Advanced Accounting 13th Edition Hoyle Solutions Manual 1

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

HOYLE SOLUTIONS MANUAL
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Education.
CHAPTER 9
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.
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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 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).
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.
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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.
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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.)
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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.
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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 Black-
Scholes 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
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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.
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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).
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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
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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:
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

Cash 60,000
AOCI 7,500
Adjustment to Net Income 7,500
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 $600 is recognized as an Option Expense over the life of the
option.
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Education.
15-17. (Option fair value hedge of a foreign currency firm commitment)
15. B
16. D
The easiest way to solve problems 15 and 16 is to prepare journal entries for
the option fair value hedge and the firm commitment. The journal entries are
as follows:
9/1/17
Foreign Currency Option 2,000.00
Cash 2,000.00
12/31/17
Foreign Currency Option 300.00
Gain on Foreign Currency Option 300.00
Loss on Firm Commitment 980.30
Firm Commitment 980.30
[($.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
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

Adjustment to Net Income 3,000.00
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15-17. (continued)

Gain on Foreign Currency Option $ 700.00
Loss on Firm Commitment (2,019.70)
Sales 77,000.00
$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
18-20. (Forward contract fair value hedge of a foreign currency firm commitment)
the forward contract fair value hedge of a firm commitment. The journal
entries are as follows:
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
Net impact on second quarter net income is $0.
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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]
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
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.
18. A
19. D
20. D Cash inflow with forward contract [1,000,000 pesos x $.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
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Education.
21-22. (Option cash flow hedge of a forecasted foreign currency transaction)
the option cash flow hedge of a forecasted transaction. The journal entries
are as follows:
11/1/17
Foreign Currency Option 1,500
Cash 1,500
12/31/17
Option Expense 400
Foreign Currency Option 400
(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.
2/1/18
Option Expense 1,100
Accumulated Other Comprehensive Income (AOCI) 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 – $.41) x 200,000 = $2,000 – $1,100 = $900.)
Foreign Currency (BRL) [200,000 x $.41] 82,000

Cash [200,000 x $.40] 80,000
Parts Inventory 82,000

Foreign Currency (BRL) 82,000
Accumulated Other Comprehensive Income (AOCI) 2,000

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Education.
21-22. (continued)

Option Expense $ (1,100)
Cost-of-Goods-Sold (82,000)
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 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)
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
9-16
Education.
26. (10 minutes) (Foreign currency payable – import purchase)
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

Accounts Payable (schillings) [50,000 x ($.33 – $.30)] 1,500
Accounts Payable (schillings) 16,500

Cash 16,500
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 [100,000 pesos x $.10 x 40% 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
9-17
Education.
28. (25 minutes) (Prepare journal entries for a foreign currency borrowing)
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

Interest Payable (euro) 7,750
Foreign Exchange Loss 70,000

Note Payable (euro) [500,000 x ($1.24 - $1.10)] 70,000

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
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, 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.
9-18
Education.
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 100,000

Note payable (dudek) [1,000,000 x $.10] 100,000
(To record the note and conversion of 1 million
dudeks into $ at the spot rate.)
12/31/17 Interest Expense 525

Interest Payable (dudek) 525
[1,000,000 x 2% x 3/12 = 5,000 dudeks x
$.105 spot rate]
(To accrue interest for the period 9/30 – 12/31/17.)

Note Payable (dudek) [1 mn x ($.105 – $.10)] 5,000
(To revalue the note payable at the spot rate of
$.105 and record a foreign exchange loss.)
9/30/18 Interest Expense [15,000 dudeks x $.12] 1,800

Foreign Exchange Loss [5,000 dudeks x ($.12 – $.105)] 75
Cash [20,000 dudeks x $.12] 2,400
(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.)
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.)
9-19
Education.
30. (continued)

Note Payable (dudek) [1 mn x ($.125 – $.105)] 20,000
(To revalue the note payable at the spot rate of
$.125 and record a foreign exchange loss.)
9/30/19 Interest Expense [15,000 dudeks x $.15] 2,250

Foreign Exchange Loss [5,000 dudeks x
($.15 – $.125)] 125
Cash [20,000 dudeks x $.15] 3,000
(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.)
Note Payable (dudek) 125,000

