You are on page 1of 60

TEST BANK

CHAPTER 7
Foreign Currency Transactions and Hedging
MULTIPLE CHOICE
1.

Topic: Valuation of forward contracts


LO 3
A U.S. company invests in a forward purchase contract for 100,000,000 yen with a
purchase price of $0.009/yen, for delivery in 45 days. The spot rate at the time the
contract is initiated is $0.0085/yen. At the end of the accounting year, the forward
contract is still outstanding. The year-end spot rate is $0.0088/yen. The year-end forward
rate for delivery at the contract date is $0.0092/yen. How is the forward contract
reported on the U.S. companys balance sheet?
a.
b.
c.
d.

$20,000 asset
$20,000 liability
$30,000 asset
$30,000 liability

ANS: a
($0.0092 - $0.009) x 100,000,000 = $20,000
2.

Topic: Cash flow hedge


LO 6
On August 1, a U.S. company enters into a forward contract, in which it agrees to buy
1,000,000 euros from a bank at a rate of $1.115 on December 1. Changes in the value of
the forward contract will be reported in other comprehensive income on the balance sheet
in which one of the following situations?
a.
b.
c.
d.

The U.S. company has receivables denominated in euros, with payment to be


received on December 1.
The U.S. company sold merchandise to a customer in Belgium on August 1, and
expects payment of 1,000,000 euros on December 1.
The U.S. company plans to sell merchandise to a customer in Belgium on August
1, with payment of 1,000,000 euros expected on December 1.
The U.S. company plans to purchase merchandise from a supplier in Belgium, with
payment of 1,000,000 euros expected to be paid on December 1.

ANS: d

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


1

Use the following information on the U.S. dollar value of the euro to answer questions 3 7
below:

October 30, 2010


December 31, 2010
April 30, 2011

Spot rate
$ 1.25
1.28
1.26

Forward rate for


April 30, 2011
delivery
$ 1.30
1.32
1.26

On October 30, 2010, a company enters a forward contract to sell 100,000 on April 30, 2011.
The companys accounting year ends December 31.
3.

Topic: Hedge of export transaction


LO 4
The forward contract hedges an outstanding 100,000 account receivable due on April 30.
What is the net effect on income in 2010 and 2011?
a.
b.
c.
d.

2010
$1,000 gain
$1,000 loss
$3,000 gain
$2,000 loss

2011
$4,000 gain
$4,000 gain
$6,000 gain
$6,000 gain

ANS: a
2010: Gain on receivable, ($1.28 - $1.25) x 100,000
Loss on forward, ($1.32 - $1.30) x 100,000
Net gain

= $3,000
= $2,000
$1,000

2011: Loss on receivable, ($1.28 - $1.26) x 100,000


Gain on forward, ($1.32 - $1.26) x 100,000
Net gain

= $2,000
= $6,000
$4,000

Cambridge Business Publishers, 2010


2
Edition

Advanced Accounting, 1st

4.

Topic: Hedge of firm commitment


LO 5
The forward contract hedges a sales order for 100,000, received October 30. The sale
was made and the 100,000 collected on April 30, 2011. Sales revenue recorded on April
30 is:
a.
b.
c.
d.

$126,000
$122,000
$130,000
$124,000

ANS: c
(100,000 x $1.26) + ($1.30 - $1.26) x 100,000 = $130,000
5.

Topic: Hedge of firm commitment


LO 5
The forward contract hedges a sales order for 100,000, received October 30. The sale
was made and the 100,000 collected on April 30, 2011. The net effect on 2010 income
is:
a.
b.
c.
d.

No effect
$2,000 loss
$3,000 gain
$1,000 gain

ANS: a
The gain on the firm commitment and loss on the forward contract are ($1.32 - $1.30) x
100,000 = $2,000, and they offset for a zero effect on 2010 income.

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


3

6.

Topic: Hedge of forecasted transaction


LO 6
The forward contract hedges a forecasted sale for 100,000, expected at the end of April
2011. The net effect on 2010 income is:
a.
b.
c.
d.

No effect
$2,000 loss
$3,000 gain
$1,000 gain

ANS: a
The loss on the forward contract is reported in other comprehensive income.
7.

Topic: Hedge of forecasted transaction


LO 6
The forward contract hedges a forecasted sale for 100,000, expected at the end of April
2011. The sale takes place on April 30, 2011, 100,000 is collected, and the forward
contract is closed. Which statement is true, concerning the sale on April 30, 2011?
a.
b.
c.
d.

The $1,000 total loss on the forward contract is reclassified from other
comprehensive income as an adjustment to sales revenue.
The $4,000 total gain on the forward contract is reclassified from other
comprehensive income as an adjustment to sales revenue.
The 2011 $6,000 gain on the forward contract is recognized as a hedging gain on
the 2011 income statement.
The 2010 $2,000 loss on the forward contract is recognized as a hedging loss on
the 2010 income statement.

ANS: b
The total gain on the forward contract is ($1.30 - $1.26) x 100,000 = $4,000. Changes
in the value of the forward are reported in other comprehensive income until the hedged
forecasted transaction is reported in income. In this case, the forecasted transaction
results in sales revenue, reported in 2011.

Cambridge Business Publishers, 2010


4
Edition

Advanced Accounting, 1st

8.

Topic: Export transaction


LO 2
On May 20, 2012, when the spot rate is $1.30/, a company sells merchandise to a
customer in Italy. The spot rate is $1.31/ on June 30, the companys year-end. Payment
of 100,000 is received on July 30, 2012, when the spot rate is $1.28/. What is the effect
on fiscal 2012 and 2013 income?
a.
b.
c.
d.

Fiscal 2012
$1,000 exchange loss
$1,000 exchange gain
No effect
No effect

Fiscal 2013
$3,000 exchange gain
$3,000 exchange loss
$2,000 exchange loss
$2,000 exchange gain

ANS: b
Fiscal 2012 exchange gain = ($1.31 - $1.30) x 100,000 = $1,000
Fiscal 2013 exchange loss = ($1.31 - $1.28) x 100,000 = $3,000
9.

Topic: Import transaction


LO 2
On May 20, 2012, when the spot rate is $1.30/, a company purchases merchandise from
a supplier in Italy. The spot rate is $1.31/ on June 30, the companys year-end. Payment
of 100,000 is made on July 30, 2012, when the spot rate is $1.28/. What is the effect on
fiscal 2012 and 2013 income?
a.
b.
c.
d.

Fiscal 2012
$1,000 exchange loss
$1,000 exchange gain
No effect
No effect

Fiscal 2013
$3,000 exchange gain
$3,000 exchange loss
$2,000 exchange loss
$2,000 exchange gain

ANS: a
Fiscal 2012 exchange loss = ($1.31 $1.30) x 100,000 = $1,000
Fiscal 2013 exchange gain = ($1.31 $1.28) x 100,000 = $3,000

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


5

Data for questions 10 and 11 are as follows:


On September 8, the Sealy Company purchased cotton at an invoice price of 20,000, when the
exchange rate was $1.32/. Payment was to be made on November 8. On November 8, Sealy
purchased the 20,000 for $1.30/, and paid the invoice.
10.

Topic: Import transaction


LO 2
The cotton should be valued in Sealy's inventory at:
a.
b.
c.
d.

$20,000
$25,600
$26,000
$26,400

ANS: d
20,000

11.

x $1.32 = $26,400

Topic: Import transaction


LO 2
The exchange gain or loss recognized by Sealy as a result of this transaction is:
a.
b.
c.
d.

No gain or loss
$400 gain
$400 loss
$1,667 gain

ANS: b
20,000 x ($1.32 - $1.30) = $400 gain

Cambridge Business Publishers, 2010


6
Edition

Advanced Accounting, 1st

Data for questions 12 and 13 are as follows:


On June 5, Teneco Corporation sold merchandise at an invoice price of 100,000, when the
exchange rate was $1.36/. Payment was to be received on August 16. On August 16, the
customer paid the 100,000. The exchange rate on that date was $1.39/.
12.

Topic: Export transaction


LO 2
The sale should be reported on Teneco's books at:
a.
b.
c.
d.

$136,000
$139,000
$ 73,530
$ 71,942

ANS: a
100,000 x $1.36 = $136,000
13.

Topic: Export transaction


LO 2
The exchange gain or loss recognized by Teneco as a result of this transaction is:
a.
b.
c.
d.

-0$3,000 gain
$3,000 loss
$3,919 loss

ANS: b
100,000 x ($1.39 - 1.36) = $3,000 gain

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


7

14.

Topic: Analysis of foreign currency risks


LO 3
A U.S. exporter has made a sale to a customer in another country. The customer is
obligated to remit payment in his local currency in 90 days. The direct spot rate is now
$1.54. The 90-day forward rate is $1.60. At which spot rate at the time the customer
remits payment would the company have been better off not hedging the export
transaction with a forward contract?
a.
b.
c.
d.

$1.52
$1.54
$1.59
$1.62

ANS: d
Any rate above $1.60 leads to higher U.S. dollar value of payment received than under the
forward contract.
15.

Topic: Foreign currency options


LO 3
A company invests $200 in a foreign exchange option with the following terms: The
company may purchase 1,000,000 zloty at a price of $.25/zloty on December 20, 2014.
Which statement is true?
a.
b.
c.
d.

