Chapter 9 Advanced

CHAPTER 9
FOREIGN CURRENCY TRANSACTIONS AND

HEDGING FOREIGN EXCHANGE RISK
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. B (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, 2013.
4. C
(Calculate foreign exchange gain/loss on foreign currency transaction)

The dollar value of the LCU receivable has decreased from $110,000 at
December 31, 2013 to $95,000 at February 15, 2014. This decrease of
$15,000 should be reported as a foreign exchange loss in 2014.
5. D
(Calculate foreign exchange gain/loss on foreign currency borrowing)

The increase in the dollar value of the euro note payable represents a
foreign exchange loss. In this case a $25,000 loss would have been
accrued in 2013 and a $10,000 loss will be reported in 2014.
6. D
(Foreign exchange gain/loss on foreign currency transaction)

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

The merchandise purchase results in a foreign exchange loss of $8,000,
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 notes principal results in a
foreign exchange loss of $20,000.
The total foreign exchange loss is $28,000 ($8,000 + $20,000).
8. D
(Forward contract cash flow hedge of foreign currency denominated

asset/liability)
The Thai baht is selling at a premium (forward rate exceeds spot rate).
The exporter will receive more dollars as a result of selling the baht
forward than if the baht had been received and converted into dollars on
April 1. Thus, the premium results in additional revenue for the exporter.
9. D
(Forward contract fair value hedge of foreign currency firm commitment)

The parts inventory will be recognized at the spot rate at the date of
purchase (FC100,000 x $.23 = $23,000).
10. D (Determine the fair value of a forward contract)

The forward contract must be reported on the December 31, 2013 balance
sheet as a liability. Barnum has locked-in to purchase ringgits at $0.042
per ringgit but could have locked-in to purchase ringgits at $0.037 per
ringgit if it had waited until December 31 to enter into the forward
contract. The forward contract must be reported at its fair value
discounted for two months at 12% [($.042 $.037) x 1,000,000 = $5,000 x .
9803 = $4,901.50].
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
12/1/13 to $33,000 at 12/31/13. The won receivable will be written down by
$2,000 and a foreign exchange loss will be reported in 2013 income.
12. B (Forward contract fair value hedge of foreign currency denominated

asset/liability)
The nominal value of the forward contract on December 31, 2013 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
December 31, 2013 that matures on March 31, 2014, $32,000 ($.0032 x 10
million). The fair value of the forward contract is the present value of
$2,000 discounted for three months ($2,000 x .9706 = $1,941.20). On

December 31, 2013, 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 2013 income is $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:
3/1
no journal entries
6/1
Premium Expense
AOCI
AOCI
Forward Contract
Foreign Currency
Forward Contract
Cash
AOCI
Adjustment to Net Income
$10,000
$10,000
$2,500
$2,500
$57,500
2,500
$60,000
$7,500
$7,500
14. C (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 is recognized as an Option Expense over the life of the option.
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:
9/1/13
Foreign Currency Option
Cash
12/31/13
Gain on Foreign Currency Option
Loss on Firm Commitment
Firm Commitment
[($.79 $.80) x 100,000 = $1,000 x .9803 = $980.30]
Net impact on 2013 net income:
3/1/14
$2,000
$2,000
$300
$300
$980.30
$980.30
$300.00
(980.30)
$(680.30)
$700
$700

$2,019.70
Firm Commitment
[($.77 $.80) x 100,000 = $3,000 $980.30 = $2,019.70]
Foreign Currency (C$)
Sales
$77,000
Cash
Foreign Currency (C$)
$80,000
Firm Commitment
$3,000
$2,019.70
$77,000
$77,000
3,000
$3,000
15-17. (continued)
Sales
17. B Net cash inflow with option ($80,000 $2,000)
Cash inflow without option (at spot rate of $.77)
Net increase in cash inflow
700.00
(2,019.70)
77,000.00
3,000.00
$78,680.30
$78,000
77,000
$ 1,000
18-20. (Forward contract fair value hedge of a foreign currency firm commitment)
for the forward contract fair value hedge of a firm commitment. The journal
3/1
no journal entries
3/31
Forward Contract
Gain on Forward Contract
($1,250 $0)
$1,250

Firm Commitment
$1,250
Net impact on first quarter net income is $0.
$1,250
$1,250
18-20. (continued)
4/30
Loss on Forward Contract

Forward Contract
[Fair value of Forward Contract is
($.120 $.118) x 500,000 = $1,000;
$1,000 $1,250 = $250]
$250
Firm Commitment
Gain on Firm Commitment
$250
$250
$250
Foreign Currency (pesos)

Sales [500,000 pesos x $.118]
$59,000
Cash [500,000 x $.120]

Foreign Currency (pesos)
Forward Contract
$60,000
Firm Commitment
$1,000
$59,000
$59,000
1,000
$1,000
Net impact on second quarter net income is: Sales $59,000 Loss on
Forward Contract $250 + Gain on Firm Commitment $250 + Adjustment to
Net Income $1,000 = $60,000.
18. A
19. C
20. B Cash inflow with forward contract [500,000 pesos x $.12]
$60,000
Cash inflow without forward contract [500,000 pesos x $.118] 59,000
Net increase in cash flow from forward contract
$ 1,000
21-22. (Option cash flow hedge of a forecasted foreign currency transaction)

for the option cash flow hedge of a forecasted transaction. The journal
11/1/13
Cash
$1,500
$1,500
12/31/13
Option Expense
$400
$400
(The option has no intrinsic value at 12/31/13 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.
2/1/14
Option Expense
$1,100
900
Accumulated Other Comprehensive Income (AOCI)
(Record expense for the decrease in time value of the
option; $1,100 $0 = $1,100; and write-up option to fair
value ($.40 $.41) x 200,000 = $2,000 $1,100 = $900.)
Foreign Currency (BRL) [200,000 x $.41]
Cash [200,000 x $.40]
$82,000
Parts Inventory (Cost-of-goods-sold)

Foreign Currency (BRL)
$82,000
Accumulated Other Comprehensive Income (AOCI)

$2,000
$80,000
2,000
$82,000
$2,000
$2,000
21-22. (continued)
Option Expense
$ (1,100)
Cost-of-Goods-Sold
(82,000)
2,000
Decrease in Net Income $ (81,100)
21. B
22. C
23. (10 minutes) (Foreign currency payable -- import purchase)
a. The decrease in the dollar value of the LCU payable from November 1
(60,000 x .345 = $20,700) to December 31 (60,000 x .333 = $19,980) is
recorded as a $720 foreign exchange gain in 2013.
b. The increase in the dollar value of the LCU payable from December 31
($19,980) to January 15 (60,000 x .359 = $21,540) is recorded as a $1,560
foreign exchange loss in 2014.
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 2013.
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 2014.
25. (10 minutes) (Foreign currency receivable export sale)
9/15
9/30
10/15
Accounts Receivable (FCU) [100,000 x $.40]

