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Chapter 12

Derivatives and Foreign Currency Transactions


Answers to Questions
1 Derivative is the name given to a broad range of financial securities. Their common characteristic is that
the derivative contracts value to the investor is directly related to fluctuations in price, rate, or some other
variable that underlies it. Interest rate, foreign currency exchange rate, commodity prices and stock prices
are common types of prices and rate risks that companies hedge.
2 edge accounting refers to accounting designed to record changes in the value of the hedged item and the
hedging instrument in the same accounting period. This enhances transparency because the hedged item
and hedging instrument accounting are linked. !rior to hedge accounting, the financial statement effect
of the hedged item and hedging instrument "ere not linked. #ince companies enter into hedges to
mitigate risks, the accounting should reflect the effect of this strategy and should clearly communicate the
strategy. The accounting and footnote disclosures re$uired for derivatives attempt to do this.
3 %n option is a contract that allo"s the holder to buy or sell a security at a particular date. The holder is
not obligated to buy or sell the security. They may allo" the contract to expire. Typically, the holder must
pay an upfront fee to the "riter of the option.
% for"ard contract and futures contract are similar because both sides of the contract are obligated to
perform. % for"ard contract is negotiated bet"een t"o parties, they agree upon delivering a certain
$uantity of goods or currency at a specific date in the future. &any allo" net settlement "hich means the
'"inner( of the contract receives cash consideration for the difference bet"een the market price of the
commodity and the contracted amount on the date the contract expires. The initial amount exchanged at
the date the contract is entered into is negligible.
% futures contract is traded on a market. The amount of commodity to be exchanged and the date of
delivery are standardi)ed. The futures rate is determined by the market at the date the contract is entered
into. These contracts are settled daily.
4 edge effectiveness involves assessing ho" "ell the hedge mitigates the gains or losses of the asset,
liability and*or anticipated transaction that it is entered into to mitigate.
The most common approaches to determining hedge effectiveness are critical term analysis and statistical
analysis.
+nder critical term analysis, the nature of the underlying variable, the notional amount of the derivative
and the item being hedged, the delivery date of the derivative and the settlement date for the item being
hedged are examined. If the critical terms of the derivative and the hedged item are identical, then an
effective hedge is assumed.
% statistical approach is used if critical terms dont match. ,ne such approach involves comparing the
correlation bet"een changes in the price of the item being hedged and the derivative. -hile the F%#.
does not specify a specific benchmark correlation coefficient, correlations of bet"een /01 and 2341 are
considered to be highly effective. ,utside of these ranges, the hedge "ould not be considered highly
effective.
5 +nder a firm purchase or sales commitment, if the hedge is considered to be effective, then it "ould
$ualify as a fair value hedge.
12-2 Derivatives and Foreign Currency Transactions
6 % company that has an existing loan that involves a variable or floating interest rate enters into a pay5
fixed, receive variable s"ap. The company is s"apping its variable interest rate payments for fixed ones.
These contracts are typically settled net. For example, if the fixed rate agreed upon is 201 for the term of
the s"ap agreement and in one year the variable rate is 61, then the company "ith the variable rate loan
must pay the difference in rates multiplied by the notional amount of the loan to the other party. If the
variable rate is 231, then the company "ill receive the difference in rates multiplied by the notional
amount of the loan. 7egardless of the movement in interest rates over the term of the s"ap, the company
"ill pay the fixed rate, net. This type of s"ap is aimed at reducing the variability in cash flo"s related to
the debt therefore it is designated as a cash flo" hedge.
7 % receive fixed, pay variable s"ap is entered into if a company has an existing loan that involves a fixed
interest rate and desires to s"ap those fixed payments for variable payments. For example, a company has
a loan "ith an /1 fixed rate and enters into a s"ap arrangement so that it "ill pay 8I.,7 9 21. If the
variable rate for a year is 61, then the company "ill pay 21 multiplied by the notional amount as "ell as
the /1 for the loan. Thus, the company has paid 61, the floating rate.
If the variable rate is :1 ;41 8I.,7 9 21<, then the company "ill pay /1 on the loan, but "ill receive
31 related to the s"ap. Thus, the company "ill pay :1, the floating rate.
This type of s"ap is aimed at reducing the variability in the fair value of the underlying loan therefore it is
designated as a fair value hedge.
8 Fair value hedge accounting is used "hen the company is attempting to reduce the price risk of an
existing asset*liability or firm purchase*sale commitment. Cash flo" hedge accounting is appropriate
"hen the company is attempting to reduce the variability in cash flo"s thus it is appropriate "hen
hedging anticipated purchases and sales.
+nder certain circumstances, hedges of existing foreign currency denominated receivables and payables
are accounted for as cash flo" hedges instead of fair value hedges. #ee $uestion 2/s solution for these
cases.
9 % transaction is measured in a particular currency if its magnitude is expressed in that currency. %ssets
and liabilities are denominated in a currency if their amounts are fixed in terms of that currency.
10 Direct $uotation= 2.30*2 > ?2.30
Indirect $uotation= 2*2.30 > ./@ euros per dollar
11 ,fficial or fixed rates are set by a government and do not change as a result of changes in "orld currency
markets. Free or floating exchange rates are those that reflect fluctuating market prices for currency based
on supply and demand factors in "orld currency markets. The +nited #tates changed from fixed to
floating ;free< exchange rates in 26A2. .ut the +.#. dollar is sometimes described as a 'filthy float(
because the +nited #tates has fre$uently engaged in currency transactions to support or "eaken the dollar
against other currencies. #uch action is taken for economic reasons, such as to make +.#. goods more
competitive in "orld markets. .oth Bapan and Cermany have engaged in currency transactions in an
attempt to support the +.#. dollar. In February 26/A, the +nited #tates and six other industrial nations
;the Croup of A or C5A< entered the 8ouvre accord to cooperate on economic and monetary policies in
support of agreed upon exchange rate levels.
12 #pot rates are the exchange rates for immediate delivery of currencies exchanged. The current rate for
foreign currency transactions is the spot rate in effect for immediate settlement of the amounts
denominated in foreign currency at the balance sheet date. istorical rates are the rates that "ere in effect
on the date that a particular event or transaction occurred. #pot rates could be fixed rates if the currency
"as a fixed rate currency as determined by the government issuing the currency.