If the spot price for zloty is $.36 on December 20, the company will gain $359,800
on the option.
If the spot price for zloty is $.24 on December 20, the company will lose $200 on
the option.
If the spot price for zloty is $.27 on December 20, the company will lose $20,200
on the option.
If the spot price for zloty is $.30 on December 20, the company will gain $24,800
on the option.

ANS: b
The option gives the holder the option to buy 1,000,000 zloty for $250,000. At a spot
price of $.24/zloty, the option has no value and the holder loses its $200 investment.

Cambridge Business Publishers, 2010


8
Edition

Advanced Accounting, 1st

16.

Topic: Hedge of import transaction


LO 4
A U.S. import company purchases boomerangs from an Australian supplier on October 1,
2013 for 100,000 Australian dollars (A$), payable February 1, 2014. On October 1, 2013,
the company enters into a forward contract to hedge the foreign currency risk resulting
from this purchase. Exchange rates are as follows:

October 1, 2013
December 31, 2013
February 1, 2014

Spot rate
$0.89
0.88
0.82

Forward
rate for 2/1
delivery
$0.85
0.84
0.82

For the import company, what is the income statement effect of the above information?
a.
b.
c.
d.

No effect in 2013, $4,000 gain in 2014


$1,000 gain in 2013, $6,000 gain in 2014
$1,000 loss in 2013, $6,000 loss in 2014
No effect in 2013, $4,000 loss in 2014

ANS: a
2013:
forward contract: ($.85 - $.84) x A$100,000 =
payable: ($.89 - $.88) x A$100,000 =
2014:
forward contract: ($.84 - $.82) x A$100,000 =
payable: ($.88 - $.82) x A$100,000 =

Test Bank, Chapter 7

$1,000 loss
1,000 gain
-0$2,000 loss
6,000 gain
$4,000 gain

Cambridge Business Publishers, 2010


9

17.

Topic: Hedge of firm commitment


LO 5
ABC Corporation issues a purchase order for 1,000,000 semiconductors to a foreign
supplier. The agreed upon total price is FC1,200,000, and the current spot rate is $1/FC.
Suppose a forward contract is taken out when the purchase order is issued, at a rate of
$0.95/FC, for delivery when the semiconductors are received. If the spot rate rises to
$1.05 when the semiconductors are received and paid for by ABC, at what value will the
semiconductors be reported on ABCs books?
a.
b.
c.
d.

$1,020,000
$1,140,000
$1,200,000
$1,260,000

ANS: b
$1.05 x FC1,200,000 =
($1.05 - $.95) x FC1,200,000 =

$1,260,000
(120,000)
$1,140,000

Use the following information to answer questions 18 and 19 below.


A U.S. company purchases a 60-day certificate of deposit from an Italian bank on October 15.
The certificate has a face value of 1,000,000, costs $1,200,000 (the spot rate is $1.20/), and
pays interest at an annual rate of 6 percent. On December 14, the certificate of deposit matures
and the company receives principal and interest of 1,010,000. The spot rate on December 14 is
$1.18/. The average spot rate for the period October 15 December 14 is $1.19/.
18.

Topic: Foreign currency lending


LO 2
The exchange gain or loss on this investment is:
a.
b.
c.
d.

$20,200 gain
$20,200 loss
$20,000 gain
$20,000 loss

ANS: d
1,000,000 x ($1.20 - $1.18) = $20,000 loss

Cambridge Business Publishers, 2010


10
Edition

Advanced Accounting, 1st

19.

Topic: Foreign currency lending


LO 2
Interest income on the investment is reported at:
a.
b.
c.
d.

$0
$11,800
$11,900
$12,000

ANS: b
10,000

x $1.18 = $11,800

Use the following information to answer questions 20 22 below:


A U.S. company anticipates that it will purchase merchandise for 10,000,000 at the end of July,
and pay for it at the end of September. On March 1, it enters a forward contract to buy
10,000,000 on September 30. The forward contract qualifies as a cash flow hedge. The
companys accounting year ends December 31. The company actually purchases the merchandise
on July 30 and closes the forward contract and pays for the merchandise on September 30. It still
holds the merchandise at the end of the year. Exchange rates are as follows:
Forward rate
for 9/30 delivery
March 1
July 30
September 30

Test Bank, Chapter 7

Spot rate
$1.40
1.42
1.43

$1.41
1.415
1.43

Cambridge Business Publishers, 2010


11

20.

Topic: Hedge of forecasted transaction


LO 6
The merchandise is reported on the year-end balance sheet at:
a.
b.
c.
d.

$14,100,000
$14,150,000
$14,200,000
$14,300,000

ANS: c
Changes in the value of the forward contract remain in other comprehensive income
until the merchandise is sold. The merchandise is reported at the spot rate at the date of
purchase, $1.42.
21.

Topic: Hedge of forecasted transaction


LO 6
What is the net effect on income for the year?
a.
b.
c.
d.

No effect
$100 loss
$100 gain
$50 gain

ANS: a
Changes in the value of the forward are reported in other comprehensive income.
The $100 loss on the payable is exactly offset by a reclassification of $100 out of other
comprehensive income, so there is no net effect on income.

Cambridge Business Publishers, 2010


12
Edition

Advanced Accounting, 1st

22.

Topic: Hedge of forecasted transaction


LO 6
When the merchandise is sold, what amount is reported for cost of goods sold?
a.
b.
c.
d.

$14,100,000
$14,150,000
$14,200,000
$14,300,000

ANS: a
At the end of the year, other comprehensive income has a credit balance of $100. When
the merchandise is sold, it is reclassified as a reduction in cost of goods sold; $14,100,000
= $14,200,000 - $100,000.
Journal entries related to questions 20 22 (in thousands):
July 30
Inventory

14,200
Accounts payable

14,200

Investment in forward

50
Other comprehensive income

September 30
Exchange loss

50
100

Accounts payable

100

Investment in forward

150
Other comprehensive income

Other comprehensive income

150
100

Exchange gain

100

Accounts payable

14,300
Cash
Investment in forward

When merchandise is sold:


Cost of goods sold
Other comprehensive income

14,100
100
Inventory

Test Bank, Chapter 7

14,100
200

14,200

Cambridge Business Publishers, 2010


13

Use the following information on the U.S. dollar value of the euro to answer questions 23 25:

November 30, 2011


December 31, 2011
March 20, 2012
23.

Spot rate
$ 1.30
1.33
1.35

Forward rate for


March 20, 2012
delivery
$ 1.29
1.31
1.35

Topic: Speculative forward purchase contract


LO 7
On November 30, 2011, a U.S. company, with a December 31 year-end, enters a forward
purchase contract for 100,000 to be delivered on March 20, 2012. The forward
contract does not qualify as a hedge. The company closes the contract at its expiration
date. Which statement is true?
a.
b.
c.
d.

No gain or loss is reported until the forward is closed on March 20


A gain of $2,000 is reported in 2012
A gain of $4,000 is reported in 2012
A gain of $6,000 is reported in 2012

ANS: c
The change in value of the forward is reported in income as the forward rate changes. For
2012, the gain is ($1.35 - $1.31) x 100,000 = $4,000.
24.

Topic: Speculative forward sale contract


LO 7
On November 30, 2011, a U.S. company, with a December 31 year-end, enters a forward
sale contract for 100,000 to be delivered on March 20, 2012. The forward contract
does not qualify as a hedge. The company closes the forward contract on December 31.
Which statement is true?
a.
b.
c.
d.

No gain or loss is reported


A loss of $1,000 is reported in 2011
A loss of $3,000 is reported in 2011
A loss of $2,000 is reported in 2011

ANS: d
The change in value of the forward is reported in income as the forward rate changes. For
2011, the loss is ($1.31 - $1.29) x 100,000 = $2,000

Cambridge Business Publishers, 2010


14
Edition

Advanced Accounting, 1st

25.

Topic: IFRS for hedge of a forecasted purchase


LO 8
On November 30, 2011, a U.S. company, with a December 31 year-end, enters a forward
purchase contract for 100,000 to be delivered on March 20, 2012. The contract hedges
a forecasted purchase of equipment. The forward is closed and the equipment purchased
on March 20. If the company follows IFRS and reports gains and losses on hedges of
forecasted transactions as basis adjustments, total depreciation expense over the life of
the equipment is:
a.
b.
c.
d.

$129,000
$130,000
$131,000
$135,000

ANS: a
The equipment is recorded at the spot rate of $1.35 x 100,000 = $135,000, adjusted for
the $6,000 [= $1.35 - $1.29) x 100,000] gain on the forward contract.
26.

Topic: Exchange rates


LO 1
The value of the euro changes from $1.39 to $1.43. Which statement is true concerning
changes in the value of the euro in relation to the U.S. dollar?
a.
b.
c.
d.

Each U.S. dollar can be exchanged for more euros.


Each euro can be exchanged for fewer U.S. dollars.
The U.S. dollar has strengthened with respect to the euro.
A $10 product can be purchased with fewer euros.

ANS: d
27.

Topic: Exchange rates


LO 1
Informal markets contracting for future delivery of foreign currencies are called:
a.
b.
c.
d.

Spot markets
Forward markets
Futures markets
Direct markets

ANS: b

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


15

28.

