Professional Documents
Culture Documents
written by
Course Information
Prerequisite Two to four years experience in
accounting
Author Biography
C. Tommy Moores, PhD, CPA, is a Professor of Accounting at the University of Nevada, Las Vegas. He has
also taught accounting at Texas Tech University and Louisiana State University. Dr. Moores is a member of
the American Accounting Association, the American Institute of CPAs, the Texas Society of CPAs, and the
Nevada Society of CPAs. He has served on the Board of Directors for the Nevada Society of CPAs. Dr. Moores
is the author or co-author of nine interactive CPE courses for MicroMash. During his career Dr. Moores has
taught CPE courses for the Texas Society of CPAs, Nevada Society of CPAs, and Financial Executives
Institute. In addition, Dr. Moores has developed continuing professional education materials for professional
business organizations and previously served as the Associate Editor for The Accounting Educators' Journal.
M. Herschel Mann, Ph.D., CPA, is the retired KPMG Professor of Accounting at Texas Tech University. He
received his Ph.D. and M.A. from the University of Alabama. His previous work experience was with Grant
Thornton LLP. At Texas Tech, he received seven university-wide teaching awards, including the President's
Excellence in Teaching Award twice. In addition, he was named as the outstanding faculty member in the
College of Business Administration and the outstanding faculty member in the Department of Accounting.
He is the author or co-author of eleven interactive CPE courses for Checkpoint Learning. He has served on
various professional committees, including the AICPA's Task Force on Accounting for Interest Income, the
Texas State Board of Public Accountancy's Technical Standards Review Committee, and the Texas Society of
CPAs' Accounting, Auditing, and Reporting Standards Committee. He has also taught numerous CPE
courses for various state societies, companies, and CPA firms, as well as the SEC Institute.
Course Description
This is the ideal financial derivatives course. It includes detailed coverage of Topic 815, Derivatives and
Hedging. Additional course highlights include qualifying criteria of fair value and cash flow hedges and their
accounting, designation of certain intercompany derivatives as hedging instruments in cash flow hedges of
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 2 of 124
foreign currency risk, and identification of foreign-currency-denominated assets and liabilities as hedged
items in fair value or cash flow hedges. It has been updated through Accounting Standards Update (ASU)
2017-09.
Learning Objectives
Upon successful completion of Accounting for Derivatives and Hedging Activities, the user should be able to:
Chapter 1. Introduction
This chapter discusses the fundamental decisions made by the Financial Accounting Standards Board
(FASB) about accounting for derivatives and hedging activities in Accounting Standards Codification® Topic
815. The course is current through Accounting Standards Update No. 2015-07 (May 2015).
Completion of “Introduction” will enable you to:
• identify the four fundamental decisions,
• identify the scope and definitions of Accounting Standards Codification (ASC) Topic 815, Derivatives and
Hedging, and
• recognize the characteristics of embedded derivatives.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 3 of 124
Topic 815, Derivatives and Hedging, does not define what a hedge is; however, hedges generally are
thought to be transactions entered into to manage (usually reduce) risk exposure to interest rate
movements, foreign-currency exchange rate variations, or most any other contractual exposure to risks.
The accounting for several types of hedging strategies using derivative instruments are explained and
illustrated in Topic 815.
Topic 815 is complicated and arduous to implement for entities with hedging activities that are not perfectly
correlated with the hedged risk. Topic 815 is more flexible in the hedge accounting rules applicable to
foreign-currency exposures. Also, many of the complicated fair value measurement requirements are not
applicable when derivative strategies are considered perfectly correlated.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 4 of 124
the essential characteristics of assets or liabilities. The FASB concluded that gains or losses on derivatives
should not be reported as assets or liabilities in a statement of financial position.
Special Accounting
Quote
Special accounting for items designated as being hedged should be provided only for qualifying items. One
aspect of qualification should be an assessment of the expectation of effective offsetting changes in fair
values or cash flows during the term of the hedge for the risk being hedged.
The FASB concluded that hedge accounting should not be permitted in all cases in which an entity might
assert that a relationship exists between items or transactions. A primary purpose of hedge accounting is to
link items or transactions whose changes in fair values or cash flows are expected to offset each other. The
FASB decided that one of the criteria for qualification for hedge accounting should focus on the extent to
which offsetting changes in fair values or cash flows on the derivative, and the hedged item or transaction
during the term of the hedge, are expected and ultimately achieved (i.e., hedge effectiveness).
Exception
Several types of contracts are specifically excluded from the scope; therefore, the accounting for
these items is unaffected. These excluded contracts include, but are not limited to, the following:
• “Regular-way” securities trades
• Normal purchases and normal sales
• Certain insurance contracts that compensate the holder only as a result of identifiable
insurable events
• Certain financial guarantee contracts
• Certain contracts that are not traded on an exchange
• Derivative instruments that serve as impediments to sales accounting
• Investment in life insurance
• Certain investment contracts
• Loan commitments
FASB ASC 815-10-15-13
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 5 of 124
Example
Examples of underlyings are:
• the LIBOR (London Interbank Offered Rate);
• a security price or security price index;
• an exchange rate or an exchange rate index;
• the price of crude oil; and
• a climate or geological condition, another physical variable, or related index.
Notional amount: The notional amount is the fixed amount or quantity that determines the size of the
change caused by the movement of the underlying. A notional amount is a number of currency units, shares,
bushels, pounds or other units specified in the contract (Section 815-10-20) that is applied to the underlying
in determining the settlement or value of the derivative instrument. Thus, the settlement of the derivative
instrument is determined by the interaction of the underlying and the notional amount.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 6 of 124
Initial net investment: Many derivative instruments require no initial net investment while others may
require a smaller initial net investment than other types of contracts that have a similar response to changes
in market factors.
If the initial investment in the contract (after adjusting for the time value of money) is more than a nominal
amount less than the initial net investment that would be commensurate with the amount that would be
exchanged either to acquire the asset related to the underlying or to incur the obligation related to the
underlying, the second condition to be classified as a derivative is satisfied.
Example
A derivative instrument may require an initial net investment as compensation for time value (e.g.,
a premium on an option) or for terms that are more favorable than market conditions (e.g., a
premium on a forward purchase contract with a price less than the current forward price).
Net settlement: Though some derivative contracts may settle through physical delivery, a derivative really
represents an investment in the change in value caused by the underlying, and not an actual investment in
the notional amount of the underlying. Thus, derivatives may be settled in cash rather than by delivery of the
underlying. ASC 815 broadens this concept to include contracts that can be settled with an asset that is
readily convertible into cash or is itself a derivative instrument, and for which a market mechanism facilitates
liquidation of the contract for a net cash payment even though the contract itself does not envision a net
cash settlement.
Example
Topic 815 provides the following examples of securities that are readily convertible to cash:
• An actively traded security
• Commodities for which there is an active market
• A foreign currency that is readily convertible into the functional currency of the reporting
entity
Study Question 1
Topic 815 applies to all entities and instruments it defines as derivatives; however, special provisions govern
which one of the following?
A Not-for-profit entities
B Oil companies
Study Question 2
The notional amount:
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 7 of 124
Study Question 3
To be classified as a derivative, the instrument must have which of the following?
1 C. Embedded Derivatives
When defining derivative instruments and determining the types of instruments that would be considered
derivative instruments under Topic 815, the FASB was concerned that entities would attempt to circumvent
the requirements by embedding a derivative instrument into a nonderivative instrument. Therefore, the
scope of Topic 815 includes derivatives that are embedded in other contracts. Subtopic 815-15 on embedded
derivatives applies only to contracts that do not meet the definition of a derivative instrument in their
entirety.
Quote
Contracts that do not in their entirety meet the definition of a derivative instrument (see
paragraphs 815-10-15-83 through 15-139), such as bonds, insurance policies, and leases, may
contain embedded derivatives. The effect of embedding a derivative instrument in another type of
contract (the host contract) is that some or all of the cash flows or other exchanges that otherwise
would be required by the host contract, whether unconditional or contingent on the occurrence of
a specified event, will be modified based on one or more underlyings.
FASB ASC 815-15-05-1
Quote
An embedded derivative instrument shall be separated from the host contract and accounted for
as a derivative instrument. . . if and only if all of the following criteria are met:
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 8 of 124
• The economic characteristics and risks of the embedded derivative instrument are not clearly
and closely related to the economic characteristics and risks of the host contract.
• The hybrid instrument is not remeasured at fair value under otherwise applicable generally
accepted accounting principles (GAAP) with changes in fair value reported in earnings as they
occur.
• A separate instrument with the same terms as the embedded derivative would, pursuant to
Section 815-10-15, be a derivative instrument subject to the requirements of this Subtopic.
(The initial net investment for the hybrid instrument shall not be considered to be the initial
net investment for the embedded derivative.)
FASB ASC 815-15-25-1
Therefore, according to (a), if the economic characteristics and risks of the embedded derivative are clearly
and closely related to the economic characteristics and risks of the host contract, the embedded derivative is
outside the scope of Topic 815.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 9 of 124
• foreign-currency hosts.
Debt hosts: The value of a debt host contract is driven by the interest rate associated with the host contract.
An embedded derivative in a host contract that possesses debt characteristics generally is clearly and closely
related to the host contract when the underlying is:
a. a nonleveraged interest rate or index;
b. a nonleveraged index of inflation; or
c. the creditworthiness of the debtor, and, therefore, should not be separated.
Quote
An embedded derivative instrument in which the only underlying is an interest rate or interest rate
index (such as an interest rate cap or an interest rate collar) that alters net interest payments that
otherwise would be paid or received on an interest-bearing host contract that is considered a debt
instrument is considered to be clearly and closely related to the host contract unless either of the
following conditions exist:
a. The hybrid instrument can contractually be settled in such a way that the investor (the holder
or the creditor) would not recover substantially all of its initial recorded investment.
b. The embedded derivative meets both of the following conditions:
1. There is a possible future interest rate scenario (even though it may be remote) under
which the embedded derivative would at least double the investor's initial rate of return
on the host contract.
2. For any of the possible interest rate scenarios under which the investor's initial rate of
return on the host contract would be doubled (as discussed in (b)(1)), the embedded
derivative would at the same time result in a rate of return that is at least twice what
otherwise would be the then-current market return (under the relevant future interest
rate scenario) for a contract that has the same terms as the host contract and that
involves a debtor with a credit quality similar to the issuer's credit quality at inception.
FASB ASC 815-15-25-26
Equity hosts: Most equity instruments have unique risk characteristics; therefore, most embedded
derivatives in a host with equity characteristics would not be clearly and closely related to the host contract,
and would have to be accounted for separately.
An exception for an investor is an option embedded in cumulative participating perpetual preferred stock
that permits the holder to convert the preferred stock to common stock.
Lease hosts: The value of a lease host contract is driven by:
a. expectations and risks from possible changes in the purchasing power of money during the term of the
lease (e.g., inflation),
b. the revenues that will be generated from the leased property, and
c. the interest rate inherent in the lease.
If the underlying is associated with any of these three items, the component embedded in the lease host
contract is considered to be clearly and closely related to the lease host contract and should not be
accounted for separately.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 10 of 124
Note
If the lease host contract contains an embedded derivative component that is not associated with
any of the three characteristics inherent in a lease, the conclusion is that the embedded derivative
component is not clearly and closely related to the lease host contract.
Foreign-currency hosts: An entity will not separate an embedded foreign currency derivative from the host
contract and consider it a derivative instrument under paragraph 815-15-25-1 if all of the following criteria
are met:
a. The host contract is not a financial instrument.
b. The host contract requires payment(s) denominated in any of the following currencies:
1. The functional currency of any substantial party to that contract
2. The currency in which the price of the related good or service that is acquired or delivered is routinely
denominated in international commerce (for example, the U.S. dollar for crude oil transactions)
3. The local currency of any substantial party to the contract
4. The currency used by a substantial party to the contract as if it were the functional currency because
the primary economic environment in which the party operates is highly inflationary (as discussed in
paragraph 830-10-45-11).
c. Other aspects of the embedded foreign currency derivative are clearly and closely related to the host
contract.
The evaluation of whether a contract qualifies for the scope exception in this paragraph shall be performed
only at inception of the contract.
FASB ASC 815-15-15-10
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 11 of 124
Unsettled foreign-currency transactions—including financial instruments that are monetary and have
principal payments and/or interest payments—denominated in a foreign currency are not to be considered to
include embedded derivative components. These instruments are subject to the provisions of Topic 830 and
require the recognition of any foreign-currency transaction gain or loss in earnings.
If an embedded derivative exists, the entity bifurcates the derivative from the host contract and accounts for
each separately. The host contract should be accounted for based on existing generally accepted accounting
principles (GAAP) and the derivative should be recorded at fair value under Topic 815. If an entity cannot
measure the fair value, then the derivative should not be separated from the host contract and the entire
hybrid contract is measured at fair value with changes in fair value recognized in earnings.
An entity that initially recognizes a hybrid financial instrument under paragraph 815-15-25-1 must separate
the hybrid instrument into a host contract and a derivative instrument. The entity may elect irrevocably to
initially and subsequently measure that hybrid financial instrument in its entirety at fair value (with changes
in fair value recognized in earnings). The entity will evaluate the financial instrument to determine that it has
an embedded derivative requiring bifurcation before the instrument can become a candidate for the fair
value election.
The fair value election is also available when a previously recognized financial instrument is subject to a
remeasurement event and the bifurcation of an embedded derivative. An entity may make the fair value
election instrument by instrument.
Hybrid financial instruments that an entity elects to account for in their entirety at fair value cannot be used
as a hedging instrument.
FASB ASC 815-15-25
Study Question 4
To be outside the scope of Topic 815, the economic characteristics and risks of the embedded derivative
must:
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 12 of 124
Study Question 5
What is a hybrid contract?
A fair value hedge should decrease or eliminate the exposure to a change in fair value that is associated with
an existing recognized asset or liability, an unrecognized firm commitment, or an identified portion thereof
due to its fixed terms, such as interest rates or prices. In other words, the purpose of a fair value hedge is to
guard against the changes in value caused by fixed terms, rates, or prices.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 13 of 124
Interactivity information:
Example
Examples of fair value hedges are:
• using a futures contract to hedge the fair value of inventory,
• using an interest rate swap to convert the interest received and/or paid from fixed to variable, and
• using a forward contract to hedge a firm commitment to buy and/or sell inventory.
A nonderivative instrument, such as a Treasury note, may not be designated as a hedging instrument except
as a foreign-currency fair value hedge or as a hedge of the foreign-currency exposure of a net investment in a
foreign operation.
The primary purpose of a fair value hedge is to achieve offsetting changes in the fair values of the derivative
and the hedged item. Fair value hedge accounting requires both the change in fair value of the hedged item
attributable to the risk being hedged and the change in the fair value of the derivative to be marked to
market through earnings. As a result, the overall fair value of an item may increase even though the fair
value attributable to the hedged risk decreases.
For example, suppose that a fixed-rate bond (held-to-maturity security) is hedged for changes in fair value
due to credit risk. That bond may decrease in value due to a credit downgrade even though its overall fair
value increases because interest rates decline. The derivative (if effective) would be expected to provide a
gain to offset the decrease in the value of the bond due to credit risk. Note that the carrying amount of the
bond would be adjusted downward even though its overall fair value increased because the fair value of the
hedged item is adjusted only for changes attributable to the risk being hedged.