13 The transaction is a foreign transaction because it involves import activities, but it is not a foreign
currency transaction for the +.#. firm because it is denominated in local currency. It is a foreign currency
transaction for the Bapanese company.
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Chapter 12 12-3
14 %t the transaction date, assets and liabilities denominated in foreign currency are translated into dollars
by use of the exchange rate in effect at that date, and they are recorded at that amount.
%t the balance sheet date, cash and amounts o"ed by or to the enterprise that are denominated in
foreign currency are adDusted to reflect the current rate. %ssets carried at market "hose current market
price is stated in a foreign currency are adDusted to the e$uivalent dollar market price at the balance sheet
date.
15 Exchange gains and losses occur because of changes in the exchange rates bet"een the transaction date
and the date of settlement. .oth exchange gains and exchange losses can occur in either foreign import
activities or foreign export activities. The statement is erroneous.
16 Exchange gains and losses on foreign currency transactions are reflected in income in the period in "hich
the exchange rate changes except for hedges of an identifiable foreign currency commitment "here
deferral is possible if certain re$uirements are met. %lso hedges of a net investment in a foreign entity are
treated as e$uity adDustments from translation. Intercompany foreign currency transactions of a long5term
nature are also treated as e$uity adDustments.
17 There "ill be a ?30 exchange loss in the period of purchase and a ?20 exchange gain in the period of
settlement=
Billing date
Purchases $1,450
ccounts pa!able "#c$ $1,450
Year-end adjustment
E%change loss $ 20
ccounts pa!able "#c$ $ 20
Settlement date
ccounts pa!able "#c$ $1,4&0
'ash $1,4(0
E%change gain 10
18 Cash flo" hedge accounting can be used "hen hedging recogni)ed currency denominated assets and
liabilities if the variability of cash flo"s is completely eliminated by the hedge. This criterion is generally
met if all of the critical terms of the hedged item and the hedge match such as the settlement date,
currency type and currency amounts. If these dont match then it must be accounted for as a fair value
hedge.
The key difference bet"een this situation and the more general cash flo" hedge case is that an existing
asset or liability is being accounted for here. +nder the more general case, the recognition of gains and
losses is deferred because an anticipated transaction is being hedged.
The foreign currency asset or liability is marked to fair value at year5end and the resulting gain or loss
account is recogni)ed, ho"ever, the gain or loss is offset by reclassifying an e$ual amount from other
comprehensive income. Thus, the asset and liability are marked to fair value, but no gain or loss related
to that adDustment is included in current period income.
The premium or discount related to the hedge contract is amorti)ed to income over the length of the
contract using the effective interest method. For example, if a 200,000 euro foreign currency receivable
due in :0 days is recorded at the spot rate of ?2.30*euro or ?230,000 and at the same date, a for"ard
contract is entered into to deliver 200,000 euros in :0 days at a for"ard rate of ?2.2/, the company kno"s
that it "ill lose ?3,000. This ?3,000 must be amorti)ed to income over the :0 day period.
19 International %ccounting #tandards Fo. @3 and @6 prescribe the accounting for derivatives. Their
re$uirements are similar to #F%# Fo. 2@@ and 2@/ in terms of determining "hen hedge accounting can be
used. The re$uirements for determining hedge effectiveness are very similar. .oth fair value and cash
flo" hedge definitions and general re$uirements are similar. o"ever, under I%# @6, firm sale or
purchase commitments can be accounted for as either fair value or cash flo" hedges "hich differs from
the F%#. re$uirement that they must be accounted for as fair value hedges.
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12-4 Derivatives and Foreign Currency Transactions
20 % for"ard contract of an anticipated foreign currency transaction is accounted for as a cash flo" hedge.
The contract is marked to fair value at each financial date and the corresponding gain or loss is included
in other comprehensive income. %ny premium or discount must be amorti)ed to income over the contract
term using an effective interest rate method. The gain ;loss< credit ;debit< is offset by a debit ;credit< from
other comprehensive income.
-hen the anticipated transaction occurs and the for"ard contract is settled, the resulting other
comprehensive income balance is amorti)ed to income in the same period as the underlying transaction is
recogni)ed in income.
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Chapter 12 12-5
SOLUTIONS TO EXERCISES
Solution E12-1
1 a. December 1, 2008 No entry is necessary
b. December 31, 2008
)ther 'o*prehensi+e Inco*e ",-E$ $9,901

.or/ard 'ontract "01$ $9,901
.or/ard contract +alue at 12231204"$1,000 , $940$5500 6 $10,0002
"1.005$
2
6 $9,901 liabilit!
c. Settlement date February 28, 2009
.or/ard 'ontract ",1$ $9,901
.or/ard 'ontract "0$ 2,500
)ther 'o*prehensi+e Inco*e "0-E$ $12,401
.or/ard contract +alue at 2224209"$1,000 , $1,005$5500 6 $2,500
asset. 7he #or/ard contract liabilit! at 12231204 is eli*inated
and the asset established. ccordingl!, the corresponding credit
to other co*prehensi+e inco*e, $12,401, /ill result in an ending
balance o# $2,500 credit in other co*prehensi+e inco*e.
8ice In+entor! "$1,005 5 500$ $502,500
'ash $502,500
7o record the rice purchase at *ar9et price
'ash $2,500
.or/ard 'ontract ",$ $2,500
7o record the #or/ard contract settle*ent
2
'ash $(00,000
-ales $(00,000
'ost o# :oods -old $500,000
)ther 'o*prehensi+e Inco*e 2,500
In+entor! $502,500
Solution E12-2
1 a. December 1, 2008
No entry is necessary
b. December 31, 2008
1oss on #or/ard contract $9,901
.or/ard 'ontract $9,901
.or/ard contract +alue at 12231204"$1,000 , $940$5500 6 $10,0002
"1.005$
2
6 $9,901 liabilit!
