Solution to Chapter 20

Chapter 20 Problem I In relation to the above data, the following relevant exchange rates are needed for further analysis in relation to hedged item and hedging instrument:

Spot Rate P40.00 P40.30 P40.20***

December 1, 20x4…………………………. December 31, 20x4…………………………. March 1, 20x5…………………………………..

Forward Rate for 3/1/20x5 Settlement (or Expiration) P40.15 (*90 days) P40.40 (**60 days)

*original 90-day forward rate on 12/1/20x4 **remaining or current forward rate on 12/31/20x4 ***the forward rate at expiration or maturity is equal to spot rate as the remaining period of the forward contract is zero.

1. Not a Hedge Accounting - Importing Transaction (Exposed Liability). a. The journal entries to record the hedged item and hedging instrument are as follows: Gross Method Hedged Item – Importing Transaction (Exposed Liability) Transaction Date Inventory ($1,200 x P40)…………... Accounts payable………………. To record purchase of goods on account using the spot rate on 2/1/1/x4. *XD – exchange dealer

48,000

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting) December 1, 20x4 Date of Inception/Hedging of 90 days Forwards

48,000

FC Receivable from XD…………… Pesos Payable to XD (P40.15 x $1,200) To record forward contract to buy $12000 using forward rate.

48,180

48,180

If the financial statements are prepared on December 1, 20x4, the value of the forward contract is as follows: Balance Sheet Presentation on 12/1/20x4 FC Receivable from XD……………………… P48,180 Less: Pesos payable to XD…………………… 48,180 Forward Contract (fair value)………………. P 0 December 31, 20x4 (Balance Sheet Date an intervening financial reporting date) FC Transaction Loss Account payable……………. [P40.30 – P48.00) x $1,200 To record a loss on the exposed liability denominated in foreign currency. *FC – foreign currency

360

360

FC Receivable from XD…………… FC Transaction Gain [(P40.40 – P40.15) x $1,200] To record a gain on foreign currency to be received from FC dealer.

300

300

If the financial statements are prepared on December 31, 20x4, the value of the forward contract is as follows: Balance Sheet Presentation on 12/31/20x4 FC Receivable from XD (P40.40 x $1,200)… P48,480 Less: Pesos payable to XD (fixed at P40.15) 48,180

Forward Contract (fair value – asset)………

P

300

On March 1, 20x5 (the transaction date and the settlement date), the journal entries are: March 1, 20x5 Settlement Date/Date of Expiration of Contract

Settlement Date Accounts payable FC Transaction gain……. [(P40.20 – P40.30) x $1,200}…….. To record a gain from 12/31/x4 to 3/1/x5 on liability denominated in FC.

Accounts payable…………………… Cash (refer to note below)……… To record payment of accounts payable at spot rate.

120

48,240

120

48,240

FC Transaction Loss FC Receivable from XD [(P40.40 – P40.20) x $1,200] To record a loss on foreign currency to be received from FC dealer.

240

Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

48,180

Investment in FC……………………. FC Receivable from XD To record receipt of foreign Currency.

48,240

240

48,180

48,240

Cash……………………………………. 48,240 Investment in FC…………………. 48,240 To record conversion of US dollars into cash for payment of accounts payable. Note: This entry may be ignored and instead the Investment in FC will be outright credited in payment of accounts payable. For succeeding illustrations the conversion of FC to peso cash to settle items acquired will be used.

These transactions can be summarized in the following table. Hedged Item (Exposed Liability)

Accounts Payable 12/1/20x4 12/31/20x4 3/1/20x5 Total gain (loss)

Balance P48,000 48,360 48,240

Transaction gain (loss) (P 360) 120 (P 240)

Hedging Instrument (Forward Contract)

FC Receivable 12/1/20x4 12/31/20x4 3/1/20x5

Balance P48,180 48,480 48,240

Transaction gain (loss) P 300 (240) P 60

Thus, the net effect is a P150 loss when the forward contract is used. “Net” Position Accounting The following illustrates the effects of “net” position accounting using the same illustration above: Hedged Item – Importing Transaction (Exposed Liability) Transaction Date Inventory ($1,200 x P40)…………... Accounts payable……………….

48,000

Hedging Instrument – Forward Contracts ( Net Position Accounting) December 1, 20x4 Date of Inception/Hedging of 90 days Forwards

48,000

Memorandum entry only, No formal journal entry as the fair value of forward

To record purchase of goods on account using the spot rate on 2/1/1/x4.

contract is zero.

It should be noted that the accounts payable for the inventory purchase is recorded using the spot rate on the transaction date (on December 1, 20x3). December 31, 20x4 (Balance Sheet Date, an intervening financial reporting date) FC Transaction Loss Accounts payable [P40.30 – P40.00) x $1,200 To record a loss on the exposed liability denominated in foreign currency. *FC – foreign currency

360

360

Forward Contract FC Transaction Gain [(P40.40 – P40.15) x $1,200] To record a gain on foreign currency to be received from FC dealer.

300

300

If the financial statements are prepared on December 31, 20x4, the value of the forward contract is as follows: Forward contract (debit balance – asset)……………………….

P 300

The income statement would report an exchange loss of P360 and an exchange gain of P250. On March 1, 20x5 (the transaction date and the settlement date), the journal entries are: March 1, 20x5 Settlement Date/Date of Expiration of Contract

Settlement Date Accounts payable FC Transaction gain……. [(40.20 – P40.30) x $1,200}…….. To record a gain from 12/31/x4 to 3/1/x5 on liability denominated in FC.

120

Accounts payable (P40.20 x $1,200) Cash (P40.20 x $1,200) or * To record payment to exchange dealer (XD)

48,240

120

FC Transaction Loss Forward Contract [(P40.40 – P40.20) x $1,200] To record a loss on foreign currency to be received from FC dealer.

240

240

Cash………………………………….. 60 Forward Contract Net settlement received from the dealer on expiration or maturity date of forward contract. *(P40.15, forward rate on the date of inception x $1,200) + cash received from the exchange dealer of P50. 48,240

Forward Contract (Asset/Liability) 12/31/x4 Gain… 300 240… …..3/1/x5 Loss 3/1/x5 Net…… 60 60

60

b.

c.

d.

e.

b.1. b.2. b.3. b.4. b.5. b.6.

P360 loss - [(P40.30 – P40.00) x $1,200] P300 gain - [(P40.40 – P40.15) x $1,200] P360 loss – P300 gain = P60 net loss (decrease in net income) P120 gain - [(P40.20 – P40.30) x $1,200} P240 loss - [(P40.40 – P40.20) x $1,200] P240 loss – P120 gain = P120 net loss (decrease in net income)

c.1. P48,360 - [P40.30, spot rate/current rate on the balance sheet date x $1,200] c.2. P48,240 – [P40.20, spot rate on the date of settlement x $1,200] d.1. d.2. d.3. d.4. e.1.

P48,180 - [P40.15, original (90-day) forward rate on the date of hedging x $1,200] No entry required Same amount with d.1 No entry required

Gross Method

FC Receivable from XD……………………… Less: Pesos payable to XD…………………… Forward Contract (fair value)……………….

P48,180 48,180 P 0

Net Method: Zero. No entry required. e.2. P300 asset Gross method

FC Receivable from XD (P40.40 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

P48,480 48,180 P 300

Net Method: P300.

Forward contract (debit balance – asset)…

P 300

e.3. P60 debit balance – asset Gross method

FC Receivable from XD (P40.20 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

Net Position 12/31/x4 Gain… 3/1/x5 Net……

300 60

P48,240 48,180 P 60

Forward Contract (Asset/Liability) 240… …..3/1/x5 Loss

f. P48,000 [P40, spot (current) rates on the date of transaction x $1,200] 2. Fair Value Hedge – Hedging an Unrecognized Foreign Currency Firm Commitment. Gross Method (for Net Position – same with Exposed Liability) a. The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – (Unrecognized Foreign Currency Firm Commitment)

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting)

December 1, 20x4

Date of Commitment (Date of Issuing the Purchase Order) No journal entry is required to record the firm commitment. The forward contract is designated as a hedge of the firm commitment to purchase inventory on March 1, 20x5. The hedge is accounted for as a fair value hedge.

Date of Inception/Hedging of 90 days Forwards FC Receivable from XD…………… Pesos Payable to XD (P40.15 x $1,200) To record forward contract to buy $1,200 using forward rate.

48,180

48,180

December 31, 20x4 (Balance Sheet Date, an intervening financial reporting date) FC Transaction Loss Firm Commitment [P40.40 – P40.15) x $1,200 To record a loss on firm commitment using the change in the forward rate. *FC – foreign currency

300

300

FC Receivable from XD…………… FC Transaction Gain [(P40.40 – P40.15) x $1,200] To record a gain on foreign currency to be received from FC dealer.

300

300

Balance Sheet Presentation on 12/31/20x4 Assets Liability FC Receivable from XD (P40.40 x $1,200)....…...P48,480 Firm Commitment…………………………………...P 300 Less: Pesos Payable to XD(fixed at P40.15)….… 48,180 Forward Contract (fair value)……………………P 300

On March 1, 20x5 (the transaction date and the settlement date), the journal entries are: Date of Transaction and Settlement Firm Commitment………… FC Transaction gain……. To record a gain on fair value of firm commitment.

240

Inventory (P40.20 x $1,200)…………. Cash ………………………………… To record the purchase of inventory for $1,200 at spot rate.

48,240

Firm Commitment……………………. Inventory……………………………. To remove the carrying amount of the firm commitment from the balance sheet6 and adjust the initial carrying amount of the machine that results from the firm

60

March 1, 20x5 Settlement Date/Date of Expiration of Contract

240

48,240

60

FC Transaction Loss …………… FC Receivable from XD……… [(P40.40 – P40.20) x $1,200] To record a loss on foreign currency to be received from exchange dealer.

240

Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

48,180

Investment in FC……………………. FC Receivable from XD To record receipt of foreign currency.

48,240

Cash……………………………………. Investment in FC……………..…... To record conversion of US dollars into cash for purchase of inventory.

48,240

240

48,180

48,240

48,240

commitment. This treatment is an accordance with PAS 39 par. 89b. Firm Commitment 3/1/x5 Gain……. 240 300… …..12/31/x4 Loss 60 60 3/1/x5 Net

b.

b.1. b.2. b.3. b.4. b.5. b.6.

