer the question(s)below.
On December 1,2011,Thomas Company,a U.S.corporation,purchases inventory from a vendor in Italy for 400,000 euros.Payment is due in 90 days.To hedge the transaction,Thomas signs a forward contract to buy 400,000 euros in 90 days at $1.3670.Thomas uses a discount rate of 6% (present value factor for 30 days = .9950;60 days = .9901;90 days = .9851).Assume the forward contract will be settled net and this is a cash flow hedge.Currency exchange rates are shown below:

What is the fair value of the forward contract at January 30?

A)$796 liability
B)$796 asset
C)$800 liability
D)$800 asset

Question 19

Use the following information to answer the question(s)below.
On December 1,2011,Thomas Company,a U.S.corporation,purchases inventory from a vendor in Italy for 400,000 euros.Payment is due in 90 days.To hedge the transaction,Thomas signs a forward contract to buy 400,000 euros in 90 days at $1.3670.Thomas uses a discount rate of 6% (present value factor for 30 days = .9950;60 days = .9901;90 days = .9851).Assume the forward contract will be settled net and this is a cash flow hedge.Currency exchange rates are shown below:

What is the fair value of the forward contract at December 31,2011?

A)$400.00 liability
B)$400.00 asset
C)$396.04 liability
D)$396.04 asset

Question 20

Taydus Corporation,a U.S.corporation,sold goods on December 2 to a company overseas,and is now carrying a receivable denominated in euros.Taydus signed a 60-day forward contract on that same date to sell euros.The spot rate was $1.40 on the date they signed the contract and the 60-day forward rate was $1.36.At the end of that month when they closed the books at their fiscal year-end,the spot rate was $1.42 and the 30-day forward rate was $1.40.Assume this is a fair value hedge.The forward contract will not be settled net.What would be reported by Taydus for the year ending December 31?

A)Net exchange gain
B)Net exchange loss
C)Deferred exchange gain
D)Deferred exchange loss

Question 21

On June 1,2011,Dapple Industries purchases an option contract for $5,000 on 10,000 gallons of aviation gas to minimize its purchasing cost price exposure.At the time,the market price is $2.50 per gallon and the option price of $2 per gallon will expire 6 months later.Dapple can exercise the option at its discretion.When Dapple prepares quarterly reports on June 30,Dapple is still holding the option.On June 30,the market price of aviation gas is $4.50 per gallon.The option is to be settled net.
On August 1,Dapple exercises the option when the gas market price is $5.00 per gallon and purchases 40,000 gallons of gas.On August 15,Dapple uses all of the gas on a charter flight.
Required:
What are Dapple's journal entries with regard to the aviation gas option? Assume this is a cash flow hedge.Ignore the time value of money.

Question 22

On November 1,2010,Ironside Company (a U.S.manufacturer)sold an airplane for 1 million New Zealand dollars (NZ$)to a New Zealand company,Wellington Corporation.Ironside will receive payment on January 30,2011 in New Zealand dollars.In order to hedge the accounts receivable position,Ironside entered into a 90-day forward contract on November 1,2010 to sell 1 million New Zealand dollars.On November 1,2010,the forward rate is US$0.79 per New Zealand dollar.The forward contract will be settled net.This is a fair value hedge.Ignore the time value of money.
The relevant exchange rates per New Zealand dollar:
Required:
Record the journal entries that Stateside would need to prepare at November 1,2010,December 31,2010 and January 30,2011.
December 31 is the fiscal year end.

Question 23

On January 1,2011,Bambi borrowed $500,000 from Lonni.The five-year term note carries a variable rate interest,based on LIBOR,and interest is payable at December 31 of each year,compounded annually.The first year's rate of interest is 6% and Bambi would like to assure that their rate does not increase.Bambi enters into a pay-fixed,receive-variable interest rate swap agreement with Third National Bank,under which Bambi will pay 6%,fixed.At December 31,2011,it is determined that Bambi's interest rate to Lonni for the next year will be 5%.Treat as a cash flow hedge.
Required:
Determine the estimated fair value of the hedge at December 31,2011,and prepare the related journal entry required to document this hedge and the related interest payment at December 31,2011.Assume the interest rate curve is flat.