An important hedge accounting concept to keep in mind is that the fair value of an instrument changes due
to the risks previously mentioned, but an entity may choose to hedge only one, or some combination, of
those risks; therefore, only changes in fair value for the risk being hedged are reflected in the financial
statements.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 14 of 124
Qualifying Criteria
Topic 815 requires certain conditions be satisfied for a hedge to qualify for hedge accounting. The conditions
are meant to ensure that hedge accounting is used in a relatively consistent manner to increase the
usefulness of the financial information that results from applying hedge accounting.
The general criteria that must be satisfied for the derivative hedging instrument and hedged item to qualify
for fair value hedge accounting can be classified into three broad categories:
Formal documentation
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 15 of 124
Quote
If the hedging instrument. . . provides only one-sided offset of the hedged risk, the increases (or
decreases) in the fair value of the hedging instrument must be expected to be highly effective in
offsetting the decreases (or increases) in the fair value of the hedged item.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 16 of 124
A written option exposes its writer to the possibility of unlimited loss but limits the gain to the amount of
premium received. In the exposure draft, the FASB expressed concern about permitting written options to be
designated as hedging instruments because a written option serves only to reduce the potential for gain. It
leaves the potential for loss on the hedged item or hedged transaction unchanged except for the amount of
premium received on the written option. Consequently, on a net basis, an entity may be worse off as a result
of trying to hedge with a written option.
After considering input received from respondents, however, the FASB decided to allow written options to be
eligible for hedge accounting in certain limited circumstances.
A written option is allowed as a fair value derivative hedging instrument in relationships involving only
recognized assets or liabilities, or an unrecognized firm commitment. For the written option to qualify for
hedge accounting, however, the combination of the hedged item and the written option must provide at
least as much potential for gains that result from a change in the underlying as exposure to losses that result
from a change in the underlying of the same percentage. The condition is met if all possible percentage
favorable changes in the underlying would provide at least as much gain as the loss that would be incurred
from an unfavorable change in the underlying of the same percentage.
Quote
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 17 of 124
A combination of options (for example, an interest rate collar) entered into contemporaneously is
considered a written option if, either at inception or over the life of the contracts, a net premium is
received in cash or as a favorable rate or other term. Furthermore, a derivative instrument that
results from combining a written option and any other non-option derivative instrument shall be
considered a written option.
FASB ASC 815-20-25-88
Study Question 6
What is the purpose of a fair value hedge?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 18 of 124
The designated risk being hedged must also meet specific conditions if the hedged item is one of the
following:
1. A held-to-maturity security
2. A nonfinancial asset or liability, other than a recognized loan servicing right or a nonfinancial firm
commitment with financial components
3. A financial asset or liability, a recognized loan servicing right, or a nonfinancial firm commitment with
financial components
FASB ASC 815-20-25-12
If assets and liabilities are grouped and hedged as a portfolio, such assets and liabilities must:
• share the same risk exposure for which they are designated as being hedged, and
• individually be expected to respond proportionately to the total change in fair value of the hedged
portfolio.
Quote
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 19 of 124
If the hedged item is a specific portion of an asset or a liability (or of a portfolio of similar assets or
a portfolio of similar liabilities), the hedged item is one of the following:
a. A percentage of the entire asset or liability (or of the entire portfolio).
b. One or more selected contractual cash flows.
c. A put option or call option (including an interest rate or price cap or an interest rate or price
floor) embedded in an existing asset or liability that is not an embedded derivative accounted
for separately pursuant to paragraph 815-15-25-1.
d. The residual value in a lessor's net investment in a direct financing or sales-type lease.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 20 of 124
9. a firm commitment either to enter into a business combination or to acquire or dispose of a subsidiary, a
minority interest, or an equity method investee; or
10. an equity instrument issued by the entity and classified in stockholders' equity in the statement of
financial position.
Held-to-maturity Security
Topic 815 prohibits entering into a derivative instrument to hedge the fair value exposure attributable to
interest rate changes of an investment security classified as held-to-maturity because doing so discredits the
intent of the held-to-maturity classification. An entity's decision to classify a security as held-to-maturity
implies that the entity's decision about holding the security will not be affected by changes in interest rates.
Exception
Topic 815 does allow an entity to hedge the fair value exposure of a held-to-maturity security
attributable to credit risk, foreign-currency risk, or both.
Topic 815 prohibits an entity from disaggregating the risk profile of a nonfinancial asset or liability and
designating one component of the profile as the hedged risk.
The standard does permit designating as a hedged risk the risk of changes in fair value of the entire
nonfinancial asset or liability. The exception is the risk of changes in the functional-currency-equivalent cash
flows attributable to changes in foreign exchange rates, which may be separately hedged in a cash flow
hedge of the forecasted purchase or sale of a nonfinancial item.
Quote
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 21 of 124
If the hedged item is a financial asset or liability, a recognized loan servicing right, or a
nonfinancial firm commitment with financial components, the designated risk being hedged is the
risk of change in:
• the overall fair value of the entire hedged item,
• its fair value attributable to changes in the designated benchmark interest rate (referred to as
the interest rate risk),
• its fair value attributable to both changes in the related foreign-currency exchange rates, or
• its fair value attributable to changes in the obligor's creditworthiness and changes in the
spread over the benchmark interest rate with respect to the hedged items credit sector at
inception of the hedge.
FASB ASC 815-20-25-12f
If the risk designated as being hedged is not “the risk of changes in the overall fair value of the
entire hedged item,” two or more of the other risks (interest rate risk, foreign-currency exchange
risk, and credit risk) may simultaneously be designated as being hedged.
FASB ASC 815-25-12f(5)
Study Question 7
Which of the following is prohibited from being designated as a hedged item in a fair value hedge?
B A liability
Study Question 8
Which of the following is prohibited from being the hedged item in a fair value hedge?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 22 of 124
In an important change to the usual deferral approach for hedging transactions, Topic 815 requires entities
to recognize in earnings, in the period that a change in value occurs, gains or losses from a derivative
designated as a fair value hedge. Additionally, changes in the fair value of the hedged item would be
concurrently recognized in income, and, as an adjustment to the carrying value of the item.
General Rule
Theoretically, if a fair value hedge is fully effective, net earnings will not be affected. Any
difference that does arise would be the effect of hedge ineffectiveness, which is consequently
recognized currently in earnings.
Topic 815 requires an even more significant change for hedges of firm commitments than it does for hedges
of assets and liabilities. Fair value hedges of an asset or a liability result in fair value adjustments to amounts
that already exist on the balance sheet; whereas fair value hedges of firm commitments require recognizing
an asset or a liability that had previously not been recognized under GAAP.
Entities will also recognize, as assets or liabilities, changes in the fair value of the firm commitment that arise
while a hedge of the firm commitment exists and that are attributable to the risk being hedged. This asset or
liability exists only for the period the commitment is hedged.
Result
If the hedge is entered into subsequent to entering into the firm commitment, the recorded asset
or liability for the firm commitment may not equal the actual fair value of the commitment.
Any unrealized gain or loss on a hedged asset, liability, or firm commitment that existed before the creation
of the hedge would not be recognized, nor would changes in value of a hedged item during the life of a
hedge that are not attributable to the risk being hedged. A fair value hedge can be entered into or removed
by designating or not designating the derivative as a hedge at any time for an asset, liability, or firm
commitment.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 23 of 124
An entity will account for the adjustment of the carrying value of a hedged asset or liability in the same
manner as other components of the carrying value of the asset or liability.
Example
An adjustment of the carrying value of a hedged asset held for sale (e.g., inventory) would remain
part of the carrying value of that asset until the asset is sold, at which point the entire carrying
value of the hedged asset would be recognized as the cost of the item sold in determining
earnings.
When the carrying value of some items is adjusted to fair value, the change is recognized in comprehensive
income (e.g., an available-for-sale security). If the item is designated as a hedged item, the adjustment to fair
value is recognized in earnings to offset the gain or loss on the hedging instrument.
If the hedged item is an interest-bearing financial instrument, any adjustment of the carrying value is
amortized to earnings. To simplify the accounting, however, amortization does not have to begin until the
hedged item is removed.
When any one of the following occurs, an entity will discontinue, prospectively (i.e., there will be no
retroactive adjustment), the accounting for the hedge:
• One or more of the fair value hedge criteria is no longer met.
• The derivative is allowed to expire or it is sold, terminated, or exercised.
• The designation as a fair value hedge is removed.
Impairment
An asset or a liability that is designated as a hedged item and accounted for in accordance with Topic 815 is
subject to the requirements of Topic 360, Property, Plant, and Equipment, for determining impairment of
the asset or for recognizing an increase in the liability. The impairment test must be applied after applying
hedge accounting for the period and adjusting the carrying value of the hedged asset or liability.
Note
Because the hedging instrument is separately recognized as an asset or a liability, it is
inappropriate to consider the carrying amount of a derivative hedging instrument in an
assessment of impairment of the related asset or liability in a fair value hedge. To do so would be
contradictory with the fact that the derivative is a separate asset or liability.
Study Question 9
Which of the following is true of the effect of a fair value hedge on earnings?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 24 of 124
Study Question 10
Fair value hedges of firm commitments result in fair value adjustments to amounts that are which of the
following?
Study Question 11
When a hedge is discontinued, how will the entity account for the discontinuance?
A Retroactively
B Prospectively
C As a prior-period adjustment
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 25 of 124
On January 1, 20X1, M&M Inc. issues a 5-year, fixed-rate 8%, nonprepayable, $5-million debt obligation.
M&M simultaneously enters into a 5-year interest rate swap with a notional amount of $5 million to convert
the debt's fixed rate to a variable rate. According to the swap contract, M&M will receive interest at a fixed
rate of 8% and pay interest at a variable rate equal to the deri-6 LIBOR. The interest rate swap has no ceiling
or floor. Both the debt and the swap require that payment be made or received on June 30 and December 31
at which time the variable rate on the swap resets. No premium or discount was incurred upon entering into
the swap because the pay and receive rates on the swap represent prevailing market rates for each
counterparty.
M&M designates the interest rate swap as a fair value hedge of the changes in fair value of the fixed-rate
debt obligation attributable to changes in the designated benchmark interest rate. M&M designates changes
in the LIBOR swap rates as the benchmark interest rate in hedging interest rate risk.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 26 of 124
Additional Assumptions
The 6-month LIBOR and the swap and debt fair values are assumed to be as follows:
Journal Entries
January 1, 20X1
Cash 5,000,000
Obligation 5,000,000
To record issuance of the obligation
June 30, 20X1
Interest expense 200,000
Cash 200,000
To record semiannual interest payment
($5,000,000 × 8% × 1/2)
Cash 50,000
Interest expense 50,000
To record semiannual settlement of the semiannual
swap [$5,000,000 × (8% – 6%) × 1/2]
Obligation (B/S) 225,000
Gain from hedge (I/S) 225,000
To record the change in the debt's fair value
Loss from hedge (I/S) 225,000
Interest rate swap (B/S) 225,000
To record the change in the swap's fair value
Journal Entries
December 31, 20X1
Interest expense 200,000
Cash 200,000
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 27 of 124
Study Question 12
What must be true to assume that there is no ineffectiveness in the hedging relationship?
Study Question 13
When the fair value of the debt decreases (i.e., the value of the liability decreases), if there is no
ineffectiveness in the hedging relationship, the interest rate swap results in which of the following?
Study Question 14
On July 1, 20X1, Company A issues $1 million of 10% fixed rate, nonprepayable debt, and simultaneously
enters into an interest rate swap to convert the fixed rate debt to a variable rate. The swap qualifies as a fair
value hedge and is so designated by Company A. At inception the rate on the swap is 8.5% and remains
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 28 of 124
unchanged for the remainder of the year. For the year ending December 31, 20X1, what is the settlement
amount of the swap?
A $7,500
B $15,000
C $50,000
D $85,000
The gain on futures for the period is based on the difference between the futures rate at the beginning of the
period and futures rate at the end of the period.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 29 of 124
For the period ending November 30, 20X1, the gain is calculated as 100,000 × ($5.10 – $5.08) = $2,000.
The gain or loss on the change in the fair value of the commitment includes changes in the fair value of the
silver, transportation, and other direct costs (all assumed for this example).
The effectiveness ratio is calculated as Futures contract (gain) loss ÷ Firm commitment (gain) loss.
The calculation for November 30, 20X1, is $2,000 ÷ $2,100 = 0.95.
RMM concludes that, at its inception and on an ongoing basis, the hedging relationship between the silver
futures and the firm commitment is highly effective.
Journal Entries
July 1, 20X1
Receivable from broker (B/S) 15,000
Cash 15,000
To record the initial margin deposit
November 30, 20X1
Inventory 508,000
Cash 508,000
To record the purchase of inventory at the current market price of $5.08
Loss on hedge activity (I/S) 2,100
Firm commitment (B/S) 2,100
To recognize the change in the fair value of the firm commitment
Receivable from broker (B/S) 2,000
Gain on hedge activity (I/S) 2,000
To recognize the change in the fair value of the futures contract
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 30 of 124
Journal Entries
Study Question 15
On July 1, 20X1, XYZ Company enters into a futures contract to buy one million pounds of a raw material.
Based on the following information, what would be the amount of the total gain on the futures for the
6-month period ending December 31, 20X1?
A $30,000
B $40,000
C $100,000
D $120,000
Study Question 16
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 31 of 124
A 104.6%
B 95.6%
C 4.5%
Additional Assumptions
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 32 of 124
The share price and fair value of CEB Company's investment in XYZ Inc. common stock are as follows:
The fair value, intrinsic value, and time value of the put option are as follows:
Because the hedge provides only one-sided protection, hedge effectiveness is only required to be assessed
during those periods when the hedge has an intrinsic value. Thus, no assessment was necessary on
December 31, 20X1.
Journal Entries
January 1, 20X1
Put option (B/S) 150,000
Cash (B/S) 150,000
To record the purchased put option
December 31, 20X1
Change in the fair value of the time
value portion of the put option (I/S) 30,000
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 33 of 124
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 34 of 124
Study Question 17
On December 31, 20X1, the fair value of a put option was $250,000, and its time value was $100,000. What
is the put option's intrinsic value on December 31, 20X1?
A $350,000
B $150,000
C $0
Study Question 18
Which of the following is true in a fair value hedge?
Study Question 19
XYZ Company has purchased a put option that it has designated as a fair value hedge. The following
information is provided for the year ending December 31, 20X1:
• Change in the fair value of the hedged item: $150,000 gain
• Change in the option's intrinsic value: $125,000 loss
What is the hedge effectiveness ratio for the year ending December 31, 20X1?
A 120%
B 83.33%
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 35 of 124
4 A. Qualifying Criteria
Nature of Cash Flow Hedges
Key Term
Under Topic 815, a cash flow hedge is the designation and use of a derivative instrument to hedge
the exposure to variability in expected future cash flows that is attributable to a particular risk.
The exposure that the derivative instrument hedges may be associated with either an existing asset or
liability or a forecasted transaction.
Cash flow hedges protect against changes in future cash flows attributable to the risk caused by variable
prices, costs, rates, or terms that cause future cash flows to be uncertain; whereas, fair value hedges protect
against the changes in value caused by fixed terms, rates, or prices.
