Advanced accounting 13th edition hoyle solutions manual 1 by albert.alba755

FOREIGN CURRENCY TRANSACTIONS AND HEDGING FOREIGN EXCHANGE RISK

Chapter Outline

I. In today’s global economy, a great many companies deal in currencies other than their reporting currencies.

A. Merchandise may be imported or exported with prices stated in a foreign currency.

B. For reporting purposes, foreign currency balances must be stated in terms of the company’s reporting currency by multiplying it by an exchange rate.

C. Accountants face two questions in restating foreign currency balances.

1. What is the appropriate exchange rate for restating foreign currency balances?

2. How are changes in the exchange rate accounted for?

D. Companies often engage in foreign currency hedging activities to avoid the adverse impact of exchange rate changes.

E. Accountants must determine how to properly account for these hedging activities.

II. Foreign exchange rates are determined in the foreign exchange market under a variety of different currency arrangements.

A. Exchange rates can be expressed in terms of the number of U.S. dollars to purchase one foreign currency unit (direct quotes) or the number of foreign currency units that can be obtained with one U.S. dollar (indirect quotes).

B. Foreign currency trades can be executed on a spot or forward basis.

1. The spot rate is the price at which a foreign currency can be purchased or sold today.

2. The forward rate is the price today at which foreign currency can be purchased or sold sometime in the future.

3. Forward exchange contracts provide companies with the ability to “lock in” a price today for purchasing or selling currency at a specific future date.

C. Foreign currency options provide the right but not the obligation to buy or sell foreign currency in the future, and therefore are more flexible than forward contracts.

III. FASB ASC 830, Foreign Currency Matters, prescribes accounting rules for foreign currency transactions.

A. Export sales denominated in foreign currency are reported in U.S. dollars at the spot exchange rate at the date of the transaction. Subsequent changes in the exchange rate until collection of the receivable are reflected through a restatement of the foreign currency account receivable with an offsetting foreign exchange gain or loss reported in income. This is known as a two-transaction perspective, accrual approach.

B. The two-transaction perspective, accrual approach also is used in accounting for foreign currency payables. Receivables and payables denominated in foreign currency create an exposure to foreign exchange risk; this is the risk that changes in the exchange rate over time will result in a foreign exchange loss.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-2

IV. FASB ASC 815, Derivatives and Hedging, governs the accounting for derivative financial instruments and hedging activities including the use of foreign currency forward contracts and foreign currency options.

A. The fundamental requirement is that all derivatives must be carried on the balance sheet at their fair value. Derivatives are reported on the balance sheet as assets when they have a positive fair value and as liabilities when they have a negative fair value.

B. U.S. GAAP provides guidance for hedges of the following sources of foreign exchange risk:

1. foreign currency denominated assets and liabilities.

2. unrecognized foreign currency firm commitments.

3. forecasted foreign denominated currency transactions.

4. net investments in foreign operations (covered in Chapter 10).

C. Companies prefer to account for hedges in such a way that the gain or loss from the hedge is recognized in net income in the same period as the loss or gain on the risk being hedged. This approach is known as hedge accounting. Hedge accounting for foreign currency derivatives may be applied only if three conditions are satisfied:

1. the derivative is used to hedge either a cash flow exposure or fair value exposure to foreign exchange risk,

2. the derivative is highly effective in offsetting changes in the cash flows or fair value related to the hedged item, and

3. the derivative is properly documented as a hedge.

D. Hedge accounting is allowed for hedges of two different types of exposure: cash flow exposure and fair value exposure. Hedges of (1) foreign currency denominated assets and liabilities, (2) foreign currency firm commitments, and (3) forecasted foreign currency transactions can be designated as cash flow hedges. Hedges of (1) and (2) also can be designated as fair value hedges. Accounting procedures differ for the two types of hedges.

E. For cash flow hedges of foreign currency denominated assets and liabilities, at each balance sheet date:

1. The hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate, and a foreign exchange gain or loss is recognized in net income.

2. The derivative hedging instrument is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a change in Accumulated Other Comprehensive Income (AOCI).

3. An amount equal to the foreign exchange gain or loss on the hedged asset or liability is then transferred from AOCI to net income; the net effect is to offset any gain or loss on the hedged asset or liability.

4. An additional amount is removed from AOCI and recognized in net income to reflect (a) the current period’s amortization of the original discount or premium onthe forward contract (if a forward contract is the hedging instrument) or (b) the change in the time value of the option (if an option is the hedging instrument).

F. For fair value hedges of foreign currency denominated assets and liabilities, at each balance sheet date:

1. The hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate, and a foreign exchange gain or loss is recognized in net income.

2. The derivative hedging instrument is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a gain or loss in net income.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-3

G. Under fair value hedge accounting for hedges of foreign currency firm commitments:

1. the gain or loss on the hedging instrument is recognized currently in net income, and

2. the change in fair value of the firm commitment is also recognized currently in net income.

This accounting treatment requires (1) measuring the fair value of the firm commitment,

(2) recognizing the change in fair value in net income, and (3) reporting the firm commitment on the balance sheet as an asset or liability. A decision must be made whether to measure the fair value of the firm commitment through reference to (a) changes in the spot exchange rate or (b) changes in the forward rate.

H. Cash flow hedge accounting is allowed for hedges of forecasted foreign currency transactions. For hedge accounting to apply, the forecasted transaction must be probable (likely to occur). The accounting for a hedge of a forecasted transaction differs from the accounting for a hedge of a foreign currency firm commitment in two ways:

1. Unlike the accounting for a firm commitment, there is no recognition of the forecasted transaction or gains and losses on the forecasted transaction.

2. The hedging instrument (forward contract or option) is reported at fair value, but because there is no gain or loss on the forecasted transaction to offset against, changes in the fair value of the hedging instrument are not reported as gains and losses in net income. Instead they are reported in other comprehensive income. On the projected date of the forecasted transaction, the cumulative change in the fair value of the hedging instrument is transferred from other comprehensive income (balance sheet) to net income (income statement).

V. IFRS is very similar to U.S. GAAP with respect to the accounting for foreign currency transactions and hedging of foreign exchange risk.

A. IAS 21 requires the use of a two-transaction perspective in accounting for foreign currency transactions with unrealized foreign exchange gains and losses accrued in net income in the period of exchange rate change.

B. IAS 39 allows hedge accounting for foreign currency hedges of recognized assets and liabilities, firm commitments, and forecasted transactions when documentation requirements and effectiveness tests are met. Hedges are designated as cash flow or fair value hedges.

C. One difference between IFRS and U.S. GAAP relates to the type of financial instrument that can be designated as a foreign currency cash flow hedge. Under U.S. GAAP, only derivative financial instruments can be used as a cash flow hedge, whereas IFRS also allows non-derivative financial instruments, such as foreign currency loans, to be designated as hedging instruments in a foreign currency cash flow hedge.

D. Another difference relates to the accounting for the time value of a foreign currency option used to hedge foreign exchange risk. Under IFRS, the time value of the option when acquired is amortized to expense on a systematic and rationale basis. This is accomplished by recognizing the change in time value of an option initially in AOCI, and then immediately reclassifying a portion of the amount deferred in AOCI as option expense.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-4

the prior written consent of McGraw-Hill Education.

Answer to Discussion Question

Do we have a gain or what? This case demonstrates the differing kinds of information provided through application of current accounting rules for foreign currency transactions and derivative financial instruments.

The Ahnuld Corporation could have received $200,000 [$2.00 x 100,000 tchecks] from its export sale to Tcheckia if it had required immediate payment. Instead, Ahnuld allows its customer six months to pay. Given the future exchange rate of $1.70, Ahnuld would have received only $170,000 if it had not entered into the forward contract. This would have resulted in a decrease in cash inflow of $30,000. In accordance with current accounting standards, the decrease in the value of the tcheck receivable is recognized as a foreign exchange loss of $30,000. This loss represents the cost of extending credit to the foreign customer if the tcheck receivable is left unhedged.