Cash [1 mn dudeks x $.15] 150,000
(To record payment of the 1 million dudek note.)
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:
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
Because of appreciation in the value of the dudek, the effective annual interest
cost ranges from 22.1% – 36.5%.
9-20
Education.
30. (continued)
The net cash flows from this borrowing are:
Cash outflows:
Interest ($2,400 + $3,000) $ 5,400
Principal 150,000
$155,400
Cash inflow:
Borrowing (100,000)
Net cash outflow $ 55,400
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].
9-21
Education.
31. (40 minutes) (Forward contract hedge of foreign currency receivable)
a. Cash Flow Hedge
Date Journal Entry Debit Credit

12/1/17 Accounts Receivable (K) 43,200.00
Sales Revenue 43,200.00
To record sales revenue and a foreign currency
account receivable.
No entry for the forward contract.

Foreign Exchange Gain 1,600.00
To revalue the foreign currency account receivable
and recognize a foreign exchange gain.
AOCI 1,960.60
Forward Contract 1,960.60
To record the change in fair value of the forward
contract as a liability.
Loss on Forward Contract 1,600.00

AOCI 1,600.00
To record a loss on forward contract to offset the
foreign exchange gain.
AOCI 400.00
Premium Revenue 400.00
To allocate the forward contract premium as revenue
over the life of the contract.
Impact on 2017 net income:

Sales Revenue $43,200.00
Loss on Forward Contract (1,600.00)
Total $43,600.00
9-22
Education.
31. (continued)
a. Cash Flow Hedge (continued)

AOCI 839.40
Forward Contract 839.40
To adjust the carrying value of the forward
contract to its current fair value.

AOCI 2,400.00
To record a loss on forward contract to offset the
foreign exchange gain.
AOCI 800.00
To allocate the forward contract premium as revenue
Foreign Currency (K) 47,200.00

Accounts Receivable (K) 47,200.00
To record the receipt of korunas from the foreign
customer.
Cash 44,400.00
To record settlement of the forward contract.

Foreign Exchange Gain $2,400.00
Total $800.00
Impact on net income over both periods, which is equal to net cash inflow:
$43,600.00 + $800.00 = $44,400.00
9-23
Education.
31. (continued)
b. Fair Value Hedge

Sales Revenue 43,200.00
To record sales revenue and a foreign currency
account receivable.


contract as a liability and recognize a loss on
forward contract.

Sales Revenue $43,200.00
Total $42,839.40
9-24
Education.
31. (continued)
b. Fair Value Hedge (continued)

Loss on Forward Contract 839.40

contract to its current fair value and recognize
a loss on forward contract.

Accounts Receivable (K) 47,200.00
To record the receipt of korunas from the foreign
customer.
Cash 44,400.00

Foreign Exchange Gain $2,400.00
Loss on Forward Contract (839.40)
Total $1,560.60
Impact on net income over both periods, which is equal to net cash inflow:
$42,839.40 + $1,560.60 = $44,400.00
9-25
Education.
32. (40 minutes) (Forward contract hedge of foreign currency payable)
a. Cash Flow Hedge

12/1/17 Cost of Goods Sold 43,200.00
Accounts Payable (K) 43,200.00
To record the purchase of materials immediately
as cost of goods sold and record a foreign currency
account payable.
12/31/17 Foreign Exchange Loss 1,600.00

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

AOCI 1,960.60
contract as an asset.
AOCI 1,600.00
Gain on Forward Contract 1,600.00
To record a gain on forward contract to offset the
foreign exchange loss.
Premium Expense 400.00

AOCI 400.00
To allocate the forward contract premium to expense

Cost of Goods Sold $(43,200.00)
Foreign Exchange Loss (1,600.00)
Premium Expense (400.00)
Total $(43,600.00)
9-26
Education.
32. (continued)
a. Cash Flow Hedge (continued)


AOCI 839.40
contract to its current fair value.
AOCI 2,400.00
To record a gain on forward contract to offset the
foreign exchange loss.
Premium Expense 800.00

AOCI 800.00
To allocate the forward contract premium to expense

Cash 44,400.00

To record the payment of korunas to the foreign
supplier.

Foreign Exchange Loss $(2,400.00)
Premium Expense (800.00)
Total $ (800.00)
Impact on net income over both periods, which is equal to net cash outflow:
$(43,600.00) + $(800.00) = $(44,400.00)
9-27
Education.
32. (continued)
b. Fair Value Hedge

12/1/17 Cost of Goods Sold 43,200.00
To record the purchase of materials immediately
as cost of goods sold and record a foreign currency
account payable.


contract as an asset and recognize a gain on
forward contract.