P300 loss - [(P40.40 – P40.15) x $1,200] P300 gain - [(P40.40 – P40.15) x $1,200] P300 loss – P300 gain = P0 P240 gain - [(P40.40 – P40.20) x $1,200} P240 loss - [(P40.40 – P40.20) x $1,200] P240 loss – P240 gain = P0

c. – same with Exposed Liability c.1. P48,180 - [P40.15, original (90-day) forward rate on the date of hedging x $1,200] c.2. No entry required c.3. Same amount with d.1 c.4. No entry required d.

d.1. Zero, no entry required d.2. P300 liability, [(P40.40 – P40.15) x $1,200] d.3. P60, liability Firm Commitment 3/1/x5 Gain……. 240 300… …..12/31/x4 Loss 60 3/1/x5 Net

e. Same with Exposed Liability e.1. Net Method: Zero. No entry required. Gross Method FC Receivable from XD……………………… Less: Pesos payable to XD…………………… Forward Contract (fair value)……………….

e.2. P300 asset Net Method: P300.

Forward contract (debit balance – asset)…

Gross method

FC Receivable from XD (P40.40 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

e.3. P60 debit balance – asset Gross method

FC Receivable from XD (P40.20 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

Net Method

Forward Contract (Asset/Liability) 12/31/x4 Gain… 300 240… …..3/1/x5 Loss 3/1/x5 Net…… 60

P48,180 48,180 P 0

P 300

P48,480 48,180 P 300

P48,240 48,180 P 60

f. P48,240, spot rate on the date of transaction. Inventory at spot rate on the date of transaction (P40.20 x $1,200)…………….P48,240 g. P48,180, original (90-day) forward rate on the date of hedging Inventory at spot rate on the date of transaction (P40.20 x $1,200)…………….P48,240 Less: Firm Commitment account – liability, 3/1/20x5………………………………. 60 Inventory at original (90-day) forward rate on the date of hedging, P40.15….P48,180 3. Cash Flow Hedge - Hedge of a Forecasted Transaction. Gross Method (for Net Position – same with Exposed Liability) a. The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – Forecasted Transaction Date of Forecast

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting) December 1, 20x4 Date of Inception/Hedging of 90 days Forwards

No journal entry is required to record the forecasted transaction. The forward contract is designated as a hedge against the exposure to increases in the dollar rate on March 1, 20x5.

FC Receivable from XD…………… Pesos Payable to XD (P40.15 x $1,200) To record forward contract to buy $1,200 using forward rate.

48,180

48,180

December 31, 20x4 (Balance Sheet Date, an intervening financial reporting date) No entry required, since it is only a forecasted transaction not guaranteed such as firm commitment.

FC Receivable from XD OCI – Exchange Gain (B/S) [(P40.40 – P40.15) x $1,200] To record a gain on foreign currency to be received from FC dealer. FC – foreign currency; OCI - Other Comprehensive Income; B/S – Balance Sheet

300

300

Balance Sheet Presentation on 12/31/20x4 FC Receivable from XD (P40.40 x $1,200)… P48,480 Less: Pesos payable to XD (fixed at P40.15) 48,180 Forward Contract (fair value - asset)…..….. P 300

On March 1, 2011 (the transaction date and the settlement date), the journal entries are: Date of Transaction and Settlement

March 1, 20x5 Settlement Date/Date of Expiration of Contract OCI – Exchange Loss (B/S)……… FC Receivable from XD……… [(P40.40 – P40.20) x $1,200] To record a loss on foreign currency to be received from FC dealer.

240

Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

48,180

Investment in FC……………………. FC Receivable from XD To record receipt of foreign

48,240

240

48,180

48,240

currency.

b.

Machinery (P40.20 x $1,200)………... Cash ………………………………… To record the purchase of equipment for $1,200 at the spot rate of P40.20

48,240

OCI – Exchange Gain……………….. Machinery………………………….. To remove the gain recognized in OCI and adjust the carrying amount if the machine that results from the hedged transaction by this amount. Also, to record the basis adjustment of the carrying value of the equipment. This entry is recorded if PAS 39 par. 98b is adopted.

60

48,240

Cash……………………………………. Investment in FC…………………. To record conversion of US dollars into cash for purchase of machinery.

60

3/1/x5

48,240

48,240

Other Comprehensive Income Loss 240 300… ….12/31/x4 Gain 60 60 3/1/x5

b.1. b.2. b.3. b.4.

Gain or loss on hedged item, 3/1/20x4: None, no entry required P300 gain, other comprehensive income - [(P40.40 – P40.15) x $1,200] None. Gain or loss on hedged item, 3/1/20x4: None, no entry required for gain or loss. the only entry is to record the purchase of machinery. b.5. P240 loss, other comprehensive income - [(P40.40 – P40.20) x $1,200] to be recorded on March 1, 20x5. The balance of the OCI – gain amounted to P60 computed as follows: 3/1/x5

Other Comprehensive Income Loss 240 300… ….12/31/x4 Gain 60 3/1/x5

c. Same with Exposed Liability c.1. Net Method: Zero. No entry required. Gross Method FC Receivable from XD……………………… Less: Pesos payable to XD…………………… Forward Contract (fair value)……………….

c.2. P300 asset Net Method: P300.

Forward contract (debit balance – asset)…

Gross method

FC Receivable from XD (P40.40 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

c.3. P60 debit balance – asset Gross method

FC Receivable from XD (P40.20 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

Net Method

Forward Contract (Asset/Liability) 12/31/x4 Gain… 300 240… …..3/1/x5 Loss

P48,180 48,180 P 0

P 300

P48,480 48,180 P 300

P48,240 48,180 P 60

3/1/x5

Net……

60

4. Not a Hedge Accounting – Speculation. Gross Method (for Net Position – same with Exposed Liability) a. The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item - Speculation

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting) December 1, 20x4 Date of Inception/Hedging of 90 days Forwards FC Receivable from XD…………… Pesos Payable to XD (P40.15 x $1,200) To record forward contract to buy $1,000 using forward rate.

48,180

48,180

December 31, 20x4 (Balance Sheet Date an intervening financial reporting date) FC Receivable from XD FC Transaction Gain [(P40.40 – P40.15) x $1,200] To record a gain on foreign currency to be received from FC dealer.

300

300

Balance Sheet Presentation on 12/31/20x4 FC Receivable from XD (P40.40 x $1,200)… P48,480 Less: Pesos payable to XD (fixed at P40.15) 48,180 Forward Contract (fair value – asset)……… P 300 March 1, 20x5 Settlement Date/Date of Expiration of Contract

b.

FC Transaction Loss………………… FC Receivable from XD…………. [(P40.40 – P40.20) x $1,200] To record a loss on foreign currency to be received from FC dealer.

240

Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

48,180

Investment in FC……………………. FC Receivable from XD To record receipt of foreign currency.

48,240

Cash……………………………………. Investment in FC…………………. To record conversion of US dollars into cash.

48,240

b.1. No gain or loss, since it is the date of hedging. b.2. P300 gain - [(P40.40 – P40.15) x $1,200], only hedging instrument.

240

48,180

48,240

48,240

b.3. P240 loss c.

d.

c.1. c.2. c.3. c.4. d.1.

P48,180 - [P40.15, original (90-day) forward rate on the date of hedging x $1,200] No entry required Same amount with c.1 No entry required

Net Method: Zero. No entry required. Gross Method FC Receivable from XD……………………… Less: Pesos payable to XD…………………… Forward Contract (fair value)……………….

P48,180 48,180 P 0

d.2. P300 asset Net Method: P300.

Forward contract (debit balance – asset)…

Gross method

FC Receivable from XD (P40.40 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

P 300

P48,480 48,180 P 300

d.3. P60 debit balance – asset Gross method

FC Receivable from XD (P40.20 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

P48,240 48,180 P 60

Net Method

Forward Contract (Asset/Liability) 12/31/x4 Gain… 300 240… …..3/1/x5 Loss 3/1/x5 Net…… 60

Problem II (Discounting the Fair Value of the Forward Contract) 1. Not a Hedge Accounting - Importing Transaction (Exposed Liability). The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – Importing Transaction (Exposed Liability) Transaction Date Purchases ($1,200 x P40)…………... Accounts payable………………. To record purchase of goods on account using the spot rate on 2/1/1/x4. *XD – exchange dealer

48,000

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting) December 1, 20x4 Date of Inception/Hedging of 90 days Forwards

48,000

FC Receivable from XD…………… Pesos Payable to XD (P40.15 x $1,200) To record forward contract to buy $1,000 using forward rate.

48,180

48,180

If the financial statements are prepared on December 1, 20x4, the value of the forward contract is as follows: Balance Sheet Presentation on 12/1/20x4 FC Receivable from XD……………………… P48,180

Less: Pesos payable to XD…………………… Forward Contract (fair value)……………….

P

48,180 0

December 31, 20x4 (Balance Sheet Date an intervening financial reporting date) FC Transaction Loss 360 FC Receivable from XD…………… 294 Account payable……………. 360 FC Transaction Gain [P40.30 – P40.00) x $1,200 To record a gain on foreign To record a loss on the exposed currency to be received from liability denominated in foreign FC dealer. currency. Note: Discounted or present value for hedged item is Gain [(P40.40 – P40.15) x $1,200]............ not necessary for exposed asset or liability since spot Less: Discount (P300 x 12% x 2/12)…………… Rate is in effect. Present value of gain*…………………………. * or P300 x 1 / (1.02); 2% represents 12%/12 = 1% x 2 months = 2%

294

P 300 ____6 P294

If the financial statements are prepared on December 31, 20x4, the value of the forward contract is as follows: Balance Sheet Presentation on 12/31/20x4 FC Receivable from XD (P40.40 x $1,200)- P6. P48,474 Less: Pesos payable to XD (fixed at P40.15)… 48,180 Forward Contract (fair value – asset)……… P 294

On March 1, 20x5 (the transaction date and the settlement date), the journal entries are: March 1, 20x5 Settlement Date/Date of Expiration of Contract

Settlement Date

Accounts payable 120 FC Transaction gain……. 120 [(P40.20 – P40.30) x $1,200}…….. To record a gain from 12/31/x4 to 3/1/x5 on liability denominated in FC. Note: Discounted or present value for hedged item is not necessary for exposed asset or liability since spot rate is in effect.

Accounts payable…………………… Cash (refer to note below)……… To record payment of accounts payable at spot rate.

