Advanced Accounting, Part Three

Midterm Examination

1. On November 2, 2007, Pete Corporation acquired 100 shares of JRS Company at a cost of P120 per share. Pete classifies them as available for sale securities. On this same date, Pete decides to hedge against a possible decline in the value of the securities by purchasing at a cost of P100, a put option to sell the 100 shares at P12 per share. The option expires on March 3, 2008. The fair value of the investment and the options follow: 11/3/07 12/31/07 3/3/08 JRS Company shares: Per share P12 P11 P10.5 Put Option (100 shares) Market value P100 P140 P150 Intrinsic value -0100 150 Time value P100 P40 P-0a. How much is the net gain (loss) on hedging activity to be recognized on December 31, 2007? b. What is the journal entry to record the exercise of the put option and the sale of the securities on March 3, 2008? 2. On November 2, 2008, Michael Inc., contracted to purchase merchandise from Malaysia for 240,000 Ringgit. The merchandise were to be delivered on January 30, 2009, and payment would be due on March 1, 2009. On November 1, 2008, Michael entered into a 120-day forward contract to hedge the foreign currency commitment. the spot rates were: November 1, 2008 1 Ringgit=P12.85 December 31, 2008 1 Ringgit=P12.88 January 30, 2009 1 Ringgit=P12.83 March 1, 2009 1 Ringgit=P12.86 The forward rate on March 1, 2009 is P12.82 and on December 31, 2009 is P12.80. a. What is Michaels net exposure to changes in the exchange rate of ringgit for pesos between November 2, 2008 and March 1, 2009? b. Prepare all journal entries from November 2, 2008, through March 1, 2009 for the purchase of the merchandise, the forward exchange contract, and the foreign currency transactions. Assume Michaels fiscal year ends on December 31, 2008. 3. Mega Company believes the price of oil will increase in the coming months. Therefore, it decides to purchase call options on oil as a price-risk-hedging device to hedge the expected increase in prices on an anticipated purchase of oil. On November 30, 2007, Mega purchase call options for 10, 000 barrels of oil at P30 per barrel at a premium of P2 per barrel, with a March 1, 2008 call date. The following is the pricing information for the term of the call: Spot Price Futures Price (for March 1, 2008 delivery) Date November 30, 2007 P30 P31 December 31, 2007 P31 P32 March 1, 2008 P33 The information for the change in the fair value of the option follows: Date November 30, 2007 December 31, 2007 March 1, 2008 Ineffective portion P20,000 P6,000 Effective portion -0P10,000 P30,000

On March 1, 2008, Mega sells the options at their value on that date and acquires 10,000 barrels of oil at the spot price. On June 1, 2008, Mega sells the oil for P34 per barrel. a. Prepare the journal entry required on November 30, 2007, to record the purchase of the call options. b. Prepare the adjusting journal entry required on December 31, 2007, to record the change in time and intrinsic value of the options.

Advanced Accounting, Part Three

Midterm Examination

c. Prepare the entries required on March 1, 2008, to record the expiration of the time value of the options, he sale of the options, and the purchase of the 10,000 barrels of oil. d. Prepare the entries required on June 1, 2008, to record the sale of the oil and any other entries required as a result of the option.