.ir* Purchase 'o**it*ent $9,901
:ain on #ir* purchase co**it*ent $9,901
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12-( Derivatives and Foreign Currency Transactions
c. Settlement date February 28, 2009
.or/ard 'ontract $9,901
.or/ard 'ontract 2,500
:ain on #or/ard contract $12,401
.or/ard contract +alue at 2224209"$1,000 , $1,005$5500 6 $2,500
asset.

1oss on #ir* purchase co**it*ent $12,401
.ir* purchase co**it*ent ",$ $9,901
.ir* purchase co**it*ent "01$ 2,500
8ice In+entor! $500,000
.ir* purchase co**it*ent 2,500
'ash $502,500
7o record the rice purchase at *ar9et price
'ash $2,500
.or/ard 'ontract ",$ $2,500
7o record the #or/ard contract settle*ent
2.
'ash $(00,000
-ales $(00,000
'ost o# :oods -old $500,000
In+entor! $500,000
Solution E12-3
1 ;o+e*ber 1, 2004 <e*orandu* entr! onl!

=ece*ber 31, 2004
2 1oss on #or/ard contract $49,&51
.or/ard 'ontract $49,&51
"100,000 % .50$21.05
7o record the change in #air +alue o# the
#or/ard contract attributable to the discounted
change in the #or/ard price
2 1oss on #ir* sales co**it*ent $49,&51
.ir* sales co**it*ent $49,&51
7o record the change in #air +alue o# the #ir*
co**it*ent
>anuar! 31, 2009
3 .or/ard 'ontract $149,&51
:ain on #or/ard contract $149,&51
"$(,$56 1.00 % 100,000$
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Chapter 12 12-7
"7o record the change in #air +alue o# the
#or/ard contract attributable to the discounted
change in the #or/ard price
3 .ir* -ales 'o**it*ent $149,&51
:ain on #ir* sales co**it*ent $149,&51
"7o record the change in #air +alue o# the #ir*
co**it*ent to sell$
3 'ash #ro* #ir* sales co**it*ent $500,000
?idget in+entor! "@2-$ $500,000
'):- $500,000
:ain on #ir* sales co**it*ent $100,000
'ash #or #or/ard contract purchase $500,000
?idget in+entor! "@2-$ $500,000
-ales $(00,000
7o record the settle*ent o# the #or/ard
contract at >anuar! 31, 2009, and purchase o#
100,000 /idgets and sale pursuant to the
contract
Solution E12-4 Usin! a "i#e$ attribute "o$el% ot&er solutions are acce'table(
)ctober 1, 2004
1 Earnings $49,012
.or/ard contract $49,012
"100,000 % "$2.00 , $1.50$$2"1.05$A4
7o record the change in #air +alue o# the
#or/ard contract attributable to the discounted
change in the #or/ard price
1 In+entor! $50,000
Earnings $50,000
7o record in+entor! *ar9ed to *ar9et
=ece*ber 31, 2004
2 .or/ard contract $49,&51
Earnings $49,&51
"100,000 % "$2.00 , $2.50$$2"1.05$
7o record the change in #air +alue o# the
#or/ard contract attributable to the discounted
change in the #or/ard price
2 Earnings $50,000
In+entor! $50,000
7o record in+entor! *ar9ed to *ar9et
>anuar! 31, 2009
3 'ash $200,000
Earnings &39
.or/ard 'ontract ",$ $200,&39
7o record the #or/ard contract settle*ent
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12-4 Derivatives and Foreign Currency Transactions
"100,000 % "$2.00 ,$2.30$
3 'ash $200,000
In+entor! $200,000
7o sell in+entor! on contract
Solution E12-)
1 b
2 d
3 d
Solution E12-*
1 7he dollar has /ea9ened against the !en because it no/ costs *ore
dollars to bu! one !en.
2 10,000,000 !en $.00&5 6 $&5,000
3 ccounts pa!able $&5,000
E%change loss 1,000
'ash $&(,000
4 Bi**er /ould ha+e entered a contract to purchase !en #or #uture receipt.
Solution E12-+
December 16, 2008
In+entor! $3(,000
ccounts pa!able "euros$ $3(,000
7o record purchase o# *erchandise #ro* ?ing 'orporation #or
30,000 euros at $1.20 spot rate.
December 31, 2008
E%change loss $ 1,500
ccounts pa!able "euros$ $ 1,500
7o adCust accounts pa!able to ?ingD "$1.25 , $1.20$ 30,000
euros.
anuary 1!, 2009
ccounts pa!able "euros$ $3&,500
E%change gain $ 300
'ash 3&,200
7o record pa!*ent o# 30,000 euros at $1.24 spot rate in
settle*ent o# account pa!able and to recogniEe gain.
Solution E12-,
dCust*ent in +alue o# account recei+able #or 2004D
"$.44 , $.40$ 90,000 '$ 6 $3,(00 e%change gain
dCust*ent in +alue o# account recei+able at settle*ent in 2009D
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Chapter 12 12-9
"$.43 , $.44$ 90,000 '$ 6 $900 e%change loss
Solution E12--
"ay 1, 2008
ccounts recei+able "#c$ $333,333
-ales $333,333
7o record sale o# in+entor! ite*s to 8o!al #or 200,000 poundsD
200,000 pounds2.(000 pounds "indirect Fuotation$.
"ay 30, 2008
'ash "#c$ $330,5&9
E%change loss 2,&54
ccounts recei+able "#c$ $333,333
7o record receipt o# 200,000 pounds #ro* 8o!al in settle*ent o#
accounts recei+ableD 200,000 pounds2.(050 pounds.