Cost of Goods Sold $(43,200.00)
Total $(42,839.40)
9-28
Education.
32. (continued)
b. Fair Value Hedge (continued)


Gain on Forward Contract 839.40
To adjust the carrying value of the forward contract
to its current fair value and recognize a gain on
forward contract.

Cash 44,400.00

To record the payment of korunas to the foreign
supplier.

Total $(1,560.60)
Impact on net income over both periods, which is equal to net cash outflow:
$(42,839.40) + $(1,560.60) = $(44,400.00)
9-29
Education.
33. (30 minutes) (Option hedge of foreign currency receivable)
a. Cash Flow Hedge
6/1 Accounts Receivable (P) 62,000

Sales [$.062 x 1,000,000] 62,000

Cash 2,500

Foreign Exchange Gain
[($.066 – $.062) x 1,000,000] 4,000
AOCI 700
[($.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
9-30
Education.
33. (continued)

Accounts Receivable (P) 5,000
[($.061 – $.066) x 1,000,000]
AOCI 800
[$1,800 – $1,000]
AOCI 5,000
Gain on Foreign Currency Option 5,000

AOCI 1,800
(Change in time value of option is recognized as expense)
Foreign Currency (P) 61,000

Cash 62,000
Impact on Net Income over the Two Accounting Periods:

Sales $62,000
Loss on Foreign Currency Option (4,000)
Foreign Exchange Loss (5,000)
Foreign currency option expense (2,500)
Impact on net income $59,500 = Net cash inflow
9-31
Education.
33. (continued)
b. Fair Value Hedge

Sales [$.062 x 1,000,000] 62,000

Cash 2,500

[($.066 – $.062) x 1,000,000]
Loss on Foreign Currency Option 700


[($.061 – $.066) x 1,000,000]
Loss on Foreign Currency Option 800


Cash 62,000
Impact on Net Income over the Two Accounting Periods:

Sales $62,000
Foreign Exchange Loss (5,000)
Impact on net income $59,500 = Net cash inflow
9-32
Education.
34. (30 minutes) (Option hedge of foreign currency payable)
a. Cash Flow Hedge
Date Fair Value Intrinsic Value Time Value Change in Time Value
6/1 $2,000 $0 $2,000 -
6/30 $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

Cash [1,000,000 x $0.002] 2,000

[($.858 – $.852) x 1,000,000]

AOCI 5,000
[$7,000 – $2,000]
AOCI 6,000
Option Expense 1,000*

AOCI 1,000
9-33
Education.
34. (continued)

[($.872 – $.858) x 1,000,000]

AOCI 13,000
[$20,000 – $7,000]
AOCI 14,000
Option Expense 1,000**

AOCI 1,000
Foreign Currency (francs) 872,000

Cash 852,000

Overall impact on net income:

Option Expense ($2,000)
9-34
Education.
34. (continued)
b. Fair Value Hedge
6/1 Inventory [$.852 x 1,000,000] 852,000


Cash [1,000,000 x $0.002] 2,000

[($.858 – $.852) x 1,000,000]

[$7,000 – $2,000]

[($.872 – $.858) x 1,000,000]

[$20,000 – $7,000]

Cash 852,000

Overall impact on net income:

Foreign Exchange Loss ($20,000)
Impact on net income ($ 2,000)
9-35
Education.
35. (30 minutes) (Forward contract cash flow hedge of foreign currency
denominated asset)
Account Receivable (FCU) Forward 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 $0 -
12/31/17 $.19 $19,000 -$2,000 $.17 $2,8831 +$2,883
4/30/18 $.18 $18,000 -$1,000 $.18 $2,0002 - $ 883
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.
2017 Journal Entries
11/01 Accounts Receivable (FCU) 21,000.00

Sales 21,000.00
There is no entry for the forward contract.
12/31 Foreign Exchange Loss 2,000.00

Accounts Receivable (FCU) 2,000.00

AOCI 2,883.00
AOCI 2,000.00
Discount expense 333.33

AOCI 333.33
[100,000 x ($.21 – $.20) x 2/6]
The impact on net income for the year 2017 is:

Sales $21,000.00
Net Gain (Loss) 0.00
Discount Expense (333.33)
Impact on net income $20,666.67
AOCI has a positive (credit) balance of $1,216.33 ($2,883.00 - $2,000.00 +

$333.33).
9-36
Education.
35. (continued)

AOCI 883.00
AOCI 1,000.00
Discount expense 666.67

AOCI 666.67
Foreign Currency (FCU) 18,000.00

Cash 20,000.00
Foreign Currency (FCU) 18,000.00

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).
9-37
Education.
36. (30 minutes) (Forward contract fair value hedge of net foreign currency
denominated asset)
Account Receivable (Payable) (mongs) Forward 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 $0 -
12/31/17 $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
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.
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]
There is no formal entry for the forward contract.

Accounts Receivable (mongs) 15,000
Accounts Payable (mongs) 9,000



Sales $265,000
Net Foreign Exchange Loss $ (6,000)
Net Gain (Loss) 1,921
Impact on net income $266,921
9-38
Education.
36. (continued)


Loss on Forward Contract 1,921

Foreign Currency (mongs) 245,000


Cash 104,000

Net Foreign Exchange Loss $(2,000)
Loss on Forward Contract (1,921)
Impact on net income $(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).
9-39
Education.
37. (40 minutes) (Forward contract fair value hedge – foreign currency receivable
and firm commitment (sale))
a. Foreign Currency Receivable
Account Receivable (ruble) Forward Forward Contract

Date Rate Value Dollar Value 1/31/18 Fair Value Fair Value
10/01/17 $.35 $35,000 - $.39 $0 -
12/31/17 $.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
1
($39,000 – $41,000) x .9901 = ($1,980.20); where .9901 is the present value factor for one
2
$40,000 – $39,000 = $1,000.
10/01 Accounts Receivable (ruble) 35,000.00

Sales 35,000.00
[100,000 x $.35]

[($.38 – $.35) x 100,000]

[($.41 – $.39) x 100,000 x .9901]

[($.40 – $.38) x 100,000]

[$1,980.20 - (($.40 – $.39) x 100,000)]
Foreign Currency (ruble) 40,000.00

Accounts Receivable (ruble) 40,000.00
Cash 39,000.00
9-40
Education.
37.a. (continued)
The overall impact on net income is:

Sales $35,000.00
Impact on net income $39,000.00 = Cash Inflow
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 Loss on Forward Contract 1,980.20


Gain on Firm Commitment 1,980.20
1/31 Forward Contract 980.20

Loss on Firm Commitment 980.20

Firm Commitment 980.20

Sales 40,000.00
Cash 39,000.00

Overall impact on Net Income is:

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
9-41
Education.
38. (30 minutes) (Forward contract fair value hedge of a foreign currency firm
commitment (purchase))
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
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.
9/30 Forward Contract 23,762.40
Foreign Currency (ringgits) [400,000 x $0.68] 272,000
Cash [400,000 x $0.60] 240,000
Inventory (Cost-of-Goods-Sold) 272,000
Foreign Currency (ringgits) 272,000
b. Assuming the inventory is sold in the fourth quarter, the net impact on net
income is negative $240,000:
Cost-of-Goods-Sold $(272,000)
Net impact on net income $(240,000)
c. The net cash outflow is $240,000.
9-42
Education.
39. (30 minutes) (Option fair value hedge of a foreign currency firm commitment
(sale))
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 $2,000 -
6/30 $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
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).
a. Journal Entries
6/1 Foreign Currency Option 2,000.00

Cash 2,000.00
There is no entry to record the sales agreement

because it is an executory contract.
6/30 Loss on Firm Commitment 5,881.80


9/1 Loss on Firm Commitment 6,118.20


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

9-43
Education.
39. (continued)
b. Impact on Net Income
The impact on net income for the second quarter is:

Loss on Firm Commitment $(5,881.80)
Impact on net income $(5,081.80)
The impact on net income for the third quarter is:

Sales $88,000.00
Loss on Firm Commitment (6,118.20)
Gain on Foreign Currency option 9,200.00
Impact on net income $103,081.80
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)
9-44
Education.
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.
Firm Commitment Option Option

11/20 $0.50 - - $0.01 $1,000 -
a) 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
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:
11/20 Foreign Currency Option 1,000

Cash 1,000
There is no entry to record the purchase agreement
12/20 Loss on Firm Commitment 3,000