Sales
$40,000
$40,000
Accounts Receivable (FCU)

Foreign Exchange Gain
[100,000 x ($.42 $.40)]
$2,000
Foreign Exchange Loss

[100,000 x ($.37 $.42)]
$5,000
Cash
$37,000
$2,000
$5,000
26. (10 minutes) (Foreign currency payable -- import purchase)
$37,000
12/1/13
Inventory
Accounts Payable (LCU) [60,000 x $.88]
$52,800
$52,800
12/31/13 Accounts Payable (LCU) [60,000 x ($.82 $.88)] $3,600

1/28/14

$4,800
Accounts Payable (LCU) [60,000 x ($.90 $.82)]
Accounts Payable (LCU)
Cash
$3,600
$4,800
$54,000
$54,000
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.
a. Inventory [50,000 pesos x 40% x $.17]......................................................$3,400
b. COGS [50,000 pesos x 60% x $.17]............................................................$5,100
c. Sales [45,000 pesos x $.18]........................................................................$8,100
d. Accounts Receivable [45,000 40,000 = 5,000 pesos x $.21].................$1,050
e. Accounts Payable [50,000 30,000 = 20,000 pesos x $.21]....................$4,200
f. Cash [(40,000 x $.19) (30,000 x $.20)].....................................................$1,600
28. (25 minutes) (Prepare journal entries for foreign currency transactions)
2/1/13
4/1/13
6/1/13
8/1/13
Equipment
Accounts Payable (L) [40,000 x $.44]
$17,600
Accounts Payable (L)

Cash [40,000 x $.45]
$17,600
400
Inventory
$14,100
Accounts Receivable (L) [40,000 x $.48]

Sales
$19,200
Cost-of-Goods Sold
Inventory [$14,100 x 70%]
10/1/13
Cash [30,000 x $.49]

Accounts Receivable (L) [$19,200 x 3/4]
$17,600
$18,000
$14,100
$19,200
$9,870
$9,870
$14,700
$14,400

11/1/13
Accounts Payable (L) [$14,100 x 2/3]

Foreign Exchange Loss [20,000 x ($.50 $.47)]
Cash [20,000 x $.50]
300
$9,400
600
$10,000
12/31/13 Foreign Exchange Loss

Accounts Payable (L) [10,000 x ($.52 $.47)]
$500
Accounts Receivable (L) [10,000 x ($.52 $.48)]

$400
2/1/14
3/1/14
$500
$400
Cash [10,000 x $.54]

Accounts Receivable (L) [10,000 x $.52]
$5,400

Cash [10,000 x $.55]
$5,200
300
$5,200
200
$5,500
29. (20 minutes) (Determine income effect of foreign currency payable import
purchase)
a.
Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (December 1, 2013), the liability had a dollar value of
$70,400 (AL 160,000 x $.44). On December 31, 2013, 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 2013.
By March 1, 2014, 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 2014.
b. Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (September 1, 2013), the liability had a dollar value of
$73,600 (AL 160,000 x $.46). On December 1, 2013, 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 2013.
c.
Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (September 1, 2013), the liability had a dollar value of
$73,600 (AL 160,000 x $.46). On December 31, 2013, 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 2013.
By March 1, 2014, 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 2014.
30. (30 minutes) (Foreign currency borrowing)

a.
9/30/13
Cash
$100,000
Note payable (dudek) [1,000,000 x $.10]
(To record the note and conversion of 1 million
dudeks into $ at the spot rate.)
12/31/13 Interest Expense

$525
Interest Payable (dudek)
[1,000,000 x 2% x 3/12 = 5,000 dudeks x
$.105 spot rate]
(To accrue interest for the period 9/30 12/31/13.)
Note Payable (dudek) [1 m x ($.105 $.10)]
(To revalue the note payable at the spot rate of
$.105 and record a foreign exchange loss.)
$5,000
9/30/14
$1,800
525
Interest Expense [15,000 dudeks x $.12]

Foreign Exchange Loss [5,000 dudeks x
($.12 $.105)]
Cash [20,000 dudeks x $.12]
(To record the first annual interest payment,
record interest expense for the period 1/1 9/30/14,
and record a foreign exchange loss on the
interest payable accrued at 12/31/13.)
$100,000
$525
$5,000
75
12/31/14 Interest Expense

$625
Interest Payable (dudek) [5,000 dudeks x $.125]
(To accrue interest for the period 9/30 12/31/14.)
$20,000
Note Payable (dudek) [1 m x ($.125 $.105)]
(To revalue the note payable at the spot rate of
$.125 and record a foreign exchange loss.)
$2,400
$625
$20,000
30. (continued)
9/30/15
Interest Expense [15,000 dudeks x $.15]

Foreign Exchange Loss [5,000 dudeks x
($.15 $.125)]
Cash [20,000 dudeks x $.15]
(To record the second annual interest payment,
record interest expense for the period 1/1 9/30/15,
and record a foreign exchange loss on the interest
payable accrued at 12/31/14.)
Note Payable (dudek)
Cash [1 m dudeks x $.15]
(To record payment of the 1 million dudek note.)
$2,250
625
125
$3,000
$125,000
25,000
$150,000
b. The effective cost of borrowing can be determined by considering the total

interest expense and foreign exchange losses related to the loan and
comparing this with the amount borrowed:
2013
Interest expense
Foreign exchange loss
Total
2014
Interest expense
Foreign exchange losses
Total
2015
Interest expense
Foreign exchange losses
Total
$525
5,000
$5,525 / $100,000 = 5.525% for 3 months =
= 22.1% for 12 months
$2,425
20,075
$22,500 / $100,000 = 22.5% for 12 months
$2,250
25,125
$27,375 / $100,000 = 27.38% for 9 months

Because of appreciation in the value of the dudek, the effective annual
borrowing costs range from 22.1% 36.5%.
30.
(continued)
The net cash flow from this borrowing is:
Cash outflows:
Interest ($2,400 + $3,000)
Principal
Cash inflow:
Borrowing
Net cash outflow
$5,400
150,000
$155,400
(100,000)
$ 55,400
Ignoring compounding, this results in an effective borrowing cost of

approximately 27.7% per year [$55,400 / $100,000 = 55.4% over two years / 2
years = 27.7% per year].
31. (40 minutes) (Forward contract hedge of foreign currency receivable)
a. Cash Flow Hedge
12/1/13
Accounts Receivable (K) [20,000 x $2.00]

Sales
$40,000
$40,000
No entry for the forward contract.