Solution E12-1. GI'P adaptedH
1
8ecei+able at 10215204 $420,000
Euros recei+ed and sold #or
I.-. dollars on 1121(204

415,000
.oreign e%change loss 2004 5,000
2 )n =ece*ber 31, 2004 Ju*i 'orp. adCusts its account pa!able deno*inated
in euros #ro* $12,000 "10,0005.$1.20$ to $12,400 "10,000 $1.24$ and
recogniEes a loss o# $400 G10,000 1'I "$1.24 , $1.20$H
3
=ece*ber 31, 2004 note pa!able $240,000
>ul! 1, 2009 note pa!able 240,000
2009 e%change loss $"40,000$
4
;ote recei+able =ece*ber 31, 2004 $140,000
*ount collected >ul! 1, 2009
"440,000 1'I 4$
105,000
2009 e%change loss $ 35,000
Solution E12-11
1 E%change gain or loss in 2004D :ain or "1oss$
ccount recei+able =ece*ber 1( $103,500
=ece*ber 31 adCusted balance
150,000 '$ $0.(4
102,000 $"1,500$
ccount pa!able =ece*ber 2 $195,250
=ece*ber 31 adCusted balance
2&5,000 '$ $0.(4
14&,000 4,250
;et e%change gain #or 2004 $ (,&50
2 E%change gain or loss in 2009D
ccount recei+able adCusted 12231 $102,000
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12-10 Derivatives and Foreign Currency Transactions
ccount recei+able 1215209 101,250 $ "&50$
ccount pa!able adCusted 12231 $14&,000
ccount pa!able 1230209 144,3&5 "1,3&5 $
;et e%change loss #or 2009 $"2,125$
Solution E12-12
1 December 12, 2008
In+entor! $3&5,000
ccounts pa!able "!en$ $3&5,000
Purchase #ro* 7o9o 'o*pan! "50,000,000 !en $.00&50$.
December 1!, 2008
ccounts recei+able "pounds$ $ ((,000
-ales $ ((,000
-ale to @ritish Products 'o*pan! "40,000 pounds $1.(5$.
2 December 31, 2008
E%change loss $ 5,000
ccounts pa!able "!en$ $ 5,000
7o adCust accounts pa!able deno*inated in !en #or e%change rate
changeD 50,000,000 !en "$.00&(0 , $.00&50$.
E%change loss $ 2,000
ccounts recei+able "pounds$ $ 2,000
7o adCust accounts recei+able deno*inated in pounds #or e%change
rate changeD 40,000 pounds "$1.(5 , $1.(0$.
3 anuary 11, 2009
ccounts pa!able "!en$ $340,000
E%change loss 2,500
'ash $342,500
7o record pa!*ent to 7o9o 'o*pan! "50,000,000 !en $.00&(5$.
anuary 1#, 2009
'ash $ (5,200
ccounts recei+able "pounds$ $ (4,000
E%change gain 1,200
7o record receipt #ro* @ritish Products 'o*pan!D 40,000 pounds
$1.(3.
Solution E12-13
"arc$ 1, 2008
In+entor! $1(,300
ccounts pa!able "pesos$ $1(,300
7o record purchase o# in+entor! ite*s deno*inated in pesosD
100,000 pesos $.1(30.
.or/ard contractKno entr! is necessar!
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Chapter 12 12-11
"ay 30, 2008
'ash "pesos$ $1(,000
E%change loss 500
'ash $1(,500
7o record receipt o# 100,000 pesos #ro* the e%change bro9er /hen
the e%change rate is $.1(00. E%change lossD 100,000 pesos
"$.1(50 , $.1(00$.
ccounts pa!able "pesos$ $1(,300
'ash "pesos$ $1(,000
E%change gain 300
7o record pa!*ent to 'a+ilier o# 100,000 pesos. :ainD 100,000
pesos "$.1(30 , $.1(00$.
Solution E12-14
1 December 1, 2008
In+entor! $5,500
ccounts Pa!able "!en$ $5,500
-pot rate is $.00055510,000,000 6 $5,500
;o entr! is necessar! related to the #or/ard contract is necessar! at
this date.
December 31, 2008
E%change 1oss $100
ccounts Pa!able "!en$ $100
Entr! to *ar9 the accounts pa!able to the spot rate at !ear,end.
)ther 'o*prehensi+e Inco*e $100
E%change gain $100
*ount reclassi#ied out o# other co*prehensi+e inco*e in order to
o##set the e%change loss since this is a cash #lo/ hedge
situation.
E%change 1oss $99.10
)ther co*prehensi+e inco*e $99.10
7he discount resulting #ro* the #or/ard contract is a*ortiEed to
inco*e o+er the contractLs ter*. 7o sol+e #or the e##ecti+e
interest rate $5,5005"10r$
2
6 $5,&00. $5,&00 6 the #or/ard rate .
0005&510,000,000 6 $5,&00. -ol+ing #or r6 1.40195M. 7he
discount a*ortiEation #or this is .01401955$5,500 6 $99.10.
Su""ary/ loss o# $99.10 is re#lected in 2004 inco*e.
2 anuary 30, 2009
E%change 1oss $100
ccounts Pa!able $100
7o *ar9 ccounts Pa!able to spot rate
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'ash "!en$ $5,&00
'ash $5,&00
7o record receipt o# 10,000,000 pesos #ro* the e%change bro9er.
)ther 'o*prehensi+e Inco*e $100
E%change :ain $100
7o record pa!*ent o# cash to the e%change bro9er.
E%change 1oss $100.90
)ther 'o*prehensi+e Inco*e $100.90
7o record a*ortiEation o# discount #or the last portion o# the
#or/ard contractLs ter*.
Su""ary/ loss o# $100.90 is re#lected in 2009 inco*e. ;otice that the
balance in )ther 'o*prehensi+e Inco*e is no/ $0. "12231204 $100 debit N
$99.10 credit 6 $.90 debit 12231204. $.90 debit 0 100 debit , $100.90 credit
6 $0 balance at 1230209$.
Solution E12-1) GI'P adaptedH
1 ssu*ing that this is a #air +alue hedge. t 12231204, $3,000 is the
#or/ard contract #air +alue G100,0005"$.90 #or/ard rate contracted ,
$.93 .or/ard contract rate at 12231204$ 6 $3,000H.
-ince this contract /ill not be settled #or &2 da!s, the present +alue
o# the contract is $2,929 using .03244M Gi612M23(5 da!sH , n6&2 and
#uture +alue o# $3,000. 7he e%change gain related to this contract is
recorded at 12231204 and the #or/ard contract asset account is debited.