However, rather than leaving the tcheck receivable unhedged, Ahnuld sells tchecks forward at a price of $180,000. Because the future spot rate turns out to be only $1.70, the forward contract provides a benefit, increasing the amount of cash received from the export sale by $10,000. In accordance with current accounting standards, the change in the fair value of the forward contract (from zero initially to $10,000 at maturity) is recognized as a gain on the forward contract of $10,000. This gain reflects the cash flow benefit from having entered into the forward contract, and is the appropriate basis for evaluating the performance of the foreign exchange risk manager. (Students should be reminded that the forward contract will not always improve cash inflow. For example, if the future spot rate were $1.85, the forward contract would result in $5,000 less cash inflow than if the transaction were left unhedged.)

The net impact on income resulting from the fluctuation in the value of the tcheck is a loss of $20,000. Clearly, Ahnuld forgoes $20,000 in cash inflow by allowing the customer time to pay for the purchase, and the net loss reported in income correctly measures this. The $20,000 loss is useful to management in assessing whether the sale to Tcheckia generated an adequate profit margin, but it is not useful in assessing the performance of the foreign exchange risk manager. The net loss must be decomposed into its component parts to fairly evaluate the risk manager’s performance.

Gains and losses on forward contracts designated as fair value hedges of foreign currency assets and liabilities are relevant measures for evaluating the performance of foreign exchange risk managers. (The same is not true for cash flow hedges. For this type of hedge, performance should be evaluated by considering the net gain or loss on the forward contract plus or minus the forward contract premium or discount.)

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-5

Answers to Questions

1. Under the two-transaction perspective, an export sale (import purchase) and the subsequent collection (payment) of cash are treated as two separate transactions to be accounted for separately. The idea is that management has made two decisions: (1) to make the export sale (import purchase), and (2) to extend credit in foreign currency to the foreign customer (obtain credit from the foreign supplier). The income effect from each of these decisions should be reported separately.

2. Foreign currency receivables resulting from export sales are revalued at the end of accounting periods using the current spot rate. An increase in the value of a receivable will be offset by reporting a foreign exchange gain in net income, and a decrease will be offset by a foreign exchange loss. Foreign exchange gains and losses are accrued even though they have not yet been realized.

3. Foreign exchange gains and losses are created by two factors: having foreign currency exposures (foreign currency receivables and payables) and changes in exchange rates. Appreciation of the foreign currency will generate foreign exchange gains on receivables and foreign exchange losses on payables. Depreciation of the foreign currency will generate foreign exchange losses on receivables and foreign exchange gains on payables.

4. The accounting for a foreign currency borrowing involves keeping track of two foreign currency payables the note payable and interest payable. As both the face value of the borrowing and accrued interest represent foreign currency liabilities, both are exposed to foreign exchange risk and can give rise to foreign currency gains and losses.

5 Hedging is the process of eliminating exposure to foreign exchange risk so as to avoid potential losses from fluctuations in exchange rates. In addition to avoiding possible losses, companies hedge foreign currency transactions, foreign currency firm commitments, and forecasted foreign currency transactions to introduce an element of certainty into the future cash flows resulting from foreign currency activities. Hedging involves establishing a price today at which foreign currency can be sold or purchased at a future date.

6 A party to a foreign currency forward contract is obligated to deliver one currency in exchange for another at a specified future date, whereas the owner of a foreign currency option can choose whether to exercise the option and exchange one currency for another or not.

7 Hedges of foreign currency denominated assets and liabilities are not entered into until a foreign currency transaction (import purchase or export sale) has taken place. Hedges of firm commitments are made when a purchase order is placed or a sales order is received, before a transaction has taken place. Hedges of forecasted transactions are made at the time a future foreign currency purchase or sale can be anticipated, even before an order has been placed or received.

8. Foreign currency options have an advantage over forward contracts in that the holder of the option can choose not to exercise if the future spot rate turns out to be more advantageous. Forward contracts, on the other hand, can lock a company into an unnecessary loss (or a reduced gain). The disadvantage associated with foreign currency options is that a premium must be paid up front even though the option might never be exercised.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-6

9 An enterprise is required to recognize all derivative financial instruments as assets or liabilities on the balance sheet and measure them at fair value.

10. The fair value of a foreign currency forward contract is determined by reference to changes in the forward rate over the life of the contract, discounted to the present value. Three pieces of information are needed to determine the fair value of a forward contract at any point in time during its life: (a) the contracted forward rate when the forward contract is entered into, (b) the current forward rate for a contract that matures on the same date as the forward contract entered into, and (c) a discount rate; typically, the company’s incremental borrowing rate.

The manner in which the fair value of a foreign currency option is determined depends on whether the option is traded on an exchange or has been acquired in the over the counter market. The fair value of an exchange-traded foreign currency option is its current market price quoted on the exchange. For over the counter options, fair value can be determined by obtaining a price quote from an option dealer (such as a bank). If dealer price quotes are unavailable, the company can estimate the value of an option using the modified BlackScholes option pricing model. Regardless of who does the calculation, principles similar to those in the Black-Scholes pricing model will be used in determining the value of the option.

11 Hedge accounting is defined as recognition of gains and losses on the hedging instrument in the same period as the recognition of gains and losses on the underlying hedged asset or liability (or firm commitment).

12 For hedge accounting to apply, the forecasted transaction must be probable (likely to occur), the hedge must be highly effective in offsetting fluctuations in the cash flow associated with the foreign currency risk, and the hedging relationship must be properly documented.

13 In both cases, (1) sales revenue (or the cost of the item purchased) is determined using the spot rate at the date of sale (or purchase), and (2) the hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate with a foreign exchange gain or loss recognized in net income.

For a cash flow hedge, the derivative hedging instrument is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a change in Accumulated Other Comprehensive Income (AOCI). An amount equal to the foreign exchange gain or loss on the hedged asset or liability is then transferred from AOCI to net income; the net effect is to offset any gain or loss on the hedged asset or liability. An additional amount is removed from AOCI and recognized in net income to reflect (a) the current period’s amortization of the original discount or premium on the forward contract (if a forward contract is the hedging instrument) or (b) the change in the time value of the option (if an option is the hedging instrument).

For a fair value hedge, the derivative hedging instrument is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a gain or loss in net income. The discount or premium on a forward contract is not allocated to net income. The change in the time value of an option is not recognized in net income.

14. For a fair value hedge of a foreign currency asset or liability (1) sales revenue (cost of purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the hedged

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-7

asset or liability is adjusted to fair value based on changes in the spot exchange rate with a foreign exchange gain or loss recognized in net income. The forward contract is adjusted to fair value based on changes in the forward rate (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a gain or loss in net income. The foreign exchange gain (loss) and the forward contract loss (gain) are likely to be of different amounts resulting in a net gain or loss reported in net income.

For a fair value hedge of a firm commitment, there is no hedged asset or liability to account for. The forward contract is adjusted to fair value based on changes in the forward rate (resulting in an asset or liability reported on the balance sheet), with a gain or loss recognized in net income. The firm commitment is also adjusted to fair value based on changes in the forward rate (resulting in a liability or asset reported on the balance sheet), and a gain or loss on firm commitment is recognized in net income. The firm commitment gain (loss) offsets the forward contract loss (gain) resulting in zero impact on net income. Sales revenue (cost of purchases) is recognized at the spot rate at the date of sale (purchase). The firm commitment account is closed as an adjustment to net income in the period in which the hedged item affects net income.