Topic: Forward sale hedging foreign currency receivable


LO 4
A U.S. company has euro-denominated receivables that it hedges with a forward sale of
euros. The euro weakens against the U.S. dollar. Which statement is true?
a.
b.
c.
d.

The gain on the receivables and the loss on the forward are reported on the income
statement.
The gain on the receivables and the loss on the forward are reported in other
comprehensive income.
The loss on the receivables and the gain on the forward are reported on the income
statement.
The loss on the receivables and the gain on the forward are reported in other
comprehensive income.

ANS: c
29.

Topic: Forward purchase hedging foreign currency payable


LO 4
A U.S. company has payables to suppliers denominated in euros, and hedges these
payables with foreign currency forward purchase contracts. The euro strengthens against
the U.S. dollar. Which statement is true?
a.
b.
c.
d.

The gain on the payables and the loss on the forward are reported on the income
statement.
The gain on the payables and the loss on the forward are reported in other
comprehensive income.
The loss on the payables and the gain on the forward are reported on the income
statement.
The loss on the payables and the gain on the forward are reported in other
comprehensive income.

ANS: c

Cambridge Business Publishers, 2010


16
Edition

Advanced Accounting, 1st

30.

Topic: Forward sale hedging forecasted transaction


LO 6
A U.S. company sells its products to customers in Japan, priced in yen. It hedges a
forecasted sale to a Japanese customer with a forward sale of yen. Changes in the value of
the hedge investment are:
a.
b.
c.
d.

Reported in other comprehensive income until the products are produced


Reported as adjustments to selling and administrative expenses when the products
are sold
Reported in income as the changes occur
Reported in other comprehensive income until the products are sold

ANS: d
31.

Topic: Special hedge accounting, cash flow hedges


LO 3, 6
Changes in the market value of forward foreign currency contracts used to hedge
forecasted sales of merchandise to customers are:
a.
b.
c.
d.

Reported on the income statement if the forwards qualify for special hedge
accounting and in other comprehensive income if they dont qualify.
Reported as a direct adjustment to retained earnings if they qualify for special
hedge accounting and on the income statement if they dont qualify.
Reported in other comprehensive income if they qualify for special hedge
accounting and on the income statement if they dont qualify.
Not reported if they qualify for special hedge accounting and reported on the
income statement if they dont qualify.

ANS: c

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


17

32.

Topic: Cash flow hedges


LO 3, 6
Which one of the following is a cash flow hedge for a U.S. company?
a.
b.
c.
d.

A hedge of euro-denominated receivables


A hedge of a planned purchase of inventory, denominated in pesos
A hedge of a sales order from a customer in the U.K., denominated in pounds
A hedge of payables denominated in U.S. dollars

ANS: b
33.

Topic: Identification of hedge investments


LO 3
Which of the following is not a hedge investment?
a.
b.
c.
d.

A U.S. company issues a purchase order to a supplier in Mexico who requires


payment in pesos, and invests in a put option in pesos.
A U.S. company has debt denominated in euros, and invests in a forward purchase
of euros.
A U.S. companys customers owe it several million pesos from credit sales, and the
company invests in a forward sale of pesos.
A U.S. company invests in corporate bonds denominated in euros and enters a put
option in euros.

ANS: a
34.

Topic: Identification of hedge investments


LO 3
You are a U.S. investor and you expect that the value of the euro, in U.S. dollar terms,
will increase. Which of the following investments would you make?
a.
b.
c.
d.

Short position in euro futures.


Put option in euros.
Borrow from a bank in Italy, payment denominated in euros.
Forward purchase of euros.

ANS: d

Cambridge Business Publishers, 2010


18
Edition

Advanced Accounting, 1st

35.

Topic: Derivatives disclosures


LO 7
SFAS 161, effective at the end of 2008, provides that:
a.
b.
c.
d.

Hedges reported as assets be combined with hedges reported as liabilities.


All hedged items be carried at market value.
Additional footnote disclosures detail hedging gains and losses by hedge type.
Hedging gains and losses be separately displayed on the income statement and not
combined with other accounts.

ANS: c
36.

Topic: Identification of hedge investments


LO 3
Which of the following is the real hedge?
a.
b.
c.
d.

A call option in euros, used to hedge a forecasted sale to a customer, denominated


in euros
A call option in euros, used to hedge an investment in securities, denominated in
euros
A put option in euros, used to hedge a receivable denominated in euros
A forward sale in euros, used to hedge debt denominated in euros

ANS: c
37.

Topic: Hedge accounting


LO 3
On August 1, a U.S. company enters into a forward contract, in which it agrees to buy
1,000,000 euros from a bank at a rate of $1.45 on December 1. Changes in the value of
the forward contract will be reported on the income statement in which one of the
following situations?
a.
b.
c.
d.

The U.S. company uses the forward contract to hedge a loan denominated in
euros.
The U.S. company uses the forward contract to hedge a forecasted purchase of
merchandise from a French supplier.
The U.S. company uses the forward contract to hedge a planned purchase of
commodities from an Italian supplier.
The U.S. company uses the forward contract to hedge an expected acquisition of
commodities from a Belgian company.

ANS: a

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


19

38.

Topic: Hedging financial risk


LO 1, 3
Which statement below best describes the process of hedging using financial derivatives?
a.
b.
c.
d.

You have inside information that the $/yen rate is going to rise, so you invest in a
financial derivative that allows you to gain if the $/yen rate rises.
You have inside information that the $/euro rate is going to fall, so you invest in a
financial derivative that allows you to gain if the $/euro rate falls.
As part of your normal business transactions, you are exposed to financial risk.
You invest in financial derivatives to increase potential gains from financial risk.
As part of your normal business transactions, you are exposed to financial risk.
You invest in financial derivatives to reduce that risk.

ANS: d
39.

Topic: Hedging financial risk


LO 1, 3
A U.S. manufacturing company imports parts from a supplier in Germany. The company is
required to pay the supplier in euros. Which investment will hedge the manufacturing
company's foreign exchange risk?
a.
b.
c.
d.

Call option in euros


Short position in euros
Forward sale of euros
Borrowing from a German bank

ANS: a
40.

Topic: Valuation of forward contracts


LO 3
How are investments in financial derivatives valued on the balance sheet?
a.
b.
c.
d.

Market value
Cost
Lower of cost or market value
Not reported

ANS: a

Cambridge Business Publishers, 2010


20
Edition

Advanced Accounting, 1st

41.

Topic: Valuation of forward contracts


LO 3
On December 1, a U.S. company agrees to buy euros on February 1 at a contract price of
$1.40. The company did not pay anything for this contract. The exchange rate for euros
declines to $1.38 (U.S. dollar strengthens) between December 1 and December 31, when
the companys reporting year ends. How is this contract reported on the companys yearend balance sheet?
a.
b.
c.
d.

In the asset section


In the liability section
As a contra asset
The contract is not reported on the balance sheet

ANS: b
42.

Topic: Hedges of firm commitments


LO 5
On July 10, 2012, a U.S. company with a December 31 year-end enters a forward contract
that locks in the selling price of won, for delivery on August 15. The forward contract
hedges a firm commitment to sell merchandise to a customer in Korea, with payment
denominated in won. The sale is made on August 1, 2012 and payment is received from
the customer on August 15. Where is the value of the firm commitment to sell reported in
the year-end financial statements for 2012?
a.
b.
c.
d.

Asset or liability on the balance sheet


Increase or decrease in other comprehensive income
Adjustment to sales revenue
Adjustment to cost of goods sold

ANS: c

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


21

43.

Topic: Foreign currency borrowing


LO 2
The XYZ Company borrows 100,000,000 euros by issuing bonds to German investors
when the spot rate is $1.25/. The interest rate is 10 percent per annum. When XYZ
accounts for this loan, which of the following will not be true?
a.
b.
c.
d.

A decrease in the exchange rate will generate an exchange gain on the bonds
payable
If the spot rate rises to $1.35/ one year hence, when the interest payment is
accrued, the interest expense will be recorded at $13,500,000
If XYZ desires to hedge these bonds, it will have to purchase euros forward
The bonds payable will be carried at $125,000,000 until they mature

ANS: d
44.

Topic: Foreign currency borrowing


LO 2
Interest expense on a loan denominated in another currency is translated at:
a.
b.
c.
d.

The average spot rate for the period the interest covers
The spot rate when the loan was made
The spot rate when the interest is recorded
The forward rate for delivery when the interest must be paid

ANS: c
45.

Topic: Hedging strategy


LO 3
U.S. manufacturers that sell to customers in other countries, priced in the currency of the
customers country, often adjust their hedging strategy depending on which way they
believe foreign currency rates are headed. Which statement best represents the adjustment
they make, if the U.S. dollar is expected to weaken?
a.
b.
c.
d.

Reduce the percentage of receivables hedged


Reduce the percentage of payables hedged
Increase the percentage of receivables hedged
Increase the percentage of payables hedged

ANS: a

Cambridge Business Publishers, 2010


22
Edition

Advanced Accounting, 1st

46.

Topic: Hedge accounting


LO 3
Two major goals of SFAS 133 are:
a.
b.
c.
d.