A cash flow hedge is a hedge of an anticipated or forecasted transaction that is probable, but the amount of
the transaction has not been fixed.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 36 of 124
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 37 of 124
The individual cash flows related to a recognized asset or liability and the cash flows related to a forecasted
transaction are both referred to in Subtopic 815-20 and Subtopic 815-30 as a forecasted transaction or
hedged transaction. In that light, a forecasted transaction is eligible for designation as a hedged transaction
in a cash flow hedge if all of the following additional criteria are met:
a. The forecasted transaction is specifically identified as either of the following:
1. A single transaction.
2. A group of individual transactions that share the same risk exposure for which they are designated
as being hedged. A forecasted purchase and a forecasted sale shall not both be included in the
same group of individual transactions that constitute the hedged transaction.
b. The occurrence of the forecasted transaction is probable.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 38 of 124
h. The forecasted transaction is not a transaction (such as a forecasted purchase, sale or dividend) involving
either of the following:
1. A parent entity's interests in consolidated subsidiaries.
2. An entity's own equity instruments.
i. If the hedged transaction is the forecasted purchase or sale of a nonfinancial asset, the designated risk
being hedged is either of the following:
1. The risk of changes in the functional-currency-equivalent cash flows attributable to changes in the
related foreign currency exchange rates.
2. The risk of changes in the cash flows relating to all changes in the purchase price or sales price of
the asset reflecting its actual location if a physical asset (regardless of whether that price and the
related cash flows are stated in the entity's functional currency or a foreign currency), not the risk of
changes in the cash flows relating to the purchase or sale of a similar asset in a different location or
of a major ingredient.
j. If the hedge transaction is a forecasted purchase or sale of a financial asset or liability (or the interest
payments on that financial asset or liability) or the variable cash inflow or outflow of an existing financial
asset or liability, the designated risk being hedged is any of the following:
1. The risk of overall changes in the hedged cash flows related to the asset or liability, such as those
relating to all changes in the purchase price or sales price (regardless of whether that price and the
related cash flows are stated in the entity's functional currency or a foreign currency)
2. The risk of changes in its cash flows attributable to changes in the designated benchmark interest
rate
3. The risk of changes in the functional-currency-equivalent cash flows attributable to changes in the
related foreign currency exchange rates
4. The risk of changes in its cash flows attributable to all of the following (referred to as credit risk):
i. Default.
ii. Changes in the obligor's creditworthiness.
iii. Changes in the spread over the benchmark interest rate with respect to the related financial
asset's or liability's credit sector at inception of the hedge.
5. If the risk designated as being hedged is not the risk of overall changes in the hedged cash flows
related to the asset or liability (regardless of whether that price and the related cash flows are stated
in the entity's functional currency or a foreign currency), two or more of the other risks (interest rate
risk, foreign exchange risk, and credit risk) simultaneously may be designated as being hedged.
k. The item is not otherwise specifically ineligible for designation.
FASB ASC 815-20-25-15
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 39 of 124
The benchmark interest rate being hedged in a hedge of interest rate risk must be specifically identified as
part of the designation and documentation at the inception of the hedging relationship. Currently, under
U.S. GAAP only the interest rates on direct Treasury obligations of the U.S. government, LIBOR, and the Fed
Funds Effective Swap Rate (also referred to as the Overnight Index Swap Rates) are considered to
benchmark interest rates.
FASB ASC 815-20-25-6A
Intra-entity derivatives
Section 815-20-25 does not require that the operating unit with the interest rate, market price, or credit risk
exposure be a party to the hedging instrument. For example, as discussed in paragraph 815-20-25-45, a
parent entity's central treasure function can enter into a derivative instrument with a third party and
designate it as the hedging instrument in a hedge of a subsidiary's interest rate risk for purposes of the
consolidated financial statements. However, for the subsidiary to qualify for hedge accounting of the interest
rate exposure in its separate-entity financial statements, it would have to be a party to the hedging
instrument.
Paragraph 815-20-25-46B specifies that an intra-entity derivative may not be designated as the hedging
instrument if the hedged risk is any of the following:
• The risk of changes in the overall cash flows of the entire hedged transaction.
• The risk of changes in the transaction's cash flows attributable to changes in the designated benchmark
interest rate.
• The risk of changes in transaction's cash flows attributable to changes in credit risk.
An entity's risk management may involve changing the interest rate characteristics of a variable-rate
financial asset or liability from one variable-rate index to another. These types of instruments are commonly
known as basis swaps.
Example
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 40 of 124
An entity may have a financial asset (i.e., notes receivable) that calls for an interest receipt based
on the prime rate and a financial liability (i.e., debt) that calls for an interest payment based on
the LIBOR. In such a situation, the entity has basis risk between the prime rate received and the
LIBOR paid. By entering into a basis swap, the entity could effectively change the LIBOR-based
liabilities into prime-based liabilities so that the asset and liabilities are on the same basis
(prime).
Paragraph 815-20-25-50 specifies that if a hedging instrument is used to modify the interest receipts or
payments associated with a recognized financial asset or liability from one variable rate to another variable
rate, the hedging instrument must meet both of the following criteria:
a. It is a link between both of the following:
1. An existing designated asset (or group of similar assets) with variable cash flows
2. An existing designated liability (or group of similar liabilities) with variable cash flows
b. It is highly effective at achieving offsetting cash flows.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 41 of 124
Paragraph 815-20-25-75 specifies that the hedging relationship must be expected to be “highly effective in
achieving offsetting cash flows attributable to the hedged risk during the term of the hedge.” The highly
effective relationship must be maintained both at inception and on an ongoing basis. The assessment of the
degree of effectiveness must be made whenever financial statements or earnings are reported. In any event,
the assessment must be made at least every three months.
It is possible that the hedging instrument provides only one-sided offset of the hedged risk. In that event,
paragraph 815-20-25-76 states that the “cash inflows (outflows) from the hedging instrument are expected
to be highly effective in offsetting the corresponding change in the cash outflows or inflows of the hedged
transaction.” As in the case of all cash flow hedges, the assessment of the hedging effectiveness must be
consistent with management's documented risk strategy for that particular type of hedging relationship.
Study Question 20
Topic 815 requires, at the inception of the hedge, formal documentation of the hedging relationship and the
entity's risk management objective and strategy for undertaking the hedge. For a cash flow hedge, which of
the following would not have to be identified in the required documentation?
Study Question 21
Topic 815 requires that the hedging relationship be expected to be highly effective in achieving offsetting
cash flows attributable to the hedged risk. When must this highly effective relationship be expected to exist?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 42 of 124
The forecasted transaction must be a single transaction or a group of individual transactions. In the case of a
group of individual transactions, paragraph 815-20-25-15 specifies that those individual transactions “must
share the same risk exposure for which they are designated as being hedged.” This requirement would
preclude a forecasted purchase and a forecasted sale from both being in the same group of individual
transactions that would make up the hedged transaction.
The objective of this requirement is for the entity to identify the hedged forecasted transaction with sufficient
specificity to make it clear whether a particular transaction is a hedged transaction when it occurs.
The following example illustrates the requirement that the hedged transaction be specifically identified.
Example
Company A determines with a high degree of probability that it will issue $5,000,000 of fixed-rate bonds
with a 5-year maturity sometime during the next six months, but it cannot predict exactly when the debt
issuance will occur. That situation might occur, for example, if the funds from the debt issuance are needed
to finance a major project to which Company A is already committed but the precise timing of which has not
yet been determined. To qualify for cash flow hedge accounting, Company A might identify the hedged
forecasted transaction as, for example, the first issuance of 5-year bonds that occurs during the next six
months.
Result
In this particular case, the designation of the first issuance may allow the hedged transaction to meet the
condition of being specifically identifiable even though the precise timing of the issuance has not been
determined.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 43 of 124
The occurrence of the forecasted transaction must be probable. The term probable is used in Topic 815 in the
same sense that it is defined in Topic 450, Contingencies. While Topic 450 defines the term as “likely to
occur,” no quantitative probabilities are provided. Considerable judgment is necessary when apply the term
probable.
In Topic 815, the FASB took the position that the likelihood that a forecasted transaction will take place
should not be based solely on management's intent because intent is not verifiable. Rather, the transaction's
probability should be supported by observable facts and the attendant circumstances. The assessment of
the likelihood that the transaction will occur should take into consideration the following circumstances:
• The frequency of similar past transactions
• The financial and operational ability of the entity to carry out the transaction
• Substantial commitments of resources to a particular activity
• The extent of loss or disruption of operations that could result if the transaction does not occur
• The likelihood that transactions with substantially different characteristics might be used to achieve the
same business purpose
Paragraph 815-20-25-15 specifies that the forecasted transaction must be with an external party, except for
forecasted intercompany transactions denominated in a foreign currency, and must present an “exposure to
variations in cash flows for the hedged risk that could affect reported earnings.”
FASB ASC 815-20-25-15
Paragraph 815-20-25-15 generally precludes the forecasted transaction from being the acquisition of an
asset or incurrence of a liability that subsequently will be remeasured at fair value with changes in fair value
attributable to the hedged risk reported currently in earnings. Topic 815 allows a recognized foreign-currency
denominated asset or liability to be the hedged item in a cash flow hedge in situations in which all of the
variability in the functional-currency-equivalent cash flows is eliminated by the effect of the hedge.
Paragraph 815-20-25-15 specifies that if the variable cash flows of the forecasted transaction relate to a
held-to-maturity debt security, the risk being hedged must be the “risk of changes in its cash flows
attributable to default or changes in the obligor's creditworthiness.”
Note
The hedged risk may not be that associated with changes in market interest rates.
The forecasted transaction may not involve a business combination. Paragraph 815-20-25-15 precludes the
transaction from involving:
a. a parent company's interests in consolidated subsidiaries,
b. a minority interest in a consolidated subsidiary,
c. an equity-method investment, or
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 44 of 124
If the hedged transaction is the forecasted purchase or sale of a nonfinancial asset, paragraph 815-20-25-15
requires that the:
Quote
designated risk being hedged is:
a. The risk of changes in the functional-currency equivalent cash flows attributable to changes
in the related foreign-currency exchange rates, or
b. The risk of changes in the cash flows relating to all change in the purchase price or sales price
of the asset. . . not the risk of changes in the cash flows relating to the purchase or sale of a
similar asset in a different location or of a major ingredient.
If the hedged transaction is the forecasted purchase or sale of a financial asset or liability, or the variable
cash inflow or outflow of an existing financial asset or liability, paragraph 815-20-25-15 requires that:
Quote
The designated risk being hedged is:
1. The risk of changes in the cash flows of the entire asset or liability, such as those relating to
all changes in the purchase price or sales price,
2. The risk of changes in its cash flows attributable to changes in market interest rates,
3. The risk of changes in the functional-currency equivalent cash flows attributable to changes
in the related foreign-currency exchange rates, or
4. The risk of changes in its cash flows attributable to default or changes in the obligor's
creditworthiness.
Note
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 45 of 124
Paragraph 815-20-25-15 also precludes an entity from designating prepayment risk as the risk
being hedged.
Study Question 22
In a cash flow hedge, the forecasted transaction must be specifically identified as a single transaction or a
group of individual transactions. Which of the following is true of a forecasted purchase and a forecasted
sale?
Study Question 23
A forecasted transaction's probability of occurrence should be supported by observable facts and the
attendant circumstances. With respect to the frequency of similar past transactions, the financial and
operational ability of the entity to carry out the transaction, and the extent of loss or disruption of operations
that could result if the transaction does not occur, which of the following should be taken into consideration
in the assessment of the likelihood that the transaction will occur?
Study Question 24
Which of the following is true in the case of a cash flow hedge of a forecasted transaction?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 46 of 124
Derivatives designated as hedges of anticipated or forecasted transactions are carried at fair value.
In Section 815-30-35, the FASB takes the general position that the effective portion of a gain or loss on a
derivative that qualifies as a cash flow hedge should be reported in other comprehensive income and any
ineffective portion in net income. Any gain or loss associated with a risk that is not the particular risk being
hedged also should be included in net income.
The gain or loss associated with an option's time value when the effectiveness of the hedge is assessed
based on the option's intrinsic value.
Time value is the difference between an option's fair value and its intrinsic value.
Private companies are now allowed to use a “simplified hedge accounting” approach to account for swaps
that are entered into for the purpose of converting a variable-rate borrowing into a fixed-rate borrowing.
Under the simplified approach, an entity may assume no ineffectiveness for qualifying swaps designated in a
hedging relationship, This approach can be applied to a cash flow hedge of a variable-rate borrowing with a
receive-variable, pay-fixed interest rate swap provided all of the following criteria are met:
a. Both the variable rate on the swap and the borrowing are based on the same index and reset period.
b. The terms of the swap are typical, and there is no floor or cap on the variable interest rate of the swap
unless the borrowing has a comparable floor or cap.
c. The repricing and settlement dates for the swap and the borrowing match or differ by no more than a
few days.
d. The swap's fair value at inception is at or near zero.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 47 of 124
e. The notional amount of the swap matches the principal amount of the borrowing being hedged. In
complying with this condition, the amount of the borrowing being hedged may be less than the total
principal amount of the borrowing.
f. All interest payments occurring on the borrowing during the term of the swap (or the effective term of
the swap underlying the forward starting swap) are designated as hedged whether in total or in
proportion to the principal amount of the borrowing being hedged.
If a private company chooses to use the simplified hedge accounting approach, it must apply it as of the
beginning of the first fiscal year in which the approach is elected.
FASB ASC 815-20-25-131D
Quote
Lesser of the following (in absolute amounts):
• The cumulative gain or loss on the derivative from inception of the hedge less (a) the excluded
component. . . and (b) the derivative's gains or losses previously reclassified from
accumulated other comprehensive income into earnings. . .
• The portion of the cumulative gain or loss on the derivative necessary to offset the cumulative
change in expected future cash flows on the hedged transaction from inception of the hedge
less the derivative's gains or losses previously reclassified from accumulated other
comprehensive income into earnings. . .
FASB ASC 815-30-35-3
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 48 of 124
Period 2 change + 20 + 35
Cumulative change $ 70 $ 75
Period One:
Derivative instrument 50
Other comprehensive income 40
Net income 10
Period Two:
Derivative instrument 20
Net income 10
Other comprehensive income 30
Only $70, the cumulative gain in fair value, is included in other comprehensive income. Since $40 was
reported in Period One, only $30 is reported in Period Two ($70 – $40).
In Period One, the limiting factor on the amount of gain or loss that could be included in other
comprehensive income was the cumulative present value of the expected future cash flows of the forecasted
transaction ($40). In Period Two, however, the limiting factor became the cumulative increase in the fair
value of the derivative.
Since all of the increase in the fair value of the derivative instrument can be included in other comprehensive
income, any increases in the fair value of the derivative that in prior years had been included in net income
(because of, at that time, hedge ineffectiveness) would be reversed through net income in the current period
and included in other comprehensive income. Thus, in this case, the $10 included in net income in Period
One is reversed through net income in Period Two and credited to other comprehensive income. Thus, the
total amount included in other comprehensive income is determined on a cumulative basis.
This limitation on the amount of gain or loss that can be included in other comprehensive income is intended
to prevent entities from deferring in other comprehensive income the ineffective portion of the gains or losses
on the hedging derivative instrument. Paragraph 815-30-35-38 specifies that the accumulated other
comprehensive income associated with cash flow hedges must be:
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 49 of 124
Quote
. . .reclassified into earnings in the same period or periods during which the hedged forecasted
transaction affects earnings (for example, when a forecasted sale actually occurs). If the hedged
transaction results in the acquisition of an asset or the incurrence of a liability, the gains and
losses in accumulated other comprehensive income shall be reclassified into earnings in the same
period or periods during which the asset acquired or liability incurred affects earnings (such as in
the periods that depreciation expense, interest expense, or cost of sales is recognized).