Question 24

Ivan has 14,000 barrels of oil that were purchased a month ago at $50.00 per barrel.On November 1,2011 Ivan hedges the value of the inventory by entering into a forward contract to sell 14,000 barrels of oil on January 31,2012 for $60.00 per barrel.The forward contract is to be settled net.
Assume this is a fair value hedge.
Required:
Assume a 6% discount rate is reasonable,and using a mixed-attribute model,prepare the journal entries to account for this hedge at the following dates:

Question 25

On January 1,2011,Bosna borrowed $100,000 from Lenda.The three-year term note carries a variable rate interest,based on LIBOR,and interest is payable at December 31 of each year,compounded annually.The first year's rate of interest is 7% and Bosna would like to assure that their rate does not increase.Bosna enters into a pay-fixed,receive-variable interest rate swap agreement with Swamp City Bank,under which Bosna will pay 7%,fixed.At December 31,2011,it is determined that Bosna's interest rate to Lenda for 2012 will be 6%.At December 31,2012,the interest rate for 2013 was determined to be 8%.Treat as a cash flow hedge.
Required:
Determine the estimated fair value of the hedge at December 31,2011,and prepare the related journal entries required to document this hedge and the related interest payments at December 31,2011,2012,and 2013,including final repayment on 12/31/13.Assume a flat interest rate curve.

Question 26

Onoly Corporation (a U.S.manufacturer)sold parts to its customer in Hong Kong on December 8,2011 with payment of 500,000 Hong Kong Dollars (HKD)to be received in sixty days on February 6,2012.Onoly has a December 31 year end.The following exchange rates apply:
Required:
1.Assuming no forward contract is taken,what is the amount of foreign currency exchange gain or loss that would be recorded in 2011,and in 2012?
2.Assuming a 60-day forward contract is taken on December 8 with the intent of hedging this foreign currency transaction,and that this hedge is properly accounted for as a cash flow hedge,what is the net effect on income to be recorded in 2011,and in 2012?

Question 27

On March 1,2011,Amber Company sold goods to a foreign customer at a price of 50,000 foreign currency units.The customer will pay in three months.At the time of the sale,Amber paid $2,000 to acquire an option to sell 50,000 foreign currency units in three months at the strike price of $0.39.On May 30,2011,the customer sent in 50,000 foreign currency units.Quarterly financial reports are prepared on March 31.Ignore the time value of money.Relevant exchange rates are as follows:
Required:
Prepare the journal entries required for these transactions,if the foreign currency option is designated as a fair value hedge.

Question 28

On December 18,2011,Wabbit Corporation (a U.S.Corporation)has a Forward Contract recorded on their ledger as a debit balance of $17,500.The forward contract was related to a purchase of electronic components purchased overseas,which were going to be re-sold in the United States.On December 20,the forward contract was settled with a payment of $20,000,and the related parts which cost $118,000 were sold for $160,000 cash.The forward contract is set up to lock in the price for the electronic components when they are sold.The forward contract was settled net.Assume this is a cash flow hedge.
Required:
Prepare the journal entries required by Wabbit on December 20.

Question 29

Wild West,Incorporated (a U.S.corporation)sold inventory to a company in the Philippines for 1,600,000 pesos on account on February 1,2011,with payment expected in 90 days.Wild West entered into a forward contract to hedge this transaction,and properly accounts for the transaction as a cash flow hedge.Wild West has a March 31 fiscal year end,and uses an 8% discount rate,resulting in a 30-day present value factor of .9934.The forward contract is settled net.The relevant exchange rates are shown below:
Required:
Record the journal entries needed by Wild West on February 1,March 31,and May 2.Round all entries to the nearest whole dollar.