12/31/13 Accounts Receivable (K)
[20,000 x ($2.10-$2.00)]
$2,000
$2,000
AOCI
$2,450.75
Forward Contract
$2,450.75
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
AOCI
$2,000
AOCI
$500
Premium revenue
[20,000 x ($2.075 $2.00) = $1,500 x 1/3 = $500]
$2,000
$500
31. (continued)
Impact on 2013 income:
Sales
Premium Revenue
Total
3/1/14
$40,000
2,000
(2,000)
500
$40,500
Accounts Receivable (K)

[20,000 x ($2.25 $2.10)]
$3,000
$3,000
AOCI
$1,049.25
Forward Contract
$1,049.25
[20,000 x ($2.25 $2.075) = $3,500 2,450.75] = $1,049.25
AOCI
$3,000
AOCI
Premium revenue
[$1,500 x 2/3 = $1,000]
$1,000
$3,000
$1,000
Foreign Currency (K) [20,000 x $2.25]

$45,000
Cash [20,000 x $2.075]

Forward Contract
Foreign Currency (K)
$41,500
3,500

Premium revenue
Total
$45,000
$45,000
$3,000
(3,000)
1,000
$1,000
Impact on net income over both periods: $40,500 + $1,000 = $(41,500); equal
to cash inflow.
31. (continued)
b. Fair Value Hedge
12/1/13 Accounts Receivable (K) [20,000 x $2.00]
Sales
$40,000
$40,000

12/31/13 Accounts Receivable (K)
[20,000 x ($2.10 $2.00)]
$2,000
$2,000

$2,450.75
Forward Contract
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
Sales
Total
3/1/14
$2,450.75
$40,000.00
2,000.00
(2,450.75)
$39,549.25

[20,000 x ($2.25 $2.10)]
$3,000
$3,000

$1,049.25
Forward Contract
$1,049.25
[20,000 x (2.25 $2.075) = $3,500 2,450.75 = $1,049.25]
$45,000
Cash [20,000 x $2.075]

Forward Contract
$41,500
3,500

Total
$45,000
$45,000
$3,000.00
(1,049.25)
$1,950.75
Impact on net income over both periods: $39,549.25 + $1,950.75 = $41,500;

equal to cash inflow.
32. (40 minutes) (Forward contract hedge of foreign currency payable)
a. Cash Flow Hedge

12/1/13Parts Inventory (COGS)
Accounts Payable (K)
[20,000 x $2.00]
$40,000
$40,000

[20,000 x ($2.10 $2.00)]
$2,000
$2,000
Forward Contract
$2,450.75
AOCI
$2,450.75
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
AOCI
$2,000
Premium Expense
$500
AOCI
[20,000 x ($2.075 $2.00) = $1,500 x 1/3 = $500]
Parts inventory (COGS)
Premium Expense
Total
$(40,000)
(2,000)
2,000
(500)
$(40,500)
$2,000
$500
32. (continued)
3/1/14

[20,000 x ($2.25 $2.10)]
$3,000
$3,000
Forward Contract
$1,049.25
AOCI
$1,049.25
[20,000 x ($2.25 $2.075) = $3,500 2,450.75 = $1,049.25]
AOCI
$3,000
Premium Expense
AOCI
[$1,500 x 2/3 = $1,000]
$1,000
$3,000
$1,000

Cash
Forward Contract
$45,000

$45,000

Premium Expense
Total
$41,500
3,500
$45,000
$(3,000)
3,000
(1,000)
$(1,000)
Impact on net income over both periods: $(40,500) + $(1,000) = $(41,500);

equal to cash outflow.
32. (continued)
b. Fair Value Hedge
12/1/13Parts inventory (COGS)
[20,000 x $2.00]
$40,000
$40,000

12/31/13

[20,000 x ($2.10 $2.00)]
$2,000
$2,000
Forward Contract
$2,450.75
$2,450.75
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
Parts inventory (COGS)
Total
3/1/14
$(40,000.00)
(2,000.00)
2,450.75
$(39,549.25)

[20,000 x ($2.25 $2.10)]
$3,000
$3,000
Forward Contract
$1,049.25
$1,049.25
[20,000 x ($2.25 $2.075) = $3,500 2,450.75 = $1,049.25]
Cash
Forward Contract
$45,000

$45,000
$41,500
3,500
$45,000
32. (continued)
Total
$(3,000.00)
1,049.25
$(1,950.75)
Impact on net income over both periods: $(39,549.25) + $(1,950.75) =

$(41,500.00); equal to cash outflow.
33. (30 minutes) (Option hedge of foreign currency receivable)
a. Cash Flow Hedge
6/1
Accounts Receivable (P)

Sales [$.045 x 1,000,000 pesos]
$45,000
$45,000

$2,000
Cash
$2,000
6/30

[($.048 $.045) x 1,000,000]
$3,000
$3,000
AOCI
[($.0018 $.0020) x 1,000,000]
Loss on Foreign Currency Option
AOCI
Option Expense
AOCI
Date
6/1
6/30
9/1
Fair Value
$2,000
$1,800
$1,000
Intrinsic Value
$0
$0
$1,000
$200
$200
$3,000
$3,000
$200
$200
Time Value
$2,000
$1,800
$0
Change in Time Value
$ 200
$1,800
33. (continued)
9/1

[($.044 $.048) x 1,000,000]
AOCI
[$1,800 $1,000]
AOCI
$4,000
$4,000
$800
$800
$4,000
$4,000
Option Expense
$1,800
AOCI
(Change in time value of option is recognized as expense)
Foreign Currency (P)
$44,000
Cash
$45,000
$1,800
$44,000
$44,000
$1,000
Impact on Net Income over the Two Accounting Periods:

Sales
$45,000
Foreign currency option expense
(2,000)
Impact on net income
$43,000 = Net cash inflow
b. Fair Value Hedge
6/1
6/30

Sales [$.045 x 1,000,000]
$45,000
$45,000

Cash
$2,000

[($.048 $.045) x 1,000,000]
$3,000

$2,000
$3,000
$200
$200
33. (continued)
9/1

[($.044 $.048) x 1,000,000]
$4,000
$4,000
$800
$800

$44,000
Cash
$45,000
$44,000
Impact on Net Income over the Two Accounting Periods:

Sales
$45,000
3,000
(4,000)
(1,000)
$43,000
= Net cash inflow
$44,000
$1,000
34. (30 minutes) (Option hedge of foreign currency payable)

a. Cash Flow Hedge
6/1
6/30
Date
6/1
6/30
9/1
Inventory [$.085 x 1,000,000]