15 For a cash flow hedge of a foreign currency asset or liability (1) sales revenue (cost of purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate with a foreign exchange gain or loss recognized in net income. The forward contract is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a change in Accumulated Other Comprehensive Income (AOCI). An amount equal to the foreign exchange gain or loss on the hedged asset or liability is then transferred from AOCI to net income; the net effect is to offset any gain or loss on the hedged asset or liability. An additional amount is removed from AOCI and recognized in net income to reflect the current period’s allocation of the discount or premium on the forward contract.

For a hedge of a forecasted transaction, the forward contract is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a change in Accumulated Other Comprehensive Income (AOCI). Because there is no foreign currency asset or liability, there is no transfer from AOCI to net income to offset any gain or loss on the asset or liability. The current period’s allocation of the forward contract discount or premium is recognized in net income with the counterpart reflected in AOCI. Sales revenue (cost of purchases) is recognized at the spot rate at the date of sale (purchase). The amount accumulated in AOCI related to the hedge is closed as an adjustment to net income in the period in which the forecasted transaction was anticipated to occur.

16 In accounting for a fair value hedge, the change in the fair value of the foreign currency option is reported as a gain or loss in net income. In accounting for a cash flow hedge, the change in the entire fair value of the option is first reported in other comprehensive income, and then the change in the time value of the option is reported as an expense in net income.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-8

Answers to Problems

1. C (Foreign exchange gain/loss on foreign currency transaction)

An import purchase causes a foreign currency payable to be carried on the books. If the foreign currency depreciates, the dollar value of the foreign currency payable decreases, yielding a foreign exchange gain.

2. D (Method of accounting for foreign currency transactions)

Current accounting standards require a two-transaction perspective, accrual approach.

3. A (Foreign exchange gain/loss on foreign currency transaction)

Foreign exchange gains related to foreign currency import purchases are treated as a component of income before income taxes. If there is no foreign exchange gain in operating income, then the purchase must have been denominated in U.S. dollars or there was no change in the value of the foreign currency from October 1 to December 1, 2017.

4. B (Calculate foreign exchange gain/loss on foreign currency transaction)

The dollar value of the LCU receivable has increased from $110,000 at December 31, 2017 to $120,000 at February 15, 2018. This increase of $10,000 should be reported as a foreign exchange gain in 2018.

5. C (Calculate foreign exchange gain/loss on foreign currency borrowing)

The decrease in the dollar value of the euro note payable represents a foreign exchange gain. In this case a $5,000 gain would have been accrued in 2017 and a $10,000 gain will be reported in 2018.

6. B (Foreign exchange gain/loss on foreign currency transaction)

A foreign currency payable will generate a foreign exchange loss when the foreign currency increases in dollar value. A foreign currency receivable will generate a foreign exchange loss when the foreign currency decreases in dollar value. Hence, the correct combination is yuan (increase) and peso (decrease).

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-9

7. B (Calculate foreign exchange gain/loss)

The merchandise purchase results in a foreign exchange gain of $10,000, the difference between the U.S. dollar equivalent at the date of purchase and at the date of settlement.

The increase in the dollar equivalent of the note’s principal results in a foreign exchange loss of $20,000.

The net foreign exchange loss is $10,000 ($10,000 gain - $20,000 loss).

8. A (Forward contract cash flow hedge of foreign currency denominated asset/liability)

The Thai baht is selling at a discount (spot rate exceeds forward rate). The exporter will receive fewer dollars as a result of selling the baht forward than if the baht had been received and converted into dollars on June 1. Thus, the discount results in an expense for the exporter.

9. C (Forward contract fair value hedge of foreign currency firm commitment)

The parts inventory will be recognized at the spot rate at the date of receipt (FC100,000 x $.22 = $22,000).

10. A (Determine the fair value of a forward contract)

The forward contract must be reported on the December 31, 2017 balance sheet as an asset. Ringling has locked-in to purchase pesos at $0.047 per peso. If it had waited until December 31 to enter into the forward contract it would have locked-in to purchase pesos at $0.049 per peso. Therefore, the forward contract has a positive fair value on December 31, 2017, and is an asset. The forward contract must be reported at its fair value discounted for two months at 12%, which is $1,960.60 [($.047 – $.049) x 1,000,000 x .9803].

11. C (Calculate foreign exchange gain/loss on foreign currency transaction)

The 10 million won receivable has changed in dollar value from $35,000 at 12/1/17 to $33,000 at 12/31/17. The won receivable will be written down by $2,000 and a foreign exchange loss will be reported in 2017 income.

12. B (Forward contract fair value hedge of foreign currency denominated asset/liability)

The nominal value of the forward contract on December 31, 2017 is a positive $2,000, the difference between the amount to be received from the forward contract actually entered into, $34,000 ($.0034 x 10 million), and the amount that could be received by entering into a forward contract on

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-10

December 31, 2017 that matures on March 31, 2018, $32,000 ($.0032 x 10 12. (continued)

Million). The fair value of the forward contract is the present value of $2,000 discounted for three months, which is $1,941.20 (2,000 x .9706). On December 31, 2017, MNC Corp. will recognize a $1,941.20 gain on the forward contract and a foreign exchange loss of $2,000 on the won receivable. The net impact on 2017 income is a decrease of $58.80.

13. A (Forward contract cash flow hedge of forecasted foreign currency transaction)

The krona is selling at a premium in the forward market, causing Pimlico to pay more dollars to acquire kroner than if the kroner were purchased at the spot rate on March 1. Therefore, the premium results in an expense of $10,000 [($.12 – $.10) x 500,000].

The Adjustment to Net Income is the amount accumulated in Accumulated Other Comprehensive Income (AOCI) as a result of recognizing the Premium Expense and the fair value of the forward contract. The journal entries would be as follows:

14. B (Option cash flow hedge of forecasted foreign currency transaction)

This is a cash flow hedge of a forecasted transaction. The original cost of the option of $600 is recognized as an Option Expense over the life of the option.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-11

3/1 no journal entries 6/1 Premium Expense 10,000 AOCI 10,000 AOCI 2,500 Forward Contract 2,500 Foreign Currency 57,500 Forward Contract 2,500 Cash 60,000 AOCI 7,500 Adjustment to Net Income 7,500

15-17.(Option fair value hedge of a foreign currency firm commitment)

15. B

16. D

The easiest way to solve problems 15 and 16 is to prepare journal entries for the option fair value hedge and the firm commitment. The journal entries are as follows:

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-12

9/1/17 Foreign Currency Option 2,000.00 Cash 2,000.00 12/31/17 Foreign Currency Option 300.00 Gain on Foreign Currency Option 300.00 Loss on Firm Commitment 980.30 Firm Commitment 980.30 [($.79 – $.80) x 100,000 = $1,000 x .9803 = $980.30] Net impact on 2017 net income: Gain on Foreign Currency Option $300.00 Loss on Firm Commitment (980.30) $(680.30) 3/1/18 Foreign Currency Option 700.00 Gain on Foreign Currency Option 700.00 Loss on Firm Commitment 2,019.70 Firm Commitment 2,019.70 [($.77 – $.80) x 100,000 = $3,000 – $980.30 = $2,019.70] Foreign Currency (C$) 77,000.00 Sales 77,000.00 Cash 80,000.00 Foreign Currency (C$) 77,000.00 Foreign Currency Option 3,000.00 Firm Commitment 3,000.00 Adjustment to Net Income 3,000.00

18-20.(Forward contract fair value hedge of a foreign currency firm commitment)

The easiest way to solve problems 18 and 19 is to prepare journal entries for the forward contract fair value hedge of a firm commitment. The journal entries are as follows:

Net impact on second quarter net income is $0.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-13

Education.

distribution

the

written

Education.