Question 30

On November 1,2010,Stateside Company (a U.S.manufacturer)sold an airplane for 1 million New Zealand dollars (NZ$)to New Zealand company Aukland Corporation.Stateside will receive payment on January 30,2011 in New Zealand dollars.In order to hedge the accounts receivable position,Stateside entered into a 90-day forward contract to sell 1 million New Zealand dollars on January 30,2011.On November 1,2010,the 90-day forward rate is US$0.73 per New Zealand dollar.The forward contract will be settled net.Account for the hedge as a fair value hedge.Ignore the time value of money.
The relevant exchange rates per New Zealand dollar:
Required:
Record the journal entries that Stateside would need to prepare at November 1,2010,December 31,2010 and January 30,2011.
December 31,2010 is the fiscal year end.

Question 31

On November 1,2010,Mayberry Corporation,a U.S.corporation,purchased from Cantata Corporation,a Mexican company,some machinery that cost 1,000,000 pesos.The invoice was payable in pesos on January 30,2011.To hedge against rapid changes in the peso,Mayberry entered into a forward contract on November 1,2010 with AB Trader & Company,a US brokerage and investment firm.The contract specified that Mayberry would buy 1,000,000 pesos from AB Trader at $0.084 per peso for settlement on January 30,2011.
Assume that all three companies are subject to the same accounting standards and have December 31st year-ends.The spot rates for pesos on November 1,December 31,and January 30,are $0.082,$0.080,and $0.089,respectively.The 30-day forward rate for pesos on December 31,2010 is $0.083.The forward contract is not settled net.
Required:
Record General Journal entries for Mayberry Corporation on November 1,December 31,and January 30.If no entry is required on a particular date,indicate "No entry" in the General Journal.This is a fair value hedge.

Question 32

On November 1,2011,Portsmith Corporation,a calendar-year U.S.corporation,invested in a purely speculative contract to purchase 1 million yen on January 30,2012,from the Karoke Trading Company,a Japanese brokerage firm.Portsmith agreed to purchase 1,000,000 yen from Karoke at a fixed price of $0.0100 per yen.Karoke agreed to transmit 1,000,000 yen to Portsmith on January 30.Net settlement is not permitted.The spot rates for yen are:
The 30-day forward rate for yen on December 31,2011 was $0.0104.
Required:
Prepare the General Journal entries that Portsmith would record on November 1,December 31,and January 30.

Question 33

Ferb Company is a U.S.-based importer of fine fabrics.They periodically place orders with an Italian manufacturer for bolts of fabric at a price typically set in euros.Because they have business on an ongoing basis in euros,Ferb also enters into forward contracts to speculate on the Euro.On September 15,Ferb entered into a 45-day forward contract to purchase 2,000,000 euros.Ferb has a year-end of September 30.The forward contract cannot be settled net.Relevant exchange rates are shown below:
Required:
Prepare the journal entries to account for the forward contract for September and October.

Question 34

On December 15,2011,Electronix Company purchased inventory from a foreign supplier for 2,000,000 foreign currency units (fcu's).Payment will be made on February 13,2012.On December 15,2011,to hedge the transaction,Electronix signed a forward contract to buy 2,000,000 fcu's in 60 days.Electronix uses a discount rate of 5% resulting in a 45-day present value factor of .9938.The forward contract will be settled net.The related exchange rates are shown below:
On December 15,2011,Electronix recorded a debit to Inventory and a credit to Accounts Payable (fcu)for $20,000,using the current spot rate.
Required:
1.Show the required entries on December 31,2011 if the hedge is a cash flow hedge.Round to the nearest whole dollar.
2.Show the required entries on December 31,2011 if the hedge is a fair value hedge.Round to the nearest whole dollar.