Disclose the fair values of derivatives investments in the footnotes of the financial
statements, and report hedged assets and liabilities at fair value on the balance
sheet.
Report the fair values of derivatives investments on the balance sheet, and report
hedged assets and liabilities at fair value on the balance sheet.
Report the fair values of derivatives investments on the balance sheet, and match
gains and losses on hedge investments and hedged assets and liabilities on the same
income statement.
Report hedged assets and liabilities at fair value on the balance sheet, and match
gains and losses on hedge investments and hedged assets and liabilities on the same
income statement.

ANS: c
47.

Topic: Hedge of forecasted transaction


LO 6
A U.S. company hedges an anticipated sale of merchandise to a foreign customer. When
are gains and losses on the hedge investment reported on the income statement?
a.
b.
c.
d.

When the customer pays for the merchandise


When the anticipated sale becomes a firm commitment
When the hedge investment is determined to be an effective hedge
When the merchandise is sold

ANS: d
48.

Topic: Speculative investments


LO 7
A U.S. company enters a forward purchase contract that does not qualify as a hedge
investment. When are gains and losses on the hedge investment reported on the income
statement?
a.
b.
c.
d.

When the forward contract changes in market value


When the forward contract is closed
When the forward contract is determined to be an effective hedge
When the merchandise is sold

ANS: a

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


23

49.

Topic: Hedge of foreign-currency-denominated payable


LO 4
A U.S. company has entered into a forward purchase contract to hedge a reported foreign
currency obligation. If the U.S. dollar weakens against the foreign currency:
a.
b.
c.
d.

The forward contract appears as a current asset on the companys balance sheet.
The forward contracts reported value exactly offsets the reported foreign currency
obligation, with no net balance sheet disclosure.
The gain on the forward contract adds to other comprehensive income.
The gain on the foreign currency obligation adds to other comprehensive income.

ANS: a
50.

Topic: IFRS for foreign currency hedging


LO 8
IFRS allows which reporting practice, not allowed under U.S. GAAP?
a.
b.
c.
d.

Reporting foreign currency derivative positions at cost rather than at market value
Reporting gains and losses on cash flow hedges as adjustments to the carrying
value of related asset acquisitions
Reporting gains and losses on firm commitment hedges as adjustments to the
carrying value of related asset acquisitions
Reporting foreign currency derivative positions at market rather than at cost

ANS: b

Cambridge Business Publishers, 2010


24
Edition

Advanced Accounting, 1st

PROBLEMS
1.

Topic: Fair value hedge of receivables and payables, cash flow hedge of
forecasted transaction
LO 4, 6
Use the following exchange rates for the Canadian dollar to answer the three questions
below concerning a U.S. companys foreign exchange activities. The companys
accounting year ends December 31.

October 31, 2010


December 31, 2010
March 31, 2011

Spot rate
$ 0.82
0.85
0.83

Forward rate for


March 31, 2011 delivery
$ 0.81
0.86
0.83

Required
Answer the following questions.
a.

The company sells merchandise to a Canadian customer for C$100,000 on October


31, 2010, and receives payment from the customer, in Canadian dollars, on March
31, 2011. What are the following balances?
i.
Sales revenue for 2010
ii.
Accounts receivable, December 31, 2010
iii.
Exchange gain or loss for 2011

b.

The company sells merchandise to a Canadian customer for C$100,000 on October


31, 2010, and receives payment from the customer, in Canadian dollars, on March
31, 2011. On October 31, 2010 it enters a forward contract to lock in the selling
price of Canadian dollars, for March 31, 2011 delivery. On March 31, 2011, it
delivers the Canadian dollars and closes the forward contract. What are the
balances?
i.
Investment in forward , December 31, 2010
ii.
Amount of U.S. dollars received March 31, 2011

c.

The company enters a forward contract on October 31, 2010 to hedge a forecasted
purchase of merchandise for C$100,000 on March 31, 2011. On March 31 it takes
delivery of the merchandise, closes the forward and pays for the merchandise. It
sells the merchandise in May. What are the balances?
i.
Investment in forward, December 31, 2010
ii.
Cost of goods sold on May sale

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


25

ANS:

2.

a.

i.
ii.
iii.

C$100,000 x $.82 = $82,000


C$100,000 x $.85 = $85,000
C$100,000 x ($.85 - $.83) = $2,000 loss

b.

i.
ii.

C$100,000 x ($.81 - $.86) = $5,000 liability


C$100,000 x $.81 = $81,000

c.

i.
ii.

C$100,000 x ($.81 - $.86) = $5,000 asset


$83,000 ($.83 - $.81)(C$100,000) = $81,000

Topic: Unhedged foreign currency transactions, hedges of firm commitments


LO 2, 4, 5
A U.S. company buys merchandise from suppliers in the U.K., and pays for the
merchandise in pounds sterling. Its accounting year ends December 31. Use the following
information on $/ to answer the questions below.

October 1, 2012
November 1, 2012
December 31, 2012
March 1, 2013

Spot rate
$1.29
1.30
1.35
1.37

Forward rate for delivery


March 1, 2013
$1.28
1.32
1.34
1.37

Required
Answer the following questions:
a.

The U.S. company takes delivery of merchandise costing 1,000,000 on November


1, 2012. The company pays for the merchandise, in pounds, on March 1, 2013.
No hedging is involved. The company sells the merchandise on June 1, 2013.
What amounts will appear on the financial statements of the U.S. company for:
i.
Accounts payable, December 31, 2012 balance sheet
ii.
Exchange gain or loss, 2012 income statement
iii.
Cost of goods sold, 2013 income statement

b.

Assume the same facts as in a. above, but the U.S. company issues a purchase
order on October 1, 2012 before taking delivery on November 1. On October 1
the company also enters a forward contract to hedge its FX risk, for delivery of
pounds on March 1, 2013. What amounts will appear on the financial statements
of the U.S. company for:
i.
Investment in forward contract, December 31, 2012 balance sheet
ii.

Cost of goods sold, 2013 income statement

Cambridge Business Publishers, 2010


26
Edition

Advanced Accounting, 1st

ANS:

3.

a.

i.
ii.
iii.

1,000,000 x $1.35 = $1,350,000


1,000,000 x ($1.30 - $1.35) = $50,000 loss
1,000,000 x $1.30 = $1,300,000

b.

i.
ii.

1,000,000 x ($1.28 - $1.34) = $60,000 asset


1,000,000 x $1.30 [1,000,000 x ($1.28 - $1.32)] = $1,260,000

Topic: Unhedged foreign currency transactions, hedges of import and


forecasted transactions
LO 2, 4, 6
Following are exchange rates for the euro (U.S. $/) . Import Express is a U.S. company
whose accounting year ends on December 31.

November 30, 2010


December 31, 2010
May 31, 2011

Spot rate
$ 1.25
1.28
1.26

Forward rate for


May 31, 2011
delivery
$ 1.30
1.32
1.26

Required
Answer the following questions.
a.

On November 30, 2010, Import Express takes delivery of merchandise on credit


from an Italian supplier for 1,000. It pays for the merchandise on May 31, 2011.
It sells the inventory to a U.S. customer during 2011. What are the correct
amounts that will appear on Import Express financial statements for each of the
following items?
i.
Accounts payable, December 31, 2010 balance sheet
ii.
Cost of goods sold, 2011 income statement
iii.
Foreign exchange loss, 2010 income statement

b.

On November 30, 2010, Import Express takes delivery of merchandise on credit


from an Italian supplier for 1,000. On the same day, it agrees to buy 1,000
(forward purchase) for delivery on May 31, 2011. Import Express closes the
forward on May 31 and pays for the merchandise. It sells the inventory to a U.S.
customer during 2011. What are the correct amounts that will appear on Import
Express financial statements for each of the following items?
i.
Investment in forward contract, December 31, 2010 (asset)
ii.
Loss on forward contract, 2011
Gain on accounts payable, 2011

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


27

c.

On November 30, 2010, Import Express forecasts that it will need to buy
merchandise for 1,000 from an Italian supplier at the end of May, 2011. It plans
to pay for the merchandise as soon as it is delivered. On November 30, 2010,
Import Express agrees to buy 1,000 (forward purchase) for delivery on May 31,
2011. The forward contract qualifies as a cash flow hedge of the forecasted
purchase of merchandise. The merchandise is actually delivered on May 31, 2011.
Import Express closes the forward and immediately pays the supplier. The
merchandise is subsequently sold to a U.S. customer later in 2011. Make the
journal entries necessary to record these events:
i.
December 31, 2010: Adjust the investment in forward contract.
ii.
May 31, 2011:
(1)
Adjust the investment in forward contract.
(2)
Close out the forward contract.
(3)
Take delivery of the merchandise and pay for it.
iii.
Record cost of sales for 2011.

ANS:
a.

Entries (not required):

11/30
Inventory

1,250
Accounts payable

12/31
Exchange loss

1,250
30

Accounts payable
5/31
Accounts payable

30
20

Exchange gain
Accounts payable

20
1,260

Cash
i.
ii.
ii.

1,260

Accounts payable, December 31, 2010 balance sheet $1,280


Cost of goods sold, 2011 income statement
$1,250
Exchange loss, 2010 income statement
$ 30

Cambridge Business Publishers, 2010


28
Edition

Advanced Accounting, 1st

b.