Accounts Payable (M)
$85,000
$85,000

Cash
$2,000

[($.088 .085) x 1,000,000]
$3,000

AOCI
[$4,000 $2,000]
$2,000
AOCI
$3,000
Option Expense
AOCI
$1,000*
Fair Value
$2,000
$4,000
$5,000
Intrinsic Value
$0
$3,000
$5,000
$2,000
$3,000
$2,000
$3,000
$1,000
Time Value
$2,000
$1,000
$0
Change in Time Value

-$1,000*
-$1,000**
34. (continued)
9/1

[($.09 $.088) x 1,000,000]
$2,000

AOCI
[$5,000 $4,000]
$1,000
AOCI
$2,000
Option Expense
AOCI
$1,000**
$2,000
$1,000
$2,000
$1,000
Foreign Currency (M)

Cash
$90,000

$90,000
Impact on net income:

Option Expense
$85,000
$5,000
$90,000
($2,000)
34.
(continued)
b. Fair Value Hedge

6/1
6/30
9/1
Inventory
[$.085 x 1,000,000]
$85,000

Cash
$2,000

[($.088 $.085) x 1,000,000]
$3,000

[$4,000 $2,000]
$2,000

[($.09 $.088) x 1,000,000]
$2,000

[$5,000 $4,000]
$1,000
$85,000
$2,000
$3,000
$2,000
$2,000
$1,000

Cash
$90,000

$90,000
Impact on net income:

$85,000
5,000
$90,000
($5,000)
3,000
($2,000)
35. (30 minutes) (Forward contract cash flow hedge of foreign currency
denominated asset)
Date
11/01/13
12/31/13
4/30/14
Account Receivable (FCU) Forward

SpotU.S. DollarChange in U.S.Rate to
RateValue Dollar Value
4/30/14
Fair Value
$.53
$53,000
$.52
$.50
$50,000
-$3,000
$.48
$.49
$49,000
-$1,000
$.49
Forward Contract
Change in
Fair Value
$0
$3,8441
+$3,844
$3,0002
- $ 844
$52,000 $48,000 = $4,000 x .961 = $3,844; where .961 is the present value factor for
four months at an annual interest rate of 12% (1% per month) calculated as 1/1.01 4.
2
$52,000 $49,000 = $3,000.
1
2013 Journal Entries

11/01/13 Accounts Receivable (FCU)
Sales
$53,000
$53,000
There is no entry for the forward contract.

$3,000
$3,000
AOCI
$3,000
Forward Contract
AOCI
$3,844
$3,000
$3,844
Discount expense
AOCI
[100,000 x ($.53 $.52) = $1,000 x 2/6 = $333.33]
The impact on net income for the year 2013 is:
Sales
Net Gain (Loss)
Discount Expense
$53,000.00
(3,000.00)
3,000.00
0.00
(333.33)
$52,666.67
$333.33
$333.33
35. (continued)
4/30/14

$1,000
AOCI
$1,000
$1,000
$1,000
AOCI
Forward Contract
$844
$844
Discount expense
AOCI
$666.67
Foreign Currency (FCU)

$49,000
Cash
Foreign Currency (FCU)
Forward Contract
$52,000
$666.67
$49,000
$49,000
3,000

Net Gain (Loss)
Discount Expense
$(1,000.00)
1,000.00
0.00
(666.67)
$(666.67)
36. (30 minutes) (Forward contract fair value hedge of net foreign currency
denominated asset)
Account Receivable (Payable) (mongs) Forward
Change in U.S.
Rate to
Date
U.S. Dollar Value
Dollar Value
1/31/14
11/30/13 $265,000 ($159,000)
$.52
12/31/13 $250,000 ($150,000) -$15,000 (-$9,000)
$.48
1/31/14 $245,000 ($147,000) -$ 5,000 (-$3,000)
$.49
Forward Contract
Change in
Fair Value
Fair Value
$0
$7,9211
+$7,921
$6,0002
- $1,921
$104,000 $96,000 = $8,000 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.
1

11/30
Accounts Receivable (mongs)

Sales
[$.53 x 500,000 mongs]
$265,000
Inventory
Accounts Payable
[$.53 x 300,000 mongs]
$159,000
$265,000
$159,000
There is no formal entry for the forward contract.

12/31

$15,000
$15,000
Accounts Payable (mongs)

$9,000
Forward Contract
$7,921
$9,000
$7,921

Sales
Net Foreign Exchange Loss $ (6,000)
7,921
Net Gain (Loss)
$265,000
1,921
$266,921
36. (continued)
1/31

$5,000

$3,000

Forward Contract
$1,921
$5,000
$3,000
$1,921
Foreign Currency (mongs)

$245,000

$147,000
Cash
Forward Contract
$104,000
$245,000
$147,000
$98,000
$6,000

Net Foreign Exchange Loss
$(2,000)
(1,921)
$(3,921)
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).
37. (40 minutes) (Forward contract fair value hedge foreign currency receivable
and firm commitment (sale))
a. Foreign Currency Receivable
10/01
Accounts Receivable (LCU)

Sales (100,000 LCUs x $.69)
$69,000
$69,000

12/31

[($.71 $.69) x 100,000]
$2,000
$2,000

$8,910.90
Forward Contract
[($.74 $.65) x 100,000 = $ 9,000 x .9901 = $ 8,910.90]
1/31

[($.72 $.71) x 100,000]
$8,910.90
$1,000
$1,000
Forward Contract
$ 1,910.90
$ 1,910.90
[($.72 $.65) x 100,000 = $ 7,000 loss 8,910.90 = $ 1,910.90 gain]
Foreign Currency (LCU)
$72,000
Cash
Forward Contract
$65,000
$7,000
$72,000
$72,000
The impact on net income:

Sale
$69,000.00
3,000.00
(8,910.90)
1,910.90
$65,000.00 = Cash Inflow
37. (continued)
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.
12/31

Forward Contract
$8,910.90
Firm Commitment
$8,910.90
Forward Contract
$1,910.90

Firm Commitment
$1,910.90
1/31
$8,910.90
$8,910.90
$1,910.90
$1,910.90

Sales
$72,000
Cash
Forward Contract
$65,000
$7,000

Firm Commitment
$7,000
$72,000
$72,000
$7,000
Impact on Net Income:

Sales
Net Loss on Forward Contract
Net Gain on Firm Commitment
$72,000
(7,000)
7,000
(7,000)
$65,000 = Cash Inflow
38. (30 minutes) (Forward contract fair value hedge of a foreign currency firm
commitment (purchase))
Forward
Date 10/31
8/1
9/30
10/31
Rate to
Fair Value
$.30
$.325
$.320 (spot)
Forward Contract
Fair Value
$0
$4,950.50 1
$4,0002
Change in
Fair Value
+ $4,950.50
$ 950.50
Firm Commitment
Change in
Fair Value
$0
$(4,950.50)1
$(4,000)2
$0
$4,950.50
+ $ 950.50
($65,000 $60,000) = $5,000 x .9901 = $4,950.5; 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
($64,000 $60,000) = $4,000.
a. Journal entries
8/1
There is no entry to record either the purchase agreement or the

forward contract as both are executory contracts.
9/30
Forward Contract
$4,950.50

Firm Commitment
$4,950.50

Forward Contract
$950.50
Firm Commitment
$950.50
Foreign Currency (rupees)

Cash
Forward Contract
$64,000
Inventories (Cost-of-Goods-Sold)
Foreign Currency (rupees)
$64,000
10/31
Firm Commitment
$4,950.50
$4,950.50
$950.50
$950.50
$60,000
4,000
$64,000
$4,000
$4,000
b. Assuming the inventory is sold in the fourth quarter, the net impact on net
income is negative $60,000:
Cost-of-Goods-Sold
Net impact on net income
$(64,000)
4,000
$(60,000)
c. The net cash outflow is $60,000.
39. (30 minutes) (Option fair value hedge of a foreign currency firm commitment
(sale))
Firm Commitment
Spot
Date Rate Fair Value
6/1
6/30
9/1
$1.00
$0.99
$0.97
Change in
Fair Value
for 9/1
$(4,901.50)1
$(15,000)2
$ 4,901.50
$10,098.50
Option
Option
Premium
Fair Value
Fair Value
Change in
$0.010
$0.016
$0.030
$5,000
$8,000
$15,000
+ $3,000
+ $7,000
$495,000 $500,000 = $(5,000) x .9803 = $(4,901.5), 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
$485,000 $500,000 = $(15,000).
a. Journal Entries
6/1

Cash
$5,000
$5,000
There is no entry to record the sales agreement

because it is an executory contract.
6/30

Firm Commitment
9/1

Firm Commitment
$4,901.50
$4,901.50
$3,000
$3,000
$10,098.50
$10,098.50
$7,000
$7,000
Foreign Currency (lek)

Sales
$485,000
Cash
Foreign Currency (lek)
$500,000
Firm Commitment
$15,000
$485,000
$485,000
15,000
$15,000
39. (continued)
b. Impact on Net Income
The impact on net income for the second quarter is:
$(4,901.50)
3,000.00
$(1,901.50)
The impact on net income for the third quarter is:

Sales
Gain on Foreign Currency option
$485,000.00
(10,098.50)
7,000.00
15,000.00
$496,901.50
The impact on net income over the second and third quarters is:
$495,000 ($496,901.50 $1,901.50)
c. Net Cash Inflow
The net cash inflow resulting from the sale is: $500,000 $5,000 = $495,000
40. (20 minutes) (Option fair value hedge of a foreign currency firm commitment
(purchase))
Firm Commitment
Spot
11/20
$.20
a) 12/20 $.21
b) 12/20 $.18
$(500)1
$1,0002
Option
Change in
Premium
Fair Value
for 12/20 Fair Value
$500
+ $1,000
$.008
$.0103
$.0004
Option
Change in
Fair Value
$400
$500
$0
+ $100
$400
$10,000 $10,500 = $(500).

$10,000 $9,000 = $1,000.
3
The premium on 12/20 for an option that expires on that date is equal to the options
intrinsic value. Given the spot rate on 12/20 of $.21, a call option with a strike price of
$.20 has an intrinsic value of $.01 per mark.
4
The premium on 12/20 for an option that expires on that date is equal to the options
intrinsic value. Given the spot rate on 12/20 of $.18, a call option with a strike price of
$.20 has no intrinsic value the premium on 12/20 is $.000.
2
a.
The option strike price ($.20) is less than the spot rate ($.21) on December 20,
the date the parts are to be paid for. Therefore, Big Arber will exercise its
option. The journal entries are as follows:
11/20

Cash
$400
$400
There is no entry to record the purchase agreement

12/20

Firm Commitment
$500

$100
$500
$100
Foreign Currency (pijio)

Cash
$10,500
Parts inventory
$10,500
$10,000
500
$10,500
The following entry is made in the period when the inventory affects net
income through cost-of-goods-sold:
Firm Commitment
40. (continued)
$500
$500
b. The option strike price ($.20) is greater than the spot rate ($.18) on December
20, the date the parts are to be paid for. Therefore, Big Arber will allow the
option to expire unexercised. Foreign currency will be acquired at the spot
rate on December 20. The journal entries are as follows:
11/20

Cash
$400
$400
There is no entry to record the purchase agreement

12/20
Firm Commitment
$1,000
$1,000
$400
$400

Cash
$9,000
Parts Inventory
$9,000
$9,000
$9,000
The following entry is made in the period when the inventory affects net
income through cost-of-goods-sold:
Firm Commitment
$1,000
$1,000
41. (20 minutes) (Option cash flow hedge of a forecasted transaction)

a.
12/15/13 Foreign Currency Option
Cash [1 million marks x $.005]
$5,000
$5,000
No journal entry related to the forecasted

transaction.
12/31/13 Foreign Currency Option
AOCI
To recognize the increase in the value of
the foreign currency option with the counterpart
recorded in AOCI.
$3,000
$3,000
Option Expense
$1,000
AOCI
To recognize the decrease in the time value
of the option as expense.
[($.584 $.58) x 1,000,000 = $4,000 $3,000 = $1,000]
3/15/14

AOCI
To recognize the increase in the value of the
Foreign Currency Option with the counterpart
recorded in AOCI.
Option Expense
AOCI
To recognize the decrease in the time value of
the option as expense.
Foreign Currency (marks)
Cash
To record exercise of the foreign currency
option at the strike price of $.58 and close
out the foreign currency option account.
$1,000
$2,000
$2,000
$4,000
$4,000
$590,000
Parts Inventory
$590,000
Foreign Currency (marks)
To record the purchase of parts and payment
of 1 million marks to the supplier.
$580,000
10,000
$590,000
41. (continued)
AOCI
To transfer the amount accumulated in AOCI
as an adjustment to net income in the period
in which the forecasted transaction occurs.
$10,000
$10,000
b. Impact on net income: 2013 Option Expense
$(1,000)
2014 Cost-of-goods-sold
Option Expense
$(590,000)
(4,000)
10,000
$(584,000)
The impact on net income over the two periods is $(585,000).