Question 35

On November 1,2010,Athom Corporation purchased 5,000 television sets for its merchandise inventory from Sockk,a South Korean firm,at a total quoted cost of 600,000,000 won (W).On this date,the spot rate for the won was $1 = 1,080W.On the same day,Athom invested $500,000 cash in a non-interest bearing account with a Japanese bank,to hedge its exposed liability position.The account payable to Sockk is due on January 30,2011.The exchange rates on December 31,2010 and January 30,2011 were $1 = 1,060W,and $1 = 1,030W,respectively.Athom agreed to pay Sockk in won.The bank deposit made by Athom will be held in won,but will be withdrawn in dollars by Athom on January 30th.Assume that Athom has a December 31 year-end.Assume this is a fair value hedge.
Required:
Prepare all the journal entries for Athom Corporation's General Journal on November 1,2010,December 31,2010,and January 30,2011.Round entries to the nearest whole dollar.If no entry is required on a particular date,indicate "No entry" in the General Journal.

Question 36

On November 1,2011,Ross Corporation,a calendar-year U.S.corporation,invested in a purely speculative contract to purchase 1 million euros on January 30,2012,from Trattoria Company,an Italian brokerage firm.Ross agreed to purchase 1,000,000 euros from Trattoria at a fixed price of $1.420 per euro.Trattoria agreed to transmit 1,000,000 euros to Ross on January 30,2012.Net settlement is not permitted.The spot rates for euros are:
The 30-day futures rate for euros on December 31,2011 was $1.405.
Required:
Prepare the General Journal entries that Ross would record on November 1,December 31,and January 30.

Question 37

Opie Industries is a manufacturer of plastic bottles.On September 1,2011,Opie purchased an option contract at a cost of $2,000.The purpose of the option is to hedge against increases in the price of this type of plastic,"PET." The option is to buy 1,000,000 pounds of PET on March 1,2012 for $.75 per pound.If the market price of PET is below $.75 on March 1,Opie will let the option expire.If the market price is above $.75,then Opie will exercise the option.The option is to be settled net.Opie assumes a 6% annual borrowing rate.Assume this is a cash flow hedge.
Required:
Prepare the entry that Opie should record on September 1,2011.Then,assuming that the price of PET is $.72 on December 31,2011 (Opie's year end),prepare the entry that Opie should record.Finally,prepare the entries for March 1,2012,assuming that the price of PET is $.78.

Question 38

On November 1,2011,Moddel Company (a U.S.corporation)entered into a 90-day forward contract to purchase 200,000 British pounds.The purpose of the forward contract is to hedge a commitment to purchase special equipment on January 30,2012 from a British firm Jeckyl Inc.The invoice price on the purchase commitment is denominated in British pounds.The forward contract is not settled net.Assume Moddel uses a 12% interest rate.Use a fair value hedge.
The relevant exchange rates are stated in dollars per pound:
Required:
1.What journal entry did Moddel record on November 1,2011?
2.What journal entries did Moddel record on December 31,2011?
3.What journal entries did Moddel record on January 30,2012 if the purchase was made?

Question 39

Astrotuff Company is planning to purchase 200,000 pounds of nylon from Tangsun Company.On November 1,2011,Astrotuff entered into a 90-day forward contract to hedge the planned purchase.The forward contract is to purchase 200,000 pounds of nylon at $1.80 per pound (forward rate at November 1,2011).On November 1,2011,the spot price of nylon is $1.75 per pound,but Astrotuff anticipates significant increases in the price of nylon.The forward contract is to be settled net.
On December 31,2011,Astrotuff's year end,the forward rate to January 30,2012 is $1.78 per pound.The spot and forward rates on January 30,2012 are $1.85 per pound.Astrotuff uses a 6% discount rate relating to their hedging activity.Astrotuff purchases 200,000 pounds of nylon on January 30 when the forward contract expires.
Required:
Prepare the necessary journal entries to account for this cash flow hedge and related purchase of nylon.

Question 40

Slickton Corporation,a U.S.holding company,enters into a forward contract on November 1,2011 to speculate in Singapore dollars (S$).The forward contract requires Slickton to sell 1,000,000 Singapore dollars to the exchange broker on January 30,2012.Net settlement is not permitted.Relevant exchange rates for the Singapore dollar are listed below:
Required:
Prepare the journal entries required by Slickton on November 1,2011,December 31,2011 (year end),and January 30,2012.