48,240

48,240

FC Transaction Loss FC Receivable from XD To record a loss on foreign currency to be received from FC dealer.

234

Overall gain (P40.20 – P40.15) x $1,200 …….. Less: 12/31/20x4 Gain at present value…….. FC Transaction loss……………………………… Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

48,180

Investment in FC……………………. FC Receivable from XD To record receipt of foreign Currency.

48,240

234

P 60 __294 P234

48,180

48,240

Cash……………………………………. 48,240 Investment in FC…………………. 48,240 To record conversion of US dollars into cash for payment of accounts payable. Note: This entry may be ignored and instead the Investment in FC will be outright credited in payment of accounts payable. For succeeding illustrations the conversion of FC to peso cash to settle items acquired will be used.

a.

b.

a.1. a.2. a.3. a.4. a.5. a.6. b.1.

P360 loss P294 gain P360 loss – P294 gain = P66 net loss (decrease in net income) P120 gain - [(P40.20 – P40.30) x $1,200} P234 loss P234 loss – P120 gain = P114 net loss (decrease in net income)

Net Method: Zero. No entry required. Gross Method FC Receivable from XD……………………… Less: Pesos payable to XD…………………… Forward Contract (fair value)……………….

P48,180 48,180 P 0

b.2. P294 asset Gross method

FC Receivable from XD (P40.40 x $1,200)- P6. Less: Pesos payable to XD (fixed at P40.15)… Forward Contract (fair value – asset)………

P48,474 48,180 P 294

Net Method: P294.

Forward contract (debit balance – asset)…

P 294

b.3. P60 debit balance – asset Gross method

FC Receivable from XD (P40.20 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

Net Method 12/31/x4 Gain… 3/1/x5 Net……

300 60

P48,240 48,180 P 60

Forward Contract (Asset/Liability) 240… …..3/1/x5 Loss

2. Fair Value Hedge – Hedging an Unrecognized Foreign Currency Firm Commitment. The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – (Unrecognized Foreign Currency Firm Commitment)

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting)

December 1, 20x4 Date of Commitment (Date of Issuing the Purchase Order) Date of Inception/Hedging of 90 days Forwards No journal entry is required to record the firm commitment. The forward contract is designated as a hedge of the firm commitment to purchase inventory on March 1, 20x5. The hedge is accounted for as a fair value hedge.

FC Receivable from XD…………… Pesos Payable to XD (P40.15 x $1,200) To record forward contract to buy $1,200 using forward rate.

48,180

This is computed using the change in the forward rate. These entries are as follows: December 31, 20x4 (Balance Sheet Date, an intervening financial reporting date)

48,180

FC Transaction Loss 294 Firm Commitment [P40.40 – P40.15) x $1,200 To record a loss on firm commitment using the change in the forward rate. Loss…………………………………..................... Less: Discount (P300 x 12% x 2/12)…………… Present value of loss*………………………….

FC Receivable from XD…………… 294 FC Transaction Gain 294 [(P40.40 – P40.15) x $1,200] To record a gain on foreign currency to be received from FC dealer. P 300 Gain [(P40.40 – P40.15) x $1,200] P 300 ____6 Less: Discount (P300 x 12% x 2/12)…………….. ____6 P294 Present value of gain*…………………………… P294 * or P300 x 1 / (1.02); 2% represents 12%/12 = 1% x 2 months = 2% 294

Balance Sheet Presentation on 12/31/20x4 Assets Liability FC Receivable from XD (P40.40 x $1,200) - P6…P48,474 Firm Commitment…………………………………...P 294 Less: Pesos Payable to XD(fixed at P40.15)….… 48,180 Forward Contract (fair value)……………………P 294

On March 1, 20x5 (the transaction date and the settlement date), the journal entries are: Date of Transaction and Settlement Firm Commitment………… FC Transaction gain……. To record a gain on fair value of firm commitment.

234

Overall loss (P40.20 – P40.15) x $1,200 ……….. Less: 12/31/20x4 Gain at present value……… FC Transaction Gain……………………………..

Inventory (P40.20 x $1,200)…………. Cash ………………………………… To record the purchase of inventory for $1,200 at spot rate.

48,240

March 1, 20x5 Settlement Date/Date of Expiration of Contract

234

P 60 __294 P234

48,240

FC Transaction Loss …………… 234 FC Receivable from XD……… To record a loss on foreign currency to be received from exchange dealer. Overall gain (P40.20 – P40.15) x $1,200 …….. Less: 12/31/20x4 Gain at present value…….. FC Transaction loss……………………………… Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

48,180

Investment in FC……………………. FC Receivable from XD To record receipt of foreign currency.

48,240

Cash……………………………………. Investment in FC……………..…... To record conversion of US dollars into cash for purchase of inventory.

48,240

234

P 60 __294 P234

48,180

48,240

48,240

Firm Commitment……………………. Inventory……………………………. To remove the carrying amount of the firm commitment from the balance sheet6 and adjust the initial carrying amount of the inventory that results from the firm commitment. This treatment is an accordance with PAS 39 par. 89b.

60

60

Firm Commitment 3/1/x5 Gain……. 234 294… …..12/31/x4 Loss 60 60 3/1/x5 Net

a.

a.1. P294 loss

Foreign Currency Exchange Loss [(P40.40 – P40.15) x $1,200]………… Less: Discount (P300 x 12% x 2/12)…………………………………………… Present value of loss*……………………………………………………………

P 300 ____6 P294

Foreign Currency Exchange Gain [(P40.40 – P40.15) x $1,200]………. Less: Discount (P300 x 12% x 2/12)…………………………………………… Present value of gain*…………………………………………………………

P 300 ____6 P294

Overall loss (P40.20 – P40.15) x $1,200 ……………………………………… Less: 12/31/20x4 Gain at present value……………………………………. FC Transaction Gain…………………………………………………………….

P 60 __294 P234

Overall gain (P40.20 – P40.15) x $1,200 …….. Less: 12/31/20x4 Gain at present value…….. FC Transaction loss………………………………

P 60 __294 P234

a.2. P294 gain

a.3. P294 loss(a.1) – P294 gain (a.2) = P0 a.4. P234 gain

a.5. P234 loss

a.6. P234 gain (a.4) – P234 loss (a.5) = P0 b.

b.1. Zero, no entry required b.2. P294 liability

Foreign Currency Exchange Loss [(P40.40 – P40.15) x $1,200]………… Less: Discount (P300 x 12% x 2/12)…………………………………………… Present value of loss* / Firm Commitment………………………………….

b.3. P60 - liability

P 300 ____6 P294

Firm Commitment 3/1/x5 Gain……. 234 294… …..12/31/x4 Loss 60 3/1/x5 Net

c.

c.1.

Net Method: Zero. No entry required. Gross Method FC Receivable from XD……………………… Less: Pesos payable to XD…………………… Forward Contract (fair value)……………….

c.2. P294 asset

P48,180 48,180 P 0

Gross method

FC Receivable from XD (P40.40 x $1,200)- P6. Less: Pesos payable to XD (fixed at P40.15)… Forward Contract (fair value – asset)………

P48,474 48,180 P 294

Net Method: P294.

Forward contract (debit balance – asset)…

P 294

c.3. P60 debit balance – asset Gross method

FC Receivable from XD (P40.20 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

Net Method 12/31/x4 Gain… 3/1/x5 Net……

300 60

P48,240 48,180 P 60

Forward Contract (Asset/Liability) 240… …..3/1/x5 Loss

3. Cash Flow Hedge - Hedge of a Forecasted Transaction. The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – Forecasted Transaction Date of Forecast

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting) December 1, 20x4 Date of Inception/Hedging of 90 days Forwards

No journal entry is required to record the forecasted transaction. The forward contract is designated as a hedge against the exposure to increases in the dollar rate on March 1, 20x5.

FC Receivable from XD…………… Pesos Payable to XD (P40.15 x $1,200) To record forward contract to buy $1,200 using forward rate.

48,180

48,180

December 31, 20x4 (Balance Sheet Date, an intervening financial reporting date) No entry required, since it is only a forecasted transaction not guaranteed such as firm commitment.

FC Receivable from XD…………… 294 OCI – Exchange Gain (B/S)….... 294 To record a gain on foreign currency to be received from FC dealer. Gain [(P40.40 – P40.15) x $1,200] P 300 Less: Discount (P300 x 12% x 2/12)…………….. ____6 Present value of gain*…………………………… P294 * or P300 x 1 / (1.02); 2% represents 12%/12 = 1% x 2 months = 2% Balance Sheet Presentation on 12/31/20x4 FC Receivable from XD (P40.40 x $1,200)-P6 P48,474 Less: Pesos payable to XD (fixed at P40.15) 48,180 Forward Contract (fair value - asset)…..….. P 294

On March 1, 20x5 (the transaction date and the settlement date), the journal entries are: Date of Transaction and Settlement

March 1, 20x5 Settlement Date/Date of Expiration of Contract OCI – Exchange Loss (B/S)………. FC Receivable from XD………

234

234

To record a loss on foreign currency to be received from FC dealer. Overall gain (P40.20 – P40.15) x $1,200 …….. Less: 12/31/20x4 Gain at present value…….. FC Transaction loss………………………………

Machinery (P40.20 x $1,200)………... Cash ………………………………… To record the purchase of equipment for $1,000 at the spot rate of P40.20

48,240

OCI – Exchange Gain……………….. Machinery………………………….. To remove the gain recognized in OCI and adjust the carrying amount if the machine that results from the hedged transaction by this amount. Also, to record the basis adjustment of the carrying value of the equipment. This entry is recorded if PAS 39 par. 98b is adopted.

60

a.

48,240

60

Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

48,180

Investment in FC……………………. FC Receivable from XD To record receipt of foreign currency.

48,240

Cash……………………………………. Investment in FC…………………. To record conversion of US dollars into cash for purchase of machinery.

48,240

3/1/x5

P 60 __294 P234

48,180

48,240

48,240

Other Comprehensive Income Loss 234 294… ….12/31/x4 Gain 60 60 3/1/x5

a.1. Gain or loss on hedged item, 3/1/20x4: None, no entry required. a.2. P294 gain, other comprehensive income Foreign Currency Exchange Gain [(P40.40 – P40.15) x $1,200]………. Less: Discount (P300 x 12% x 2/12)…………………………………………… Present value of gain*…………………………………………………………

P 300 ____6 P294

a.3. None a.4. Gain or loss on hedged item, 3/1/20x4: None, no entry required for gain or loss. The only entry is to record the purchase of machinery. a.4. P234 gain

Overall loss (P40.20 – P40.15) x $1,200 ……………………………………… Less: 12/31/20x4 Gain at present value……………………………………. FC Transaction Gain…………………………………………………………….