December 31, 2008
.or/ard 'ontract $2,929
E%change :ain $2,929
7o record #or/ard contract at *ar9et
E%change 1oss $10,000
ccounts Pa!able $10,000
7o *ar9 accounts pa!able to #air +alue at 12231204 "this assu*es that
the accounts pa!able /as *ar9ed to *ar9et on 12212204, the date the
#or/ard contract /as entered into$
2 7his #ir* purchase co**it*ent /ould be accounted #or as a #air +alue
hedge.
December 31, 2008
.or/ard 'ontract $2,929
E%change :ain $2,929
E%change 1oss $2,929
.ir* purchase co**it*ent $2,929
3 7he #or/ard contract /ould again be recorded at #air +alue throughout
the li#e o# the contract. 7here#ore, a $2,929 gain /ould be reported
at 12231204.
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Chapter 12 12-13
Solution E12-1*
%&ril 1, 2008
'ontract recei+able $35,250
'ontract pa!able "#c$ $35,250
7o record #or/ard contract to sell 50,000 'anadian dollars to the
e%change bro9er at the #or/ard rate o# .&05 #or deli+er! on <a!
31 #or $35,250.
"ay 31, 2008
'ash "#c$ $3(,250
-ales $3(,250
7o record sale o# #ittings to ?indsor #or 50,000 'anadian
dollarsD "$.&25 50,000 'anadian$
'ontract pa!able "#c$ $35,250
E%change loss on #or/ard contract 1,000
'ash "#c$ $3(,250
7o record pa!*ent o# the contract deno*inated in 'anadian dollars
to the e%change bro9er.
'ash $35,250
'ontract recei+able $35,250
7o record receipt o# the $35,250 #ro* the e%change bro9er to
settle the account recei+able deno*inated in I.-. dollars.
-ales $ 1,000
E%change loss $ 1,000
7o reclassi#! e%change loss on #or/ard contract as an adCust*ent
o# the selling price.
0lternati1e solution/
)n %&ril 1, 2008, no entr! is necessar! i# the #or/ard contract allo/ed net
settle*ent. I# this is the case, the "ay 31, 2008 entries /ould beD
"ay 31, 2008
'ash $3(,250
-ales $3(,250
7o record sale o# #ittings to ?indsor #or 50,000 'anadian
dollarsD "$.&25 50,000 'anadian$. ssu*ing i**ediate con+ersion
o# the 'anadian dollars to I.-. dollars at the current e%change
rate.
E%change loss on #or/ard contract 1,000
'ash $1,000
7o record net settle*ent o# the e%change contract.
-ales $ 1,000
E%change loss $ 1,000
7o reclassi#! e%change loss on #or/ard contract as an adCust*ent
o# the selling price.
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Solution E12-1+
1 Entr! on ;o+e*ber 2 #or contract /ith the e%change bro9erD
'ontract recei+able "#c$ $ &,400
'ontract pa!able $ &,400
7o record contract to purchase 1,000,000 !en in 90 da!s at the
#uture rate.
I# this contract allo/ed #or net settle*ent, then no entr! /ould be
necessar! on ;o+e*ber 2.
2 ;o Cournal entr! needed as the 30,da! #uture rate at the end o# the
!ear is at $.00&4 /hich /as the sa*e rate as the 90,da! rate on
;o+e*ber 2.
Solution E12-1,
Co""ent/ 7he contract recei+able and pa!able are both recorded instead o#
recording the contract net because <artin *ust deli+er the euros to the
e%change bro9er, net settle*ent is not allo/ed.
'ct(ber 2, 2008
'ontract recei+able $(53,000
'ontract pa!able "#c$ $(53,000
7o record contract to sell 1,000,000 euros to e%change bro9er in
140 da!s #or the #or/ard rate o# $.(530.
December 31, 2008
'ontract pa!able "#c$ $ 12,000
E%change gain $ 12,000
7o adCust contract pa!able in euros to the 90,da! #or/ard rate o#
$.(410.
"arc$ 31, 2009
'ontract pa!able "#c$ $(41,000
E%change loss 14,000
'ash "#c$ $(55,000
7o record pa!*ent o# 1,000,000 euros to e%change bro9er /hen spot
rate is $.(550.
'ash $(53,000
'ontract recei+able $(53,000
7o record receipt o# I.-. dollars #ro* e%change bro9er in
settle*ent o# account.
SOLUTIONS TO 2RO3LE4S
Solution 212-1
1. 7his hedge is designed to *itigate the i*pact o# price changes on
natural gas. -ince one /ould e%pect that natural gas price changes and
#utures *ar9et prices o# natural gas to be highl! correlated, this is
li9el! to be a highl! e##ecti+e hedge.
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Chapter 12 12-15
2. 7his /ould be accounted #or as a cash #lo/ hedge since this is a hedge
o# an anticipated transaction.
3. )(*ember 2, 2008
.utures contract $100,000
'ash $100,000
=eposit is $5,000 5 20 contracts 6 $100,000
December 31, 2008
)ther 'o*prehensi+e Inco*e $50,000
.utures 'ontract $50,000
t 12231204, the #utures contract price #or deli+er! on the sa*e date
as our contract is $(.&5 , $&.00 6 $.25 loss per <<@tu 5 10,000 5 20
contracts 6 $50,000 loss.
February 2, 2009
.utures contract $20,000
)ther 'o*prehensi+e Inco*e $20,000
$(.45 , $(.&5 6 $.10 5 10,000 5 20 contract 6 $20,000 gain
'ash $&0,000
.utures contract $&0,000
7o record #inal settle*ent o# #utures contract.
:as In+entor! $1,3&0,000
'ash $1,3&0,000
7o record the purchase o# natural gas at *ar9et rates.
February 3, 2009
'ash $1,(00,000
:as 8e+enue $1,(00,000
7o record gas sale at $4.00 per <<@tu
'ost o# :oods -old $1,3&0,000
:as In+entor! $1,3&0,000
'ost o# :oods -old $30,000
)ther 'o*prehensi+e Inco*e $30,000
7o record cost o# goods sold so that it re#lects the #utures contract
rate per the hedging contract, $&.00 per <<@tu.