c. Net cash outflow for parts: $585,000 = ($5,000 + $580,000)
42. (60 minutes) (Unhedged foreign currency transaction; forward contract and
option hedge of foreign currency liability; forward contract and option hedge
of foreign currency firm commitment (purchase))
Part a. Foreign Currency Liability (Unhedged)
9/15
9/30
10/31
Inventory
Accounts Payable (euro)
$200,000

$10,000

$10,000
$200,000
$10,000
$10,000
Foreign Currency (euro)

Cash
$220,000

$220,000
$220,000
$220,000
42. (continued)
Part b. Forward Contract Fair Value Hedge of a Foreign Currency Liability
Spot
Date Rate Value
9/15
$1.00
9/30
$1.05
10/31
$1.10
Accounts Payable (C)

Forward
U.S. Dollar
Change in U.S.
Rate to
Dollar Value 10/31 Fair Value
$200,000
$1.06
$210,000
+$10,000
$1.09
$220,000
+$10,000
$1.10
Forward Contract
Change in
Fair Value
$0
$5,940.60 1
+$5,940.60
$8,000.00 2
+$2,059.40
$218,000 $212,000 = $6,000 x .9901 = $5,940.60; 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
$220,000 $212,000 = $8,000.
9/15
Inventory
$200,000
$200,000

9/30

Forward Contract
10/31

$10,000
$10,000
$5,940.60
$5,940.60
$10,000
$10,000
Forward Contract
$2,059.40

Cash
Forward Contract
$220,000

$220,000
$2,059.40
$212,000
8,000
$220,000
42. (continued)
Part c. Forward Contract Fair Value Hedge of a Foreign Currency Firm
Commitment (Purchase)
9/15
There is no formal entry for the forward contract or the purchase order.
9/30
Forward Contract
$5,940.60

Firm Commitment
$5,940.60
Forward Contract
$2,059.40

Firm Commitment
$2,059.40

Cash
Forward Contract
$220,000
Inventory
$220,000
10/31
$5,940.60
$5,940.60
$2,059.40
$2,059.40
$212,000
8,000
$220,000
The following entry is made in the period when the inventory affects net income
through cost-of-goods-sold:
Firm Commitment
$8,000
$8,000
42. (continued)
Part d. Option Cash Flow Hedge of a Foreign Currency Liability
The following schedule summarizes the changes in the components of the fair
value of the euro call option with a strike price of $1.00 for October 31.
Spot
Date
Rate
09/15 $1.00
09/30 $1.05
10/31 $1.10
1
Option
Fair
Premium
Value
$.035 $7,000
$.070 $14,000
$.100 $20,000
Change
in Fair
Value
+ $7,000
+ $6,000
Intrinsic
Value
$0
$10,0002
$20,000
Time
Value
$7,0001
$4,0002
$03
Change
in Time
Value
- $3,000
- $4,000
Because the strike price and spot rate are the same, the option has no intrinsic
value. Fair value is attributable solely to the time value of the option.
With a spot rate of $1.05 and a strike price of $1.00, the option has an intrinsic
value of $10,000. The remaining $4,000 of fair value is attributable to time value.
The time value of the option at maturity is zero.
9/15
Inventory
Cash
9/30

AOCI
AOCI
Option Expense
AOCI
$200,000
$200,000
$7,000
$7,000
$10,000
$10,000
$7,000
$7,000
$10,000
$10,000
$3,000
$3,000
42. (continued)
10/31

AOCI
AOCI
Option Expense
AOCI
$10,000
$10,000
$6,000
$6,000
$10,000
$10,000
$4,000
$4,000

Cash
$220,000

$220,000
$200,000
$20,000
$220,000
42. (continued)
Part e. Option Fair Value Hedge of a Foreign Currency Firm Commitment
(Purchase)
Firm Commitment
Option
Spot
Change in
Premium
Fair Value
for 10/31
9/15
$1.00
$0
$.035
9/30
$1.05
$ (9,901)
$ 9,901 1
$.070
10/31
$1.10
$(20,000)
$10,099
$.100

Fair Value
$ 7,000
$14,000
$20,000
Change in
Fair Value
+$7,000
+$6,000
$210,000 $200,000 = $(10,000) x .9901 = $(9,901), 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.
9/15
9/30
10/31

Cash
$7,000

$7,000

Firm Commitment
$9,901

$6,000

Firm Commitment
$7,000
$7,000
$9,901
$6,000
$10,099
$10,099

Cash
$220,000
Inventory
$220,000
$200,000
20,000
$220,000
The following entry is made in the period when the inventory affects net income
through cost-of-goods-sold:
Firm Commitment
$20,000
$20,000
Chapter 9 Develop Your Skills

Research CaseInternational Flavors and Fragrances
The responses to this assignment might change over time as the company
changes its use of foreign currency derivatives or changes the manner in
which it discloses its foreign currency hedging activities in the annual report.
The following responses are based on IFFs 2010 annual report.
1. In 2010, IFF provided information in the annual report related to its
management of foreign exchange risk in the following locations:
a. Item 1A. Risk Factors. -- impact of currency fluctuation or devaluation
b. Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
c. Note 14. Financial Instruments. derivatives
2. IFF uses foreign currency forward contracts to reduce exposure to cash
flow volatility arising from foreign currency fluctuations associated with
intercompany loans, certain foreign currency receivables and payables
(hedges of foreign currency denominated assets and liabilities), and
anticipated purchases of raw materials used in operations (hedges of
forecasted transactions).
The company uses a Japanese Yen- U.S. Dollar swap to hedge monthly
sale and purchase transactions between the U.S. and Japan.
The company also uses forward contracts to hedge net investments in
foreign operations. (This topic is discussed in more detail in Chapter 10.)
3. In Item 7a., IFF indicates that the notional amount and maturity dates of
such (i.e., forward) contracts match those of the underlying transactions.
Toward the end of Note 14, the company also indicates that no
ineffectiveness was experienced in the above noted cash flow hedges
during the year ended December 31, 2010.
Accounting Standards CaseForecasted Transactions