Entries (not required):

11/30
Inventory

1,250
Accounts payable

12/31
Exchange loss

1,250
30

Accounts payable
Investment in forward

30
20

Exchange gain
5/31
Accounts payable

20
20

Exchange gain
Exchange loss

20
60

Investment in forward
Foreign currency
Investment in forward

60
1,260
40

Cash
Accounts payable

1,300
1,260

Foreign currency
i.
ii.

Test Bank, Chapter 7

1,260

Investment in forward contract, December 31, 2010 (asset) $20


Loss on forward contract, 2011
$60
Gain on accounts payable, 2011
$20

Cambridge Business Publishers, 2010


29

c.

i.

Investment in forward

20
Other comprehensive income

ii.
(1)
Other comprehensive income

20
60

Investment in forward

60

(2)
Foreign currency
Investment in forward

1,260
40
Cash

1,300

(3)
Inventory

1,260
Foreign currency

1,260

iii.
Cost of goods sold

1,300
Other comprehensive income
Inventory

Cambridge Business Publishers, 2010


30
Edition

40
1,260

Advanced Accounting, 1st

4.

Topic: Forward purchase, cash flow hedge that becomes a fair value hedge
LO 4, 5, 6
Use the following information on exchange rates for the euro to answer the question
below.

October 1, 2011
December 31, 2011
January 31, 2012
March 31, 2012
April 30, 2012

Spot
rate
$1.45
1.50
1.52
1.56
1.60

Forward
rate for
4/30/12
delivery
$1.48
1.53
1.55
1.58
1.60

On October 1, 2011, a U.S. company forecasts that it will take delivery of merchandise
from a supplier in Portugal for 10,000,000 around the end of March, 2012, with payment
expected to be made, in euros, about one month later. The company closes its books on
December 31. The following events occur:
1.
2.
3.
4.
5.
6.

October 1, 2011: The company enters a forward purchase agreement for delivery
of 10,000,000 on April 30, 2012. This position qualifies as a hedge of the
forecasted transaction described above. No initial investment is required.
December 31, 2011: The company closes its books.
January 31, 2012: The company issues a purchase order to the supplier for
10,000,000 in merchandise, to be delivered March 31, 2012.
March 31, 2012: The company takes delivery of the merchandise.
April 30, 2012: The company closes the forward contract and pays the supplier
10,000,000.
May 15, 2012: The company sells the merchandise to a U.S. customer for
$22,500,000.

Required
Prepare the journal entries to record the above events on the indicated dates.

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


31

ANS:
December 31, 2011: End of year adjusting entry:
Investment in forward
Other comprehensive
income
January 31, 2012:
Adjust the investment:
Investment in forward
Other comprehensive
income

500,000
500,000
200,000
200,000

March 31, 2012:

Adjust for the period January 31 - March 31, and take delivery of
the merchandise.
Investment in forward
300,000
Other comprehensive
income
300,000
Exchange loss

300,000
Firm commitment

Other comprehensive income

300,000
300,000

Exchange gain
Inventory
Firm commitment

15,300,000
300,000
Accounts payable

Cambridge Business Publishers, 2010


32
Edition

300,000

15,600,000

Advanced Accounting, 1st

April 30, 2012:

Adjust for the period March 31 to April 30, close the forward
contract and pay the supplier.
Investment in forward
200,000
Other comprehensive
income
200,000
Exchange loss

400,000
Accounts payable

400,000

Other comprehensive income

400,000
Exchange gain

400,000

Foreign currency

16,000,000
Investment in forward
Cash

Accounts payable

1,200,000
14,800,000
16,000,000

Foreign currency
Cost of goods sold
Other comprehensive income

14,800,000
500,000
Inventory

Test Bank, Chapter 7

16,000,000

15,300,000

Cambridge Business Publishers, 2010


33

5.

Topic: Hedge of firm commitment


LO 5
Following is information on $/ exchange rates:

March 1, 2012
June 30, 2012
August 15, 2012

Spot rate
$1.50
1.60
1.65

Forward rate for delivery


August 15, 2012
$1.55
1.62
1.65

A U.S. company buys from suppliers in Germany, and pays the suppliers in euros. The
U.S. companys accounting year ends June 30. On March 1, 2012, the company sends a
purchase order to a German supplier for 1,000,000 in merchandise, payable in euros,
delivery to take place August 15, 2012. On the same day the company enters into a
forward contract for delivery of 1,000,000 on August 15. The forward qualifies as a
hedge of a firm commitment. On August 15, the company closes the forward contract,
takes delivery of the merchandise, and pays the supplier. The company sells the
merchandise to its customers on August 31, 2012.
Required
What amounts will appear on the financial statements of the U.S. company for:
a.
b.

Investment in forward contract, June 30, 2012 balance sheet


Cost of goods sold, fiscal 2013 income statement

ANS:
a.
b.

1,000,000 x ($1.62 - $1.55) = $70,000


Value of firm commitment = 1,000,000 x ($1.65 - $1.55) = $100,000 credit
Currency paid = $1,650,000 - firm commitment offset $100,000 = $1,550,000

Cambridge Business Publishers, 2010


34
Edition

Advanced Accounting, 1st

6.

Topic: Hedge of firm commitment


LO 5
On November 1, 2012, a U.S. company issues a purchase order to buy merchandise for
1,000,000. The company expects to take delivery of the merchandise on January 10,
2008, and will pay the supplier on March 1, 2013. To hedge its FX risk, on November 1,
2012 the company invests in a forward contract for delivery of 1,000,000 on March 1,
2013. The company sells the merchandise to a U.S. customer for $2,000,000 in cash on
April 1, 2013. Assume the forward contract qualifies as a fair value hedge of the firm
commitment to buy merchandise.
Exchange rates for the euro ($/) are below.

November 1, 2012
December 31, 2012
January 10, 2013
March 1, 2013

Spot rate
$ 1.40
1.41
1.44
1.45

Forward rate for


March 1, 2013 delivery
$1.42
1.43
1.435
1.45

Required
For each date below, prepare the necessary journal entries to record the events and/or
adjustments needed.
a.
b.
c.
d.

December 31, 2012 (end of year closing)


January 10, 2013 (takes delivery of merchandise)
March 1, 2013 (closes the forward and pays the bill)
April 1, 2013 (sells the merchandise to a U.S. customer). Assume the company
uses the perpetual inventory method.

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


35

ANS:
a.
December 31, 2012
Investment in forward

10,000
Exchange gain

Exchange loss

10,000
10,000

Firm commitment

10,000

Rate changes from $1.42 to $1.43.


b.
January 10, 2013
Investment in forward

5,000
Exchange gain

Exchange loss

5,000
5,000

Firm commitment
Rate changes from $1.43 to $1.435.
Inventory
Firm commitment

5,000
1,425,000
15,000

Accounts payable
c.
March 1, 2013
Exchange loss

1,440,000
10,000

Accounts payable

10,000

Rate changes from $1.44 to $1.45.


Investment in forward

15,000

Exchange gain
Rate changes from $1.435 to $1.45.
Foreign currency

15,000
1,450,000

Cash
Investment in forward
Accounts payable

1,420,000
30,000
1,450,000

Foreign currency
d.
April 1, 2013
Cash

1,450,000
2,000,000

Sales revenue
Cost of goods sold

1,425,000
Inventory

Cambridge Business Publishers, 2010


36
Edition

2,000,000
1,425,000

Advanced Accounting, 1st

7.

Topic: Import and export transactions


LO 2
Following is information on $/ exchange rates:
November 1, 2013
December 31, 2013
February 15, 2014
March 1, 2014

Spot rate
$1.42
1.38
1.36
1.35

Required
Answer the following questions:
a.

A U.S. company sells merchandise to customers in euro countries, with payment to


be received in euros. Sales totaling 1,000,000 occur on November 1, 2013.
Payment is made on March 1, 2014. The U.S. companys accounting year ends
December 31. What amounts will appear on the financial statements of the U.S.
company for:
i.
Sales revenue, 2013 income statement
ii.
Accounts receivable, 12/31/13 balance sheet
iii.
Exchange gain or loss, 2013 income statement

b.

A U.S. company buys merchandise from suppliers in euro countries, payable in


euros. Purchases of 1,000,000 are made on November 1, 2013. The U.S.
company pays the suppliers on February 15, 2014. The U.S. company sells the
merchandise to its customers on March 1, 2014. The U.S. companys accounting
year ends December 31. What amounts will appear on the financial statements of
the U.S. company for:
i.
Accounts payable, 12/31/13 balance sheet
ii.
Exchange gain or loss, 2014 income statement
iii.
Cost of goods sold, 2014 income statement

ANS:
a.

i.
ii.
iii.

1,000,000 x $1.42 = $1,420,000


1,000,000 x $1.38 = $1,380,000
1,000,000 x ($1.38 - $1.42) = $40,000 loss

b.

i.
ii.
iii.

1,000,000 x $1.38 = $1,380,000


1,000,000 x ($1.38 - $1.36) = $20,000 gain
1,000,000 x $1.42 = $1,420,000

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


37

8.

Topic: Hedges of export transactions


LO 4
A U.S. company sells merchandise to a Greek customer on February 1, 2010 for
1,000,000. The customer pays the bill on May 1, 2010. To hedge foreign exchange risk,
on February 1, 2010 the U.S. company enters a forward sale contract for 1,000,000 with
a May 1 delivery date. On May 1 the company collects the 1,000,000 from the customer
and closes the forward contract. Relevant rates are as follows:
February 1, 2010
May 1, 2010

Spot
$1.345
1.330

5/1 Forward
$1.348
1.330

Required
Make the journal entries to record the following transactions, including appropriate
adjusting entries:
a.
b.