Solution 212-2
NOTE/ 2arts 4 an$ ) belo5 are co"'ute$ usin! t&e correcte$ "ar6et 'rices o7
8- 'er troy ounce on 9ece"ber 31: 2.., 'art 4( an$ 8-.). on ;ebruary 1: 2..-
'art )(. T&e "ar6et 'rices liste$ in t&e 'roble" are incorrect.
1. Jes, because the ter*s o# the purchase co**it*ent and the hedge
instru*ent *atch.
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12-1( Derivatives and Foreign Currency Transactions
2. 7his is a #air +alue hedge because a #ir* purchase co**it*ent is being
hedged instead o# an anticipated purchase.
3.
-il+er options $1,000
'ash $1,000
4. December 31, 2008
1oss on #ir* purchase co**it*ent $1,194,030
'hange in +alue o# #ir* purchase co**it*ent $1,194,030
-il+er options $1,193,030
:ain $1,193,030
1,200,000 5 $1 change "$10,$9$ 6 $1,200,000 /hich /ill occur in 1
*onth "purchase and option e%piration$. $1,200,00021.005 6 $1,194,030.
7his is the present +alue o# the #ir* purchase co**it*ent and the
option at 12231204 assu*ing (M annual interest.
-ince the option alread! has a $1,000 balance, $1,193,030 /ill need to
be recorded.
).
'hange in +alue o# #ir* purchase co**it*ent $594,030
:ain $594,030
7o record the change in the #ir* purchase co**it*ent. "$9 , $9.50$5
1,200,000. 7he ending balance is $(00,000 a#ter this adCust*ent.
1oss $594,030
-il+er option $594,030
7he sil+er options +alue has also declined. Ho/e+er, the co*pan! /ill
still e%ercise the option.
'ash $(00,000
-il+er option $(00,000
7o record e%ercise o# option.
-il+er in+entor! $11,400,000
'hange in +alue o# #ir* purchase co**it*ent (00,000
'ash $12,000,000
7o record purchase o# sil+er in+entor!.
Solution 212,3
1 7he purpose o# this hedge is to reduce +ariabilit! in cash #lo/s in the
#uture since the #ir* entered into a +ariable interest loan and is
s/apping that #or a #i%ed interest rate. 7his is there#ore a cash #lo/
hedge.
2 )ne /ould e%pect that this is a highl! e##ecti+e hedge because the
notional a*ount, $400,000 and the length o# the ter* o# the s/ap
agree*ent agree.
3 a. 7he 1I@)8 rate at 12231204 is 5M, thus 2009Ls interest rate on the
+ariable loan /ill be 5M 0 2M 6 &M. 7he s/ap #i%ed rate is 4M.
'a*pion /ill pa! .01 percent *ore than the +ariable rate. 7he #air
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Chapter 12 12-17
+alue o# the s/ap is the present +alue o# the esti*ated #uture net
pa!*ents.
=ate o# pa!*ent Esti*ated pa!*ent
based on 12231204
1I@)8 rate
.actor Present Oalue
12231209 .015$400,000 12"1.0&$ $ 3,&34
12231210 .015$400,000 12"1.0&$
2
3,493
12231211 .015$400,000 12"1.0&$
3
3,2(5
12231212 .015$400,000 12"1.0&$
4
3,051
7otal $13,54&
b.
December 31, 2008
)ther 'o*prehensi+e Inco*e ",-E$ $13,54&
Interest 8ate -/ap "01$ $13,54&
7o record the #air +alue o# interest rate s/ap, cash #lo/ hedge
at 12231204.
Interest E%pense $32,000
'ash $32,000
7o record interest pa!*ent.
4.
December 31, 2009
Interest E%pense $24,000
'ash $ 24,000
7o record pa!*ent to Oeneta @an9 o# the interest e%pense #or the
!ear under the +ariable rate loan. 7he rate set on the loan at
121209 /as &M.
Interest E%pense $ 4,000
'ash $ 4,000
7o record the pa!*ent due on the interest rate s/ap because the
#i%ed rate is 4M. 7his represents the net settle*ent a*ount.
Interest rate s/ap ",1$ $ 4,34&
)ther 'o*prehensi+e Inco*e "0-E$ $ 4,34&
7o record the change in #air +alue o# the interest rate s/ap.
7he ne/ +ariable rate #or 2010 /hich is set at 12231209 is 5.5M 0
2M. s a result, the esti*ated a*ount that 'a*pion /ould pa! is
reduced #ro* 1M to .5M.
=ate o# pa!*ent Esti*ated pa!*ent
based on 12231204
1I@)8 rate
.actor Present Oalue
12231204 .0055$400,000 12"1.0&5$ $ 1,4(0
12231209 .0055$400,000 12"1.0&5$
2
1,&31
12231210 .0055$400,000 12"1.0&5$
3
1,(10
7otal $ 5,200
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12-14 Derivatives and Foreign Currency Transactions
7he unadCusted Interest 8ate -/ap liabilit! is $13,54& credit, the
adCusted is $5,200 credit, the Interest 8ate -/ap 1iabilit! *ust be
reduced b! $4,34&.
Solution 212-4
1, 2 Per @alance E%change :ain
@oo9s -heet or "1oss$
%cc(unts recei*able
I.-. dollars $24,500 $24,500
-/edish Prona "20,000 $.(($
11,400 13,200 $1,400
@ritish pounds"25,000 $1.(5$
41,000 41,250 250
$41,300 $42,950 1,(50
%cc(unts &ayable
I.-. dollars $ (,450 $ (,450
'anadian dollars "10,000 $.&0$
&,(00 &,000 $ (00
@ritish pounds "15,000 $1.(5$
24,450 24,&50 "300 $
$34,900 $34,(00 300
;et e%change gain $1,950
3 'ollect recei+ablesD
'ash $24,500
ccounts recei+able $24,500
7o record collection o# accounts recei+able.
'ash $13,400
ccounts recei+able "Prona$ $13,200
E%change gain 200
7o collect 20,000 Prona at $.(& spot rate.
'ash $40,&50
E%change loss 500
ccounts recei+able "pounds$ $41,250
7o collect 25,000 pounds at $1.(3 spot rate.