Net impact on 2018 net income: Gain on Foreign Currency Option $ 700.00 Loss on Firm Commitment (2,019.70) Sales 77,000.00 Adjustment to Net Income 3,000.00 $78,680.30 17. B Net cash inflow with option ($80,000

$2,000) $78,000 Cash inflow without option (at spot rate of $.77) 77,000 Net increase in cash inflow $ 1,000

without

prior

consent of McGraw-Hill

15-17. (continued)

–

6/1 no journal entries 6/30 Forward Contract 2,400 Gain on Forward Contract 2,400 ($2,400 – $0) Loss on Firm Commitment 2,400 Firm Commitment 2,400

18-20. (continued) 7/31 Loss on Forward Contract 400 Forward Contract 400 [Fair value of Forward Contract is (($.120 – $.118) x 1,000,000) = $2,000; $2,000 – $2,400 = $400]

The impact on third quarter net income is: Sales $118,000 – Loss on Forward Contract $400 + Gain on Firm Commitment $400 + Adjustment to Net Income $2,000 = $120,000.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-14

Education.

Firm Commitment 400 Gain on Firm Commitment 400 Foreign Currency (pesos) 118,000 Sales [1,000,000 pesos x $.118] 118,000 Cash [1,000,000 x $.120] 120,000 Foreign Currency (pesos) 118,000 Forward Contract 2,000 Firm Commitment 2,000 Adjustment to Net Income 2,000

18. A 19. D 20. D Cash inflow with forward contract [1,000,000 pesos

$.12] $120,000 Cash inflow without forward contract [1,000,000 pesos x $.118] 118,000 Net increase in cash flow from forward contract $ 2,000

21-22. (Option cash flow hedge of a forecasted foreign currency transaction)

The easiest way to solve problems 21 and 22 is to prepare journal entries for the option cash flow hedge of a forecasted transaction. The journal entries are as follows:

(The option has no intrinsic value at 12/31/17 so the entire change in fair value is due to a change in time value; $1,500 – $1,100 = $400 decrease in time value. The decrease in time value of the option is recognized as an expense in net income.)

Option Expense decreases net income by $400.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-15

11/1/17 Foreign Currency Option 1,500 Cash 1,500 12/31/17 Option Expense 400 Foreign Currency Option 400

2/1/18 Option Expense 1,100 Foreign Currency Option 900 Accumulated Other Comprehensive Income (AOCI) 2,000

$.41)

200,000

Foreign Currency (BRL) [200,000 x $.41] 82,000 Cash [200,000 x $.40] 80,000 Foreign Currency Option 2,000 Parts Inventory 82,000 Foreign Currency (BRL) 82,000 Accumulated Other Comprehensive Income (AOCI) 2,000 Adjustment to Net Income 2,000

(Record expense for the decrease in time value of the option; $1,100 – $0 = $1,100; and write-up option to fair value ($.40 –

= $2,000 – $1,100 = $900.)

21-22. (continued)

21. B

22. C

23. (10 minutes) (Foreign currency payable – import purchase)

a. The decrease in the dollar value of the markka payable from November 1 (100,000 x .754 = $75,400) to December 31 (100,000 x .742 = $74,200) is recorded as a $1,200 foreign exchange gain in 2017.

b. The increase in the dollar value of the markka payable from December 31 ($74,200) to January 15 (100,000 x .747 = $74,700) is recorded as a $500 foreign exchange loss in 2018.

24. (10 minutes) (Foreign currency receivable – export sale)

a. The ostra receivable decreases in dollar value from (50,000 x $1.05) $52,500 at December 20 to $51,000 (50,000 x $1.02) at December 31, resulting in a foreign exchange loss of $1,500 in 2017.

b. The further decrease in dollar value of the ostra receivable from $51,000 at December 31 to $49,000 (50,000 x $.98) at January 10 results in an additional $2,000 foreign exchange loss in 2018.

25. (10 minutes) (Foreign currency receivable – export sale)

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-16

Net impact on 2018 net income: Option Expense $ (1,100) Cost-of-Goods-Sold (82,000) Adjustment to Net Income 2,000 Decrease in Net Income $ (81,100)

9/15 Accounts Receivable (crowns) [100,000 x $.60] 60,000 Sales 60,000 9/30 Accounts Receivable (crowns) 6,000 Foreign Exchange Gain 6,000 [100,000 x ($.66 – $.60)] 10/15 Foreign Exchange Loss 4,000 Accounts Receivable (crowns) 4,000 [100,000 x ($.62 – $.66)] Cash 62,000 Accounts Receivable (crowns) 62,000

26. (10 minutes) (Foreign currency payable – import purchase)

27. (15 minutes) (Determine U.S. dollar balance for foreign currency transactions)

Inventory and Cost of Goods Sold are reported at the spot rate at the date the inventory was purchased. Sales are reported at the spot rate at the date of sale. Accounts Receivable and Accounts Payable are reported at the spot rate at the balance sheet date. Cash is reported at the spot rate when collected and the spot rate when paid.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-17

Education. All

reproduction or distribution

the prior written

Education.

rights reserved. No

without

consent

McGraw-Hill

12/15/15 Inventory 14,000 Accounts Payable (schillings) [50,000 x $.28] 14,000 12/31/15 Foreign Exchange Loss 1,000 Accounts Payable (schillings) [50,000 x ($.30 – $.28)] 1,000 1/25/16 Foreign Exchange Loss 1,500 Accounts Payable (schillings) [50,000 x ($.33 – $.30)] 1,500 Accounts Payable (schillings) 16,500 Cash 16,500

a. Inventory [100,000 pesos x $.10 x

unsold]...................................... $4,000 b. COGS [100,000 pesos x $.10 x 60% sold]................................................ $6,000 c. Sales [80,000 pesos x $.12]....................................................................... $9,600 d. Accounts Receivable [80,000 – 70,000 = 10,000 pesos x $.15].............. $1,500 e. Accounts Payable [100,000 – 60,000 = 40,000 pesos x $.15]................. $6,000 f. Cash [(70,000 x $.13) – (60,000 x $.14)]....................................................... $700

40%

28. (25 minutes) (Prepare journal entries for a foreign currency borrowing)

29.

a. Benjamin, Inc. has a liability of AL 160,000. On the date that this liability was created (December 1, 2017), the liability had a dollar value of $70,400 (AL 160,000 x $.44). On December 31, 2017, the dollar value has risen to $76,800 (AL 160,000 x $.48). The increase in the dollar value of the liability creates a foreign exchange loss of $6,400 ($76,800 – $70,400) in 2017.

By March 1, 2018, when the liability is paid, the dollar value has dropped to $72,000 (AL 160,000 x $.45) creating a foreign exchange gain of $4,800 ($72,000 – $76,800) to be reported in 2018.

b. Benjamin, Inc. has a liability of AL 160,000. On the date that this liability was created (September 1, 2017), the liability had a dollar value of $73,600 (AL 160,000 x $.46). On December 1, 2017, when the liability is paid, the dollar value has decreased to $70,400 (AL 160,000 x $.44). The drop in the dollar value of the liability creates a foreign exchange gain of $3,200 ($70,400 – $73,600) in 2017.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-18

4/1/17 Cash 550,000 Note Payable (euro) [500,000 x $1.10] 550,000 10/1/17 Interest Expense [500,000 x 5% x 6/12 x $1.20] 15,000 Cash 15,000 12/31/17 Interest Expense [500,000 x 5% x 3/12 x $1.24] 7,750 Interest Payable (euro) 7,750 Foreign Exchange Loss 70,000 Note Payable (euro) [500,000 x ($1.24 - $1.10)] 70,000 3/31/18 Interest Expense [500,000 x 5% x 3/12 x $1.28] 8,000 Interest Payable (euro) 7,750 Foreign Exchange Loss [500,000 x 5% x 3/12 x ($1.28 – $1.24)] 250 Cash [500,000 x 5% x 6/12 x $1.28] 16,000 Note Payable (euro) 620,000 Foreign Exchange Loss [500,000 x ($1.28 - $1.24)] 20,000 Cash [500,000 x $1.28] 640,000

(20 minutes) (Determine income effect of foreign currency payable – import purchase)

29. (continued)

c. Benjamin, Inc. has a liability of AL 160,000. On the date that this liability was created (September 1, 2017), the liability had a dollar value of $73,600 (AL 160,000 x $.46). On December 31, 2017, the dollar value has risen to $76,800 (AL 160,000 x $.48). The increase in the dollar value of the liability creates a foreign exchange loss of $3,200 ($76,800 – $73,600) in 2017. By March 1, 2018, when the liability is paid, the dollar value has dropped to $72,000 (AL 160,000 x $.45) creating a foreign exchange gain of $4,800 ($72,000 – $76,800) to be reported in 2018.