Foreign Currency (forint) 53,000
Cash 50,000
Merchandise Inventory 53,000
9-45
Education.
40. (continued)
By 12/31 Cost-of-Goods-Sold 53,000


(This final entry is made in the same period when inventory affects
net income through cost-of-goods-sold, i.e., prior to 12/31)
The net effect on net income for the year ended 12/31 is:
Loss on Firm Commitment $ (3,000)
Cost-of-Goods Sold (53,000)
Net decrease in net income $(51,000)
The net decrease in net income is equal to net cash outflow:

Cash paid for foreign currency option $ 1,000
Cash paid for merchandise inventory 50,000
Net cash outflow $51,000
b. The option strike price ($0.50) is greater than the spot rate ($.48) on December
20, the date the parts are to be paid for. Therefore, Spitz 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 Foreign Currency Option 1,000

Cash 1,000
There is no entry to record the purchase agreement
12/20 Firm Commitment 2,000

Gain on Firm Commitment 2,000
Loss on Foreign Currency Option 1,000
Cash 48,000
9-46
Education.
40. (continued)
By 12/31 Cost-of-Goods-Sold 48,000


(This final entry is made in the same period when inventory affects
net income through cost-of-goods-sold, i.e., prior to 12/31)
The net effect on net income for the year ended 12/31 is:
Gain on Firm Commitment $ 2,000
Cost-of-Goods Sold (48,000)
Adjustment to Net Income (2,000)
Net decrease in net income $(49,000)
The net decrease in net income is equal to net cash outflow:

Cash paid for foreign currency option $ 1,000
Cash paid for merchandise inventory 48,000
Net cash outflow $49,000
9-47
Education.
41. (20 minutes) (Option cash flow hedge of a forecasted transaction)
a. A foreign currency option with a strike price of $0.58 was purchased on

12/15/17 for $5,000 (1 million marks x $.005) when the spot rate was $0.58.
Because the strike price and spot rate are identical, the option has no intrinsic
value at this point in time. The fair value of the option of $5,000 is all
attributable to time value. The journal entry to record the purchase of the
option is:
12/15/17 Foreign Currency Option 5,000

Cash [1 million marks x $.005] 5,000
No journal entry related to the forecasted

transaction.
The fair value of the option on 12/31/17 has increased from $5,000 to $8,000
($3,000 increase). Given that the spot rate is now $0.584, the option has an
intrinsic value of $4,000 (1 million marks x ($0.584 - $0.58)). The fair value of
the option is equal to the sum of its intrinsic value and its time value.
Because the option has a fair value of $8,000 and an intrinsic value of $4,000,
the time value of the option at 12/31/17 is $4,000. There is a $1,000 decrease
in the time value of the option since 12/15/17. The journal entries to recognize
the increase in the fair value of the option and the decrease in the time value
of the option are:

AOCI 3,000
To recognize the increase in the value of
the foreign currency option with the counterpart
recorded in AOCI.

AOCI 1,000
To recognize the decrease in the time value
of the option as expense.
The fair value of the option on 3/15/18 has increased from $8,000 to $10,000
($2,000 increase). Given that the spot rate is now $0.59, the option has an
intrinsic value of $10,000 (1 million marks x ($0.59 - $0.58)). Because the
option has a fair value of $10,000 and an intrinsic value of $10,000, the time
value of the option at 3/15/16 is zero. A time value of zero on 3/15/18 makes
sense given that the option expires on that date, and there is no more time for
the option to increase in value. There is a $4,000 decrease in the time value of
the option since 12/31/18. The journal entries to recognize the increase in the
fair value of the option and the decrease in the time value of the option are:
9-48
Education.
41. (continued)

AOCI 2,000
To recognize the increase in the value of the
Foreign Currency Option with the counterpart
recorded in AOCI.