February 1 sale to the Greek customer.


May 1 collection of the receivable and closing of the contract.

ANS:
a.
Accounts receivable

1,345,000
Sales revenue

b.
Exchange loss

1,345,000
15,000

Accounts receivable
Investment in forward

15,000
18,000

Exchange gain
Foreign currency

18,000
1,330,000

Accounts receivable
Cash

1,348,000
Investment in forward
Foreign currency

Cambridge Business Publishers, 2010


38
Edition

1,330,000
18,000
1,330,000

Advanced Accounting, 1st

9.

Topic: Hedge of firm commitment


LO 5
On February 1, 2010, a U.S. company issues a purchase order to buy merchandise from a
Greek supplier for 1,000,000. On February 1, 2010 the U.S. company enters a forward
purchase contract for 1,000,000 with a July 1 delivery date. The forward qualifies as a
hedge of the firm commitment to buy the merchandise. On May 1, 2010, the company
takes delivery of the merchandise. On July 1, 2010, the company closes the forward and
pays the bill. Relevant exchange rates are as follows:

February 1, 2010
May 1, 2010
July 1, 2010

7/1 forward
rate
$1.350
1.344
1.330

Spot rate
$1.345
1.340
1.330

Required
a.
Make the journal entries to record the following transactions, including
appropriate adjusting entries:
i.
May 1 delivery of merchandise.
ii.
July 1 closing of forward contract and payment of bill.
b.
Assume the U.S. company sells the merchandise to a U.S. customer for
$1,600,000. What is the reported gross margin (sales revenue minus cost of goods
sold) on the sale?
ANS:
a.
i.
Exchange loss

6,000
Investment in forward

Firm commitment

6,000
6,000

Exchange gain
Inventory

1,346,000
Firm commitment
Accounts payable

Test Bank, Chapter 7

6,000
6,000
1,340,000

Cambridge Business Publishers, 2010


39

ii.
Exchange loss

14,000
Investment in forward

Accounts payable

14,000
10,000

Exchange gain

10,000

Foreign currency
Investment in forward

1,330,000
20,000
Cash

1,350,000

Accounts payable

1,330,000
Foreign currency

b.
10.

1,330,000

$1,600,000 - $1,346,000 = $254,000

Topic: Hedge of forecasted transaction


LO 6
A U.S. corporation purchases merchandise from a German supplier on a regular basis. On
November 8, 2012, the corporation purchased 100,000 for delivery on March 8, 2013,
in anticipation of an expected purchase of merchandise for 100,000 at the beginning of
March. The forward contract qualifies as a hedge of a forecasted transaction. The
corporation took delivery of the merchandise, settled the forward contract, and paid the
German supplier 100,000 on March 8, 2013. The merchandise was subsequently sold on
April 10, 2013 to a U.S. customer for $200,000. The corporations accounting year ends
on December 31. Relevant exchange rates are as follows:

November 8, 2012
December 31, 2012
March 8, 2013
April 10, 2013

Spot rate
1.25
1.27
1.24
1.23

Forward rate for delivery


March 8, 2013
1.26
1.28
1.24
N/A

Required
a.
Prepare the adjusting entry necessary to update the investment in forward at
December 31, 2012.
b.
Prepare the entries necessary to take delivery of the merchandise and close the
forward on March 8, 2013.
c.
Prepare the entry necessary to record cost of goods sold on April 10, 2013.

Cambridge Business Publishers, 2010


40
Edition

Advanced Accounting, 1st

ANS:
a.
Investment in forward

2,000
Other comprehensive income

b.
Other comprehensive income

2,000
4,000

Investment in forward
Foreign currency
Investment in forward

4,000
124,000
2,000

Cash

126,000

Inventory

124,000
Foreign currency

124,000

c.
Cost of goods sold

126,000
Inventory
Other comprehensive income

Test Bank, Chapter 7

124,000
2,000

Cambridge Business Publishers, 2010


41

11.

Topic: Valuation of forward contracts, hedging entries


LO 3, 4, 6
A U.S. company enters into the following forward contracts on October 15, 2011:
1.
2.

Agreement to sell 100,000,000 yen on January 15, 2012 at $0.0088


Agreement to buy 1,000,000 new shekels on February 15, 2012 at $0.221

Forward and spot rates for yen and shekels are as follows:

October 15, 2011


December 31,2011

Forward rate
Spot rate
for 1/15/12
for yen
delivery of yen
$ .0086
$ .0088
.0084
.0085

Forward rate
Spot rate
for 2/15/12
for new
delivery of new
shekels
shekels
$.220
$ .221
.222
.219

The companys accounting year ends December 31.


Required
a.
How are the forward contracts valued on the companys December 31, 2011
balance sheet? For each contract, specify the amount and whether it is a current
asset or a current liability.
b.
Assume that the forward contract to sell yen is an effective hedge of a 100,000,000
yen forecasted sale to customers in Japan. Make the adjusting entry for this
contract at December 31, 2011.
c.
Assume the forward contract to buy new shekels is an effective hedge of a
1,000,000 new shekel obligation currently on the companys books. Make the
adjusting entry for this contract at December 31, 2011.
ANS:
a.

Forward sale in yen: ($.0088 - $.0085) x 100,000,000 = $30,000 current asset


Forward purchase in new shekels: ($.221 - $.219) x 1,000,000 = $2,000 current
liability

b.
Investment in forward

30,000
Other comprehensive income

c.
Exchange loss

2,000
Investment in forward

Cambridge Business Publishers, 2010


42
Edition

30,000

2,000

Advanced Accounting, 1st

12.

Topic: Hedge of firm commitment


LO 5
On March 1, 2011, a U.S. company issued a purchase order to a supplier in the Cayman
Islands for goods with a price of KYD 5,000,000. The goods will be delivered July 1,
2011, and payment will be made on September 1, 2011. On March 1, 2011, the company
purchased KYD 5,000,000 for delivery September 1, 2011. The forward contract is an
effective hedge of the firm commitment to purchase goods from the Cayman Islands. The
goods are delivered as expected on July 1, and the company follows through on the
forward contract and makes the payment to the supplier on September 1. The companys
accounting year ends on December 31.
Spot and forward rates are as follows ($/KYD):
March 1, 2011
July 1, 2011
September 1, 2011

Spot Rate
$1.22
1.21
1.19

Forward rate for delivery


on September 1, 2011
$1.21
1.20
1.19

Required
Answer the following questions regarding how the above information is reported on the
companys financial statements:
a.
b.

What is the net hedging gain or loss for 2011?


Suppose the goods purchased from the Cayman Islands are sold to a U.S.
customer for $8,000,000. What is the gross margin (sales revenue less cost of
goods sold) on the sale? Show calculations clearly.

ANS:
a.

Loss on forward: ($1.21 - $1.19) x 5,000,000 =


Gain on firm commitment: ($1.21 - $1.20) x 5,000,000 =
Gain on accounts payable: ($1.21 - $1.19) x 5,000,000 =
Net

b.

Inventory is recorded as follows when the goods are delivered on July 1:

Inventory

$100,000 loss
50,000 gain
100,000 gain
$ 50,000 gain

6,100,000
Firm commitment
Accounts payable

50,000
6,050,000

The gross margin on the sale is:


Sales
Cost of goods sold
Gross margin

Test Bank, Chapter 7

$8,000,000
6,100,000
$1,900,000

Cambridge Business Publishers, 2010


43

13.

Topic: Forward purchase, cash flow hedge that becomes a fair value hedge
LO 4, 5, 6
A U.S. company purchases merchandise from a Hong Kong supplier on a regular basis.
The following events occur:

October 1, 2012: The company purchased $H1,000,000 for delivery on May 1,


2013, in anticipation of an expected payment of $H for a forecasted merchandise
purchase.
December 1, 2012: The company issued a purchase order for $H1,000,000 in
merchandise from the supplier.
March 1, 2013: The company took delivery of the merchandise.
May 1, 2013: The company closed the forward contract and paid the supplier.
May 31, 2013: The company sold the merchandise to a U.S. customer for
$200,000.

The companys accounting year ends December 31.


Exchange rates ($/H) are as follows:

October 1, 2012
December 1, 2012
December 31, 2012
March 1, 2013
May 1, 2013

Spot rate
$0.125
0.127
0.128
0.131
0.132

Forward rate for


delivery 5/1/13
$0.127
0.129
0.131
0.1315
0.132

Required
Prepare the journal entries to record the above transactions, including necessary adjusting
entries. Assume the hedge qualifies for special hedge accounting.

Cambridge Business Publishers, 2010


44
Edition

Advanced Accounting, 1st

ANS:
Adjusting entries at December 31, 2012:
Investment in forward
Other comprehensive income
To record increase in value of forward contract ($.127 to $.131)
Exchange loss

4,000
4,000
2,000

Firm commitment
To record loss on firm commitment ($.129 to $.131)

2,000

Other comprehensive income

2,000

Exchange gain
2,000
To reclassify other comprehensive income to income to match against loss on firm
commitment.
March 1, 2013
Investment in forward

500

Other comprehensive income


To mark the forward to market ($.131 to $.1315)

500

Exchange loss

500

Firm commitment
To mark the firm commitment to market ($.131 to $.1315)

500

Other comprehensive income

500

Exchange gain
500
To reclassify other comprehensive income to income to match against firm commitment
loss.
Inventory
Firm commitment

128,500
2,500

Accounts payable
To record delivery of merchandise, adjusted for firm commitment balance.