Questions asked in the case are:
Is managements intent sufficient to assess that a forecasted transaction is
likely to occur?
If not, what additional evidence must be considered?
Source of guidance: FASB ASC 815-20-55-24 Derivatives and Hedging; HedgingGeneral; Implementation Guidance and Illustrations; Probability of a
Forecasted Transaction
ASC 815-20-55-24 states: An assessment of the likelihood that a forecasted
transaction will take place should not be based solely on management's intent
because intent is not verifiable. The transaction's probability should be
supported by observable facts and the attendant circumstances. Consideration
should be given to all of the following circumstances in assessing the likelihood
that a transaction will occur.
a. The frequency of similar past transactions
b. The financial and operational ability of the entity to carry out the transaction
c. Substantial commitments of resources to a particular activity (for example, a
manufacturing facility that can be used in the short run only to process a
particular type of commodity)
d. The extent of loss or disruption of operations that could result if the
transaction does not occur
e. The likelihood that transactions with substantially different characteristics
might be used to achieve the same business purpose (for example, an entity
that intends to raise cash may have several ways of doing so, ranging from a
short-term bank loan to a common stock offering).
The answers to the specific questions asked in the case are:
Managements intent is not sufficient to assess whether a forecasted
transaction is likely to occur.
Additional evidence listed in items a. e. in ASC 815-20-55-24 must be
considered in assessing that likelihood.
Excel CaseDetermine Foreign Exchange Gains and Losses

1., 2. and 3. Spreadsheet for the calculation of the foreign exchange gains
(losses) related to Import/Export Companys foreign currency
transactions for the year 2010.
Foreign
Currency
Brazilian
real (BRL)
Swiss
franc
(CHF)
Swiss
franc
(CHF)
Euro
Euro
Chinese
yuan
(CNY)
South
Korean
won
(KRW)
Total Net
Foreign
Exchange
Gain
(Loss)
Type of
Transaction
Import
purchase
(payable)
Export sale
(receivable)
Import
purchase
(payable)
Export sale
(receivable)
Export sale
(receivable)
Import
purchase
(payable)
Import
purchase
(payable)
Amount in
Foreign
Currency
Transaction
Date
Exchange
Rate at
Transaction
Date
$ Value on
Transaction
Date
Settlement
Date
Exchange
Rate at
Settlemen
t Date
$ Value on
Settlement
Date
Foreign
Exchange
Gain
(Loss)
(87,000)
1/4/2010
0.577477
(50,240.50)
5/4/2010
0.57428
(49,962.36)
278.14
51,700
1/4/2010
0.967455
50,017.42
5/4/2010
0.913718
47,239.22
(2,778.20)
(55,000)
5/4/2010
0.913718
(50,254.49)
10/4/2010
1.02836
(56,559.80)
(6,305.31)
37,200
4/1/2010
1.3468
50,100.96
9/1/2010
1.28
47,616.00
(2,484.96)
37,200
4/1/2010
1.3468
50,100.96
10/1/2010
1.3726
51,060.72
959.76
(342,000)
1/4/2010
0.146471
(50,093.08)
10/4/2010
0.14945
(51,111.90)
(1,018.82)
(55,600,000)
1/4/2010
0.00086557
(48,125.69)
10/4/2010
0.0008892
(49,439.52)
(1,313.83)
Source of exchange rates: www.x-rates.com, Historical Lookup

Import/Export Company reported a net foreign exchange loss of $12,663.22 in
2010 income.
Possible discussion points for instructors: Note that all transactions had a $
value on transaction date of approximately $50,000. The size of the foreign
exchange gains and losses reported in the last column differs substantially
across transactions because of different rates and directions of change in the
exchange rates across the currencies in which Import/Export Company had
exposures. At one extreme, the large depreciation in value of the CHF from
1/4/10 to 5/4/10 coupled with an asset exposure resulted in a large foreign
exchange loss. The large appreciation in value of the CHF from 5/4/10 to
10/4/10 coupled with the CHF liability exposure also generated a large foreign
exchange loss. The depreciation in value of the Euro from 4/1/10 to 9/1/10
resulted in a foreign exchange loss on one of the companys Euro receivables;
the overall appreciation in value of the Euro from 4/1/10 to 10/1/10 resulted in a
foreign exchange gain on a second Euro receivable.
Analysis CaseCash Flow Hedge
1. Given the $6,000 total Premium Expense, the forward rate on 2/1/13 must
(12,663.22)
have been $1.06 [($1.06 $1.00 spot) x 100,000 euros = $6,000].

2. Given that the forward contract is reported as a liability of $1,980 ($2,000 x
.9901), the forward rate at 3/31/13 must have been $1.04 [($1.04 $1.06) x
100,000 euros = $2,000]. The fact that the forward contract is a liability
signals that the forward rate at 3/31 is less than the forward rate on 2/1.
3. Given that the cost of goods sold is $103,000, the spot rate on 5/1/13 must
have been $1.03. Linber must pay $1.06 per euro under the forward
contract, so the forward contract results in an economic loss of $3,000
[($1.06 $1.03) x 100,00 euros]. The negative adjustment to net income
reflects this economic loss.
4. The Premium Expense of $6,000 reflects the increase in cost for the parts
from the date the transaction was forecasted until the date of purchase. If
Linber had purchased 100,000 euros on 2/1/13 at the spot rate of $1.00, it
could have saved $6,000.
Internet CaseHistorical Exchange Rates

1. Spreadsheets for the calculation of the foreign exchange gains (losses)
related to Pier Ten Companys foreign currency account receivables.
Currency
Code
Indian rupee
INR
Philippine peso
PHP
Japanese yen
Malaysian
ringgit
JPY
Currency
MYR
Code
Indian rupee
INR
Philippine peso
PHP
Japanese yen
Malaysian
ringgit
JPY
Currency
MYR
Code
Indian rupee
INR
Philippine peso
PHP
Japanese yen
Malaysian
ringgit
JPY
MYR
Foreign
Currency
Account
Receivable
898,00
0
874,00
0
1,662,50
0
62,55
0
Foreign
Currency
Account
Receivable
898,00
0
874,00
0
1,662,50
0
62,55
0
Foreign
Currency
Account
Receivable
898,00
0
874,00
0
1,662,50
0
62,55
0
Exchange
Rate on
12/14/10
0.022215
0.022811
0.01197
0.32
Exchange
Rate on
12/31/10
0.022371
0.022925
0.012329
0.324465
Exchange
Rate on
1/14/11
0.022053
0.022596
0.012049
0.326744
U.S. Dollar
Value on
12/14/10
$19,949.0
7
19,936.8
1
19,900.1
3
20,016.0
0
$79,802.0
1
U.S. Dollar
Value on
12/31/10
$20,089.1
6
20,036.4
5
20,496.9
6
20,295.2
9
$80,917.8
6
U.S. Dollar
Value on
1/14/11
$19,803.5
9
19,748.9
0
20,031.4
6
20,437.8
4
$80,021.80
Foreign
Exchange
Gain (Loss)
on 12/31/10
$
140.09
99.6
4
596.8
4
279.2
9
$ 1,115.85
Foreign
Exchange
Gain (Loss)
on 1/14/11
$ (285.56)
(287.5
5)
(465.5
0)
142.5
5
$ (896.06)
Currency
Code
Indian rupee
INR
Philippine peso
PHP
Japanese yen
Malaysian
ringgit
JPY
MYR
Foreign
Currency
Account
Receivable
898,00
0
874,00
0
1,662,50
0
62,55
0
U.S. Dollar
Value on
12/14/10
$ 19,949.07
19,936.8
1
19,900.1
3
20,016.0
0
$ 79,802.01
U.S. Dollar
Value on
1/14/11
$19,803.5
9
19,748.9
0
20,031.4
6
20,437.8
4
$80,021.8
0
Net
Foreign
Exchange
Gain (Loss)
$ (145.48)
(187.9
1)
131.3
4
421.8
4
$
219.79
Source of exchange rates: www.x-rates.com, Historical Lookup, accessed