P 60 __294 P234

a.5. P234 loss, other comprehensive income – {[(P40.40 – P40.20) x $1,200] – P6} to be recorded on March 1, 20x5. The balance of the OCI – gain amounted to P60 computed as follows: 3/1/x5

b.

Other Comprehensive Income Loss 234 294… ….12/31/x4 Gain 60 3/1/x5

b.1.

Net Method: Zero. No entry required. Gross Method FC Receivable from XD……………………… Less: Pesos payable to XD…………………… Forward Contract (fair value)……………….

P48,180 48,180 P 0

b.2. P294 asset Gross method

FC Receivable from XD (P40.40 x $1,200)- P6. Less: Pesos payable to XD (fixed at P40.15)… Forward Contract (fair value – asset)………

P48,474 48,180 P 294

Net Method: P294.

Forward contract (debit balance – asset)…

b.3. P60 debit balance – asset Gross method

FC Receivable from XD (P40.20 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

Net Method 12/31/x4 Gain… 3/1/x5 Net……

300 60

P 294

P48,240 48,180 P 60

Forward Contract (Asset/Liability) 240… …..3/1/x5 Loss

4. Not a Hedge Accounting – Speculation. The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item - Speculation

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting) December 1, 20x4 Date of Inception/Hedging of 90 days Forwards FC Receivable from XD…………… Pesos Payable to XD (P40.15 x $1,200) To record forward contract to buy $1,000 using forward rate.

48,180

48,180

December 31, 20x4 (Balance Sheet Date an intervening financial reporting date) FC Receivable from XD 294 FC Transaction Gain 294 To record a gain on foreign currency to be received from FC dealer. Gain [(P40.40 – P40.15) x $1,200] P 300 Less: Discount (P300 x 12% x 2/12)…………….. ____6 Present value of gain*…………………………… P294 * or P300 x 1 / (1.02); 2% represents 12%/12 = 1% x 2 months = 2% Balance Sheet Presentation on 12/31/20x4 FC Receivable from XD (P40.40 x $1,200)-P6 P48,474 Less: Pesos payable to XD (fixed at P40.15) 48,180 Forward Contract (fair value – asset)……… P 294

March 1, 20x5 Settlement Date/Date of Expiration of Contract FC Transaction Loss………………… 234 FC Receivable from XD…………. To record a loss on foreign currency to be received from FC dealer. Overall gain (P40.20 – P40.15) x $1,200 …….. Less: 12/31/20x4 Gain at present value…….. FC Transaction loss………………………………

a.

Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

48,180

Investment in FC……………………. FC Receivable from XD To record receipt of foreign currency.

40,200

Cash……………………………………. Investment in FC…………………. To record conversion of US dollars into cash.

48,240

a.1. P294 gain

Foreign Currency Exchange Gain [(P40.40 – P40.15) x $1,200]………. Less: Discount (P300 x 12% x 2/12)…………………………………………… Present value of gain*…………………………………………………………

P 300 ____6 P294

Overall gain (P40.20 – P40.15) x $1,200 …….. Less: 12/31/20x4 Gain at present value…….. FC Transaction loss………………………………

P 60 __294 P234

a.3. P294 gain. a.5. P234 loss – other comprehensive income

b.

b.1. Zero, no entry required b.2. P294 liability

Foreign Currency Exchange Loss [(P40.40 – P40.15) x $1,200]………… Less: Discount (P300 x 12% x 2/12)…………………………………………… Present value of loss* / Firm Commitment………………………………….

b.3. P60 - liability

P 300 ____6 P294

Firm Commitment 3/1/x5 Gain……. 234 294… …..12/31/x4 Loss 60 3/1/x5 Net

c.

c.1.

Net Method: Zero. No entry required. Gross Method FC Receivable from XD……………………… Less: Pesos payable to XD…………………… Forward Contract (fair value)……………….

P48,180 48,180 P 0

234

P 60 __294 P234

48,180

40,200

48,240

c.2. P294 asset Gross method

FC Receivable from XD (P40.40 x $1,200)- P6. Less: Pesos payable to XD (fixed at P40.15)… Forward Contract (fair value – asset)………

P48,474 48,180 P 294

Net Method: P294.

Forward contract (debit balance – asset)…

P 294

c.3. P60 debit balance – asset Gross method

FC Receivable from XD (P40.20 x $1,200)… Less: Pesos payable to XD (fixed at P40.15) Forward Contract (fair value – asset)………

Net Method 12/31/x4 Gain… 3/1/x5 Net……

300 60

P48,240 48,180 P 60

Forward Contract (Asset/Liability) 240… …..3/1/x5 Loss

Problem III The following relevant exchange rates are needed for further analysis in relation to hedged item and hedging instrument:

November 1, 20x4…………………. December 31, 20x4…………………. March 1, 20x5…………………………………… August 1, 20x5………………………………..

Spot Rate P40.60 P40.75 P40.70 P41.55****

Forward Rate for 8/1/20x5 Settlement (or Expiration) P41.25 (*270 days) P41.00 (**210 days) P40.95 (***150 days)

*original 270-day forward rate on 12/1/20x4 **remaining or current forward rate on 12/31/20x4 ***remaining or current forward rate on 3/1/20x5 ***the forward rate at expiration or maturity is equal to spot rate as the remaining period of the forward contract is zero.

The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – (Unrecognized Foreign Currency Firm Commitment)

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting)

November 1, 20x4 Date of Commitment (Date of Issuing the Purchase Order) Date of Inception/Hedging of 270 days Forwards No journal entry is required to record the firm commitment. The forward contract is designated as a hedge of the firm commitment to purchase inventory on March 1, 20x5. The hedge is accounted for as a fair value hedge.

FC Receivable from XD…………… Pesos Payable to XD (P41.25 x $1,200) To record forward contract to buy $1,200 using forward rate.

49,500

49,500

December 31, 20x4 (Balance Sheet Date, an intervening financial reporting date) Firm Commitment ……………………. FC Transaction Gain……………... [P41.25 – P41.00) x $1,200 To record a loss on firm

300

300

FC Transaction Loss……………….. FC Receivable from XD………… (P41.25 – P41.00) x $1,200] To record a loss on foreign

300

300

commitment using the change in the forward rate.

currency to be received from FC dealer.

Assets Firm Commitment…………………………………...P 300

Liability Pesos payable to XD (fixed at P41.25)………..P 49,500 Less: FC Receivable from XD (at spot rate)…. 49,200 Forward Contract (fair value)………………….P 300

On March 1, 20x5 (the transaction date), the journal entries are: Transaction Date (Exposed Liability) Inventory (P40.70 x $1,200)…………. Accounts payable………………. (P40.70 x $1,200) To record the purchase of inventory for $1,200 at spot rate and recognize accounts payable.

48,840

Inventory ……………………………… Firm Commitment ……………….. To remove the carrying amount of the firm commitment from the balance sheet6 and adjust the initial carrying amount of the inventory that results from the firm commitment. This treatment is an accordance with PAS 39 par. 89b.

300

March 1, 20x5

48,840

300

Firm Commitment 12/31/x4 Gain….. 300 3 / 1/x5 300 300 August 1, 20x5 Settlement Date/Date of Expiration of Contract

Settlement Date FC Transaction Loss………………… Accounts payable…. [(P41.55 – P40.70) x $1,200}…….. To record a loss from 3/1/x5 to 8/1/x5 on liability denominated in FC.

Accounts payable…………………… Cash…………………………………. To record payment of accounts payable at spot rate.

Problem IV

1,020

49,860

1,020

49,860

FC Receivable from XD……………. FC Transaction Gain……………. [(P41.55 – P41.00) x $1,200] To record a gain on foreign currency to be received from FC dealer.

660

Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

49,500

Investment in FC……………………. FC Receivable from XD To record receipt of foreign currency.

49,860

Cash……………………………………. Investment in FC…………………. To record conversion of US dollars into cash for payment of accounts payable.

49,860

660

49,500

49,860

49,860

The following relevant exchange rates are needed for further analysis in relation to hedged item and hedging instrument:

December 1, 20x4…………………………. December 31, 20x4…………………………. March 1, 20x5…………………………………..

Spot Rate P40.00 P40.30 P40.20***

Forward Rate for 3/1/20x5 Settlement (or Expiration) P40.15 (*90 days) P40.40 (**60 days)

*original 90-day forward rate on 12/1/20x4 **remaining or current forward rate on 12/31/20x4 ***the forward rate at expiration or maturity is equal to spot rate as the remaining period of the forward contract is zero.

The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – Forecasted Transaction Date of Forecast

Hedging Instrument – Forward Contracts ( Broad Approach or Gross Position Accounting) December 1, 20x4 Date of Inception/Hedging of 90 days Forwards

No journal entry is required to record the forecasted transaction. The forward contract is designated as a hedge against the exposure to increases in the dollar rate on March 1, 20x5.

FC Receivable from XD…………… Pesos Payable to XD (P40.15 x $1,200) To record forward contract to buy $1,200 using forward rate.

48,180

48,180

December 31, 20x4 (Balance Sheet Date, an intervening financial reporting date) No entry required, since it is only a forecasted transaction not guaranteed such as firm commitment.

FC Receivable from XD OCI – Exchange Gain (B/S) [(P40.40 – P40.15) x $1,200] To record a gain on foreign currency to be received from FC dealer. FC – foreign currency; OCI - Other Comprehensive Income; B/S – Balance Sheet

300

300

Notice that unlike the fair value hedge, there is no offsetting firm commitment entry since this is a forecasted transaction. The exchange gain or loss is reported in comprehensive income and will affect the income statement when the inventory is eventually sold. On the balance sheet, the forward contract is reported as an asset at its fair value of P300, and the offsetting amount is reported in other comprehensive income (as a gain). Balance Sheet Presentation on 12/31/20x4 FC Receivable from XD (P40.40 x $1,200)… P48,480 Less: Pesos payable to XD (fixed at P40.15) 48,180 Fair value of Forward Contract, 12/1/20x4.. P 300

On March 1, 2011 (the transaction date and the settlement date), the journal entries are: Date of Transaction and Settlement

March 1, 20x5 Settlement Date/Date of Expiration of Contract OCI – Exchange Loss (B/S)……… FC Receivable from XD……… [(P40.40 – P40.20) x $1,200] To record a loss on foreign

240

240

currency to be received from FC dealer.