4 -ettle*ent o# accounts pa!ableD
ccounts pa!able $ (,450
'ash $ (,450
7o record pa!*ent o# accounts deno*inated in dollars.
ccounts pa!able "'anadian $$ $ &,000
E%change loss 100
'ash $ &,100
7o record pa!*ent o# account deno*inated in 'anadian dollars at
$.&1 spot rate.
ccounts pa!able "pounds$ $24,&50
'ash $24,300
E%change gain 450
7o record pa!*ent o# 15,000 pounds at $1.(2 spot rate.
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Chapter 12 12-19
Solution 212-)
1, 2 @alance E%change :ain
Per @oo9s -heet or "1oss$
%cc(unts recei*able
@ritish pounds "100,000 1.((0$
$1(5,000 $1((,000 $1,000
Euros "250,000 $.(&0$
1(5,000 1(&,500 2,500
-/edish 9rona "1(0,000 $.(40$
105,(00 102,400 "3,200$
>apanese !en "2,000,000 $.00&($
15,000 15,200 200
$450,(00 $451,100 500
%cc(unts &ayable
'anadian dollars"150,000 $.(9$
$105,000 $103,500 $1,500
-/edish 9rona "220,000 $.135$
24,(00 29,&00 "1,100$
>apanese !en "4,500,000 $.00&($
33,300 34,200 "900 $
$1((,900 $1(&,400 "500 $
;et e%change gain $ 0
3 7he co*pan! /ould need to enter into a contract to deli+er 250,000
euros "sell the*$ since it /ould be recei+ing euros and /ould need to
con+ert the* into I- dollars.
Solution 212-*
1. 7his is a #air +alue hedge because the #i%ed rate loanLs #air +alue
#luctuates o+er ti*e as *ar9et interest rates change. @! entering into
this s/ap agree*ent that #luctuation is eli*inated. -o /hile the
interest rate #luctuates, the loanLs #air +alue re*ains constant
re#lecting the #i%ed rate in the s/ap.
2. 1i9e P12,(, the ter*s *atch, thus this is considered to be a highl!
e##ecti+e hedge.
3. a.
=ate o# pa!*ent Esti*ated pa!*ent
based on 12231204
1I@)8 rate
.actor Present Oalue
12231209 .015$400,000 12"1.09$ $ 3,(&0
12231210 .015$400,000 12"1.09$
2
3,3(&
12231211 .015$400,000 12"1.09$
3
3,049
12231212 .015$400,000 12"1.09$
4
2,434
7otal $12,9(0
b. December 31, 2008
Interest E%pense $32,000
'ash $32,000
7o record interest due on #i%ed rate loan at 12231204
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12-20 Derivatives and Foreign Currency Transactions
1oan Pa!able ",1$ $12,9(0
Interest 8ate -/ap $12,9(0
7o record the interest rate s/ap at #air +alue, co*putations belo/.
;otice that the carr!ing +alue o# the loan is no/ $34&,040 "$400,000 ,
$12,9(0$. 7his agrees /ith the present +alue o# the loan at the *ar9et
rate o# 9M.
2roo7/ $400,0002"1.09$
4
6 $243,3&0 Q6 the present +alue o# the *aturit!
+alue. 7he present +alue o# the interest pa!*ents is
$32,0005POI."i69,n64$6 $103,(&0.
7he total *ar9et +alue o# the loan is $243,3&0 0 $103,(&0 6 $34&,041.
4.

December 31, 2009
Interest E%pense $32,000

'ash $32,000
7o record interest due on #i%ed rate *ortgage
Interest E%pense $4,000
'ash $4,000
7o record s/ap pa!*ent
Interest 8ate -/ap $&,452
1oan Pa!able $&,452
7o adCust interest rate s/ap to #air +alue, $5,104.
;otice that no/ the loan pa!able carr!ing +alue isD
$400,000 N 12,9(0 0 &,452 6 $394,492. 7his a*ount agrees /ith the
present +alue o# the loan at the *ar9et rate on this date, 4.5M.
Proo#D $400,0002"1.045$
3
6 $313,1(3KPresent +alue o# the *aturit! +alue
o# the loan.
7he present +alue o# the interest pa!*ents 6 $32,0005POI."i64.5,n63$6
$41,&29.
7he present +alue o# the loan at a *ar9et rate o# 4.5M is there#ore
$313,1(3 0 $41,&29 6 $394,492.
Solution 212-+
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=ate o# pa!*ent Esti*ated pa!*ent
based on 12231204
1I@)8 rate
.actor Present Oalue
12231210 .0055$400,000 12"1.045$ 1,443
12231211 .0055$400,000 12"1.045$
2
1,(99
12231212 .0055$400,000 12"1.045$
3
1,5((
7otal $ 5,104
Chapter 12 12-21
1 Entries on pril 1
ccounts recei+able "pesos$ $33,0(0
-ales $33,0(0
7o record sales on account deno*inated in pesosD 200,000 pesos 2
(.049( 1'Is
;o entr! to record the contract is necessar!
2 Entries on <a! 30
'ash "pesos$ $33,3&4
ccounts recei+able "pesos$ $33,0(0
E%change gain 314
7o record collection o# recei+able in 1'IsD 200,000 1'Is 2
5.992 1'Is
'ash $33,224
E%change loss 150
'ash "pesos$ $33,3&4
7o record deli+er! o# 200,000 pesos to the e%change bro9er.
Solution 212-,
1 +ntry (n 'ct(ber 2, 2008
'ontract recei+able "euros$ $31,&50
'ontract pa!able $31,&50
7o record #or/ard contract to purchase 50,000 euros at $.(350 as
a hedge o# a #ir* co**it*ent.
2 December 31, 2008 adjustment
'ontract recei+able "euros$ $ 350
E%change gain $ 350
7o adCust the contract recei+able #or 50,000 euros to the $.(420
#uture e%change rate at =ece*ber 31, 2004D 50,000 euros "$.(420
, $.(350$.
E%change loss $ 350
'hange in +alue o# #ir* co**it*ent $ 350
7o record the change in the +alue o# the underl!ing #ir*
co**it*ent hedged.
3 +ntries (n "arc$ 31, 2009
'ontract pa!able $31,&50
'ash $31,&50
7o pa! e%change bro9er #or 50,000 euros at the #or/ard rate o#
$.(350 established on )ctober 2, 2004.