December 12, 2012.
2. Pier Ten would have reported a net foreign exchange gain of $1,115.85 in
2010 and a net foreign exchange loss of $896.06 in 2011 related to these
foreign currency receivables. The transactions denominated in Indian
rupees and Philippine pesos resulted in a net foreign exchange loss of
$145.48 and $187.91, respectively. The PHP receivable would have been
the most important to hedge.
3. Assuming a strike price equal to the December 14, 2010 spot rate, the only
foreign currency transactions for which the purchase of a put option
costing $100 would have been beneficial are the transactions in Indian
rupees and Philippine pesos. Net cash inflow from the INR receivable
would have been $45.48 greater ($145.48 FX loss avoided less $100.00
cost of option) if a put option had been acquired and the net cash flow
from the PHP receivable would have been $87.91 greater ($187.91 FX loss
avoided less $100.00 cost of option) if a put option had been acquired.
Put options in JPY and MYR would have had no value at 1/14/11. The
purchase of JPY and MYR options would have resulted in a decrease in
net cash inflow to Pier Ten of $200.00 (the cost of the options).
Communication CaseForward Contracts and Options

To: Mr. Dewey Nukem, CEO, Palmetto Bug Extermination Company (PBEC)
The primary advantage of using forward contracts to hedge foreign exchange
risk is that there is no cost to enter into them. The disadvantage is that the
company is obligated to exchange foreign currency for dollars at the
contracted forward rate. Depending upon the future spot rate, this may or
may not be advantageous for the company. In contrast, the primary
disadvantage of using foreign currency options to hedge foreign exchange
risk is that there is an up-front cost incurred to purchase them. The primary
advantage is that the company is not required to exchange foreign currency
for dollars at the option strike price if it is disadvantageous to do so. The
company can simply allow the option to expire unexercised and the only cost
is the initial premium that was paid to acquire the option.
Exporters sometimes use forward contracts to hedge export sales (import
purchases) when the foreign currency is selling at a forward premium
(discount) as this locks in premium revenue (discount revenue). The risk
associated with this strategy is that the customer may or may not pay on
time. If an exporter enters into a forward contract to sell foreign currency,
and the customer does not pay on time, the exporter will need to purchase
foreign currency at the spot rate to settle the forward contract. This is
essentially the same as speculation; a gain or loss could arise. In this case,
the exporter might be better off by purchasing a foreign currency put option.
The exporter can simply allow the option to exercise if it has not received
foreign currency from the customer by the expiration date.
Since PBEC is making import purchases, it has more control over the timing
of when it will need foreign currency. In that case, it should be safe to enter
into a forward contract to purchase foreign currency on the date when PBEC
plans to pay for its purchases. However, there is always the risk that the
supplier does not deliver on time, in which case the forward contract
provides PBEC with foreign currency for which it has no current use.
The bottom line is that there is no right or wrong answer to the question
which hedging instrument should be used to hedge the Swiss franc exposure
to foreign exchange risk. Both forward contracts and option have the
advantages and disadvantages.

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CHAPTER 9

FOREIGN CURRENCY TRANSACTIONS AND

(Calculate foreign exchange gain/loss on foreign currency transaction)

(Calculate foreign exchange gain/loss on foreign currency borrowing)

(Foreign exchange gain/loss on foreign currency transaction)

(Calculate foreign exchange gain/loss)

(Forward contract cash flow hedge of foreign currency denominated

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

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

(Calculate foreign exchange gain/loss on foreign currency transaction)

12. B (Forward contract fair value hedge of foreign currency denominated

$2,000 discounted for three months ($2,000 x .9706 = $1,941.20). On

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

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

Loss on Firm Commitment

Loss on Firm Commitment

Net impact on first quarter net income is $0.

Loss on Forward Contract

Foreign Currency (pesos)

Cash [500,000 x $.120]

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

Parts Inventory (Cost-of-goods-sold)

Accumulated Other Comprehensive Income (AOCI)

Accounts Receivable (FCU) [100,000 x $.40]

Accounts Receivable (FCU)

Foreign Exchange Loss

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

12/31/13 Accounts Payable (LCU) [60,000 x ($.82 $.88)] $3,600

Foreign Exchange Loss

Accounts Payable (L)

Accounts Receivable (L) [40,000 x $.48]

Cash [30,000 x $.49]

Foreign Exchange Gain

Accounts Payable (L) [$14,100 x 2/3]

12/31/13 Foreign Exchange Loss

Accounts Receivable (L) [10,000 x ($.52 $.48)]

Cash [10,000 x $.54]

Accounts Payable (L) [10,000 x $.52]

30. (30 minutes) (Foreign currency borrowing)

12/31/13 Interest Expense

Interest Expense [15,000 dudeks x $.12]

12/31/14 Interest Expense

Interest Expense [15,000 dudeks x $.15]

b. The effective cost of borrowing can be determined by considering the total

= 36.5% for 12 months

Ignoring compounding, this results in an effective borrowing cost of

Accounts Receivable (K) [20,000 x $2.00]

No entry for the forward contract.

Accounts Receivable (K)

Foreign Currency (K) [20,000 x $2.25]

Cash [20,000 x $2.075]

Impact on 2014 income:

No entry for the forward contract.

Loss on Forward Contract

Accounts Receivable (K)

Loss on Forward Contract

Cash [20,000 x $2.075]

Impact on 2014 income:

Impact on net income over both periods: $39,549.25 + $1,950.75 = $41,500;

a. Cash Flow Hedge

No entry for the forward contract.

Foreign Exchange Loss

Foreign Currency (K) [20,000 x $2.25]

Accounts Payable (K)