Inventory (P40.20 x $1,200)………... Cash ………………………………… To record the purchase of merchandise for $1,200 at the spot rate of P40.20

48,240

48,240

Pesos Payable from XD……………. Cash………………………………. To record payment to exchange dealer.

48,180

Investment in FC……………………. FC Receivable from XD To record receipt of foreign currency.

48,240

Cash……………………………………. Investment in FC…………………. To record conversion of US dollars into cash for purchase of machinery.

48,240

48,180

48,240

48,240

Suppose that in April 1, 20x5, the inventory is sold for P54,000 cash. The entries to record the sale and to reclassify the amounts from Other Comprehensive Income (a P50 gain, including P250 gain on December 31, 20x4, plus the P200 loss on March 1, 20x5) into earnings are as follows: April 1, 20x5 Settlement Date/Date of Expiration of Contract

Date of Transaction (Sale) Cash………... Sales………………………………… To record the sale of merchandise.

54,000

Cost of goods sold…………………… Inventory, at cost………………… To record cost of sales.

48,240

OCI – Exchange Loss……………….. Cost of goods sold....................... To remove the gain recognized in OCI and release the OCI to profit or loss. This entry is recorded in accordance with PAS 39 par. 98a is adopted.

60

54,000

48,240

60

3/1/x5

Other Comprehensive Income Loss 240 300… ….12/31/x4 Gain 60 60 3/1/x5

Problem V 1. Indirect exchange rates for Australian dollars were: December 1, 20x4: FC70,000 / P42,000 = 1.667 [P1 equals FC 1.667] December 31, 20x4: FC70,000 / P41,700 = 1.679 [P1 equals FC 1.679] 2.

The balance in the account Foreign Currency Payable to Exchange Broker was P39,900 at December 31, 20X5, computed as: P39,900 = FC 70,000 x P.57 Dec. 31 forward rate

3.

The direct exchange rate for the 60-day forward contract for the 70,000 foreign currency (FC) was FC 1 = P.58. This is the result of the following computation: (P40,600 / FC 70,000) = P.58.

4.

P40,600 is the amount of Pesos Receivable from Exchange Broker in the adjusted trial balance at December 31, 20x4. The balance in this account does not change because it is denominated in Philippine peso.

5.

Indirect spot exchange rates for FC2 were: October 2: FC2 400,000 / P80,000 = 5 [P1 equals FC2 5] December 31: FC2 400,000 / P80,800 = 4.950 [P1 equals FC2 4.950] Or, 4.950 = FC2 1 / P.2020

6.

The Pesos Payable to Exchange Broker was P82,000 in both the adjusted and unadjusted trial balances. The entry to record the forward contract for the 400,000 FC2 on October 2, 20x4, appears below. Note that the account Pesos Payable to Exchange Broker is denominated in pesos and does not change as a result of exchange rate changes. Foreign Currency Receivable from Exchange Broker (FC2) Pesos Payable to Exchange Broker (P)

82,000

82,000

7.

The direct exchange rate for the 120-day forward contract in FC2 on October 2, 20x4, was P.205. This amount is determined in the following manner: P82,000 / FC2 400,000 = P.205. The P82,000 is the amount of the pesos payable to exchange broker. This amount is computed by using the forward rate.

8.

The accounts payable balance was P80,800 at December 31, 20x4. P80,800 = FC2 400,000 x P.2020 Dec. 31 spot rate The entries to support the computations for are presented below: 1. Transactions with Foreign Company 1 (FC1) December 1, 20x4 Accounts Receivable (FC1) Sales P42,000 = FC1 70,000 x (P1/FC1 1.667) Pesos Receivable from Exchange Broker Foreign Currency Payable to Exchange Broker (FC1) P40,600 = FC1 70,000 x P.58 Dec. 1 forward rate, and also peso amount stated in problem information (P.58 = P40,600 / FC1 70,000) December 31, 20x4 Foreign Currency Transaction Loss Accounts Receivable (FC1) P300 = change in accounts receivable (FC1) as noted in problem information. Foreign Currency Payable to Exchange Broker Foreign Currency Transaction Gain P39,900 = FC1 70,000 x P.57 Dec. 31 forward rate

42,000

42,000

40,600 40,600

300

700

300

700

- 40,600 = FC1 70,000 x P.58 Dec. 1 forward rate P 700 = FC1 70,000 x (P.57 - P.58) 2.

Transactions with Foreign Company 2 (FC2) October 2, 20x4 Equipment Accounts Payable (FC2) P80,000 = FC2 400,000 x P.20

80,000

Foreign Currency Receivable from Exchange Broker (FC2) Pesos Payable to Exchange Broker P82,000 = FC2 400,000 x P.2050, and the P82,000 is presented in the problem for the foreign currency receivable.

82,000

December 31, 20x4 Foreign Currency Transaction Loss Accounts Payable (FC2) P80,800 = FC2 400,000 x P.202 Dec. 31 spot rate - 80,000 = FC2 400,000 x P.200 October 2 spot rate P 800 = FC2 400,000 x (P.202 - P.200) Foreign Currency Transaction Loss Foreign Currency Receivable from Exchange Broker P81,000 = FC2 400,000 x P.2025 Dec. 31 forward rate - 82,000 = FC2 400,000 x P.2050 Oct. 2 forward rate P 1,000 = FC2 400,000 x (P.2025 - P.2050)

80,000

82,000

800

800

1,000 1,000

Problem VI Based on the data given, the following situations can be derived:

12/ 1/20x4 12/31/20x4 3/ 1/20x5

Market or Spot Rate P1.20 P1.28 P1.27

Strike price (exercise price or option price) P1.20 P1.20 P1.20

Foreign Currency Option Situation At-the-money In-the-money In-the-money

Element Existing TV TV & IV IV***

Time Value** P360 P240 P 0

TV – time value; IV – intrinsic value. * (Market price less – option price) x foreign currencies ** Fair value of option – intrinsic value ***time already expired, so need to determine time value unless It is a residual amount.

Intrinsic Value* P 0 P4,800 P4,200

The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – Importing Transaction (Exposed Liability) Transaction Date Inventory (60,000 FC x P1.2)……….. Accounts payable……………….

72,000

Hedging Instrument – Option Contracts December 1, 20x4 Date of Inception/Hedging of 90 days Forwards

72,000

Investment in FC Call Option…….. Cash………………………………..

360

360

To record purchase of goods on account using the spot rate on 12/1/1/x4.

To record purchase of call option.

December 31, 20x4 (Balance Sheet Date an intervening financial reporting date) FC Transaction Loss………………….. Account payable………………… [P1.28 – P1.20) x 60,000 FC To record a loss on the exposed liability denominated in foreign currency.

4,800

4,800

Investment in FC Call Option…… FC Transaction Gain…. (P5,040 – P360 = P4,680) To record a gain on call option.

4,680

4,680

On March 1, 20x5 (the transaction date and the settlement date), the journal entries are: March 1, 20x5 Settlement Date/Date of Expiration of Contract

Settlement Date Accounts payable……………. FC Transaction gain……. [(P1.28 – P1.27) x 60,000 FC…….. To record a gain from 12/31/x4 to 3/1/x5 on liability denominated in FC.

600

Accounts payable…………………… Cash [(P1.20 x 60,000 FC) + P4,200, proceeds from call option]………………………….. To record payment of accounts payable at spot rate.

76,200

600

76,200

FC Transaction Loss…………………. Investment in FC Call Option… (P5,040 – P4,200) To record a loss on call option

840

Cash……………………………………. Investment in FC Call Option… To record the derecognition of call option on realization.

4,200

840

4,200

Problem VII The following table summarizes the succeeding journal entries in relation to hedged item and hedging instrument:

Date 11/20/x4 12/20/x4

Firm Commitment Total Spot Fair Change in Rate value Fair Value P0.20 P0.21 (P 600)* (P 600)**

Call Option (CO)Premium per FC P.002 P.010***

Call Option Contract (CO Premium x FCs) Fair Value of Call Option P120 P600

Change in Fair Value P480

* $12,000 – $12,600 = $(600). **(P0.21 – P0.20, spot) x 60,000 FC. ***The premium on 12/20 for an option that expires on that date is equal to the option’s intrinsic value. Given the spot rate on 12/20 of P.21, a call option with a strike price of P.20 has an intrinsic value of P.01 per mark.

Based on the above data, the following situations can be derived:

11/20/20x4 12/20/20x4

Market or Spot Rate P0.20 P0.21

Strike price (exercise price or option price) P0.20 P0.20

Foreign Currency Option Situation At-the-money In-the-money

TV – time value; IV – intrinsic value. * (Market price less – option price) x foreign currencies ** Fair value of option – intrinsic value

Element Existing TV IV

Time Value** P120 P 0

Intrinsic Value* P 0 P 600

The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – Importing Transaction (Firm Commitment) Hedging Instrument – Option Contracts November 20, 20x4 Date of Commitment Date of Inception/Hedging of 90 days Forwards

There is no entry to record the sales agreement because it is an executory contract.

Date of Transaction and Settlement FC Loss on Firm Commitment……… Firm Commitment………………… [(P.21 – P0.20) x 60,000 FC] To record loss on firm commitment based on spot rate.

600

Equipment…………………………….. Cash [(P0.20 x 60,000 FC) + P600, proceeds from call option]………………………….. To record purchase of equipment at spot rate (P.21 x 60,000 FC)

12,600

Firm Commitment …………………… Equipment…………………………. To derecognized firm commitment and adjust the carrying amount of equipment.

600

Investment in FC Call Option…… Cash………………………………. To record purchase of call option.

120

120

December 20, 20x4 Settlement Date/Date of Expiration of Contract

600

12,600

Investment in FC Call Option…… FC Transaction Gain…. (P600 – P480 = P100) To record a gain on call option.

120

Cash……………………………….. Investment in FC Call Option To record the derecognition of call option on realization.