FASB ASC 815-30-35-38
The change in the fair value of the hedged item (the forecasted transaction) is not recognized in the financial
statements because the forecasted transaction itself has not been recognized in the financial statements.
Section 815-30-40 specifies that the hedge accounting for a cash flow hedge should continue to be used
unless one of the following occurs:
One or more of the qualifying criterion for cash flow hedges is no longer met.
Study Question 25
An entity uses a derivative instrument to hedge a forecasted transaction that is probable. Which of the
following is true regarding gain or loss resulting from changes in the fair value of the hedging derivative
instrument?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 50 of 124
Study Question 26
Under Topic 815, when should a cash flow hedge cease to be accounted for as a cash flow hedge?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 51 of 124
To record the semiannual interest on the debt at the LIBOR swap rate ($1,000,000 ×
7% × 6/12)
The resulting credit balance in the interest rate swap account means that it is a liability from the standpoint
of ABC Company.
The item being hedged by ABC Company is its variable interest cash flow that is based on the LIBOR. Since
the LIBOR swap rate can vary, ABC Company's interest cash flow is a variable, rather than a fixed, amount.
The anticipated cash flow is the amount of interest that ABC Company will pay during the term of the note.
With the interest rate swap, ABC Company's net interest expense is $40,000, which is the amount
associated with the fixed interest rate of 8%, rather than the $35,000 amount that would have been incurred
without the swap.
The $22,000 change in the fair value of the interest rate swap (the hedging derivative instrument) is
included in ABC Company's other comprehensive income rather than in net income. If the interest rate swap
contract is allowed to remain in effect until the December 31, 20X3, maturity date of the note payable, the
fair value of the swap at that date will be zero. Thus, the accumulated other comprehensive income
associated with the interest rate swap will be zero on December 31, 20X3.
Study Question 27
An entity uses a derivative instrument to hedge a forecasted transaction that is probable. How should the
gain or loss resulting from changes in the fair value of the hedging derivative instrument be recognized?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 52 of 124
Study Question 28
On December 31, 20X0, Company A issues at face value a $1 million note, nonprepayable, with interest
based on the LIBOR swap rate. The note is due on December 31, 20X3, with semiannual interest payments
on each June 30 and December 31. On the same day, Company A enters into an interest rate swap with
Company B for a notional amount of $1 million. Under the swap, Company A will receive payments based on
the LIBOR swap rate and will pay interest based on an 8% fixed rate. The swap calls for annual settlement
with the first settlement on December 31, 20X1, and the last on December 31, 20X3. If the December 31,
20X1, LIBOR swap rate is 10%, how will the fair value of the interest rate swap appear on Company A's
December 31, 20X1 balance sheet?
A As an asset
B As a liability
Study Question 29
On January 1, 20X1, Company XYZ issues at face value a $1 million note, nonprepayable, with interest based
on the LIBOR swap rate. The note is due on December 31, 20X3. Simultaneously, XYZ enters into an interest
rate swap to convert the variable rate debt to a fixed rate of 10%. The swap qualifies as a cash flow hedge
and is so designated by XYZ. The variable rate on the debt resets and settlement is made on each June 30
and December 31. Assuming that the LIBOR swap rate was 8% on January 1, 20X1, what would Company
XYZ's net settlement amount be on June 30, 20X1?
On October 1, 20X1, Alpha Company, a calendar-year entity, determines that it will need 100,000 units of
gadgets on or about March 31, 20X2. On October 1, 20X1, Alpha enters into a futures contract to purchase
gadgets at $5.00 per unit. Alpha designates the futures contract as a cash flow hedge of its forecasted
inventory purchase of 100,000 units of gadgets on March 31, 20X2. The closing price of the March 31, 20X2,
futures contract was $4.70 on December 31, 20X1, and $5.20 on March 31, 20X2. Assume the spot rate was
$5.00 on October 1, 20X1; $4.68 on December 31, 20X1; and $5.20 on March 31, 20X2. On March 31, 20X2,
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 53 of 124
Alpha purchased 100,000 units of gadgets at $5.20 per unit and closed out the futures contract that was
purchased on October 1, 20X1.
The gains (losses) on the futures contract and the forecasted purchase gains (losses) may be summarized as
follows:
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 54 of 124
Cash 20,000
Futures contract 20,000
To record the settlement of the futures contract
Topic 815 specifies that in a cash flow hedge of a forecasted purchase of a nonfinancial asset the designated
risk that is being hedged is the risk of changes in the cash flows relating to all changes in the purchase price
of the asset. Accordingly, the effective portion of the futures contract's gain or loss is reported in other
comprehensive income, and the ineffective portion is reported currently in net income. Amounts
accumulated in other comprehensive income are reclassified as earnings when the related inventory is sold.
The futures contract (the hedging derivative instrument) would be presented on Alpha's December 31, 20X1,
balance sheet as a liability (credit balance) at its fair value of $30,000. The $30,000 unrealized loss in 20X1
would be included in Alpha's other comprehensive income. In addition, assuming this is Alpha's only other
comprehensive income item, the accumulated balance of $30,000 would be included as accumulated other
comprehensive income in the stockholders' equity section of Alpha's December 31, 20X1, balance sheet.
After the futures contract is settled on March 31, 20X2, there is a $20,000 net credit balance in accumulated
other comprehensive income. This balance will remain in accumulated other comprehensive income until the
100,000 gadgets are sold. Assuming that the gadgets were in fact purchased on March 31, 20X2, at the spot
rate of $5.20, the entry would be:
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 55 of 124
At the time the gadgets are sold (assuming for simplicity that they were all sold at one time), the following
entries would be recorded:
The $5,000 debit to net income (loss on hedging activity) represents the $5,000 excess of (1) the cumulative
gain or loss on the derivative from inception of the hedge ($30,000) over (2) the portion of the cumulative
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 56 of 124
gain or loss on the derivative necessary to offset the cumulative change in expected future cash flows on the
hedged transaction from inception of the hedge ($25,000 in Alpha's case).
Study Question 30
An entity uses a derivative instrument to hedge a probable forecasted purchase of inventory. The hedge
qualifies as a cash flow hedge. When will the gain or loss associated with changes in the fair value of the
hedging derivative instrument be recognized in net income?
Study Question 31
An entity uses a derivative instrument as a cash flow hedge of a forecasted purchase of its bronze bar
inventory. Which of the following is true?
Study Question 32
An entity uses a derivative instrument as a cash flow hedge of a forecasted transaction. At the balance sheet
date, the derivative instrument has a credit balance. How should the derivative instrument be recognized?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 57 of 124
Additional Assumptions
Assume that the following apply:
The gain (loss) on futures for the period is based on the difference between the futures rate at the beginning
of the period and futures rate at the end of the period.
For the period ending December 31, 20X1, the loss is calculated as:
The gain or loss on the change in the fair value of the anticipated sale includes changes in the fair value of
the silver, transportation, and other direct costs (all assumed for this example).
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 58 of 124
The effectiveness ratio is calculated as follows: Futures contract gain (loss) ÷ Anticipated sales gain (loss).
The calculation for December 31, 20X1, is:
MTK concludes that, at its inception and on an ongoing basis, the hedging relationship between the silver
futures and the forecasted sale is highly effective.
Journal Entries
October 1, 20X1:
Due from broker 10,000
Cash 10,000
To record the initial margin deposit
April 1, 20X2:
Other comprehensive income 6,000
Due from broker 6,000
To recognize the change in the fair value of the futures contract
Cash 518,000
Cost of sales (cost to manufacture) 200,000
Sales 518,000
Inventory 200,000
To record the sale of 100,000 troy ounces of silver
Sales 8,000
Other comprehensive income 8,000
To reclassify the unrealized loss from OCI to net income
($2,000 + $6,000)
Cash 2,000
Due from broker 2,000
To record settlement of futures contract [$10,000 – ($2,000 + $6,000)]
Study Question 33
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 59 of 124
ABC Company anticipates the sale of a specified number of ounces of gold. To hedge the possible decline in
the price of gold, ABC sells gold futures for a specified price. An increase in the price of gold would make the
fair value of the futures:
A increase.
B decrease.
C remain unchanged.
Study Question 34
An entity anticipates the sale of a specified number of ounces of silver in Year 2. To hedge the possible
decline in the price of silver, in Year 1 the entity sells silver futures for a specified price. Assuming that the
hedge qualified as a cash flow hedge, how would a decrease in the price of silver affect net income of Year 1?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 60 of 124
Foreign-currency may expose an entity to foreign-currency exchange gains or losses if exchange rates
change between the transaction date and the settlement date. There are a number of foreign-currency
financial instruments that an entity may use to control these foreign-currency risk exposures. Most of these
foreign-currency financial instruments qualify as derivatives.
The accounting for instruments that are used as hedges depends on whether the hedge qualifies for hedge
accounting. Just because the instrument may serve as an economic hedge does not necessarily mean that
under Topic 815 it qualifies for hedge accounting. Under hedge accounting, the foreign-currency exchange
gains and losses are accounted for according to the particular type of hedge. Gains or losses associated with
hedges that do not qualify for hedge accounting must be included in net income.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 61 of 124
There are three types of foreign-currency hedges that qualify for hedge accounting:
1. Foreign-currency fair value hedges
2. Foreign-currency cash flow hedges
3. Hedges of a foreign-currency net investment in a foreign entity
Paragraph 815-25-35-1 specifies two important measurement requirements for fair value hedges. The first is
that gains or losses associated with changes in the fair value of the hedging instrument (the derivative
instrument) be recognized in net income in the period in which the change in fair value takes place. The
second is that changes in the fair value of the hedged item must be recognized in net income and as an
adjustment to the carrying amount of the hedged item.
Under Topic 815 the FASB allows a recognized foreign-currency denominated asset or liability to be the
hedged item even though the related foreign-currency transaction gains or losses are recognized in
earnings.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 62 of 124
Topic 815 generally requires the hedging instrument to be a derivative instrument. In the case of a foreign-
currency fair value hedge of an unrecognized firm commitment, however, the hedging instrument also may
be a foreign-currency-denominated nonderivative instrument.
Available-for-sale security
Unrealized gains and losses associated with available-for-sale securities are included in other
comprehensive income rather than in net income. Therefore, if an available-for-sale security is the hedged
item, changes in the fair value of the hedged item would not be included in net income. The exclusion from
net income of the gain or loss resulting from changes in the fair value of the hedged available-for-sale
security is inconsistent with the basic notion in Topic 815 that gains and losses associated with changes in
the fair value of the hedged item (the available-for-sale security) should be included in net income.
Therefore, as in the case of hedges of firm commitments, the FASB chose to change the accounting for
hedges of the foreign-currency exposure of an available-for-sale security. Under Topic 815, the FASB
requires that hedges of available-for-sale securities be accounted for as fair value hedges.
Study Question 35
The use of derivative instruments (e.g., forward contracts) as hedges of the foreign-currency exposure of
recognized assets and liabilities denominated in a foreign currency qualifies for which of the following?
Study Question 36
Topic 815 requires what accounting treatment for gains or losses associated with changes in the fair value of
the hedging instrument in a foreign-currency fair value hedge?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 63 of 124
The accounting issues associated with cash flow hedges in general were discussed in previous chapters. The
emphasis in this subchapter is on foreign-currency cash flow hedges.
An entity may have exposure to variability in expected future cash flows. That exposure may be associated
with an existing recognized asset or liability or a forecasted transaction.
For example, an entity is exposed to variability in expected future cash flows if it has a variable-rate note
payable. An entity also is exposed to variability if it has a forecasted transaction (as opposed to a firm
commitment) at a price or exchange rate subject to variation.
An entity may designate a derivative instrument as hedging the exposure to variability in expected future
cash flows attributable to a particular risk. Topic 815 specifies for cash flow hedges in general that the
hedging derivative instrument should be carried at fair value with the effective portion of the derivative's gain
or loss recognized in other comprehensive income rather than in net income. The effective portion is the
extent to which the changes in the fair value of the hedging instrument actually serve to offset the particular
risk exposure being hedged. These gains and losses recognized in other comprehensive income
subsequently are recognized in net income in the same period or periods the hedged item affects net
income.
Additional Criteria
A foreign-currency cash flow must also meet the following additional criteria:
a. For consolidated financial statements, either (1) the operating unit that has the foreign-currency
exposure is a party to the hedging instrument or (2) another member of the consolidated group that has
the same functional currency as that operating unit is a party to the hedging instrument. [To qualify for
applying the guidance in (2), there may be no intervening subsidiary with a different functional currency.]
b. The hedged transaction is denominated in a currency other than the hedging unit's functional currency.
c. All of the criteria in Subtopic 815-30 are met, except for the criterion that requires that the forecasted
transaction be with a party external to the reporting entity.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 64 of 124
Note
The use of a nonderivative instrument as a hedge of a foreign-currency cash flow cannot qualify
for hedge accounting as described in Topic 815.
Study Question 37
A foreign-currency cash flow hedge must meet the general criteria specified in Topic 815 for other cash flow
hedges. A foreign-currency cash flow hedge also must meet specific additional criteria to qualify for hedge
accounting, however. Which of the following is not one of those specific additional criteria?
Study Question 38
How frequently may a nonderivative instrument be designated as the hedging instrument in a foreign-
currency cash flow hedge?
A Rarely
C Never
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 65 of 124
changes in exchange rates to be recognized in other comprehensive income and closed to the cumulative
translation adjustment account (a specific component of the accumulated other comprehensive income
balance sheet account). A net investment in a foreign operation includes incorporated and unincorporated
business units: subsidiaries, divisions, branches, joint ventures, and equity-method investees.
If a financial instrument (derivative or nonderivative) that would give rise to a foreign-currency transaction
gain or loss under Topic 830 is designated as hedging the foreign-currency exposure of a net investment in a
foreign operation, Topic 815 requires that the hedging instrument be measured at fair value, with the
effective portion of the gain or loss recognized in other comprehensive income. These changes in other
comprehensive income also are closed to the cumulative translation adjustment.
A hedge of the foreign-currency exposure of a net investment in a foreign operation is reported in a manner
similar to that of a cash flow hedge.
The derivative (forward contract) and the investment in the foreign entity both must be remeasured at each
balance sheet date and at the settlement date. The forward contract is remeasured based on the fair value of
the forward contract. The fair value of the forward contract is determined by multiplying the change in the
forward rate by the number of foreign-currency units and discounting this amount for the remaining time to
the settlement date.
Thus, Topic 815 essentially retains the requirements of Topic 830 for hedges of net investments in foreign
operations. Under Topic 815, the hedged net investment is viewed as a single asset, as opposed to several
individual assets and liabilities that comprise the balance sheet of the subsidiary. Otherwise, a hedge of a net
investment in foreign operations would not qualify for hedge accounting under Topic 815 because one of the
specific qualifying criteria is that the hedged item be a single item or a group of similar items. Thus, Topic
815 specifically allows a hedge of a net investment in foreign operations to qualify for hedge accounting.
Topic 815 does not change the accounting of Topic 830 for translating financial statements of
foreign operations.
Study Question 39
Where should the gain or loss on a hedging instrument that is designated as, and is effective as, an economic
hedge of a net investment in a foreign operation be recognized?