AOCI 4,000
To recognize the decrease in the time value of
the option as expense.
Additional journal entries recorded on 3/15/18 are:
Foreign Currency (marks) 590,000

Cash 580,000
To record exercise of the foreign currency
option at the strike price of $.58 and close
out the foreign currency option account.
Parts Inventory 590,000

Foreign Currency (marks) 590,000
To record the purchase of parts and payment
of 1 million marks to the supplier.
AOCI 10,000
To transfer the amount accumulated in AOCI
as an adjustment to net income in the period
in which the forecasted transaction occurs.
b. Impact on net income: 2017 – Option Expense $(1,000)
2018 – Cost-of-goods-sold $(590,000)

Option Expense (4,000)
$(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)
9-49
Education.
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 Inventory 200,000.00

Accounts Payable (euro) 200,000.00


Foreign Currency (euro) 220,000.00

Cash 220,000.00

Foreign Currency euro) 220,000.00
9-50
Education.
42. (continued)
Part b. Forward Contract Fair Value Hedge of a Foreign Currency Liability
Accounts Payable (C) Forward Forward Contract

Date Rate Value Dollar Value 10/31 Fair Value Fair Value
9/15 $1.00 $200,000 - $1.06 $0 -
1
9/30 $1.05 $210,000 +$10,000 $1.09 $5,940.60 +$5,940.60
10/31 $1.10 $220,000 +$10,000 $1.10 $8,000.002 +$2,059.40
1
($218,000 – $212,000) 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 200,000.00






Cash 212,000.00

9-51
Education.
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.





Cash 212,000.00
Inventory 220,000.00
The following entry is made in the period when the inventory affects net income
through cost-of-goods-sold:

9-52
Education.
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.
Change Change
Spot Option Fair in Fair Intrinsic Time in Time
Date Rate Premium Value Value Value Value Value
09/15 $1.00 $.035 $7,000 - $0 $7,0001 -
09/30 $1.05 $.070 $14,000 + $7,000 $10,0002 $4,0002 - $3,000
10/31 $1.10 $.100 $20,000 + $6,000 $20,000 $03 - $4,000
1 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.
2 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.
3 The time value of the option at maturity is zero.
9/15 Inventory 200,000.00


Cash 7,000.00


AOCI 7,000.00
AOCI 10,000.00
Option Expense 3,000.00

AOCI 3,000.00
9-53
Education.
42. (continued)


AOCI 6,000.00
AOCI 10,000.00
Option Expense 4,000.00

AOCI 4,000.00

Cash 200,000.00

9-54
Education.
42. (continued)
Part e. Option Fair Value Hedge of a Foreign Currency Firm Commitment

(Purchase)
Firm Commitment Option Foreign Currency Option

9/15 $1.00 $0 - $.035 $ 7,000 -
9/30 $1.05 $ (9,901) –$ 9,9011 $.070 $14,000 +$7,000
10/31 $1.10 $(20,000) –$10,099 $.100 $20,000 +$6,000
1
($200,000 – $210,000) x .9901 = $(9,901), where .9901 is the present value factor for one

Cash 7,000.00

.



Cash 200,000.00
Inventory 220,000.00
The following entry is made in the period when the inventory affects net income
through cost-of-goods-sold:

9-55
Education.
Chapter 9 Develop Your Skills
Research Case—International 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 IFF’s 2014 annual report.
1. In 2014, IFF provided information in the annual report related to its

management of foreign exchange risk in the following locations:
a. Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
c. Note 14. Financial Instruments, under “derivatives.”
2. Note 14 (page 80) indicates that IFF uses “foreign currency forward
contracts with the objective of reducing exposure to cash flow volatility
associated with our intercompany loans, foreign currency receivables and
payables (i.e., hedges of foreign currency denominated assets and
liabilities), and anticipated purchases of raw materials used in operations
(i.e., hedges of forecasted transactions).” (Comments in parentheses have
been added.)
The company also uses forward contracts to hedge net investments in
foreign operations. (This topic is discussed in more detail in the next
chapter of this book.)
3. Toward the end of Note 14 (page 82), the company indicates that “the
ineffective portion of the above noted cash flow hedges and net investment
hedges was not material for the years ended December 31, 2014 and 2013.”
9-56
Education.
Accounting Standards Case—Forecasted Transactions
Questions asked in the case are:

• Is management’s 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; Hedging-

General; 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:

• Management’s 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.
9-57
Education.
Excel Case—Determine Foreign Exchange Gains and Losses
Note to Instructors: At the time this case is assigned to students, please verify that
www.x-rates.com still reports the exchange rates used in the solution below.
These exchange rates were obtained from www.x-rates.com in January 2016.
For unexplained reasons, in the past, www.x-rates.com has made changes
over time to the historical exchange rates that it reports.
1., 2. and 3. Spreadsheet for the calculation of the foreign exchange gains (losses)
related to Import/Export Company’s foreign currency transactions for
the year 2015.
Exchange Exchange Foreign