Test Bank, Chapter 7

131,000

Cambridge Business Publishers, 2010


45

May 1, 2013
Investment in forward

500

Other comprehensive income


To mark the forward to market ($.1315 to $.132)
Exchange loss

500
1,000

Accounts payable
To mark accounts payable to market ($.131 to $.132)

1,000

Other comprehensive income

1,000
Exchange gain
1,000
To reclassify other comprehensive income to income to match against accounts payable
loss.
Foreign currency

132,000
Investment in forward
Cash

5,000
127,000

To close forward contract.


Accounts payable

132,000
Foreign currency

132,000

To pay the supplier.


May 31, 2013
Cost of goods sold
Other comprehensive income

127,000
1,500

Inventory
128,500
Note: Remaining other comprehensive income balance is $4,000 - $2,000 + $500 - $500 +
$500 - $1,000 = $1,500 gain.

Cambridge Business Publishers, 2010


46
Edition

Advanced Accounting, 1st

14.

Topic: Cash flow hedge accounting versus regular accounting


LO 3, 6
Following is information on exchange rates for the euro:
October 1, 2011
December 31, 2011
January 31, 2012
March 31, 2012
April 30, 2012

Spot rate
$1.45
1.50
1.52
1.56
1.60

Forward rate for 4/30/12 delivery


$1.48
1.53
1.55
1.58
1.60

On October 1, 2011, a U.S. company forecasts that it will buy merchandise from a
supplier in Portugal for 10,000,000 around the end of March, 2012, with payment
expected to be made, in euros, about one month later. The company closes its books on
December 31. The following events occur:
1.
2.
3.
4.
5.
6.

October 1, 2011: The company enters a forward purchase agreement for delivery
of 10,000,000 on April 30, 2012. No initial investment is required.
December 31, 2011: The company closes its books.
January 31, 2012: The company issues a purchase order to the supplier for
10,000,000 in merchandise, to be delivered March 31, 2012.
March 31, 2012: The company takes delivery of the merchandise.
April 30, 2012: The company closes the forward contract and pays the supplier
10,000,000.
May 15, 2012: The company sells the merchandise to a U.S. customer for
$22,500,000.

Required
Fill in the schedule below, showing the amounts related to the above events that will be
reported in the companys annual reports for 2011 and 2012. Show related journal entries
in the next schedule. Show liabilities and gains in parenthesis.

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


47

ANS:

Account title

Forward contract qualifies as a


hedge of the forecasted
transaction
2011

Investment in forward
(balance sheet)
Other comprehensive
income (Balance sheet)

2012

$ 500,000
(500,000)

2011

2012

--

$ 500,000

--

--

--

--

(Gains) and losses (income


statement)

--

--

Cost of goods sold (income


statement)

--

$14,800,000

Cambridge Business Publishers, 2010


48
Edition

The forward contract does not


qualify as a hedge

(500,000)

--

$ (200,000)
(300,000)
(200,000)
400,000
$ (300,000)
$15,600,000

Advanced Accounting, 1st

Forward contract is a qualified hedge


December 31
Investment in forward 500,000
OCI
500,000
January 31
Investment in forward
OCI

200,000
200,000

March 31
Investment in forward 300,000
OCI
300,000
Exchange loss
300,000
Firm commitment
300,000
OCI
300,000
Gain
300,000
Inventory
15,300,000
Firm commitment
300,000
A/P
15,600,000
April 30
Investment in forward
200,000
OCI
200,000
Exchange loss
400,000
A/P
400,000
OCI
400,000
Exchange gain
400,000
Foreign currency
16,000,000
Cash
14,800,000
Investment in for.
1,200,000
A/P
16,000,000
Foreign currency
16,000,000
May 15
CGS
OCI
Inventory

Test Bank, Chapter 7

14,800,000
500,000

Forward contract is not a qualified hedge


Investment in forward
Exchange gain

500,000

Investment in forward
Exchange gain

200,000

Investment in forward
Exchange gain
--

300,000

500,000

200,000

300,000

-Inventory
A/P
15,600,000

15,600,000

Investment in forward
Exchange gain
200,000
Exchange loss
A/P
400,000
--

200,000
400,000

Foreign currency
Cash
14,800,000
Investment in for.
A/P
Foreign currency

16,000,000

CGS
Inventory
15,600,000

15,600,000

1,200,000
16,000,000
16,000,000

15,300,000

Cambridge Business Publishers, 2010


49

15.

Topic: Cash flow hedge accounting versus regular accounting


LO 3, 6
Following are exchange rates for the Canadian dollar.

October 31, 2011


December 31, 2011
March 31, 2012

Spot rate
$ 0.80
0.84
0.82

Forward rate for March 31,


2012 delivery
$ 0.81
0.86
0.82

A U.S. company enters a forward contract on October 31, 2011 to hedge a forecasted
purchase of merchandise for C$1,000,000 on March 31, 2012. On March 31 it takes
delivery of the merchandise, closes the forward and pays for the merchandise. It sells the
merchandise in May. The companys accounting year ends December 31.
Required
What are the balances for the following accounts, assuming the forward contract qualifies
as a hedge of the forecasted transaction for the period October 31, 2011 to March 31,
2012, and also if the forward contract does not qualify as a hedge?
a.
b.
c.
d.

Other comprehensive income balance, December 31, 2011


Gain/loss on forward contract, 2011 income statement
Gain/loss on forward contract, 2012 income statement
2012 cost of goods sold

ANS:
Qualifies as hedge
Other comprehensive income, December
31, 2011 (gain)
2011 income statement
gain on forward contract
2012 income statement
loss on forward contract
2012 cost of goods sold

Cambridge Business Publishers, 2010


50
Edition

$ 50,000

Does not qualify


$

50,000

0
810,000

40,000
820,000

Advanced Accounting, 1st

16.

Topic: Hedge of firm commitment, import transaction, speculation


LO 2, 5, 7
Electronic Importers, a U.S. company, has the following outstanding balances as of
December 31, 2011, its accounting year-end.
Forward purchase contract dated December 1, 2011 for 20,000,000 yen to hedge a firm
commitment to purchase computer hardware for 20,000,000 yen in 90 days ending on
March 1, 2012.
Account payable for 70,000,000 yen for unpaid merchandise acquired on December 16,
2011 and due on January 15, 2012.
Forward sale contract dated December 16, 2011 for 30,000,000 yen to speculate in
exchange rate changes and due on January 15, 2012.
Exchange rates quoted in the U.S. for Japanese yen are:
Spot rate
90-day forward
60-day forward
30-day forward
15-day forward

12/1/11
$.00620
.00630
.00620
.00610
.00615

12/16/11 12/31/11
$.00610 $.00600
.00620
.00610
.00610
.00603
.00600
.00590
.00605
.00595

1/15/12
$.00593
.00600
.00590
.00580
.00585

3/1/12
$.00580
.00590
.00580
.00570
.00575

Required
a.
Calculate the gain or loss on Electronic Importers' 2011 income statement due to
the above items. Specify the amount and whether it is a gain or loss.
b.
Calculate the balances at which the forward purchase contract and the forward sale
contract would be reported in the December 31, 2011 balance sheet.
c.
At what amount (U.S. dollars) should the computer hardware be valued on March
1, 2012?

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


51

ANS:
a.

Forward purchase contract: no income effect due to offsetting gain and loss on
contract and firm commitment.

Accounts payable 70,000,000 x ($.00610 - $.00600) =


Forward sale 30,000,000 x ($.00600 - $.00595) =

b.

$7,000 gain
1,500 gain
$8,500 gain

Forward purchase contract:


($.0063 - $.00603) x 20,000,000 = $5,400 current liability
Forward sale contract:
($.006 - $.00595) x 30,000,000 = $1,500 current asset

c.
($.0058 x 20,000,000) =
Plus firm commitment balance:
($.0063 - $.0058) x 20,000,000
Hardware balance, 3/1/12

Cambridge Business Publishers, 2010


52
Edition

$116,000
10,000
$126,000

Advanced Accounting, 1st

17.

Topic: Import transactions, hedge of firm commitment, hedge of forecasted


transaction, speculation
LO 2, 5, 6, 7
Each of the following situations is independent of the others. Acme Importers is a U.S.
company with a December 31 year-end. Use the following information on exchange rates
(US$/$Canadian) to answer each question.

September 1, 2012
October 1, 2012
December 31, 2012
February 1, 2013

Spot rate
$.80
.78
.75
.69

Forward rate
for delivery on
2/1/13
$.82
.79
.74
.69

Required
For each situation, (1) make the journal entries necessary to record the events, including
year-end adjustments, and (2) calculate the effect on Acme's income in the year 2012, and
in the year 2013. Show the amounts and whether they are gains or losses.
a.
b.

c.

d.

e.