A In net income
Study Question 40
For purposes of applying Topic 815, Derivatives and Hedging, a net investment in a foreign operation does
not include which of the following?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 66 of 124
C Subsidiaries
D Equity-method investees
Study Question 41
Under Topic 815, Derivatives and Hedging, for a hedge of an investment in foreign operations to qualify for
hedge accounting, the hedging instrument must meet which criteria?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 67 of 124
The forward contract is being used to hedge an unrecognized foreign-currency firm commitment
denominated in a foreign currency. The forward contract hedges the changes in the fair value of the firm
commitment that are attributable to changes in the foreign-currency exchange rate.
No entries are required by Domestic Company on October 1, 20X1 related to the firm commitment or related
to the forward contract.
In the case of foreign-currency fair value hedges, Topic 815 requires that the hedging derivative instrument
(the forward contract in Domestics case) be recognized at fair value. Since the fair value of the forward
contract at the inception of the contract is zero, no entry is required at October 1, 20X1, for the forward
contract.
The fair value of any forward contract is zero at the inception of the contract if the forward rate is
the market forward rate.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 68 of 124
Topic 815 requires that the gain or loss on the hedged item attributable to the hedged risk should
adjust the carrying amount of the hedged item (the purchase commitment in Domestics case)
and be recognized currently in earnings. Since the fair value of the firm commitment at the
inception of the commitment is zero, however, no entry is required on October 1, 20X1, for the firm
commitment.
Using this approach, and assuming a 6% discount rate, the fair value of Domestics forward contract and the
change in the fair value from October 1, 20X1, to December 31, 20X1, is determined as follows:
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 69 of 124
In similar fashion, the fair value of the forward contract on March 1, 20X2 (the settlement date), and the
change in the fair value from December 31, 20X1, to March 1, 20X2, is determined as follows:
The required entries for March 1, 20X2, are shown below.
The net effect of the forward contract was to lock in a cash outflow of $15,100, the forward rate at the
October 1, 20X1, inception of the forward contract. The difference between the $15,100 forward amount and
the $15,000 spot rate amount on October 1, 20X1, when the firm commitment was entered into, is the
insurance premium that Domestic is willing to pay to avoid possible exchange losses. Since the 10,000Z
received under the forward contract serve as the 10,000Z needed to pay for the inventory, the $15,100 paid to
the broker represents the effective cost of the inventory. Under this approach, the $100 insurance premium is
treated as a part of the cost of the inventory rather than being immediately charged against net income.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 70 of 124
Example
Domestic's forward contract was initially measured at fair value (zero) at the inception of the forward
contract, remeasured at fair value ($891) at the balance sheet date, and remeasured at fair value ($500) at
the settlement date.
Requirement Two: Changes in the fair value of the forward contract must be included in net income.
Example
Domestic included an $891 gain related to the hedging derivative instrument in 20X1 net income and a $391
loss in 20X2 net income.
Requirement Three: Changes in the fair value of the hedged item that are attributable to changes in the
foreign-currency forward rate must be included in net income and serve as an adjustment of the hedged
item.
Example
Domestic included an $891 loss related to the hedged item in 20X1 net income and a $391 gain in 20X2 net
income. The net $500 loss served as a decrease in the carrying amount of the firm commitment and,
consequently, in the carrying amount of the inventory when it was purchased.
Study Question 42
An entity uses a forward contract to hedge an unrecognized firm commitment that is denominated in a
foreign currency. This hedge qualifies for hedge accounting purposes as which of the following?
C If it is a recognized commitment
Study Question 43
An entity has an unrecognized purchase commitment for 1,000 units of a foreign currency (FC) on June 1,
20X1. To hedge the possible adverse effects of changes in the fair value of the firm commitment that are
attributable to changes in the foreign-currency exchange rate, the entity enters into a forward contract to
receive 1,000FC on June 1, 20X1. An increase in the exchange rate from 1FC = $2.00 to 1FC = $2.40 would
have what effect on the fair value of the forward contract?
Study Question 44
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 71 of 124
An entity has an unrecognized purchase commitment for 1,000 units of a foreign currency (FC) on June 1,
20X1. To hedge the possible adverse effects of changes in the fair value of the firm commitment that are
attributable to changes in the foreign-currency exchange rate, the entity enters into a forward contract to
receive 1,000FC on June 1, 20X1. An increase in the exchange rate from 1FC = $2.00 to 1FC = $3.50 would
cause what change in the amount of the purchase commitment that is recognized on the entity's balance
sheet?
A An increase of $1,500
B A decrease of $1,500
C No change
Note
These are the same facts as those used in Example 1 for a foreign-currency fair value hedge in the
immediately preceding subchapter (hedge of a firm commitment), except that this example
illustrates the hedge of a forecasted transaction.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 72 of 124
The use of similar facts (except with respect to the nature of the hedged item) emphasizes the similarities
and differences between the accounting requirements for foreign-currency fair value hedges and those for
foreign-currency cash flow hedges.
Since Domestics forward contract in this subchapter is being used to hedge a forecasted transaction, the
hedge is accounted for as a foreign-currency cash flow hedge rather than as a foreign-currency fair value
hedge.
In the previous subchapter, “Example 1: Foreign-Currency Fair Value Hedge,” Domestic entered
into a formal firm commitment and, as a result, the hedge was accounted for under Topic 815 as a
foreign-currency fair value hedge.
Because it anticipates the purchase of 10,000 units of inventory on March 1, 20X2, and the payment will be in
zags (a foreign currency), Domestic is exposed to changes in the exchange rate between U.S. dollars and
zags. Domestic's forward contract hedges this foreign-currency exposure.
Domestic also has the risk exposure that the cost of 10,000 units of inventory will change between October 1,
20X1, and March 1, 20X2, for reasons other than changes in the foreign-currency exchange rates. The
forward contract, however, only hedges one type of risk—the foreign-currency risk associated with changes in
the exchange rate. The forward contract does not hedge the other types of risk.
No entries are required to be made by Domestic Company on October 1, 20X1, related to the forecasted
purchase or related to the forward contract.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 73 of 124
In the case of foreign-currency cash flow hedges, Topic 815 requires that the hedging derivative instrument
(the forward contract in Domestics case) be recognized at fair value. Since the fair value of the forward
contract at the inception of the contract is zero, no entry is required at October 1, 20X1, for the forward
contract.
Topic 815 specifies that the gain or loss on the hedged item attributable to the hedged risk should not be
recognized in the financial statements. Therefore, no entry is required on October 1, 20X1, with respect to the
forecasted transaction (the budgeted purchase of the inventory).
On December 31, 20X1, Domestic must record the change in the fair value of the forward contract. Only the
effective portion is recognized in other comprehensive income. Any ineffective portion is recognized in net
income. For example, if the forward contract had been for 15,000Z (instead of 10,000Z), the gain or loss
related to the extra 5,000Z of the forward contract would be included in net income rather than in other
comprehensive income.
Assume that Domestic assesses hedge effectiveness based on the entire change in fair value of the forward
contract. This means that the $100 premium paid due to the difference between the spot rate and the
forward rate on October 1, 20X1 (10,000Z × ($1.51 – $1.50) = $100) is included in the measurement of the
gain or loss recognized in other comprehensive income. In that case, the entries on December 31, 20X1, are
as follows:
The fair value ($891) and the change in the fair value of the forward contract ($891 – $0 = $891) were
computed in an earlier example.
The gain resulting from the increase in the fair value of the forward contract is credited to other
comprehensive income. The other comprehensive income account is closed into an accumulated other
comprehensive income account, which is a balance sheet account.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 74 of 124
Assuming that the 10,000 units of inventory are purchased on March 1, 20X2, the cumulative gain or loss
from changes in the fair value of the forward contract will remain in the accumulated other comprehensive
income account until those units of inventory are sold by Domestic.
The fair value of the forward contract decreased $391 ($891 fair value on December 31, 20X1 – $500 fair
value on March 1, 20X2) from December 31, 20X1, to March 1, 20X2.
Therefore, the following entries are required on March 1, 20X2, with respect to the forward contract:
March 1, 20X2:
Other comprehensive income 391
Forward contract 391
To recognize the change in the fair value of the forward contract
Foreign currency (10,000Z × $1.56 spot rate on 15,600
03/01/X2)
Cash (10,000Z × $1.51 forward rate on 10/01/X1) 15,100
Forward contract 500
To record settlement of the forward contract with the broker with the
foreign currency received recorded at the spot rate on the settlement
date and the U.S. dollars paid recorded at the forward rate that existed
at the inception of the contract on October 1, 20X1
The other comprehensive income account would be closed into the accumulated comprehensive income
account. The accumulated other comprehensive income account then would have a $500 credit balance,
shown as follows:
Dr. (Cr.)
Gain recognized on 12/31/X1 $ (891)
Loss recognized on 03/01/X2 391
Recall that no firm commitment was made to purchase the 10,000 units of inventory. If Domestic purchases
the 10,000 units on March 1, 20X2, there is no locked-in price. That is, Domestic will have to pay the market
price on March 1, 20X2. The forward contract hedged the exposure to risk from changes in the fair value of
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 75 of 124
the inventory attributable to changes in the foreign-currency exchange rate, but did not hedge other risk
exposures. If there were no other influences on the price of the 10,000 units of inventory, they would cost
Domestic 10,000Z on March 1, 20X2. In that case, the entry to record the purchase of the inventory would be
as follows:
It is quite possible, if not probable, that the inventory will cost some amount other than 10,000Z. In that
case, the inventory would be recorded at the number of zags paid times the spot rate on March 1, 20X2 (the
date of acquisition).
The net effect of the forward contract was to hedge the risk exposure associated with changes in the foreign-
currency exchange rate.
Assuming the price of the inventory did not change (that is, that it cost 10,000Z on March 1, 20X2), the
forward contract locked in a purchase price of the inventory of $15,100, which was the forward rate at the
October 1, 20X1, inception of the forward contract.
The inventory is currently recorded at $15,600, based on the spot rate of $1.56 on March 1, 20X2. Recall that
accumulated other comprehensive income has a $500 credit balance that arose from the changes in the fair
value of the forward contract from October 1, 20X1, to March 1, 20X2. This $500 credit balance will be
transferred to net income proportionately as the 10,000 units of inventory are sold.
If all of the units are sold at the same time for $20,000, the following entries will be recorded:
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 76 of 124
Study Question 45
An entity uses a forward contract to hedge the foreign-currency exchange risk associated with a hedged
item. How should the hedge be accounted for if the hedged item is a firm purchase commitment?
Study Question 46
An entity has a forecasted purchase of inventory for 1,000 units that will be denominated in a foreign
currency (FC) on February 1, 20X2. To hedge the possible adverse effects of changes in the foreign-currency
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 77 of 124
exchange rate, the entity enters into a forward contract on November 30, 20X1, to receive 1,000FC on
February 1, 20X2. The exchange rate is 1FC = $2.00 on November 30, 20X1, and 1FC = $2.40 on December
31, 20X1, the end of the entity's fiscal year. What effect would the increase in the foreign-currency exchange
rate have on net income in 20X1 (ignoring income taxes)?
No entries are necessary at the October 1, 20X1, inception because the fair value of the forward contract at
that date is zero.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 78 of 124
The derivative (forward contract) and the investment in the foreign entity both must be remeasured on each
balance sheet date and at the settlement date.
The forward contract is remeasured at its fair value.
Remember
The fair value of the forward contract is determined by multiplying the change in the forward rate
(expressed as units of foreign currency per U.S. dollar) by the number of foreign-currency units
and discounting this amount for the remaining time to the settlement date.
Assuming a 6% discount rate, the fair value of the forward contract on December 31, 20X1 (balance sheet
date), and the change in fair value from October 1, 20X1, to December 31, 20X1, are as follows:
The fair value of the forward contract on March 1, 20X2 (settlement date), and the change in fair value from
December 31, 20X1, to March 1, 20X2, are as follows:
The investment in the foreign entity must be remeasured based on the change in the fair value of the
investment in the investee that is attributable to the change in the foreign-currency spot rates.
The changes for Domestic's investment in its equity-method investee are shown as follows:
Change October 1, 20X1, to December 31, 20X1:
($1.58 spot rate 12/31/X1 – $1.50 spot rate 10/01/X1) × 10,000 zags = $800 gain
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 79 of 124
($1.56 spot rate 3/01/X2 – $1.58 spot rate 12/31/X1) × 10,000 zags = $200 loss
The investment in the foreign entity must be remeasured based on the changes in the fair value of the
investment in the investee attributable to the change in the foreign-currency spot rate.
Therefore, Domestic's investment in its investee is remeasured to reflect the exchange gain associated with
the change in the spot rate from October 1, 20X1, to December 31, 20X1. Since Domestic's investment in the
investee is an asset, if Domestic converted its 10,000Z asset into U.S. dollars at the spot rate on December
31, 20X1, it would receive 800 more U.S. dollars than if it had converted the 10,000Z investment into dollars
on October 1, 20X1. Thus, with respect to the investment in the investee, the change in currency rate is a gain.
The change in the fair value of the forward contact was an $891 loss.
Topic 815 limits the amount recognized in other comprehensive income to, in absolute amount, the lesser of
that amount ($891) or the amount recognized in the current period as an adjustment to the investment
account ($800). That is, the amount debited to other comprehensive income in the second entry on
December 31, 20X1, may not exceed the amount debited or credited to other comprehensive income in the
first entry on December 31, 20X1 ($800). Any excess of the change in the fair value of the forward contract
over the change in the fair value of the investment attributable to the change in the spot rate must be
recognized in net income.
$ 800
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 80 of 124
The purpose of the limitation discussed previously is that the excess reflects the extent to which the hedging
instrument was ineffective in hedging the foreign-currency risk of the investment in the investee. Under Topic
815, the ineffective portion of any hedge must be recognized in net income.
The entries on March 1, 20X2, the settlement date of the forward contract, are shown.
On March 1, 20X2, the investment is remeasured for the change in the fair value ($200 loss) of the
investment attributable to the change in the spot rate from $1.56 on December 31, 20X1, to $1.58 on March 1,
20X2.
The second entry on March 1, 20X2, remeasures the forward contract based on the change in the fair value of
the forward contract. The offsetting entry to other comprehensive income, however, cannot exceed the $200
gain or loss recorded in the first entry on March 1, 20X2, related to the investment. The $191 absolute amount
difference between the change in the fair value of the forward contract ($391) and the change in the fair
value of the investment attributable to the change in the spot rates ($200) is recognized in net income.
March 1, 20X2:
Other comprehensive income (cumulative translation adjustment) 200
Investment in investee 200
To remeasure the net investment in a foreign entity
Forward contract 391
Other comprehensive income (cumulative translation adjustment) 200
Gain (net income) 191
To remeasure the forward contract
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 81 of 124
The following screens summarize the basic measurement and recognition requirements for a hedge of a net
investment in a foreign entity and Domestics compliance with those requirements.
Requirement One: The hedging derivative instrument (the forward contract) must be measured at fair value.
Example
Domestic's forward contract was initially measured at fair value (zero) at the inception of the forward
contract, remeasured at fair value ($891) on the balance sheet date, and remeasured at fair value ($500) on
the settlement date.
Requirement Two: Changes in the fair value of the forward contract must be included in other
comprehensive income to the extent that the hedging instrument serves as an effective hedge of the hedged
item.
Example
In 20X1, Domestic recognized an $891 loss in the fair value of the forward contract. The amount included in
other comprehensive income in 20X1, however, was limited to the $800 change in the fair value of the
investment in a foreign entity attributable to the change in the foreign-currency spot rates. The remaining
$91 of the loss was recognized in net income. In 20X2, Domestic recognized a $391 gain in the fair value of
the forward contract. The amount included in other comprehensive income in 20X2 was limited to the $200
change in the fair value of the investment in a foreign entity attributable to the change in the foreign-
currency spot rates. The remaining $191 of the gain was recognized in net income.