600

120

600

600

Problem VIII The relevant exchange rates and option premiums are as follows: 11/20/20x4 P0.20 0.20 P480

Spot rate (market price) Strike price (exercise price) Fair value of call option

N/A – not applicable

12/20/20x4 P0.18 0.20 N/A

The following table summarizes the succeeding journal entries in relation to hedged item and hedging instrument:

Date 11/20/x4 12/31/x4

Firm Commitment Total Spot Fair Change in Rate value Fair Value P0.20 P0.18 P1,200* P1,200**

Call Option (CO)Premium per FC P.002 P.000***

Call Option Contract (CO Premium x FCs) Fair Value of Call Option P120 P 0

Change in Fair Value (P120)

* P12,000 – P10,800 = P1,200 **(P.20 – P.18) x 60,000 FC ***The premium on 12/20 for an option that expires on that date is equal to the option’s intrinsic value. Given the spot rate on 12/20 of P.18, a call option with a strike price of P.20 has no intrinsic value – the premium on 12/20 is P.000.

Based on the above data, the following situations can be derived:

11/20/20x4 12/20/20x4

Market or Spot Rate P0.20 P0.18

Strike price (exercise price or option price) P0.20 P0.20

Foreign Currency Option Situation In-the-money In-the-money

TV – time value; IV – intrinsic value. * (Market price less – option price) x foreign currencies ** None since the option price is greater than the market price.

Element Existing TV & IV IV

Time Value** P120 P 0

Intrinsic Value* P 0 P 0

The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – Importing Transaction (Firm Commitment) Hedging Instrument – Option Contracts November 20, 20x4 Date of Commitment Date of Inception/Hedging of 90 days Forwards

There is no entry to record the sales agreement because it is an executory contract.

Date of Transaction and Settlement Firm Commitment……… FC Gain on Firm Commitment [(P0.20 – P0.18) x 60,000 FC] To record loss on firm commitment based on spot rate.

1,200

Equipment…………………………….. Cash [(P0.20 x 60,000 FC) + P0, no proceeds from call option]………………………….. To record purchase of equipment at spot rate (P.21 x 50,000 FC)

12,000

Equipment……….…………………… Firm Commitment………………. To derecognized firm commitment and adjust the carrying amount of equipment.

Investment in FC Call Option…… Cash………………………………. To record purchase of call option.

120

120

December 20, 20x4 Settlement Date/Date of Expiration of Contract

1,200

1,200

12,000

FC Transaction Loss……….…… Investment in FC Call Option (P120 – P0 = P120) To record a gain on call option.

120

120

No entry required since the Investment in call option has no value.

1,200

Problem IX Based on the data given in the problem, the following situations can be derived:

1/ 1/20x4 6/30/20x4 12/31/20x4

Market or Spot Rate P1.15 P1.18 P1.17

Strike price (exercise price or option price) P1.14 P1.14 P1.14

Foreign Currency Option Situation In-the-money In-the-money In-the-money

Element Existing TV & IV TV & IV IV***

Time Value** P8,400 P4,800 P 0

TV – time value; IV – intrinsic value. * (Market price less – option price) x foreign currencies ** Fair value of option – intrinsic value ***time already expired, so need to determine time value unless It is a residual amount.

Intrinsic Value* P12,000 P48,000 P36,000

The journal entries to record the hedged item and hedging instrument are as follows: Hedged Item – Importing Transaction (Forecasted Transaction) Transaction Date

Hedging Instrument – Option Contracts December 1, 20x4 Date of Inception/Hedging of 90 days Forwards

No journal entry is required to record the forecasted transaction. The forward contract is designated as a hedge against the exposure to increases in the dollar rate on March 1, 20x5.

Investment in FC Call Option…….. Cash……………………………….. To record purchase of call option.

20,400

20,400

December 31, 20x4 (Balance Sheet Date an intervening financial reporting date) No entry required, since it is only a forecasted transaction not guaranteed such as firm commitment.

Investment in FC Call Option…….. OCI – FC Transaction Gain (B/S) [P1.18 – P1.14) x 1,200,000 = P52,800 – P20,400 = P32,400] To record a gain on call option.

32,400

OCI – FC Transaction Gain (B/S) FC Transaction Gain To reclassify 80% of OCI to earnings (720,000 /900,000) = 80% ; (80% × P32,400 = P25,920)

25,920

32,400

25,920

On December 31, 20x4 (the transaction date and the settlement date), the journal entries are: Date of Transaction and Settlement

December 31, 20x4 Settlement Date/Date of Expiration of Contract FC Transaction Loss…………………. Investment in FC Call Option… [(P1.17 – P1.14) x 1,200,000 baht = P36,000 – P52,800] To record a loss on call option

16,800

OCI – FC Transaction Gain (B/S)…. FC Transaction Gain………….… To record reclassify the remaining P6,480 of FC gain from OCI to earnings (180,000/900,000 x P32,400).n This entry is recorded if PAS 39 par. 98b is adopted.

6,480

Cash……………………………………. Investment in FC Call Option… [(P1.17 – P1.14) x 1,200,000 baht] To record the derecognition of call option on realization.

36,000

16,800

6,480

36,000

Multiple Choice Problems 1. c Peso Value in 3 months = 3,750 + 37.50 = 3,787.50 FC Value in 3 months = 5,000 + 87.50 = 5,087.50 Fwd rate 3,787.50 ÷ 5,087.50 = .745 2. e Pound should be FCU 11/10/x6: Original forward rate on the date of hedging..……………………….P 1.64 Balance Sheet date: Remaining (current) forward rate – 12/31/20x6......……. 1.59 Gain on forward contract per FC………...…………………………………………..P .05 Multiplied by: No. of FCs……………………………………………………………….. 100,000 Gain on forward contract..…………………………………………………………….P 5,000 3. a Euro should be FCU 10/22/x6: Original forward rate on the date of hedging..……………………….P 0.45 Balance Sheet date: Remaining (current) forward rate – 12/31/20x6.………. 0.445 Gain on forward contract per FC…………………………………………………..P .005 Multiplied by: No. of FCs……………………………………………………………….. 100,000 Gain on forward contract.....………………………………………………………….P 500 4. c -15,000,000 x P.0092 5. b - 15,000,000 x P.0094 6. b - 15,000,000 (P.0094 - P.0092) 7. d - 15,000,000 x P.0091 8. c - 15,000,000 (P.0091 - P.0094) 9. a – forward contract is zero on the date of hedging 10. b – since it is a gain (refer to No. 11) therefore the value of forward contract is an asset 11. d - P4,500 - P0 12. c 13. c - P3,000 - P4,500 14. b - 1,000,000 x P1.116 15. d - 1,000,000 x P1.129 16. a - 1,000,000 (P1.129 - P1.116) 17. a - 1,000,000 x P1.138 18. c - 1,000,000 (P1.138 - P1.129) 19. d – forward contract is zero on the date of hedging 20. a 21. b 22. c 23. d - (P8,000 - P6,000) 24. e – there is no fair value of forward contract on the date of hedging. 25. b – (100,000 FCU x P.74, the forward rate on the date of hedging), the entry would be as follows (using the gross or broad approach): Forward contract receivable……………………………………………… 74,000 Pesos payable to exchange dealer……………………………. 74,000 26. d

Original value of Forward Contract Receivable-FC Current (6/30) value of the Fwd Contract Rec-FC Increase in value of Forward Contract Receivable Value of Receivable, discounted at 8%, n 1 Value of receivable

100,000 x .74 = 74,000 100,000 x .75 = 75,000 1,000 1,000 - (1,000 x [.08 ÷ 12]) = 993 74,000 + 993 = 74,993

or, FC Receivable – date of hedging, 6/1 20x4……………………………………...P 74,000 Add: Forward contract gain P1,000 x [1/1 + (8%/12 x 1 month remaining)].. 993 Forward Contract (FC) Receivable, 6/30/20x4…………………………………. P 74,993

27. d January 1: Origininal forward rate on the date of hedging..………………..P 0.94 March 1: Spot rate…………………………………………………………………… 0.93 Gain……………………………………………………………………………………..P 0.01 Multiplied by: No. of FCs……………………………………………………………. 100,000 FC Forward Contract Gain…………………………………………………………P 1,000 28. c Hedging Instrument: January 1: Origininal forward rate on the date of hedging..………………..P 0.94 March 1: Spot rate…………………………………………………………………… 0.93 Gain……………………………………………………………………………………..P 0.01 Multiplied by: No. of FCs……………………………………………………………. 100,000 FC Forward Contract Gain…………………………………………………………P 1,000 Hedged Item: January 1: Spot rate………………………………………………..………………..P 0.945 March 1: Spot rate…………………………………………………………………… 0.930 Loss………………………………………………………………………………………P 0.015 Multiplied by: No. of FCs…………………………………………………………….. 100,000 Foregin currency exchange loss……..………………………………………….. P 1,500 Net loss………………………………………………………………………………….P 500 29. d Hedged Item: January 1: Spot rate………………………………………………..………………..P 0.945 March 1: Spot rate…………………………………………………………………… 0.930 Loss………………………………………………………………………………………P 0.015 Multiplied by: No. of FCs…………………………………………………………….. 100,000 Foreign currency exchange loss……..………………………………………….. P 1,500 30. c – (P.1865 – P.1850) gain x 100,000 FC = P150 gain 31. c – using spot rate 32. c 5/1: Original forward rate (90 days)……..……………………………….P .693 6/30: Current (remaining) forward rate (30 days)……....……………… .695 Forex gain per unit.......……………………………………………………….P .002 Multiplied by: Number of foreign currencies……………………………. 500,000 Foreign exchange gain due to hedging instrument……..……………P 1,000 Less: Discount – P1,000 x 6% x 30/360 days………………………………. 5 PV of foreign exchange gain due to hedging instrument……………P 995 Or, alternatively the computation of present value may also be presented as: Foreign exchange gain………………………………………………...P 1,000 Divided by: [1% + (6%/12 x 1 month = equivalent to 30 days)]….. 1.005 PV of foreign exchange gain due to hedging instrument……….P 995 Note: Since, the discount rate is given it is assumed that all times present value should be computed. Present value for hedged item is not necessary for exposed asset or liability since spot rate is in effect. Unlike, the other types of hedging wherein, forward rates is used to determine the gain or loss on the hedged item 33. c Foreign exchange loss due to Hedged Item: 5/1: Spot rate………………………………………………………………P .687