On September 1, 2012 Acme Importers agrees to buy merchandise from Montreal


Suppliers. Delivery will take place on October 1, 2012, and Acme will pay
Montreal Suppliers C$5,000 on February 1, 2013.
On September 1, 2012, Acme Importers makes a firm commitment to buy
merchandise from Montreal Suppliers. Delivery will take place on October 1,
2012, and Acme will pay Montreal Suppliers C$5,000 on February 1, 2013. On
October 1, 2012, Acme enters into a forward purchase contract with ABC
Exchange Dealers for the purchase of C$5,000, to be delivered February 1, 2013.
On September 1, 2012, Acme Importers makes a firm commitment to buy
merchandise from Montreal Suppliers. Delivery will take place on October 1,
2012, and Acme will pay Montreal Suppliers C$5,000 on February 1, 2013. On
September 1, 2012, Acme enters into a forward purchase contract with ABC
Exchange Dealers for the purchase of C$5,000, to be delivered February 1, 2013.
The merchandise remains in Acme's inventory as of December 31, 2013.
The CFO at Acme Importers believes that the U.S. dollar will continue to
strengthen with respect to the Canadian dollar. On October 1, 2012, he enters into
a speculative forward sale contract with ABC Exchange Dealers for delivery of
C$5,000 on February 1, 2013.
On September 1, 2012, Acme Importers forecasts that it will buy merchandise
from a Canadian supplier. Delivery and payment of C$5,000 is expected to take
place on October 1, 2012. On September 1, 2012, Acme enters into a forward
purchase contract with ABC Exchange Dealers for the purchase of C$5,000 for
$0.76, to be delivered October 1, 2012. The merchandise purchase occurs as
forecasted, and the merchandise remains in Acmes inventory as of December 31,
2013.

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


53

ANS:
1a.
10/1

Merchandise

3,900
Accounts payable

3,900

(5,000 x $.78)
12/31
10/1

Accounts payable

150
Exchange gain

150

[($.78 - $.75) x 5,000]


2/1

Accounts payable

300
Exchange gain

300

[($.75 - $.69) x 5,000]


2/1

Accounts payable

3,450
Cash

3,450

(5,000 x $.69)
b.
10/1

Merchandise

3,900
Accounts payable

12/31

3,900

Accounts payable

150
Exchange gain

12/31

150

Exchange loss

250
Investment in forward

250

[($.79 - $.74) x 5,000]


2/1

Accounts payable

300
Exchange gain

2/1

300

Exchange loss

250
Investment in forward

250

[($.74 - $.69) x 5,000]


2/1

Foreign currency
Investment in forward

3,450
500
Cash

2/1

Accounts payable

3,450
Foreign currency

Cambridge Business Publishers, 2010


54
Edition

3,950
3,450

Advanced Accounting, 1st

c.
10/1

Exchange loss

150
Investment in forward

150

[($.82 - $.79) x 5,000]


10/1

Firm commitment

150
Exchange gain

10/1

150

Merchandise

3,900
Accounts payable

10/1

Merchandise

3,900
150

Firm commitment
12/31

Exchange loss

150
250

Investment in forward
12/31

Accounts payable

250
150

Exchange gain
2/1

150

Exchange loss

250
Investment in forward

Accounts payable

250
300

2/1
Exchange gain
2/1
2/1

300

Foreign currency

3,450

Investment in forward

500
Cash

3,950

Accounts payable

3,450

2/1
Foreign currency

Test Bank, Chapter 7

3,450

Cambridge Business Publishers, 2010


55

d.
12/31

Investment in forward

250
Exchange gain

250

[($.79 - $.74) x 5,000]


2/1

Investment in forward

250
Exchange gain

250

[($.74 - $.69) x 5,000]


2/1

Foreign currency

3,450
Cash

3,450

Cash

3,950

2/1
Foreign currency
Investment in forward
e.
10/1

Investment in forward

3,450
500
100

Other comprehensive
income

100

[($.78-.76) x 5,000]
10/1

Foreign currency

3,900
Investment in forward
Cash

Merchandise

100
3,800
3,900

10/1
Foreign currency
2.
(a)
(b)
(c)
(d)
(e)

3,900

Income effects:

2012
$150 gain
100 loss
100 loss
250 gain
-0-

Cambridge Business Publishers, 2010


56
Edition

2013
$300 gain
50 gain
50 gain
250 gain
-0-

Advanced Accounting, 1st

18.

Topic: Borrowing in foreign currency


LO 2
A U.S. company purchases a 60-day certificate of deposit from a German bank on October
15. The certificate has a face value of 10,000,000, costs $13,800,000 (the spot rate is
$1.38/ on October 15), and pays interest at an annual rate of 8 percent. On December
14, the certificate of deposit matures and the company receives principal and interest due
to it. The spot rate on December 14 is $1.40/. The average spot rate for the period
October 15 - December 14 is $1.39/.
Required
Prepare all necessary journal entries to record the above events on the U.S. company's
books.
ANS:
10/15
Temporary investments

13,800,000
Cash

12/14
Temporary investments

13,800,000
200,000

Exchange gain
$200,000 = ($1.40 - $1.38) x 10,000,000.
Foreign currency
Temporary
investments
Interest income
$186,667 = (10,000,000 x 8% x 2/12) x $1.40

Test Bank, Chapter 7

200,000
14,186,667
14,000,000
186,667

Cambridge Business Publishers, 2010


57

19.

Topic: Speculation in forward contracts


LO 7
On November 1, 2013, a U.S. company thinks the exchange rate for the euro will fall, so it
enters into a forward contract in the amount of 1,000,000, for delivery on March 15,
2014. This is a speculative contract. The companys accounting year ends December 31.
The company closes the contract on February 1, 2014. Exchange rates are as follows ($/
):

November 1, 2013
December 31, 2013
February 1, 2014
March 15, 2014

Spot rate
$ 1.42
1.46
1.47
1.50

Forward rate for


March 15, 2014 delivery
$ 1.43
1.45
1.48
1.50

Required
a.
Does the company enter a forward purchase or a forward sale contract? Explain.
b.
Prepare the journal entries necessary on December 31, 2013 and February 1, 2014
to record the above events.
ANS:
a.

A forward sale locks in the selling price. If the rate falls, as the company expects,
it will gain by buying euros at the lower price and selling at the higher contract
price.

b.
December 31, 2013
Loss

20,000
Investment in forward
To adjust the forward contract to fair value; $20,000 = ($1.45 - $1.43) x
1,000,000.

20,000

February 1, 2014
Loss

30,000
Investment in forward
To adjust the forward contract to fair value; $30,000 = ($1.48 - $1.45) x
1,000,000.

30,000

The company closes the forward by entering a forward purchase for delivery on March 15,
2014, at $1.48/. So the company sells at $1.43 and buys at $1.48, for a net cash outflow
of ($1.48 - $1.43) x 1,000,000 = $50,000.
Investment in forward
Cash
To close the forward contract on February 1, 2014.

Cambridge Business Publishers, 2010


58
Edition

50,000
50,000

Advanced Accounting, 1st

20.

Topic: IFRS for hedging forecasted transactions


LO 8
On February 15, 2011, an Italian company, with a June 30 year-end, enters a forward
purchase contract for $1,000,000 to be delivered on August 1, 2011. The contract hedges
a forecasted purchase of equipment. The forward is closed and the equipment purchased
on August 1. The equipment has a 2-year life, and is straight-line depreciated. Following
is information on exchange rates (/$):

February 15, 2011


June 30, 2011
August 1, 2011

Spot rate
0.80
0.74
0.72

Forward rate for August 1,


2011 delivery
0.81
0.76
0.72

The company follows IFRS and uses the basis adjustment approach to reporting cash flow
hedges.
Required
Prepare the journal entries to record the following events:
a.
b.
c.
d.

June 30, 2011 adjusting entry


August 1, 2011 adjusting entries and transactions
June 30, 2012 adjusting entry for the equipment
If the company followed U.S. GAAP, how would the June 30, 2012 entry differ?

Test Bank, Chapter 7

Cambridge Business Publishers, 2010


59

ANS:
a.
June 30, 2011
Other comprehensive income

50,000

Investment in forward
50,000
To adjust the forward contract to fair value; 50,000 = (.81 - .76) x $1,000,000.
b.
August 1, 2011
Other comprehensive income

40,000
Investment in forward
40,000
To adjust the forward contract to fair value; 40,000 = (.76 - .72) x $1,000,000.

Foreign currency
Investment in forward

720,000
90,000
Cash

810,000

To close the forward contract.


Equipment

720,000
Foreign currency

720,000

To purchase the equipment.


Equipment

90,000

Other comprehensive income


To adjust the equipment for the accumulated loss on the forward.

90,000

c.
June 30, 2012
Depreciation expense

371,250
Equipment, net
371,250
To record depreciation expense for fiscal 2012; 371,250 = (810,000/2) x 11/12.

d.
June 30, 2012
Depreciation expense

330,000

Equipment, net
330,000
To record depreciation expense for fiscal 2012; 330,000 = (720,000/2) x 11/12.
Depreciation expense

41,250

Other comprehensive income


41,250
To reclassify other comprehensive income as an adjustment of depreciation
expense for fiscal 2012; 41,250 = (90,000/2) x 11/12.

Cambridge Business Publishers, 2010


60
Edition

Advanced Accounting, 1st