Study Question 47
A U.S. company has an equity-method investee in a foreign country. The functional currency of the investee
is the zag (Z). The company enters into a forward contract to sell 10,000Z at the forward rate of $2.00, which
is the market forward rate. An increase in the forward rate from 1Z = $2.00 to 1Z = $2.20 will cause which of
the following?
Study Question 48
A U.S. company has an equity-method investee in a foreign country. The functional currency of the investee
is the zag (Z). On November 1, 20X1, the company enters into a forward contract to sell 10,000Z at the
forward rate of $2.00, which is the market forward rate. As of the December 31, 20X1, balance sheet date, the
forward rate has decreased from 1Z = $2.00 to 1Z = $1.70. The spot rate on November 1, 20X1, is 1Z = $1.90
and on December 31, 20X1, is 1Z = $1.65. Ignoring discounting, what was the change in the fair value of the
forward contract from November 1, 20X1, to December 31, 20X1?
A A decrease of $3,000
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 82 of 124
B An increase of $3,000
C An increase of $2,500
D A decrease of $2,500
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 83 of 124
The effect of cash flow hedge accounting is to report a gain or loss in other comprehensive income (i.e.,
outside earnings) in the period in which it occurs and then to reclassify that gain or loss into earnings in a
later period. It would be mechanically impossible for an entity that only reports an amount comparable to
total comprehensive income to apply cash flow hedge accounting.
For a not-for-profit entity to apply cash flow hedge accounting, the FASB would have to define a
subcomponent of the total change in net assets during a period that would be comparable to earnings for a
for-profit entity.
Any attempt to define that measure was beyond the scope of the project that led to Topic 815. Therefore,
these derivative instruments are accounted for as speculative derivative instruments. Accordingly, they are
recognized at fair value in the statement of financial position with the change in fair value recognized
currently as a change in net assets in the statement of financial performance.
Study Question 49
Which of the following statements regarding not-for-profit entities is true?
8 B. Disclosures
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 84 of 124
Qualitative Disclosures
The qualitative description must differentiate among derivative instruments (and nonderivative instruments)
designated as the following:
• Fair value hedging instruments
• Hedging instruments for hedges of the foreign-currency exposure of a net investment in a foreign
operation
• Derivative instruments designated as cash flow hedging instruments and all other derivatives
Qualitative disclosures about an entity's objectives and strategies for using derivative instruments may be
more meaningful if the objectives and strategies are described in the framework of an entity's overall risk
exposures relating to interest rate risk, foreign-currency exchange rate risk, commodity price risk, credit risk,
and equity price risk. Those additional qualitative disclosures, if made, must include a discussion of those
exposures even if the entity does not manage all of those exposures by using derivative instruments.
An entity that holds or issues derivative instruments (or nonderivative instruments that are designated and
qualify as hedging instruments) for every annual and interim reporting period for which a statement of
financial position and statement of financial performance are presented must disclose the following:
1. Its objectives for holding or issuing those instruments, the context needed to understand those
objectives, and its strategies for achieving those objectives. The information should be disclosed about
those instruments in the context of each instrument's primary underlying risk exposure (e.g., interest
rate, credit, foreign exchange rate, or overall price).
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 85 of 124
Additionally, those instruments are to be distinguished between those used for risk management
purposes and those used for other purposes.
2. Information that would enable users of its financial statements to understand the volume of its
derivative activity. Entities shall select the format and the specifics of disclosures relating to their volume
of derivative activity that are most relevant and practicable for their individual facts and circumstances.
FASB ASC 815-10-50-1A
Quantitative Disclosures
Quantitative disclosures are required for every annual and interim reporting period for which a statement
of financial position and statement of financial performance are presented.
An entity that holds or issues derivative instruments (and nonderivative instruments that are designated and
qualify as either fair value hedging instruments or cash flow hedging instruments) must disclose the
following for every annual and interim period for which a statement of financial position and statement of
financial performance are presented:
A. The location and fair value amounts of derivative instruments reported in the statement of financial
position
1. The fair value of derivative instruments must be presented on a gross basis, even if they are subject to
master netting arrangements and qualify for net presentation in accordance with Section 815-10-45 the
derivative instruments are not to be added to or netted against the fair value amounts.
2. Fair value amounts must be presented as separate asset and liability values segregated between
derivatives that are designated and qualifying as hedging instruments and those that are not. Within
each of those categories (designated and qualifying hedges versus those that are not), fair value
amounts must be presented by type of derivative contract.
3. The disclosure will identify the line item(s) in the statement of financial position where the fair value
amounts for these categories of derivative instruments are included.
FASB ASC 815-10-50-4B
Quantitative Disclosures
B. The location and amount of the gains and losses included in the statement of financial position (or the
statement of financial performance). Gains and losses should be presented separately for the following:
1. Derivative instruments designated and qualifying as hedging instruments in fair value hedges and
related hedged items designated and qualifying in fair value hedges
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 86 of 124
2. The effective portion of gains and losses on derivative instruments designated and qualifying in cash
flow hedges and net investment hedges that was recognized in other comprehensive income (OCI)
during the current period
3. The effective portion of gains and losses on derivative instruments designated and qualifying in cash
flow hedges and net investment hedges that was originally reported in OCI in the statement of financial
position and reclassified into earnings
4. The effective portion of gains and losses on derivative instruments designated and qualifying in cash
flow hedges and net investment hedges representing (a) the amount of the hedges' ineffectiveness and
(b) the amount, if any, excluded from the assessment of hedge effectiveness
5. Derivative instruments not designated and qualifying as hedging instruments
The information should be presented separately by type of derivative contract. The disclosure should identify
the line item(s) in the statement of financial performance in which the gains and losses for these categories
are included.
The required quantitative disclosures should be presented in tabular format except for the information
required for hedged items by (b)(1). Information about hedged items can be presented in a tabular or
nontabular format.
FASB ASC 815-10-50-4C
Quantitative Disclosures
C. For derivative instruments that are not designated or qualifying as hedging instruments, if an entity
includes those derivative instruments in its trading activities (e.g., as part of its trading portfolio that includes
both derivative and nonderivative or cash instruments), the entity can elect to not separately disclose gains
and losses as required by (b)(5) provided that the entity discloses all of the following:
1. The gains and losses on its trading activities (including both derivative and nonderivative instruments)
recognized in the statement of financial performance, separately by major types of items (such as fixed
income/interest rates, foreign exchange, equity, commodity, and credit)
2. The line items in the statement of financial performance in which trading activities gains and losses are
included
3. A description of the nature of its trading activities and related risks, and how the entity manages those
risks
FASB ASC 815-10-50-4F
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 87 of 124
An entity that holds or issues derivative instruments (or nonderivative instruments that are designated and
qualify as either fair value hedging instruments or cash flow hedging instruments) must disclose the
following for every annual and interim reporting period for which a statement of financial position is
presented:
a. The existence and nature of credit-risk-related contingent features and the circumstances in which the
features could be triggered in derivative instruments that are in a net liability position at the end of the
reporting period
b. The aggregate fair value amounts of derivative instruments that contain credit-risk-related contingent
features that are in a net liability position at the end of the reporting period
c. The aggregate fair value of assets that are already posted as collateral at the end of the reporting period,
and (1) the aggregate fair value of additional assets that would be required to be posted as collateral
and/or (2) the aggregate fair value of assets needed to settle the instrument immediately, if the credit-
risk-related contingent features were triggered at the end of the reporting period.
FASB ASC 815-10-50-4H
Quantitative Disclosures
For derivative instruments, as well as nonderivative instruments that may give rise to foreign-currency
transaction gains or losses under Topic 830, that have been designated and have qualified as fair value
hedging instruments and for the associated hedged items, the following must be disclosed:
1. The net gain or loss recognized in earnings during the reporting period representing (a) the amount of
the hedges' ineffectiveness and (b) the component of the derivative instruments' gain or loss, if any,
excluded from the assessment of hedge effectiveness
2. The amount of net gain or loss recognized in earnings when a hedged firm commitment no longer
qualifies as a fair value hedge
For derivative instruments that have been designated and have qualified as cash flow hedging instruments
and for the related hedged transactions, the following must be disclosed:
1. A description of the transactions or other events that will result in the reclassification into earnings of
gains and losses that are reported in accumulated other comprehensive income, and the estimated net
amount of the existing gains or losses at the reporting date that is expected to be reclassified into
earnings within the next 12 months
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 88 of 124
2. The maximum length of time over which the entity is hedging its exposure to the variability in future cash
flows for forecasted transactions excluding those forecasted transactions related to the payment of
variable interest on existing financial instruments
3. The amount of gains and losses reclassified into earnings as a result of the discontinuance of cash flow
hedges because it is probable that the original forecasted transactions will not occur by the end of the
originally specified time period or within an additional 2-month period of time thereafter
Quantitative Disclosures
Reporting Cash Flows of Derivative Instruments that Contain Financing Elements
A derivative that at its inception includes off-market terms or requires an up-front cash payment, or both,
often contains a financing element. If an other-than-insignificant financing element is present at inception
(other than a financing element included in an at-the-market derivative instrument with no prepayments),
then the borrower will report the cash inflows and outflows for the derivative as financing activities in the
statement of cash flows.
If information on derivative instruments (or nonderivative instruments that are designated and qualify as
either fair value hedging instruments or cash flow hedging instruments) is disclosed in more than a single
footnote, an entity shall cross-reference from the derivative footnote to other footnotes in which derivative-
related information is disclosed.
FASB ASC 815-10-50-4A-50-4I
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 89 of 124
Gains and losses from hedging activities may arise from different types of risks. There is no requirement to
classify and present separately in other comprehensive income the net gain or loss on designated derivative
instruments by the different types of hedged risks.
Quote
As part of the disclosures of accumulated other comprehensive income. . ., an entity shall
separately disclose the beginning and ending accumulated derivative gain or loss, the related net
change associated with current period hedging transactions, and the net amount of any
reclassification into earnings.
In addition, an entity is required to present, either on the face of the statement where net income
is presented or in the notes, significant amounts reclassified out of AOCI by the respective line
items of net income but only if the amount reclassified is required under U.S. GAAP to be
reclassified to net income in its entirety in the same reporting period. For other amounts that are
not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is
required to cross-reference to other disclosures required under U.S. GAAP that provide additional
detail about those amounts.
Quote
An entity shall report hybrid financial instruments measured at fair value under the election and
under the practicability exception. . . in a manner that separates those reported fair values from
the carrying amounts of assets and liabilities subsequently measured using another
measurement attribute on the face of the statement of financial position. To accomplish that
separate reporting, an entity may either (a) display separate line items for the fair value and non-
fair-value carrying amounts or (b) present the aggregate of those fair value and non-fair-value
amounts and parenthetically disclose the amount of fair value included in the aggregate amount.
FASB ASC 815-15-45-1
An entity shall provide information that will allow users to understand the effect of changes in the
fair value of hybrid financial instruments measured at fair value under the election and under the
practicability exception. . . on earnings (or other performance indicators for entities that do not
report earnings).
FASB ASC 815-15-50-2
Section 825-10-50 requires publicly-held entities to make certain disclosures about the fair values of their
financial instruments. However, a nonpublic entity is not required to provide those disclosures for items
disclosed at fair value but not measured at fair value in the statements of financial positions.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 90 of 124
Study Question 50
When does Topic 815 require an entity to make certain quantitative disclosures?
Study Question 51
Which of the following is not a required comprehensive income disclosure?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 91 of 124
Business Combination
A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions
sometimes referred to as true mergers or mergers of equals also are business combinations.
Consolidation
The presentation of a single set of amounts for an entire reporting entity. Consolidation requires elimination
of intra-entity transactions and balances.
FASB ASC Master Glossary
Credit Risk
Credit risk is the possibility that a loss may occur from the failure of another party to perform according to
the terms of a contract.
Credit risk is the probability of loss from a debtor's default. In banking, credit risk is a major factor in
determining the interest rate charged on a loan.
For purposes of a hedged item in a fair value hedge, credit risk is the risk of changes in the hedged item's fair
value attributable to both of the following:
a. Changes in the obligor's creditworthiness
b. Changes in the spread over the benchmark interest rate with respect to the hedged item's credit sector
at inception of the hedge.
For purposes of a hedged transaction in a cash flow hedge, credit risk is the risk of changes in the hedged
transaction's cash flows attributable to all of the following:
a. Default
b. Changes in the obligor's creditworthiness
c. Changes in the spread over the benchmark interest rate with respect to the related financial asset's or
liability's credit sector at inception of the hedge.
FASB Master Glossary
Denominate
To denominate is to fix the value of an asset or liability in terms of a specific currency regardless of changes
in the exchange rate (e.g., if a domestic company purchases goods on account from a foreign company which
are denominated in foreign currency, then the payable is also denominated in foreign currency and must be
paid in foreign currency, not in dollars, and the transaction is a foreign currency transaction).
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 92 of 124
Contrasted to “measuring” the element: any asset or liability can be measured in any currency by using
exchange rates. However, the right to receive (obligation to pay) a fixed amount of a currency is, by definition,
“denominated” in that currency, regardless of the currency in which it is “measured.” An asset (liability)
which is denominated in a particular currency is a monetary asset, and an asset which is not denominated in
any particular currency is a nonmonetary asset.
Derivative Instruments
A derivative instrument is a financial instrument or other contract that possesses all three of the following
characteristics:
1. It has (a) one or more underlyings and (b) one or more notional amounts or payment provisions or both.
2. It requires no initial net investment or an initial net investment that is smaller than would be required for
other types of contracts that would be expected to have a similar response to changes in market factors.
3. Its terms require or permit net settlement, it can readily be settled net by a means outside the contract,
or it provides for delivery of an asset that puts the recipient in a position not substantially different from
net settlement.
FASB Master Glossary
Equity Method
Under the equity method, an investor shall recognize its share of the earnings or losses of an investee in the
periods for which they are reported by the investee in its financial statements rather than in the period in
which an investee declares a dividend. An investor shall adjust the carrying amount of an investment for its
share of the earnings or losses of the investee after the date of investment and shall report the recognized
earnings or losses in income. An investor's share of the earnings or losses of an investee shall be based on
the shares of common stock and in-substance common stock held by that investor.
FASB ASC 323-10-35-4
Investment at
= Cost
acquisition
Cost + Share of earnings – Share of dividends – Adjustments to after-acquisition
Investment =
income of investee
Investment revenue = Share of earnings – Adjustments to income of investee
Fair Value
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. A fair value measurement is for a
particular asset of liability. Therefore, the measurement should consider attributes specific to the asset or
liability.
FASB Master Glossary
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 93 of 124
A fair value hedge is an instrument designated by an entity as hedging the exposure to changes in the fair
value of an asset or a liability or an identified portion thereof (hedged item) that is attributable to a particular
risk.
FASB Master Glossary
Financial Instrument
A financial instrument is cash, evidence of an ownership interest in an entity, or a contract that both:
• imposes on one entity a contractual obligation to:
1. deliver cash or another financial instrument to a second entity, or
2. exchange other financial instruments on potentially unfavorable terms with the second entity, and
• provides the second entity a contractual right to:
1. receive cash or another financial instrument from the first entity, or
2. exchange other financial instruments on potentially favorable terms with the first entity.