6/30: Spot rate……………………………………………………………… .691 Forex loss per foreign currency…….……………………………………..P .04 Multiplied by: Number of foreign currencies………………………….. 500,000 Foreign exchange loss due to hedged item ………………………..P 2,000 PV of foreign exchange gain due to hedging instrument (forward contract – refer to No. 32).………………………......... 995 Net Income effect – decrease ………………………………………........ P 1,005 34. d 5/1: Original forward rate (90 days)…..…………………………………….P .693 8/1: Spot rate…………………………………………………………………… .696 Forex gain per currency ……………………………………………………….P .003 Multiplied by: Number of foreign currencies……………………………….. 500,000 Total Foreign Exchange gain due to hedging instrument (forward contract)............................................................................. .....P 1,500 Less: 6/30 cut-off - PV of foreign exchange gain due to hedging instrument (forward contract – refer to No. 32)………………..... 995 August 1 - Foreign exchange gain due to hedging instrument (forward contract)……………………………………………………….P 505 35. e Hedging Instrument: Origininal forward rate on the date of hedging……………………………….P 0.105 Balance Sheet date: Remaining (current) forward rate – 12/3/1/20x4…… 0.095 Loss………………………………………………………………………………………P 0.010 Multiplied by: No. of FCs……………………………………………………………. 50,000 FC Forward Contract Loss…………………………………………………………..P 500 Multiplied by: PV factor……………………………………..………………………. .98,03 Forward contract – a liability account (since it is a loss)………………………P 490.15 36. b – (forward rate > spot rate – premium) seller’s point of view considered as premium revenue since it was sold at a higher rate. 37. b November 1, 20x4: Foreign Currency Receivable from Exchange Broker (FC) 12,600 Pesos Payable to Exchange Broker 12,600 Signed 90-day forward exchange contract to purchase 100,000 FC: P12,600 = 100,000 FC x P.126 forward rate 38. c December 31, 20x4 Foreign Currency Receivable from Exchange Broker (FC) 300 Foreign Currency Transaction Gain 300 Revalue foreign currency receivable to fair value: P300 = 100,000 FC x (P.129 - P.126) 39. b January 30, 20x5 Pesos Payable to Exchange Broker (Pesos) 12,600 Cash 12,600 Deliver pesos to exchange broker in accordance with forward exchange contract: P12,600 = 100,000 FC x P.126 contract rate

40. b January 30, 20x5 Pesos Payable to Exchange Broker (Pesos) 12,600 Cash 12,600 Deliver pesos to exchange broker in accordance with forward exchange contract: P12,600 = 100,000 FC x P.126, the 90-day forward rate 41. a January 30, 20x5 Foreign Currency Transaction Loss 200 Foreign Currency Receivable from Exchange Broker (FC) 200 Adjust foreign currency receivable to current peso equivalent: P12,700 = 100,000 FC x P.127 Jan. 30 spot rate - 12,900 = 100,000 FC x P.129 Dec. 31 forward rate P 200 = 100,000 FC x (P.127 - P.129) Foreign Currency Units 12,700 Foreign Currency Receivable from Exchange Broker 12,700 Receive 100,000 FC from exchange broker: P12,700 = 100,000 FC x P.127 spot rate 42. d PAS 32 and 39 (PFRS 9) requires the FCU payable be recorded at the forward rate on the date of hedging. Letter (d) is the required entry under the old practice wherein the FCU payable are recorded using the spot rate on the date of hedging. 43. b Receivable balance: P319,500 (spot rate on the balance sheet date, P.71 x 450,000 FCU) Gain or loss: P9,000 loss [(P.73 – P.71) x 450,000 FCU] 44. c – (forward rate > spot rate= premium) buyer’s point of view considered as premium expense since it was purchase at a higher rate plus a loss on firm commitment (i.e., P1.21 – P1.20) 45. e Firm Commitment: 11/10/x6: Original forward rate on the date of hedging..……………………….P 1.64 Balance Sheet date: Remaining (current) forward rate – 12/31/206…………. 1.59 Loss on Forward Contract per FC…………………………………………………....P .05 Multiplied by: No. of FCs……………………………………………………………….. 100,000 Loss on forward contract……………………………………………………………….P 5,000 46. e Firm Commitment: 11/10/x6: Original forward rate on the date of hedging..……………………….P 1.64 Balance Sheet date: Remaining (current) forward rate – 12/31/20x6......……. 1.59 Gain on forward contract per FC………...…………………………………………..P .05 Multiplied by: No. of FCs……………………………………………………………….. 100,000 Gain on forward contract..…………………………………………………………….P 5,000 47. b Firm Commitment: 10/22/x6: Original forward rate on the date of hedging..……………………….P 0.45 Balance Sheet date: Remaining (current) forward rate – 12/31/20x6.………. 0.445 Gain on forward contract per FC…………………………………………………..P .005 Multiplied by: No. of FCs……………………………………………………………….. 100,000

Gain on forward contract.....………………………………………………………….P 48. a December 1, 20x6: Spot rate – P1.64 x 100,000....…………............. Less: Firm Commitment – liability (credit balance) 8/3/20x6: Original (120-day) forward rate…………………….P 12/1/20x6: Remaining (60-day) forward rate………………… Loss on Firm Commitment………………………………………....P Multiplied by: No. of FCs…………………………………………… Value of machine...........................………………………………………

500

P164,000 1.60 1.64 0.04 100,000

4,000 P160,000

49. c - refer to No. 48 (Note: There is no more commitment after the date of transaction which is 12/1/20x6) 50. c December 9, 20x6: Spot rate – P2.45 x 100,000……………………… P245,000 Add: Firm Commitment – asset (debit balance) 11/10/20x6: Original (90-day) forward rate…………………….P 2.44 12/9/20x6: Remaining (30-day) forward rate………………… 2.46 Gain on Firm Commitment………………………………………..P 0.02 Multiplied by: No. of FCs…………………………………………… 100,000 2,000 Value of sales, 1/31/20x6…...............…………………………………… P243,000 51. b - refer to No. 50 for computation ((Note: There is no more commitment after the date of transaction which is 12/9/20x6) 52. c - Forward contracts always have a value of P0 at the date they are established 53. a 54. a - P10,000 - P0 55. c - The forward contract gain or loss is offset by the loss or gain on the sales commitment 56. b 57. c - P25,000 - P10,000 58. c - The forward contract gain or loss is offset by the loss or gain on the sales commitment 59. a - (50,000,000 x P.0088) + [50,000,000 (P.0092 - P.0087)] 60. b - Forward contracts always have a value of P0 at the date they are established 61. c 62. d - P7,500 - P0 63. c - The forward contract gain or loss is offset by the loss or gain on the sales commitment 64. d 65. b - P2,500 + P7,500 66. a - The forward contract gain or loss is offset by the loss or gain on the sales commitment 67. b - (2,500,000 x P1.129) + [2,500,000 (P1.139 - P1.138)] 68. b January 31: Spot rate – P1.59 x 100,000………………………............. P159,000 Add: Firm Commitment – asset (debit balance) 11/30/20x3: Original (90-day) forward rate…………………….P 1.65 1/31/20x4: Remaining (30-day) forward rate………………… 1.60 Gain on Firm Commitment………………………………………..P 0.05 Multiplied by: No. of FCs…………………………………………… 100,000 5,000 Value of merchandise, 1/31/20x4……………………………………… P164,000 The entry would be as follows on 1/31/20x4:

Inventory………………………………………………………………… 164,000 Firm Commitment……………………………………………. 5,000 Cash (P1.59 x 100,000)………………………………………. 159,000 69. d – the original (30-day) forward rate on the date of hedging. Thus, Hedged Item (Commitment): Foreign currency exchange loss [(P.28 – P.25) x 100,000 FC]……. 3,000 Firm Commitment………………………………………………. 3,000 Inventory (P.28 x 100,000 FC)……………………………………………28,000 Cash……………………………………………………………….. 28,000 Firm Commitment………………………………………………………… 3,000 Inventory…………………………………………………………..

3,000

Therefore, inventory should be valued at P25,000 (P28,000 – P3,000) 70. e – the inventory should be valued based on the spot rate on the date of transaction since it was assumed that the firm commitment account will be closed through earnings account. Normally, the firm commitment should be closed to the asset account in accordance with PAS 39 par.98b. 71. e - the accounts payable should be valued based on the spot rate on the date of transaction. 72. c Firm Commitment: Original forward rate on the date of hedging…………………………………….P .58 Balance Sheet date: Remaining (current) forward rate – 6/30/20x4…………. .56 Loss on Firm Commitment per FC…………………………………………………..P .02 Multiplied by: No. of FCs……………………………………………………………….. 200,000 Loss on firm commitment……………………………………………………………….P 4,000 Loss on commitment (debit) results in a credit to Firm Commitment, thus: Loss on Firm Commitment…………………………………………… 4,000 Firm Commitment (a liability account)…………………….. 4,000 73. b Fwd value 4/1 Fwd value 6/30 Decrease in Fair Value of Payable PV of change: 4,000 ÷ 1.01 [n 1; i (.12 ÷ 12) = .01]

200,000 x 0.58 200,000 x 0.56

116,000 112,000 4,000 3,960

Current value of fwd contract = 116,000 - 3,960 = 112,040 or, FC payable – date of hedging, 4/1 20x4………………………………………….P 116,000 Less: Forward contract gain [P4,000 x 1/1 + (8%/12 x 1 month remaining)]... 3,960 FC payable – date of hedging, 6/30/ 20x4……………………………………….P 112,040

74. c – (P2.17 – P2.14) x 200,000 FCs = P6,000 loss. No need to compute present value because the contract already expired. 75. b Notional amount Forward rate for remaining time Initial forward rate Change in original forward rate Fair value of fwd contract in future pesos: Original forward value Current forward value (Gain) Loss in forward rate Current present value PV of (P150) n=1; i=0.667% PV of (P225) n=0; no discounting Prior present value Change in present value 76. d Notional amount Forward rate for remaining time Initial forward rate Change in original forward rate Fair value of fwd contract in future dollars: Original forward value Current forward value (Gain) Loss in forward rate Current present value PV of (P150) n=1; i=0.667% PV of (P225) n=0; no discounting Prior present value Change in present value

1-Aug 15,000 0.690

30-Aug 15,000 0.680 0.690 (0.010)

30-Sep 15,000 0.675 0.690 (0.015)

10,350 10,200 (150)

10,350 10,125 (225)

(149) 0 (149)