'ash "euros$ $32,400
'ontract recei+able "euros$ $32,100
E%change gain &00
7o record receipt o# 50,000 euros #ro* e%change bro9er /hen spot
rate is $.(5(0.
E%change 1oss $ &00
'hange in +alue o# #ir* co**it*ent $ &00
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7o record the change in the +alue o# the underl!ing #ir*
co**it*ent hedged.
Purchases $32,400
'ash "euros$ $32,400
7o record purchase and pa!*ent in euros at $.(5(0 spot rate.
'hange in +alue o# #ir* co**it*ent $ 1,050
Purchases 1,050
7o record the adCust*ent o# purchases #or the change in the +alue
o# the #ir* co**it*ent. 7his e##ecti+el! #i%es the purchase at
the original #or/ard rate.
Solution 212--
?e /ill assu*e that the hedge contract is to be settled net.
December 2, 2008
;o entr!
December 31, 2008
)ther co*prehensi+e inco*eD e%change loss $ 4,950
.or/ard contract $ 4,950
.or/ard contract, 12231204, $1.(9 N contract rate $1.(4 6 $.01 5
500,000 6 $5,000. 7his is to be paid in t/o *onths so the
present +alue assu*ing (M annual interest rate isD $5,0002
"1.005$
2
6 $4,950.
E%change 1oss $ 3,34(
)ther co*prehensi+e inco*e $ 3,34(
7o record discount a*ortiEation. -ee table belo/
"arc$ 1, 2009
'ash "#c$ $455,000
-ales $455,000
7o record deli+er! o# eFuip*ent to 8a*sa! 1td. and collection o#
500,000 pounds at the $1.&1 spot rate.
)ther co*prehensi+e inco*eD e%change loss $10,050
.or/ard contract $10,050
7o increase the #or/ard contract to the #inal liabilit! a*ountD
$1.&1,$1.(4 6 $.035500,000 6 $15,000 , $4,950 6 $10,050
adCust*ent.
E%change 1oss $(,(53
)ther co*prehensi+e inco*e $(,(53
7o record discount a*ortiEation. "-ee table belo/$
.or/ard contract $15,000
'ash $15,000
7o record #or/ard contract pa!*ent.
-ales $10,000
)ther co*prehensi+e inco*e $10,000
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Chapter 12 12-23
=iscount a*ortiEationD
7he spot rate at the date the #or/ard contract /as entered into
$1.&05500,000 6 $450,000. $1.(4 5 500,000 6 $440,000. 7he discount o#
$10,000 *ust be a*ortiEed o+er the contract period. 7he e##ecti+e
interest rate eFuates these t/o a*ounts using a 3 *onth ti*e period,
that rate is .393&M.
=ate =iscount a*ortiEation @alance
$ 450,000
=ece*ber 31, 2004 $ 3,34( 44(,(54
>anuar! 31, 2009 3,333 443,320
<arch 1, 2009 3,320 440,000
Solution 212-1.
1 December 16, 2008
EFuip*ent $((4,000
ccounts pa!able "#c$ $((4,000
7o record purchase o# eFuip*ent "400,000 pounds $1.(&$.
2 December 31, 2008
ccounts pa!able "#c$ $ 4,000
E%change gain $ 4,000
7o adCust accounts pa!able #or currenc! e%change rate changeD
400,000 pounds "$1.(& , $1.(5$.
)ther 'o*prehensi+e Inco*e $ &,940
.or/ard 'ontract $ &,940
7o record the #or/ard contract loss at 12231204
E%change loss $ 4,000
)ther 'o*prehensi+e Inco*e $ 4,000
7o reclassi#! an a*ount #ro* )ther 'o*prehensi+e Inco*e to o##set
the gain on the accounts pa!able
E%change 1oss $ 1,994
)ther 'o*prehensi+e Inco*e $ 1,994
7o a*ortiEe the pre*iu*. 7he pre*iu* is the di##erence bet/een
the $((4,000 spot price #or pounds at the date the contract /as
entered into and $(&2,000, the contracted a*ount. 7his
di##erence *ust be a*ortiEed to inco*e o+er the 30 da! period.
7he e##ecti+e interest rate is co*puted as #ollo/sD
$(&2,000 6 $((4,0005 "10r$
30
, sol+ing #or r "the dail! interest
rate$ 6 .0199025M. $((4,0005.0001990255156 $1,994.
=ece*ber 31, 2004 account balancesD
ccounts Pa!able $((0,000
.or/ard 'ontract &,940 credit
)ther co*prehensi+e inco*e 2,014 credit
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E%change loss "net$ 1,994
3 anuary 1!, 2009
ccounts pa!able "#c$ $4,000
E%change gain $ 4,000
7o *ar9 the accounts pa!able to #air +alue.
)ther co*prehensi+e inco*e $4,020
.or/ard contract $ 4,020
7o *ar9 the #or/ard contract to #air +alue.
E%change loss $4,000
)ther 'o*prehensi+e Inco*e $ 4,000
7o record the reclassi#ication #ro* )'I to o##set the e%change
gain on the accounts pa!able
E%change loss $2,00(
)ther 'o*prehensi+e Inco*e $2,00(
7o record the a*ortiEation o# the pre*iu*
7he total pre*iu* is $4,000 "$(&2,000 , $((4,000$, the portion
le#t to be a*ortiEed is $4,000 , $1,994 6 $2,00(.
'ash "#c$ $(5(,000
.or/ard contract 1(,000
'ash $(&2,000
7o record the settle*ent o# the #or/ard contract.
ccounts pa!able "#c$ $(5(,000
'ash "#c$ $(5(,000
7o record pa!*ent o# accounts pa!able in pounds.
>anuar! 15, 2009 account balancesD
ccounts Pa!ableD $0
.or/ard 'ontractD
$&,940 credit 0 $4,020 N $1(,000 6 $0
)ther 'o*prehensi+e Inco*eD
$2,014 credit , $4,020 dr 0 $4,000 cr 0 $2,00( cr 6 $0
E%change 1oss "net$D $2,00(
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