FASB Master Glossary
Firm Commitment
Firm commitment is an agreement with an unrelated party, binding on both parties and usually legally
enforceable, with the following characteristics:
a. The agreement specifies all significant terms, including the quantity to be exchanged, the fixed price,
and the timing of the transaction. The fixed price may be expressed as a specified amount of an entity's
functional currency or of a foreign currency. It may also be expressed as a specified interest rate or
specified effective yield.
b. The agreement includes a disincentive for nonperformance that is sufficiently large to make performance
probable. (FASB definition)
FASB Master Glossary
Forecasted Transaction
A forecasted transaction is a transaction that is expected to occur for which there is no firm commitment.
Because no transaction or event has yet occurred and the transaction or event when it occurs will be at the
prevailing market price, a forecasted transaction does not give an entity any present rights to future benefits
or a present obligation for future securities. (FASB Statement 133)
FASB Master Glossary
Foreign Currency
A foreign currency is a currency other than the functional currency of the entity being referred to (for
example, the dollar could be a foreign currency for a foreign entity). Composites of currencies, such as the
Special Drawing Right, used to set prices or denominate amounts of loans, and so forth, have the
characteristics of foreign currency
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 94 of 124
Foreign-Currency Transaction
Transaction whose terms are denominated (fixed) in a currency other than the entity's functional currency;
arise when an enterprise
• Buys or sells on credit goods or services whose prices are denominated in a foreign currency,
• Borrows or lends funds and the amounts payable or receivable are denominated in a foreign currency,
• Is a party to an unperformed forward exchange contract, or
• For other reasons, acquires or disposes of assets, or incurs or settles liabilities, denominated in a foreign
currency.
FASB Master Glossary
Forward Contract
A forward contract obligates one party to buy and another to sell a specific asset for a fixed price at a future
date. Forward contracts are not traded on an exchange.
Forward Rate
The exchange rate agreed upon currently for delivery of currencies at some specific date in the future. (SFAS
52.162)
Functional Currency
Functional currency is the currency of the primary economic environment in which the entity operates, i.e.,
the currency in which the entity normally generates and expends cash (usually the local currency) (FASB
Master Glossary). The functional currency depends on the facts and circumstances of the environment in
which the entity operates. (SFAS 52.5-.11 and Appendix A)
Economic factors that should be considered, individually and collectively, in the determination of the
functional currency include the following:
• Cash flow indicators
• Sales price indicators
• Sales market indicators
• Financing indicators
• Intercompany transactions and arrangements indicators
• Management judgment
(The functional currency may or may not be the same as the local currency and the reporting currency of the
entity.)
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 95 of 124
Futures Contract
A standard and transferable form of contract that binds the seller to deliver to the bearer a standard amount
and grade of a commodity to a specific location at a specified time. It usually includes a schedule of
premiums and discounts for quality variation.
FASB Master Glossary
Hedge
A hedge is a protection against loss, specifically against a foreign exchange loss. It is the act of buying (or
selling) a foreign currency for future delivery on the same date that the entity enters into a foreign currency
transaction in order to eliminate the risk of (“exposure to”) fluctuations in the exchange rate ( i.e., the gain or
loss that results from the foreign currency transaction—the purchase or sale of goods denominated in a
foreign currency—is exactly offset by a loss or gain on the hedging transaction because the exchange rate for
both (opposing) transactions are the same on both the date the transactions were entered into and the date
they were settled).
Hedges may also be speculative (i.e., a forward contract that does not cover an open receivable or
payable—a forward contract designated as an economic hedge of a net investment (the ownership interest)
in a foreign entity or purely speculating that the exchange rates will move in an expected direction). Any gain
or loss resulting from such hedges is recognized as a separate component of equity (similar to the
recognition of translation gain or loss.)
Hedge Accounting
The basic idea under hedge accounting is to recognize changes in the value of the hedging item in the same
manner and in the same period that unrealized gains and losses related to the hedged item are recognized.
Hedge Effectiveness
Hedge effectiveness is the extent to which changes in fair values or cash flows on a hedged item or
transaction can be offset with a designated hedging item (i.e., a derivative instrument) during the term of the
hedge, as initially expected and ultimately achieved.
Topic 815, Derivatives and Hedging, specifies that “highly effective” is intended to be essentially the same as
the notion of “high correlation” prior to the FASB Codification. High correlation was generally established as
a range between 80–125%, (using ratio analysis) or a coefficient of determination, or R-Square, of 80%,
estimated using regression analysis.
Held-to-Maturity Securities
Investments in debt securities shall be classified as held-to-maturity only if the reporting entity has the
positive intent and ability to hold those securities to maturity. Held-to-maturity securities are reported at
amortized cost.
Related dividend and interest income, amortization of any premium or discount from their acquisition, and
realized gains and losses from their sale are included in earnings.
An entity shall not classify a debt security as held-to-maturity if the entity has the intent to hold the security
for only an indefinite period. Consequently, a debt security shall not, for example, be classified as held-to-
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 96 of 124
maturity if the entity anticipates that the security would be available to be sold in response to any of the
following circumstances:
a. Changes in market interest rates and related changes in the security's prepayment risk.
b. Needs for liquidity (for example, due to the withdrawal of deposits, increased demand for loans,
surrender of insurance policies, or payment of insurance claims).
c. Changes in the availability of and the yield on alternative investments.
d. Changes in funding sources and terms.
e. Changes in foreign currency risk.
FASB ASC 325-10-25
Highly Effective
Topic 815, Derivatives and Hedging, specifies that “highly effective” is intended to be essentially the same as
the notion of “high correlation” prior to the FASB Codification. High correlation was generally established as
a range between 80–125%, (using ratio analysis) or a coefficient of determination, or R-Square, of 80%,
estimated using regression analysis.
Example
An example of this would be a corporation that has most of its debt in variable short-term
instruments and a corporation that has most of its debt in fixed long-term obligations. This might
describe a bank and a credit union. Their swap agreement would change the complexion of their
respective interest rate risks. They would still be subject to interest rate risk, but less so than
without having made the swap.
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 97 of 124
Notional Amount
The notional amount is the fixed amount or quantity that determines the size of the change caused by the
movement of the underlying. It is the number of units specified in the contract (e.g., a number of currency
units, shares, bushels, or pounds) that is applied to the underlying in determining the settlement or value of
the derivative instrument.
Spot Rate
The exchange rate for immediate delivery of currencies exchanged.
FASB Master Glossary
Underlying
A specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, or
other variable (including the occurrence or nonoccurrence of a specified event such as a scheduled payment
under a contract). An underlying may be a price or rate of an asset or liability but is not the asset or liability
itself. An underlying is a variable that, along with either a notional amount or a payment provision,
determines the settlement of a derivative instrument.
FASB Master Glossary
Written Option
A written option is a contract that gives the holder the right to acquire an underlying (in the case of a written
call option) or the right to sell an underlying (in the case of a written put option) at an exercise or strike price
throughout the option term. The writer or issuer of the option receives a premium from the holder for the
holder's right to benefit from changes in the value of the underlying.
Final Exam
Welcome to Accounting for Derivatives and Hedging Activities. Below is the full list of final exam questions
associated with this course. When you launch the final exam for this course, it will contain a randomized
subset of the questions below, totaling 40 questions. During the actual final exam, the questions will not
appear in the same order as they do below. Note: Each attempt at the final exam will result in a new
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 98 of 124
randomized subset of the questions below. You must earn a score of at least 70.00% in order to pass the
exam and receive CPE credit for this course.
After you have answered all the questions, select the "Submit Answers" button to receive your score.
Exam Question 1
According to the FASB, what is the only relevant measure for derivatives?
A Historical cost
B Fair value
C Amortized cost
Exam Question 2
Derivative instruments represent rights or obligations that:
Exam Question 3
Which of the following contract types is within the scope of Topic 815?
Exam Question 4
Which of the following is a notional amount?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 99 of 124
A An asset or a liability
Exam Question 5
What is an underlying?
A An asset or a liability
Exam Question 6
Which of the following is a major type of host contract?
A Interest host
B Receivable host
C Functional-currency host
D Equity host
Exam Question 7
An embedded foreign-currency derivative component:
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 100 of 124
Exam Question 8
Most equity instruments have unique risk characteristics; therefore, most embedded derivatives in a host
with equity characteristics:
Exam Question 9
Which of the following is not required to be included in the formal documentation of the hedging
relationship and certain key elements of the hedging strategy?
D Hedging objective
Exam Question 10
Which of the following conditions is not necessary for an entity to assume no ineffectiveness in an interest
rate swap that qualifies as a fair value hedge?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 101 of 124
Exam Question 11
In addition to the usual hedging criteria, a fair value hedge must meet specific conditions if the hedged item
is which of the following?
A An available-for-sale security
B A held-to-maturity security
Exam Question 12
Which of the following may be designated as a hedged item?
C A held-to-maturity security
Exam Question 13
Which of the following may not be designated as a hedged item?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 102 of 124
Exam Question 14
Which of the following results in the discontinuance of hedge accounting?
Exam Question 15
On January 1, 20X1, Jones Inc. issues a 5-year, fixed-rate 6%, nonprepayable, $1 million debt obligation.
Jones simultaneously enters into a 5-year interest rate swap with a notional amount of $1 million to convert
the debt's fixed rate to a variable rate. According to the swap contract, Jones will receive interest at a fixed
rate of 6% and pay interest at a variable interest rate equal to the LIBOR swap rate. The LIBOR swap rate
was 4.5% on January 1, 20X1, and 5.5% on June 30, 20X1. The variable rate on the swap resets on June 30
and December 31.
The interest rate swap meets all the necessary criteria to be designated a fair value hedge of the changes in
fair value of the fixed-rate debt obligation attributable to changes in interest rates. Additionally, the hedge
meets all the conditions necessary for Jones to assume that there is no ineffectiveness. Which of the
following is the correct entry to record settlement of the interest rate swap on June 30, 20X1?
B Cash 15,000
D Cash 7,500
Exam Question 16
On July 1, 20X1, Coley Inc. issues a 10-year, fixed-rate 8%, nonprepayable, $500,000 debt obligation. Coley
simultaneously enters into a 10-year interest rate swap with a notional amount of $500,000 to convert the
debt's fixed rate to a variable rate. The interest rate swap meets all the necessary criteria to be designated a
fair value hedge of the changes in fair value of the fixed-rate debt obligation attributable to changes in
interest rates. Additionally, the hedge meets all the conditions necessary for Coley to assume that there is no
ineffectiveness. On December 31, 20X1, market conditions result in recognition of a $20,000 liability for the
swap. What is the fair value of the debt on December 31, 20X1?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 103 of 124
A $520,000
B $500,000
C $480,000
D $460,000
Exam Question 17
On July 1, 20X1, Alexander Inc. issues a 10-year, fixed-rate 8%, nonprepayable, $750,000 debt obligation.
Alexander simultaneously enters into a 10-year interest rate swap with a notional amount of $750,000 to
convert the debt's fixed rate to a variable rate. The interest rate swap meets all the necessary criteria to be
designated a fair value hedge of the changes in fair value of the fixed-rate debt obligation attributable to
changes in interest rates. Additionally, the hedge meets all the conditions necessary for Alexander to assume
that there is no ineffectiveness. On December 31, 20X1, market conditions result in recognition of a $20,000
asset for the swap. What is the fair value of the debt on December 31, 20X1?
A $770,000
B $750,000
C $730,000
D $720,000
Exam Question 18
An entity has an interest rate swap that qualifies as a fair value hedge. When the fair value of the debt
increases, if there is no ineffectiveness in the hedging relationship, which of the following is true?
Exam Question 19
Pope Inc. enters into a fixed price contract on October 1, 20X1, to sell 500,000 troy ounces of silver to Steyn
Jewelry Manufacturing at $5.30 per troy ounce. Pope immediately hedges the metal component of the firm
sales commitment by purchasing an over-the-counter silver futures contract and paying a margin deposit of
$40,000. The futures contract requires Pope to purchase 500,000 troy ounces of silver at $5.25 per troy
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 104 of 124
ounce. The forward contract is appropriately designated as a fair value hedge of Pope's firm commitment to
sell 500,000 troy ounces of silver to Steyn in nine months. On June 1, 20X2, Pope purchased 500,000 troy
ounces of silver at $5.20 per troy ounce. The silver inventory will be used to fulfill the firm commitment to
Steyn. The entry to record the initial margin deposit is which of the following?
Exam Question 20
Streets Inc. enters into a fixed price contract on October 1, 20X1, to sell 500,000 troy ounces of silver to
Ogan Jewelry Manufacturing at $5.30 per troy ounce. Streets Inc. immediately hedges the metal component
of the firm sales commitment by purchasing an over-the-counter silver futures contract and paying a margin
deposit of $40,000. The futures contract requires Streets to purchase 500,000 troy ounces of silver at $5.25
per troy ounce. The forward contract is appropriately designated as a fair value hedge of Streets' firm
commitment to sell 500,000 troy ounces of silver to Ogan in nine months. On June 1, 20X2, Streets
purchases 500,000 troy ounces of silver at $5.20 per troy ounce. The silver inventory will be used to fulfill
the firm commitment to Ogan. The following information is available for October 1, 20X1, and December 31,
20X1:
What is the gain on futures for the period ending December 31, 20X1?
A $10,000
B $15,000
C $20,000
D $25,000
Exam Question 21
Arata Inc. enters into a fixed price contract on October 1, 20X1, to sell 500,000 troy ounces of silver to Toner
Jewelry Manufacturing at $5.30 per troy ounce. Arata immediately hedges the metal component of the firm
sales commitment by purchasing an over-the-counter silver futures contract and paying a margin deposit of
$40,000. The futures contract requires Arata to purchase 500,000 troy ounces of silver at $5.20 per troy
ounce. The forward contract is appropriately designated as a fair value hedge of Arata's firm commitment to
sell 500,000 troy ounces of silver to Toner in nine months. On June 1, 20X2, Arata purchases 500,000 troy
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 105 of 124
ounces of silver at $5.20 per troy ounce. The silver inventory will be used to fulfill the firm commitment to
Toner. The entry to record the sale of silver to Toner will include:
Exam Question 22
Calculate the hedge effectiveness ratio based on the following information:
B 98.6%
C 100%
D 105.8%
Exam Question 23
The time value of a purchased put option is which of the following?
Exam Question 24
The purchase of a put option results in the recognition of which of the following?
A A liability
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 106 of 124
B An asset
C A gain
D A loss
Exam Question 25
When an entity excludes changes in the time value of a put option from the assessment of hedge
effectiveness, which of the following is true of a decrease in the time value of the put option?
Exam Question 26
If a put option used to hedge an available-for-sale security provides only one-sided protection, which of the
following is true?
Exam Question 27
On December 31, 20X1, the fair value of a put option was $275,000, and its time value was $200,000. What
is the put option's intrinsic value on December 31, 20X1?
A $475,000
B $275,000
C $200,000
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 107 of 124
D $75,000
Exam Question 28
Parker Company is considering a number of possible actions to hedge certain risks. Which of the following
hedges that Parker is considering is not an example of a cash flow hedge?
Exam Question 29
Which of the following is an example of a cash flow hedge?
Exam Question 30
At the inception of the hedge, Topic 815 requires formal documentation of the hedging relationship and the
entity's risk management objective and strategy for undertaking the hedge. For a cash flow hedge, which of
the following is not required to be included in the formal documentation?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 108 of 124
Exam Question 31
In the case of a cash flow hedge, the occurrence of the forecasted transaction must be which of the
following?