30. (30 minutes) (Foreign currency borrowing)

a. 9/30/17 Cash

Note payable (dudek) [1,000,000 x $.10]

(To record the note and conversion of 1 million dudeks into $ at the spot rate.)

x 2% x 3/12 = 5,000 dudeks x $.105 spot rate]

(To accrue interest for the period 9/30 – 12/31/17.)

revalue the note payable at the spot rate of $.105 and record a foreign exchange loss.)

(To record the first annual interest payment, record interest expense for the period 1/1 – 9/30/18, and record a foreign exchange loss on the interest payable accrued at 12/31/17.)

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-19

100,000

12/31/17 Interest Expense 525 Interest Payable (dudek) 525

[1,000,000

Foreign Exchange Loss 5,000 Note Payable (dudek)

5,000

9/30/18 Interest Expense [15,000 dudeks

1,800 Interest Payable (dudek) 525 Foreign Exchange Loss [5,000 dudeks x ($.12

$.105)] 75 Cash [20,000 dudeks x

2,400

x ($.105 – $.10)]

(To

x $.12]

–

$.12]

12/31/18 Interest Expense 625 Interest Payable (dudek) [5,000 dudeks x $.125] 625

(To accrue interest for the period 9/30 – 12/31/18.)

30. (continued)

(To revalue the note payable at the spot rate of $.125 and record a foreign exchange loss.)

(To record the second annual interest payment, record interest expense for the period 1/1 – 9/30/19, and record a foreign exchange loss on the interest payable accrued at 12/31/18.)

b. The effective interest rate on the loan can be determined by summing the total interest expense and foreign exchange losses related to the loan and comparing this with the amount borrowed:

Because of appreciation in the value of the dudek, the effective annual interest cost ranges from 22.1% – 36.5%.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-20

distribution

the

without

prior written consent of McGraw-Hill Education.

Foreign Exchange Loss 20,000 Note Payable (dudek)

20,000

9/30/19 Interest Expense [15,000 dudeks x $.15] 2,250 Interest Payable (dudek) 625 Foreign Exchange Loss [5,000 dudeks

($.15 – $.125)] 125 Cash [20,000 dudeks x $.15] 3,000

12/31/18

[1 mn x ($.125 – $.105)]

Note Payable (dudek) 125,000 Foreign Exchange Loss 25,000 Cash [1 mn dudeks x $.15] 150,000 (To record

dudek

payment of the 1 million

note.)

2017 Interest expense $525 Foreign exchange loss 5,000 Total $5,525 / $100,000 = 5.525% for 3 months 5.525% x 12/3 = 22.1% for 12 months 2018 Interest expense $2,425 Foreign exchange losses 20,075 Total $22,500 / $100,000 = 22.5% for 12 months 2019 Interest expense $2,250 Foreign exchange losses 25,125 Total $27,375 / $100,000 = 27.38% for 9 months 27.38% x 12/9 = 36.5% for 12 months

30. (continued)

The net cash flows from this borrowing are:

Ignoring compounding, this results in an average effective interest rate of approximately 27.7% per year [($55,400 / $100,000) = 55.4% over two years; 55.4% / 2 years = 27.7% per year].

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-21

Cash outflows: Interest ($2,400

$3,000) $ 5,400 Principal 150,000 $155,400 Cash inflow: Borrowing (100,000) Net cash outflow $ 55,400

31. (40 minutes) (Forward contract hedge of foreign currency receivable)

a. Cash Flow Hedge

To record sales revenue and a foreign currency account receivable.

No entry for the forward contract.

To revalue the foreign currency account receivable and recognize a foreign exchange gain.

To record the change in fair value of the forward contract as a liability.

To record a loss on forward contract to offset the foreign exchange gain.

To allocate the forward contract premium as revenue over the life of the contract.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-22

Date Journal Entry Debit Credit 12/1/17 Accounts Receivable (K) 43,200.00 Sales Revenue 43,200.00

12/31/17 Accounts Receivable (K) 1,600.00 Foreign Exchange Gain 1,600.00

AOCI 1,960.60 Forward Contract 1,960.60

Loss on Forward Contract 1,600.00 AOCI 1,600.00

AOCI 400.00 Premium Revenue 400.00

Impact on 2017 net income: Sales Revenue $43,200.00 Foreign Exchange Gain 1,600.00 Loss on Forward Contract (1,600.00) Premium Revenue 400.00 Total $43,600.00

31. (continued)

a. Cash Flow Hedge (continued)

To revalue the foreign currency account receivable and recognize a foreign exchange gain.

To adjust the carrying value of the forward contract to its current fair value.

To record a loss on forward contract to offset the foreign exchange gain.

To allocate the forward contract premium as revenue over the life of the contract.

To record the receipt of korunas from the foreign customer.

To record settlement of the forward contract.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-23

Date Journal Entry Debit Credit 3/1/18 Accounts Receivable (K) 2,400.00 Foreign Exchange Gain 2,400.00

AOCI 839.40 Forward Contract 839.40

Loss on Forward Contract 2,400.00 AOCI 2,400.00

AOCI 800.00 Premium Revenue 800.00

Foreign Currency (K) 47,200.00 Accounts Receivable (K) 47,200.00

Cash 44,400.00 Forward Contract 2,800.00 Foreign Currency (K) 47,200.00

Impact on 2018 net income: Foreign Exchange Gain $2,400.00 Loss on Forward Contract (2,400.00) Premium Revenue 800.00 Total $800.00

income

periods,

Impact

net

over both

which is equal to net cash inflow: $43,600.00 + $800.00 = $44,400.00

To record sales revenue and a foreign currency account receivable.

No entry for the forward contract.

To revalue the foreign currency account receivable and recognize a foreign exchange gain.

To record the change in fair value of the forward contract as a liability and recognize a loss on forward contract.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-24

31. (continued)

Date Journal Entry Debit Credit 12/1/17 Accounts Receivable (K) 43,200.00 Sales Revenue 43,200.00

b. Fair Value Hedge

12/31/17 Accounts Receivable (K) 1,600.00 Foreign Exchange Gain 1,600.00

Loss on Forward Contract 1,960.60 Forward Contract 1,960.60

Impact on 2017 net income: Sales Revenue $43,200.00 Foreign Exchange Gain 1,600.00 Loss on Forward Contract (1,960.60) Total $42,839.40

31. (continued)

b. Fair Value Hedge (continued)

To revalue the foreign currency account receivable and recognize a foreign exchange gain.