Amount in Trans- Rate at $ Value on Settle- Rate at $ Value on Exchange
Foreign Type of Foreign action Transaction Transaction ment Settlement Settlement Gain
Currency Transaction Currency Date Date Date Date Date Date (Loss)
Brazilian
real Import
(BRL) purchase (130,000) 1/10/15 0.380286 $(49,437.18) 5/10/15 0.335345 $(43,594.85) $5,842.33
Chilean
peso Import
(CLP) purchase (30,000,000) 1/10/15 0.001627 (48,810.00) 5/10/15 0.001654 (49,620.00) (810.00)
Swiss
franc
(CHF) Export sale 50,000 1/10/15 0.985902 49,295.10 4/10/15 1.019833 50,991.65 1,696.55
Swiss
franc Import
(CHF) purchase (50,000) 4/10/15 1.019833 (50,991.65) 7/10/15 1.062713 (53,135.65) (2,144.00)
Euro Export sale 45,000 1/10/15 1.184203 53,289.14 4/10/15 1.05972 47,687.40 (5,601.74)
Euro Export sale 45,000 4/10/15 1.05972 47,687.40 7/10/15 1.115184 50,183.28 2,495.88
Chinese
yuan Import
(CNY) purchase (300,000) 1/10/15 0.161162 (48,348.60) 7/10/15 0.161071 (48,321.30) 27.30
Total Net
Foreign
Exchange $1,506.33
Gain
(Loss)
Source of exchange rates: www.x-rates.com, Historical Lookup
Import/Export Company reported a net foreign exchange gain of $1,506.33 in

2015 net 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 BRL from 1/10/15 to 5/10/15
coupled with the BRL liability exposure generated a large foreign exchange
gain.
9-58
Education.
Excel Case (continued)

On the other hand, the relatively small appreciation in the value of the CLP over
the same time period resulted in a foreign exchange loss on a foreign currency
payable.
A depreciation in the Euro from 1/10/15 to 4/10/15 coupled with the Euro asset
exposure resulting from the export sale on 1/10/15 generated a large foreign
exchange loss. The subsequent appreciation in value of the Euro from 4/10/15
to 7/10/15 coupled with an asset exposure resulting from the export sale on
4/10/15 created a foreign exchange loss.
Interestingly, the Swiss franc appreciated against the U.S. dollar during the
same time period that the Euro depreciated (1/10 – 4/10) and depreciated when
the Euro appreciated (4/10 – 7/10).
Intervention by the Chinese government to peg the yuan to the U.S. dollar
resulted in a relatively small exchange rate change from 1/1/15 to 7/1/1/5, which
resulted in a very small foreign exchange gain on the yuan liability exposure.
Analysis Case—Cash Flow Hedge
1. Given the $6,000 total Premium Expense, the forward rate on 2/1/15 must
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 3/31/15 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 5/1/15 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 100,000 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 2/1/15 at the spot rate of $1.00, it
could have saved $6,000.
9-59
Education.
Internet Case—Historical Exchange Rates
Note to Instructors: At the time this case is assigned to students, please verify that
www.x-rates.com still reports the exchange rates used in the solution below.
These exchange rates were obtained from www.x-rates.com in January 2016.
For unexplained reasons, in the past, www.x-rates.com has made changes
over time to the historical exchange rates that it reports.
1. Spreadsheets for the calculation of the foreign exchange gains (losses)

related to Pier Ten Company’s foreign currency account receivables.
Foreign
Currency Exchange U.S. Dollar
Account Rate on Value on
Currency Code Receivable 9/15/15 9/15/15
Indian rupee INR 3,319,000 0.015066 $ 50,004.05
Philippine peso PHP 2,337,000 0.021404 50,021.15
Japanese yen JPY 6,017,000 0.008311 50,007.29
Malaysian ringgit MYR 214,800 0.232814 50,008.45

$ 200,040.94
Foreign Foreign
Currency Exchange U.S. Dollar Exchange
Account Rate on Value on Gain (Loss)
Currency Code Receivable 9/30/15 9/30/15 on 9/30/15
Indian rupee INR 3,319,000 0.015264 $ 50,661.22 $ 657.16
Philippine peso PHP 2,337,000 0.021398 50,007.13 (14.02)
Japanese yen JPY 6,017,000 0.008349 50,235.93 228.65
Malaysian ringgit MYR 214,800 0.22748 48,862.70 (1,145.74)