A Guaranteed
B Reasonably possible
C Probable
D Remote
Exam Question 32
Which of the following is true in the case of a cash flow hedge?
Exam Question 33
An entity uses a derivative instrument to hedge a forecasted transaction that is probable. How should the
gain or loss resulting from changes in the fair value of the hedging instrument be treated?
Exam Question 34
Alpha Company appropriately accounts for its hedge as a cash flow hedge. Which of the following would not
require Alpha Company to cease accounting for this hedge as a cash flow hedge?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 109 of 124
Exam Question 35
In the case of a cash flow hedge, the hedging derivative instrument is carried on the balance sheet at:
A fair value.
B historical cost.
C unamortized cost.
D replacement cost.
Exam Question 36
On December 31, 20X0, Beta Company issues at face value a $1 million note, nonprepayable, with interest
based on the LIBOR swap rate. The note is due on December 31, 20X4, with annual interest payments on
each December 31. On the same day, Beta Company enters into an interest rate swap with Gamma Company
for a notional amount of $1 million. Under the swap, Beta Company will receive payments based on the
LIBOR swap rate and will pay interest based on a 9% fixed rate. The variable rate on the swap resets on
December 31. Assume that on December 31, 20X0, the LIBOR swap rate is 8% and that through December
31, 20X1, the fair value of the swap decreases $15,000. Which of the following is true?
Exam Question 37
On December 31, 20X0, Delta Company issues at face value a $1 million note, nonprepayable, with interest
based on the LIBOR swap rate. The note is due on December 31, 20X4, with annual interest payments on
each December 31. On the same day, Delta Company enters into an interest rate swap with Gamma
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 110 of 124
Company for a notional amount of $1 million. Under the swap, Delta Company will receive payments based
on the LIBOR swap rate and will pay interest based on a 9% fixed rate. The variable rate on the swap resets
annually on December 31. Assume that on December 31, 20X0, the LIBOR swap rate is 8% and that through
December 31, 20X1, the fair value of the swap decreases $15,000. Which of the following is true?
Exam Question 38
On December 31, 20X0, Tau Company issues at face value a $1 million note, nonprepayable, with interest
based on the LIBOR swap rate. The note is due on December 31, 20X4, with annual interest payments on
each December 31. On the same day, Tau Company enters into an interest rate swap with Gamma Company
for a notional amount of $1 million. Under the swap Tau Company will receive payments based on the LIBOR
swap rate and will pay interest based on a 9% fixed rate. The variable rate on the swap resets annually on
December 31. Assume that on December 31, 20X0, the LIBOR swap rate is 8% and that through December
31, 20X1, the fair value of the swap decreases $15,000. Which of the following is true?
Exam Question 39
On December 31, 20X0, Park Company issues at face value a $1 million note, nonprepayable, with interest
based on the LIBOR swap rate. The note is due on December 31, 20X4, with annual interest payments on
each December 31. On the same day, Park Company enters into an interest rate swap with Bench Company
for a notional amount of $1 million. Under the swap, Park Company will receive payments based on the
LIBOR swap rate and will pay interest based on a 10% fixed rate. The variable rate on the swap resets
annually on December 31. Assume that on December 31, 20X0, the LIBOR swap rate is 12% and that through
December 31, 20X1, the fair value of the swap increases $23,000. Which of the following is true?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 111 of 124
Exam Question 40
On December 31, 20X0, Poplar Company issues at face value a $1 million note, nonprepayable, with interest
based on the LIBOR swap rate. The note is due on December 31, 20X4, with annual interest payments on
each December 31. On the same day, Poplar Company enters into an interest rate swap with Sage Company
for a notional amount of $1 million. Under the swap, Poplar Company will receive payments based on the
LIBOR swap rate and will pay interest based on a 10% fixed rate. The variable rate on the swap resets
annually on December 31. Assume that on December 31, 20X0, the LIBOR swap rate is 12% and that through
December 31, 20X1, the fair value of the swap increases $23,000. Which of the following is true of the
settlement?
Exam Question 41
On December 31, 20X0, Lark Company issues at face value a $1 million note, nonprepayable, with interest
based on the LIBOR swap rate. The note is due on December 31, 20X4, with annual interest payments on
each December 31. On the same day, Lark Company enters into an interest rate swap with Wren Company for
a notional amount of $1 million. Under the swap Lark Company will receive payments based on the LIBOR
swap rate and will pay interest based on a 10% fixed rate. The variable rate on the swap resets annually on
December 31. Assume that on December 31, 20X0, the LIBOR swap rate is 12% and that through December
31, 20X1, the fair value of the swap increases $23,000. Which of the following is true?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 112 of 124
Exam Question 42
On October 1, 20X1, Clark Company, a calendar-year entity, determines that it will need 100,000 units of
widgets on or about March 31, 20X2. On October 1, 20X1, Clark enters into futures contracts to purchase
widgets at $4.00 per unit. Clark designates the futures contracts as a cash flow hedge of its forecasted
inventory purchase of 100,000 units of widgets on March 31, 20X2. The closing price of the March 31, 20X2,
futures contract was $3.80 on December 31, 20X1, and $4.30 on March 31, 20X2. The spot rate on March 31,
20X2, was $4.30. On March 31, 20X2, Clark purchased 100,000 units of widgets at $4.30 per widget and
closed out the futures contracts that were purchased on October 1, 20X1. How should the $20,000 decrease
in the fair value of the futures contract for the three months ending December 31, 20X1, be recognized?
Exam Question 43
On October 1, 20X1, Blake Company, a calendar-year entity, determines that it will need 100,000 units of
widgets on or about March 31, 20X2. On October 1, 20X1, Blake enters into futures contracts to purchase
widgets at $4.00 per unit. Blake designates the futures contracts as a cash flow hedge of its forecasted
inventory purchase of 100,000 units of widgets on March 31, 20X2. The closing price of the March 31, 20X2,
futures contracts was $3.80 on December 31, 20X1, and $4.30 on March 31, 20X2. The spot rate on March 31,
20X2, was $4.30. On March 31, 20X2, Blake purchased 100,000 units of widgets at $4.30 per widget and
closed out the futures contracts that were purchased on October 1, 20X1. How would the $20,000 balance in
the futures contracts account be treated on December 31, 20X1?
Exam Question 44
Park Company uses a derivative instrument to hedge a forecasted transaction. Which of the following best
describes how Park Company should report any gains or losses related to the hedge?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 113 of 124
Exam Question 45
An entity uses a derivative instrument as a cash flow hedge of a forecasted transaction. The derivative
instrument has a credit balance at the balance sheet date. How should the derivative instrument be treated?
Exam Question 46
An entity anticipates the sale of a specified number of ounces of gold in Year 2. To hedge the possible
decline in the price of gold, in Year 1 the entity sells gold futures for a specified price. Assuming the hedge
qualified as a cash flow hedge, how would a decrease in the price of gold affect other comprehensive income
of Year 1?
A It would increase.
B It would decrease.
Exam Question 47
An entity anticipates the sale of a specified number of ounces of silver. To hedge the possible decline in the
price of silver, the entity sells silver futures for a specified price. What would result from an increase in the
price of silver?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 114 of 124
Exam Question 48
An entity anticipates the sale of a specified number of ounces of gold in Year 2. To hedge the possible
decline in the price of gold, in Year 1 the entity sells gold futures for a specified price. Assuming that the
hedge qualified as a cash flow hedge, how would a decrease in the price of gold affect net income of Year 1?
A It would increase.
B It would decrease.
Exam Question 49
Which of the following is true regarding the use of derivative instruments as hedges of the foreign-currency
exposure of recognized assets and liabilities denominated in a foreign currency?
Exam Question 50
Which of the following is not addressed in Topic 815, ?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 115 of 124
Exam Question 51
Under Topic 815, which of the following would not qualify for fair value hedge accounting?
Exam Question 52
Under Topic 815, which of the following would qualify for fair value hedge accounting?
Exam Question 53
Where is the gain or loss on a derivative instrument that does not qualify for hedge accounting currently
recognized?
C In net income
D As a direct charge or credit to stockholders' equity
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 116 of 124
Exam Question 54
A foreign-currency cash flow hedge must meet the general criteria specified in Topic 815, for other cash flow
hedges. A foreign-currency cash flow hedge also must meet specific additional criteria to qualify for hedge
accounting. Which of the following is one of those specific additional criteria?
Exam Question 55
A foreign-currency cash flow hedge must meet the general criteria specified in Topic 815, for other cash flow
hedges. A foreign-currency cash flow hedge also must meet specific additional criteria to qualify for hedge
accounting. Which of the following is not included in those specific additional criteria?
Exam Question 56
Which of the following does Topic 815, , require of gains or losses associated with changes in the fair value of
the hedging instrument in a foreign-currency cash flow hedge?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 117 of 124
Exam Question 57
Assuming that the hedge otherwise qualifies as a foreign-currency cash flow hedge, which of the following is
true?
Exam Question 58
How should the gain or loss on a hedging instrument that is designated as, and is effective as, an economic
hedge of an investment in a foreign operation be reported?
Exam Question 59
For purposes of applying Topic 815, , which of the following forms of business units would not qualify as a
net investment in a foreign operation?
A A subsidiary
B A branch
C A joint venture
D A product line
Exam Question 60
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 118 of 124
An entity uses a forward contract to hedge a firm purchase commitment that is denominated in a foreign
currency. Assuming that all other related criteria are met, this hedge qualifies as which of the following?
Exam Question 61
Beta Company has an unrecognized purchase commitment for 10,000 units of a foreign currency (FC) on
April 1, 20X1. To hedge the possible adverse effects of changes in the fair value of the firm commitment that
are attributable to changes in the foreign-currency exchange rate, Beta Company enters into a forward
contract to receive 10,000FC on April 1, 20X1. What would be the result from an increase in the exchange
rate from 1FC = $4.00 to 1FC = $4.50?
Exam Question 62
Alpha Company has an unrecognized purchase commitment for 10,000 units of a foreign currency (FC) on
April 1, 20X1. To hedge the possible adverse effects of changes in the fair value of the firm commitment that
are attributable to changes in the foreign-currency exchange rate, Alpha Company enters into a forward
contract to receive 10,000FC on April 1, 20X1. What impact would result from a decrease in the exchange
rate from 1FC = $3.00 to 1FC = $2.40?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 119 of 124
Exam Question 63
Lane Company has an unrecognized purchase commitment for 1,000 units of foreign currency (FC) on May 1,
20X1. To hedge the possible adverse effects of changes in the fair value of the firm commitment that are
attributable to changes in the foreign-currency exchange rate, Lane company enters into a forward contract
to receive 1,000FC on May 1, 20X1. What would be the result from an increase in the exchange rate from 1FC
= $3.00 to 1FC = $3.60?
Exam Question 64
Delta Company has a forecasted purchase of inventory for 10,000 units that will be denominated in a foreign
currency (FC) on March 1, 20X2. To hedge the possible adverse effects of changes in the foreign-currency
exchange rate, on October 31, 20X1, Delta Company enters into a forward contract to receive 10,000FC on
March 1, 20X2. The forward rate is 1FC = $3.00 on October 31, 20X1, and 1FC = $3.50 on December 31, 20X1,
the end of Delta Company's fiscal year. This increase in the forward rate would have which of the following
effects on net income in 20X1?
A An increase
B A decrease
Exam Question 65
Tau Company has a forecasted purchase of inventory of 10,000 units that will be denominated in a foreign
currency (FC) on March 1, 20X2. To hedge the possible adverse effects of changes in the foreign-currency
exchange rate, on October 31, 20X1, Tau Company enters into a forward contract to receive 10,000FC on
March 1, 20X2. The forward rate is 1FC = $3.50 on October 31, 20X1, and 1FC = $3.00 on December 31, 20X1,
the end of Tau Company's fiscal year. This decrease in the forward rate would have which of the following
effects on net income in 20X1?
A An increase
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 120 of 124
B A decrease
Exam Question 66
Assume that Domestic Company, a U.S. company, on October 1, 20X1, forecasts the purchase of 10,000 units
of inventory from its principal supplier in a foreign country on March 1, 20X2, and payment would be made in
a foreign currency, zags (Z). Currently, the inventory would cost 10,000Z (1Z per unit). On October 1, 20X1,
Domestic enters into a forward contract to receive 10,000Z on March 1, 20X2. Under the forward contract
Domestic agrees to pay the broker $14,100 U.S. dollars based on the forward rate on October 1, 20X1, of
$1.41, which is the market forward rate. The exchange rates and fair values of the forward contract are as
follows:
Ignoring discounting, on December 31, 20X1, which of the following entries should be made?
Exam Question 67
An entity uses a forward contract as a hedge of a forecasted transaction denominated in a foreign currency.
Assuming that all other criteria are met, how must the hedge be accounted for?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 121 of 124
Exam Question 68
An entity uses a forward contract as a hedge of a forecasted transaction denominated in a foreign currency.
Assuming that all criteria are met for the hedge to be accounted for as a foreign-currency cash flow hedge,
how must the forward contract be measured?
A At fair value
B At acquisition cost
C At unamortized cost
D At book value
Exam Question 69
An entity uses a forward contract as a hedge of a forecasted transaction denominated in a foreign currency.
Assuming that all criteria are met for the hedge to be accounted for as a foreign-currency cash flow hedge,
where must changes in the fair value of the forward contract be included?
A In net income
Exam Question 70
Omega Company, a U.S. company, has an equity-method investee in a foreign country. The functional
currency of the investee is the zag (Z). Omega enters into a forward contract to sell 10,000Z at the forward
rate of $2.00. Which of the following statements is true?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 122 of 124
Exam Question 71
Alpha Company, a U.S. company, has an equity-method investee in a foreign country. The functional
currency of the investee is the zag (Z). Alpha enters into a forward contract to sell 10,000Z at the forward
rate of $2.00, which is the market forward rate. What impact will an increase in the forward rate from 1Z =
$2.00 to 1Z = $2.20 have?
Exam Question 72
Micro Company, a U.S. company, has an equity-method investee in a foreign country. The functional currency
of the investee is the zag (Z). On November 1, 20X1, Micro enters into a forward contract to sell 10,000Z at
the forward rate of $2.00, which is the market forward rate. As of the December 31, 20X1, balance sheet date
the forward rate had increased from 1Z = $2.00 to 1Z = $2.40. The spot rate on November 1, 20X1, was 1Z =
$1.90 and on December 31, 20X1, was 1Z = $2.35. Ignoring discounting, what was the change in the fair value
of the forward contract from November 1, 20X1, to December 31, 20X1?
A A $4,000 increase
B A $4,000 decrease
C A $4,500 increase
D A $4,500 decrease
Exam Question 73
Entities that do not report earnings as a separate caption in a statement of financial performance are
prohibited by Topic 815 from designating a derivative instrument as a hedge of which of the following?
B A foreign-currency transaction
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 123 of 124
Exam Question 74
Which of the following is true for not-for-profit entities?
Exam Question 75
Why are not-for-profit entities not permitted to use cash flow hedge accounting?
Exam Question 76
Which of the following is not a required disclosure for cash flow hedges?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017
Entire Course (including glossary) Page 124 of 124
Exam Question 77
Which of the following is not a disclosure that an entity must make concerning accumulated other
comprehensive income?
Exam Question 78
An entity must do which of the following?
https://cpe.checkpointlearning.thomsonreuters.com/CourseContent/Content/TRTA/63562... 10/30/2017