To adjust the carrying value of the forward contract to its current fair value and recognize a loss on forward contract.

record settlement of the forward contract.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-25

Date Journal Entry Debit Credit 3/1/18 Accounts Receivable (K) 2,400.00 Foreign Exchange Gain 2,400.00

Loss on Forward Contract 839.40 Forward Contract 839.40

Foreign Currency (K) 47,200.00 Accounts Receivable (K) 47,200.00

the

korunas

Cash 44,400.00 Forward Contract 2,800.00 Foreign Currency (K) 47,200.00

Impact on 2018 net income: Foreign Exchange Gain $2,400.00 Loss on Forward Contract (839.40) Total $1,560.60 Impact

$42,839.40 + $1,560.60

$44,400.00

To record

receipt of

from the foreign customer.

on net income over both periods, which is equal to net cash inflow:

32. (40 minutes) (Forward contract hedge of foreign currency payable)

a. Cash Flow Hedge

To record the purchase of materials immediately as cost of goods sold and record a foreign currency account payable.

No entry for the forward contract.

To revalue the foreign currency account payable and recognize a foreign exchange loss.

To record the change in fair value of the forward contract as an asset.

To record a gain on forward contract to offset the foreign exchange loss.

To allocate the forward contract premium to expense overthe life of the contract.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-26

Date Journal Entry Debit Credit 12/1/17 Cost of Goods Sold 43,200.00 Accounts Payable (K) 43,200.00

12/31/17 Foreign Exchange Loss 1,600.00 Accounts Payable (K) 1,600.00

Forward Contract 1,960.60 AOCI 1,960.60

AOCI 1,600.00 Gain on Forward Contract 1,600.00

Premium Expense 400.00 AOCI 400.00

Cost of Goods Sold $(43,200.00) Foreign Exchange Loss (1,600.00) Gain on Forward Contract 1,600.00 Premium Expense (400.00) Total $(43,600.00)

Impact on 2017 net income:

32. (continued)

a. Cash Flow Hedge (continued)

2017

To revalue the foreign currency account payable and recognize a foreign

loss.

To adjust the carrying value of the forward contract to its current fair value.

To record a gain on forward contract to offset the foreign

To allocate the forward contract premium to expense over the life of the contract.

To record settlement of the forward contract.

To record the payment of korunas to the foreign supplier.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-27

Date Journal Entry Debit Credit 3/1/18 Foreign Exchange Loss 2,400.00 Accounts Payable (K) 2,400.00

Forward Contract 839.40 AOCI 839.40

exchange

AOCI 2,400.00 Gain on Forward Contract 2,400.00

exchange

Premium Expense 800.00 AOCI 800.00

loss.

Foreign Currency (K) 47,200.00 Cash 44,400.00 Forward Contract 2,800.00

Accounts Payable (K) 47,200.00 Foreign Currency (K) 47,200.00

Impact on 2018 net income: Foreign Exchange Loss $(2,400.00) Gain on Forward Contract 2,400.00 Premium Expense (800.00) Total $ (800.00)

on net income over both periods,

outflow: $(43,600.00) + $(800.00) = $(44,400.00)

Impact

which is equal to net cash

32. (continued)

b. Fair Value Hedge

To record the purchase of materials immediately as cost of goods sold and record a foreign currency account payable.

No entry for the forward contract.

To revalue the foreign currency account payable and recognize a foreign exchange loss.

To record the change in fair value of the forward contract as an asset and recognize a gain on forward contract.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e

9-28

Date Journal Entry Debit Credit 12/1/17 Cost of Goods Sold 43,200.00 Accounts Payable (K) 43,200.00

12/31/17 Foreign Exchange Loss 1,600.00 Accounts Payable (K) 1,600.00

Forward Contract 1,960.60 Gain on Forward Contract 1,960.60

Impact on 2017 net income: Cost of Goods Sold $(43,200.00) Foreign Exchange Loss (1,600.00) Gain on Forward Contract 1,960.60 Total $(42,839.40)

32. (continued)

b. Fair Value Hedge (continued)

To revalue the foreign currency account payable and recognize a foreign exchange loss.

To adjust the carrying value of the forward contract to its current fair value and recognize a gain on forward contract.

To record the payment of korunas to the foreign supplier.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-29

Date Journal Entry Debit Credit 3/1/18 Foreign Exchange Loss 2,400.00 Accounts Payable (K) 2,400.00

Forward Contract 839.40 Gain on Forward Contract 839.40

Foreign Currency (K) 47,200.00 Cash 44,400.00 Forward Contract 2,800.00

Accounts Payable (K) 47,200.00 Foreign Currency (K) 47,200.00

Impact on 2018 net income: Foreign Exchange Loss $(2,400.00) Gain on Forward Contract 839.40 Total $(1,560.60) Impact

$(42,839.40) + $(1,560.60)

$(44,400.00)

To record settlement of the forward contract.

on net income over both periods, which is equal to net cash outflow:

33. (30 minutes) (Option hedge of foreign currency receivable)

a. Cash Flow Hedge

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-30

Education.

6/1 Accounts Receivable (P) 62,000 Sales [$.062 x 1,000,000] 62,000 Foreign Currency Option 2,500 Cash 2,500 6/30 Accounts Receivable (P) 4,000 Foreign Exchange Gain [($.066 – $.062) x 1,000,000] 4,000 AOCI 700 Foreign Currency Option 700 [($.0018 – $.0025) x 1,000,000] Loss on Foreign Currency Option 4,000 AOCI 4,000 Option Expense 700 AOCI 700 Date Fair Value Intrinsic Value Time Value Change in Time Value 6/1 $2,500 $0 $2,500 –6/30 $1,800 $0 $1,800 – $ 700 9/1 $1,000 $1,000 $0 – $1,800

33. (continued)

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-31 Copyright

9/1 Foreign Exchange Loss 5,000 Accounts Receivable (P) 5,000 [($.061 – $.066) x 1,000,000] AOCI 800 Foreign Currency Option 800 [$1,800 – $1,000] AOCI 5,000 Gain on Foreign Currency Option 5,000 Option Expense 1,800 AOCI 1,800 (Change in time value of option is recognized as expense) Foreign Currency (P) 61,000 Accounts Receivable (P) 61,000 Cash 62,000 Foreign Currency (P) 61,000 Foreign Currency Option 1,000 Impact on Net Income over the Two Accounting Periods: Sales $62,000 Foreign Exchange Gain 4,000 Loss on Foreign Currency Option (4,000) Foreign Exchange Loss (5,000) Gain on Foreign Currency Option 5,000 Foreign currency option expense (2,500) Impact on net income $59,500 = Net cash inflow

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-32

Education.

McGraw-Hill

33. (continued)

6/1 Accounts Receivable (P) 62,000 Sales [$.062 x 1,000,000] 62,000 Foreign Currency Option 2,500 Cash 2,500 6/30 Accounts Receivable (P) 4,000 Foreign Exchange Gain 4,000 [($.066 – $.062) x 1,000,000] Loss on Foreign Currency Option 700 Foreign Currency Option 700 9/1 Foreign Exchange Loss 5,000 Accounts Receivable (P) 5,000 [($.061 – $.066) x 1,000,000] Loss on Foreign Currency Option 800 Foreign Currency Option 800 Foreign Currency (P) 61,000 Accounts Receivable (P) 61,000 Cash 62,000 Foreign Currency (P) 61,000 Foreign Currency Option 1,000 Impact on Net Income over the Two Accounting Periods: Sales $62,000 Foreign Exchange Gain 4,000 Foreign Exchange Loss (5,000) Loss on Foreign Currency Option (1,500) Impact on net income $59,500 = Net cash inflow

b. Fair Value Hedge

34. (30 minutes) (Option hedge of foreign currency payable)

a. Cash Flow Hedge

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-33

Date Fair Value Intrinsic Value Time Value Change in Time Value 6/1 $2,000 $0 $2,0006/30 $7,000 $6,000 $1,000 -$1,000* 9/1 $20,000 $20,000 $0 -$1,000** 6/1 Inventory [$.852 x 1,000,000] 852,000 Accounts Payable (francs) 852,000 Foreign Currency Option 2,000 Cash [1,000,000 x $0.002] 2,000 6/30 Foreign Exchange Loss 6,000 Accounts Payable (francs) 6,000 [($.858 – $.852) x 1,000,000] Foreign Currency Option 5,000 AOCI 5,000 [$7,000 – $2,000] AOCI 6,000 Gain on Foreign Currency Option 6,000 Option Expense 1,000* AOCI 1,000