$ 199,766.98 $ (273.96)
9-60
Education.
Internet Case (continued)
Foreign Foreign
Currency Exchange U.S. Dollar Exchange
Account Rate on Value on Gain (Loss)
Currency Code Receivable 10/15/15 10/15/15 on 10/15/15
Indian rupee INR 3,319,000 0.015441 $ 51,248.68 $ 587.46
Philippine peso PHP 2,337,000 0.021822 $ 50,998.01 $ 990.89
Japanese yen JPY 6,017,000 0.008455 $ 50,873.74 $ 637.80
Malaysian ringgit MYR 214,800 0.24175 $ 51,927.90 $ 3,065.20

$ 205,048.33 $ 5,281.35
Foreign
Currency U.S. Dollar U.S. Dollar Net Foreign
Account Value on Value on Exchange
Currency Code Receivable 9/15/15 10/15/15 Gain (Loss)
Indian rupee INR 3,319,000 $ 50,004.05 $ 51,248.68 $ 1,244.63
Philippine peso PHP 2,337,000 50,021.15 50,998.01 $ 976.87
Japanese yen JPY 6,017,000 50,007.29 50,873.74 $ 866.45
Malaysian ringgit MYR 214,800 50,008.45 51,927.90 $ 1,919.45

$200,040.94 $ 205,048.33 $ 5,007.39
Source of exchange rates: www.x-rates.com, Historical Lookup
2. Pier Ten would have reported a net foreign exchange loss of $273.96 in the
fiscal year ended September 30, 2015 and a net foreign exchange gain of
$5,281.35 in the fiscal year ended September 30, 2016 related to these
foreign currency receivables. Over the entire life of these foreign currency
receivables, Pier Ten would have reported a net gain of $5,007.39.
3. Assuming a strike price equal to the September 30, 2015 spot rate, the
purchase of a put option would not have been beneficial for any of the
foreign currency transactions. In each case, the foreign currency
appreciated in U.S. dollar value from September 15 to October 15 so an
option to sell the foreign currency on October 15, 2015 at the September 15
spot rate would have been allowed to expire without being exercised. Pier
Ten would not recognize a net gain on any of the options.
9-61
Education.
Communication Case—Forward 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.
9-62
Education.

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

ADVANCED ACCOUNTING 13TH EDITION

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Answer to Discussion Question

5. Hedging is the process of eliminating exposure to foreign exchange risk so as to avoid

9. An enterprise is required to recognize all derivative financial instruments as assets or

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

An import purchase causes a foreign currency payable to be carried on the

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

Current accounting standards require a two-transaction perspective,

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

Foreign exchange gains related to foreign currency import purchases are

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

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

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

7. B (Calculate foreign exchange gain/loss)

The merchandise purchase results in a foreign exchange gain of $10,000,

8. A (Forward contract cash flow hedge of foreign currency denominated

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

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

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

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

The nominal value of the forward contract on December 31, 2017 is a

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

The krona is selling at a premium in the forward market, causing Pimlico to

3/1 no journal entries

6/1 Premium Expense 10,000

Foreign Currency 57,500

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

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

Loss on Firm Commitment 2,019.70

Foreign Currency (C$) 77,000.00

Firm Commitment 3,000.00

Net impact on 2018 net income:

17. B Net cash inflow with option ($80,000 – $2,000) $78,000

6/1 no journal entries

6/30 Forward Contract 2,400

Loss on Firm Commitment 2,400

Net impact on second quarter net income is $0.

7/31 Loss on Forward Contract 400

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

Option Expense decreases net income by $400.

Foreign Currency (BRL) [200,000 x $.41] 82,000

Parts Inventory 82,000

Accumulated Other Comprehensive Income (AOCI) 2,000

Net impact on 2018 net income:

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

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

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

9/15 Accounts Receivable (crowns) [100,000 x $.60] 60,000

9/30 Accounts Receivable (crowns) 6,000

10/15 Foreign Exchange Loss 4,000

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

12/15/15 Inventory 14,000

12/31/15 Foreign Exchange Loss 1,000

1/25/16 Foreign Exchange Loss 1,500