34. (continued)

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-34

Education.

distribution

the

Education.

without

prior written consent of McGraw-Hill

9/1 Foreign Exchange Loss 14,000 Accounts Payable (francs) 14,000 [($.872 – $.858) x 1,000,000] Foreign Currency Option 13,000 AOCI 13,000 [$20,000 – $7,000] AOCI 14,000 Gain on Foreign Currency Option 14,000 Option Expense 1,000** AOCI 1,000 Foreign Currency (francs) 872,000 Cash 852,000 Foreign Currency Option 20,000 Accounts Payable (francs) 872,000 Foreign Currency (francs) 872,000 Overall impact on net income: Option Expense ($2,000)

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-35

34. (continued)

6/1 Inventory [$.852 x 1,000,000] 852,000 Accounts Payable (francs) 852,000 Foreign Currency Option 2,000 Cash [1,000,000 x $0.002] 2,000 6/30 Foreign Exchange Loss 6,000 Accounts Payable (francs) 6,000 [($.858 – $.852) x 1,000,000] Foreign Currency Option 5,000 Gain on Foreign Currency Option 5,000 [$7,000 – $2,000] 9/1 Foreign Exchange Loss 14,000 Accounts Payable (francs) 14,000 [($.872 – $.858) x 1,000,000] Foreign Currency Option 13,000 Gain on Foreign Currency Option 13,000 [$20,000 – $7,000] Foreign Currency (francs) 872,000 Cash 852,000 Foreign Currency Option 20,000 Accounts Payable (francs) 872,000 Foreign Currency (francs) 872,000 Overall impact on net income: Foreign Exchange Loss ($20,000) Gain on Foreign Currency Option 18,000 Impact on net income ($ 2,000)

Fair Value Hedge

35. (30 minutes) (Forward contract cash flow hedge of foreign currency denominated asset)

1 ($20,000 – $17,000) x .961 = $2,883; where .961 is the present value factor for four months at an annual interest rate of 12% (1% per month) calculated as 1/1.014 .

2 $20,000 – $18,000 = $2,000.

There is no entry for the forward contract.

The impact on net income for the year 2017 is:

AOCI has a positive (credit) balance of $1,216.33 ($2,883.00 - $2,000.00 + $333.33).

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-36

Account Receivable (FCU)

Forward Contract Spot U.S. Dollar Change in U.S. Rate to Change in Date Rate Value Dollar Value 4/30/18 Fair Value Fair Value 11/01/17 $.21 $21,000 - $.20 $012/31/17 $.19 $19,000 -$2,000 $.17 $2,8831 +$2,883 4/30/18 $.18 $18,000 -$1,000 $.18 $2,0002 - $ 883

Forward

2017 Journal Entries 11/01 Accounts Receivable (FCU) 21,000.00 Sales 21,000.00

12/31 Foreign Exchange Loss 2,000.00 Accounts Receivable (FCU) 2,000.00 Forward Contract 2,883.00 AOCI 2,883.00 AOCI 2,000.00 Gain on Forward Contract 2,000.00 Discount expense 333.33 AOCI 333.33 [100,000 x ($.21 – $.20) x 2/6]

Sales $21,000.00 Foreign Exchange Loss (2,000.00) Gain on Forward Contract 2,000.00 Net Gain (Loss) 0.00 Discount Expense (333.33) Impact on net income $20,666.67

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-37

Education.

2018 Journal Entries 4/30 Foreign Exchange Loss 1,000.00 Accounts Receivable (FCU) 1,000.00 AOCI 883.00 Forward Contract 883.00 AOCI 1,000.00 Gain on Forward Contract 1,000.00 Discount expense 666.67 AOCI 666.67 Foreign Currency (FCU) 18,000.00 Accounts Receivable (FCU) 18,000.00 Cash 20,000.00 Foreign Currency (FCU) 18,000.00 Forward Contract 2,000.00 The impact on net income for the year 2018 is: Foreign Exchange Loss $(1,000.00) Gain on Forward Contract 1,000.00 Net Gain (Loss) 0.00 Discount Expense (666.67) Impact on net income $(666.67) AOCI has a balance of zero ($1,216.33 - $883.00 - $1,000.00 + $666.67).

35. (continued)

36. (30 minutes) (Forward contract fair value hedge of net foreign currency denominated asset)

1 ($104,000 – $96,000) x .9901 = $7,921; where .9901 is the present value factor for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.01.

2 $104,000 – $98,000 = $6,000.

There is no formal entry for the forward contract.

The impact on net income for the year 2017 is:

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-38

Account Receivable (Payable)

Forward Contract Change in U.S. Rate to Change in Date U.S. Dollar Value Dollar Value 1/31/18 Fair Value Fair Value 11/30/17 $265,000 ($159,000) - $.52 $012/31/17 $250,000 ($150,000) -$15,000 (-$9,000) $.48 $7,9211 +$7,921 1/31/18 $245,000 ($147,000) -$ 5,000 (-$3,000) $.49 $6,0002 - $1,921

(mongs) Forward

2017 Journal Entries 11/30 Accounts Receivable (mongs) 265,000 Sales 265,000 [$.53 x 500,000] Inventory 159,000 Accounts Payable 159,000 [$.53 x 300,000]

12/31 Foreign Exchange Loss 15,000 Accounts Receivable (mongs) 15,000 Accounts Payable (mongs) 9,000 Foreign Exchange Gain 9,000 Forward Contract 7,921 Gain on Forward Contract 7,921

Sales

Net Foreign Exchange Loss

(6,000) Gain on Forward Contract 7,921 Net Gain (Loss) 1,921 Impact on net income $266,921

$265,000

36. (continued)

The net effect on the balance sheet is an increase in cash of $104,000 and an increase in inventory of $159,000 with a corresponding increase in retained earnings of $263,000 ($266,921 – $3,921).

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-39

Education.

2018 Journal Entries 1/31 Foreign Exchange Loss 5,000 Accounts Receivable (mongs) 5,000 Accounts Payable (mongs) 3,000 Foreign Exchange Gain 3,000 Loss on Forward Contract 1,921 Forward Contract 1,921 Foreign Currency (mongs) 245,000 Accounts Receivable (mongs) 245,000 Accounts Payable (mongs) 147,000 Foreign Currency (mongs) 147,000 Cash 104,000 Foreign Currency (mongs) 98,000 Forward Contract 6,000 The impact on net income for the year 2018 is: Net Foreign Exchange Loss $(2,000) Loss on Forward Contract (1,921) Impact on net income $(3,921)

37. (40 minutes) (Forward contract fair value hedge – foreign currency receivable and firm commitment (sale))

a. Foreign

1 ($39,000 – $41,000) x .9901 = ($1,980.20); where .9901 is the present value factor for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.01.

2 $40,000 – $39,000 = $1,000.

There is no formal entry for the forward contract.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-40

Currency Receivable Account

Spot U.S. Dollar Change in U.S. Rate to Change in Date Rate Value Dollar Value 1/31/18 Fair Value Fair Value 10/01/17 $.35 $35,000 - $.39 $012/31/17 $.38 $38,000 +$3,000 $.41 $(1,980.20)1 - $1,980.20 1/31/18 $.40 $40,000 +$2,000 $.40 $(1,000.00)2 + $ 980.20

Receivable (ruble) Forward Forward Contract

10/01 Accounts Receivable (ruble) 35,000.00 Sales 35,000.00 [100,000 x $.35]

12/31 Accounts Receivable (ruble) 3,000.00 Foreign Exchange Gain 3,000.00 [($.38 – $.35) x 100,000] Loss on Forward Contract 1,980.201 Forward Contract 1,980.20 [($.41 – $.39) x 100,000 x .9901] 1/31 Accounts Receivable (ruble) 2,000.00 Foreign Exchange Gain 2,000.00 [($.40 – $.38) x 100,000] Forward Contract 980.20 Gain on Forward Contract 980.20 [$1,980.20 - (($.40 – $.39) x 100,000)] Foreign Currency (ruble) 40,000.00 Accounts Receivable (ruble) 40,000.00 Cash 39,000.00 Forward Contract 1,000.00 Foreign Currency (ruble) 40,000.00

37.a. (continued)

The overall impact on net income is:

b. Foreign Currency Firm Commitment (Sale)

10/01 There is no entry to record either the sales agreement or the forward contract as both are executory contracts.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e

9-41

Sales $35,000.00 Foreign Exchange Gain 5,000.00 Loss on Forward Contract (1,980.20) Gain on Forward Contract 980.20 Impact on net income $39,000.00 = Cash Inflow

12/31 Loss on Forward Contract 1,980.20 Forward Contract 1,980.20 Firm Commitment 1,980.20 Gain on Firm Commitment 1,980.20 1/31 Forward Contract 980.20 Gain on Forward Contract 980.20 Loss on Firm Commitment 980.20 Firm Commitment 980.20 Foreign Currency (ruble) 40,000.00 Sales 40,000.00 Cash 39,000.00 Forward Contract 1,000.00 Foreign Currency (ruble) 40,000.00 Adjustment to Net Income 1,000.00 Firm Commitment 1,000.00 Overall

on Net Income

Sales $40,000.00 Net Loss on Forward Contract (1,000.00) Net Gain on Firm Commitment 1,000.00 Adjustment to Net Income (1,000.00) $39,000.00 = Cash Inflow

impact

is:

38. (30 minutes) (Forward contract fair value hedge of a foreign currency firm commitment (purchase))

1 ($264,000 – $240,000) x .9901 = $23,762.40; where .9901 is the present value factor for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.01.

2 ($272,000 – $240,000) = $32,000.

a. Journal entries

8/1 There is no entry to record either the purchase agreement or the forward contract as both are executory contracts.

b. Assuming the inventory is sold in the fourth quarter, the net impact on net income is negative $240,000:

c. The net cash outflow is $240,000.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-42

Forward Forward Contract Firm Commitment Rate to Change in Change in Date 10/31 Fair Value Fair Value Fair Value Fair Value 8/1 $.60 $0 - $0 $0 9/30 $.66 $23,762.401 +$23,762.40 $(23,762.40)1 – $23,762.40 10/31 $.68 (spot) $32,000.002 +$8,237.60 $(32,000.00)2 – $8,237.60

9/30 Forward Contract 23,762.40 Gain on Forward Contract 23,762.40 Loss on Firm Commitment 23,762.40 Firm Commitment 23,762.40 10/31 Forward Contract 8,237.60 Gain on Forward Contract 8,237.60 Loss on Firm Commitment 8,237.60 Firm Commitment 8,237.60 Foreign Currency (ringgits) [400,000 x $0.68] 272,000 Cash [400,000 x $0.60] 240,000 Forward Contract 32,000 Inventory (Cost-of-Goods-Sold) 272,000 Foreign Currency (ringgits) 272,000 Firm Commitment 32,000 Adjustment to Net Income 32,000

Cost-of-Goods-Sold $(272,000) Adjustment to Net Income 32,000 Net impact on net income $(240,000)

39. (30 minutes) (Option fair value hedge of a foreign currency firm commitment (sale))

1 ($94,000 – $100,000) x .9803 = $(5,881.80), where .9803 is the present value factor for two months at an annual interest rate of 12% (1% per month) calculated as 1/1.012 .

2 $88,000 – $100,000 = $(12,000).

There is no entry to record the sales agreement because it is an executory contract.

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-43

Firm Commitment Option Option Spot Change in Premium Change in Date Rate Fair Value Fair Value for 9/1 Fair Value Fair Value 6/1 $1.00 - - $0.020 $2,0006/30 $0.94 $(5,881.80)1 – $5,881.80 $0.028 $2,800 + $800 9/1 $0.88 $(12,000)2 – $6,118.20 N/A $12,000 + $9,200

a. Journal Entries 6/1 Foreign Currency Option 2,000.00 Cash 2,000.00

6/30 Loss on Firm Commitment 5,881.80 Firm Commitment 5,881.80 Foreign Currency Option 800.00 Gain on Foreign Currency Option 800.00 9/1 Loss on Firm Commitment 6,118.20 Firm Commitment 6,118.20 Foreign Currency Option 9,200.00 Gain on Foreign Currency Option 9,200.00 Foreign Currency (lek) 88,000.00 Sales 88,000.00 Cash 100,000.00 Foreign Currency (lek) 88,000.00 Foreign Currency Option 12,000.00 Firm Commitment 12,000.00 Adjustment to Net Income 12,000.00

39. (continued)

b. Impact on Net Income

The impact on net income for the second quarter is:

The impact on net income over the second and third quarters is: $98,000 ($103,081.80– $5,801.80)

c. Net Cash Inflow

The net cash inflow resulting from the sale is: $98,000 ($100,000 – $2,000)

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-44

Loss on Firm Commitment $(5,881.80) Gain on Foreign Currency Option 800.00 Impact on net income $(5,081.80)

Sales $88,000.00 Loss on Firm Commitment (6,118.20) Gain on Foreign Currency option 9,200.00 Adjustment to Net Income 12,000.00 Impact on net income $103,081.80

The impact on net income for the third quarter is:

40. (30 minutes) (Option fair value hedge of a foreign currency firm commitment (purchase))

Firm commitment to pay 100,000 forints on 12/20. Option with strike price of $0.50 acquired on 11/20.

1 $50,000 – $53,000 = $(3,000).

2 $50,000 – $48,000 = $2,000.

3 The premium on 12/20 for an option that expires on that date is equal to the option’s intrinsic value. Given the spot rate on 12/20 of $0.53, a call option with a strike price of $0.50 has an intrinsic value of $0.03 per forint.

4 The premium on 12/20 for an option that expires on that date is equal to the option’s intrinsic value. Given the spot rate on 12/20 of $0.48, a call option with a strike price of $0 50 has no intrinsic value – the premium on 12/20 is $0.00.

a. The option strike price ($0.50) is less than the spot rate ($0.53) on December 20, the date the parts are to be paid for. Therefore, Spitz will exercise its option. The journal entries are as follows:

Chapter 09 - Foreign Currency Transactions and Hedging Foreign Exchange Risk – Hoyle, Schaefer, Doupnik, 13e 9-45

Firm Commitment Option Option Spot Change in Premium Change in Date Rate Fair Value Fair Value for 12/20 Fair Value Fair Value 11/20 $0.50 - - $0.01 $1,000a) 12/20 $0.53 $(3,000)1 – $3,000 $0.033 $3,000 + $2,000 b) 12/20 $0.48 $ 2,0002 + $2,000 $0.0004 $0 – $1,000

11/20 Foreign Currency Option 1,000 Cash 1,000 There is no entry to record the purchase agreement because it is an executory contract. 12/20 Loss on Firm Commitment 3,000 Firm Commitment 3,000 Foreign Currency Option 2,000 Gain on Foreign Currency Option 2,000 Foreign Currency (forint) 53,000 Cash 50,000 Foreign Currency Option 3,000 Merchandise Inventory 53,000 Foreign Currency (forint) 53,000

Advanced accounting 13th edition hoyle solutions manual 1