1-Aug 15,000 0.690

(225) 149 (76)

30-Aug 15,000 0.680 0.690 (0.010)

30-Sep 15,000 0.675 0.690 (0.015)

10,350 10,200 (150)

10,350 10,125 (225)

(149) 0 (149)

(225) 149 (76)

77. c - Forward contracts always have a value of P0 at the date they are established 78. a 79. d - [(P600) - P0] 80. b 81. c - [P300 - (P600)] 82. b - Forward contracts always have a value of P0 at the date they are established 83. a 84. c - [(P1,950) - P0] 85. c 86. b - [P635 - (P1,905)] 87. c Cost of equipment…………………………………………………………………..P 211,000 Less: Fair value of the equipment………………………………………………… 199,000 Impairment loss……………………………………………………………………….P 12,000 88. a – (P17,500 – P13,200) reclassified to earnings

89. e Original forward rate on the date of hedging…………………………………P 1.64 Balance Sheet date: Remaining (current) forward rate – Dec. 31, 20x6… 1.59 Loss……………………………………………………………………………………..P 0.05 Multiplied by: No. of FCs…………………………………………………………… 100,000 FC Forward Contract Loss…………………………………………………………..P 5,000 90. a P400 = 10,000 foreign currency units x (P.82 - P.78). The loss is calculated using only forward rates. On December 31, 20x4, the loss is the difference between the 90-day future rate on November 1 (P.78) and the 30-day forward rate on December 31 (P.82). 91. b - speculation (gain or loss – income statement) Original forward rate on the date of hedging…………………………………P 0.033 Balance Sheet date: Remaining (current) forward rate – Dec. 31, 20x4… 0.036 Loss……………………………………………………………………………………..P 0.003 Multiplied by: No. of FCs……………………………………………………………. 100,000 FC Forward Contract Loss…………………………………………………………P 300 92. b - (220,000 FCUs)x (P0.68) = P149,600 93. B - (220,000 FCUs)x(P.68 - P.70) = P4,400 loss (To adjust the contract to the 30 day futures amount) 94. b Manage an exposed position: Value the forward exchange contract (FEC) at its fair value, measured by changes in the forward exchange rate (FER). Note that the question asks only for the effect on income from the forward contract transaction; thus, any effect on income from the foreign currency denominated account payable is not included in the answer. FER, 12/12/x4 P.90 FER, 12/31/x4 P.93 AJE: Forward Contact Receivable Foreign Exchange Gain Revalue forward contract: P3,000 = 100,000 FCU x (P.93 - P.90) change in forward rates Foreign Exchange Loss Account Payable Revalue foreign currency payable: P10,000 = 100,000 FCU x (P.98 - P.88) change in spot rates

95. b Hedge of a Firm Commitment: Value FEC based on changes in forward rate. AJE: Forward Contract Receivable Foreign Exchange Gain Revalue forward contract, using the forward rates. Foreign Exchange Loss Firm Commitment Recognize loss on firm commitment.

3,000

10,000

3,000

3,000

3,000

10,000

3,000

3,000

Again, note that the question asks only about the effect on income from the forward contract, not the underlying firm commitment portion of the transaction

96. b Speculation: Value forward exchange contract at fair value based on changes in the forward rate AJE: Forward Contract Receivable 3,000 Foreign Exchange Gain 3,000 97. b Call Option: P29.80 (Market price/Spot Price) > P27.90 (Option/Strike Price)..P1.90 in-the-money Put Option P14.25 (Market price/Spot Price) > P16.40 (Option/Strike Price).. 2.15 in-the-money Intrinsic Value………………………………………………………………….. P4.05 98. d

January 1, 20x6 (the inception date of the 1-yr. put FX option period) FX Contract Value—Option ............................................................ 8,000 Cash ........................................................................................... To record cost of put option acquired.

Note: P1.40, OP > P1.368, Market/spot rate – In-the-money (put option) March 31, 20x6 (an intervening financial reporting date) FX Contract Value—Option ............................................................ 30,000 FX Gain (P30,000 × 300,000 FCUs/1,000,000 FCUs)............. OCI—FX Gain (P30,000 × 700,000 FCUs/1,000,000 FCUs) To adjust option’s carrying value to its fair value of P106,000 (a given amount). P106,000 – P6,000 = P100,000)

8,000

9,000 21,000

99. a Note: P1.40, OP > P1.368, Market/spot rate – Out-of-the-money (call option). Time value element only, therefore any gain or loss is charged to profit and loss or current earnings, not OCI. 100. d

January 1, 20x6 (the inception date of the 1-yr. put FX option period) FX Contract Value—Option ............................................................ 16,000 Cash ........................................................................................... To record cost of put option acquired.

Note: P.25, OP < P.292, Market/spot rate – In-the-money (Call option) March 31, 20x6 (an intervening financial reporting date) FX Contract Value—Option ............................................................ 80,000 FX Gain (P80,000 × 500,000 FCUs/2,000,000 FCUs) x 50%.. OCI—FX Gain (P80,000 – P10,000)……................................. To adjust option’s carrying value to its fair value of P106,000 (a given amount). P96,000 – P16,000 = P80,000)

16,000

10,000 70,000

Items 101 through 107 Solution Guide Table: December 16 Spot rate (Market Price) ... P .16 Strike price (Option Price) P .16 Notional amount (in Bolivar) 1,000,000 Intrinsic value (if Market is < Option (Strike)*........ P 0 Time value** ........................ P 4,000 Fair (Total) value of Option. P 4,000

December 31 P .15 P .16 1,000,000

February 14 P .147 .16 1,000,000

P 10,000 3,300 P 13,300

P 13,000 0 P 13,000

* (Option Price – Market Price ) x notional amount ** Fair value of option less Intrinsic Value

101. d - The notional amount is the total face amount of the asset or liability that underlies the derivative contract. A notional amount may be expressed in the number of currency units, shares, bushels, pounds or other units specified in the financial instrument. Choices letter (a), (b), and (c) are all fair value of the option contract at different dates. 102. c On December 31, 20x4: Fair value of Call Option…………………………………………………………..P 13,300 Intrinsic Value: ( P.16 Option price less P.15 market price, lower if put option) x 1,000,000 bolivar……………………………………. 10,000 Time Value……………………………………………………………………………P 3,300 103. c (P3,300 – P4,000 = P700 loss); refer to the solution guide table for further analysis. 104. a – (P10,000 – P0 = P10,000 gain); refer to the solution guide table for further analysis. 105. b Hedging Instrument/Hedging Transaction/Option Contract: Inception date: Fair value of call option…………………….............................P 4,000 Balance sheet date: Fair value of call option……………………………........ 13,300 Foreign exchange gain……………………………………………………............P 9,300 106. c Foreign Currency Transaction (Hedged Item): 12/16/20x4: Spot rate…………………………………………………………………P .16 12/31/20x4: Spot rate………………………………………………………………... .15 Forex loss per unit……………………………………………………………………. P .01 Multiplied by: Number of foreign currencies…………………………………… 1,000,000 Foreign exchange loss..........…………………………………................................P 10,000 Hedging Instrument/Hedging Transaction/Option Contract: Inception date: Fair value of call option……………………..............................P 4,000 Balance sheet date: Fair value of call option………………………………….. 13,300 Foreign exchange gain……………………………………………………………...P 9,300 Net foreign exchange loss……………………………………………………………..P 700 107. c Foreign Currency Transaction (Hedged Item): 12/31/20x4: Spot rate…………………………………………………………………..P 2/14/20x5: Spot rate…………………………………………………………………..

.150 .147

Forex loss per unit………………………………………………………………………P .003 Multiplied by: Number of foreign currencies…………………………………….. 1,000,000 Foreign exchange loss..........…………………………………..................................P 3,000 Hedging Instrument/Hedging Transaction/Option Contract: Balance sheet date (12/31/x4): Fair value of call option….…………..............P 13,300 Expiration date (2/14/x5): Fair value of call option..…………………………….. 13,000 Foreign exchange loss………………………………………………………………..P 300 Total foreign exchange loss……………………………………………………………..P 3,300 108. c 12/1/20x4:Spot rate……………………………………………………………P .92 12/31/20x4:Spot rate…………………………………………………………. .93 Foreign currency gain……………………………………………. …………P .01 x: No. of foreign currencies…………………………………………………. 1,000,000 Foreign currency gain due to hedged item/commitment…………...P 10,000 Less: Discount – P10,000 x 12% x 2/12 (January and February).…........ 200 PV of foreign exchange gain due to hedged item/commitment.... P 9,800* Or, alternatively the computation of present value may also be presented as: Foreign exchange gain – equity..…………………………………………P 10,000 Divided by: [100% + (12%/12 x 2 months remaining)]………………….. 1.02 PV of foreign exchange gain due to hedged item/commitment….P 9,803* *P3 discrepancy due to rounding-off. 109. c 12/1/20x4: Fair value of Option (P10,000 x P.009)……………………………..P 9,000 12/31/20x4: Fair value of Option (P10,000 x P.006)…………………………… 6,000 Foreign currency loss on hedging transaction (option contract)…………P 3,000 110. b– refer to No. 101 for computation. It is an asset since the counterpart entry is a gain. Thus, the entry should be: Firm Commitment…………………………………………………….9, 803 Foreign Currency Gain on Hedged Item/Commitment…. 9,803 111. c

PV of foreign exchange gain due to hedged item/commitment (refer to No. 70)…………………………………………………………………. P 9,803 Foreign currency loss on hedging transaction (option contract) – refer to no. 71)………………………………………………………………… ( 3,000) Impact on net income – increase………………………………………………… P 6,803

112. b Sales (3/1/20x5 spot rate: P.90 x FC 1,000,000) ……………………… P900,000 Foreign exchange loss on hedged item/commitment, 3/31/20x5: 12/1/20x4 Spot rate…………………………………………………..P .92 3/31/20x5 Spot rate…………………………………………………... .90 Foreign currency loss……………………………………. …………P .02 x: No. of foreign currencies………………………………………… 1,000,000 Foreign currency loss for the entire hedged item/commitment…………………………………………… P 20,000 Add back: PV of foreign gain due to hedged item/commitment………………………………………….… 9,803 ( 29,803)

Adjustment: Firm Commitment Account balance (credit balance) – since the P20,000 is a foreign currency loss then the firm commitment account is a credit balance……………………… Foreign currency gain on hedging transaction (option contract) 12/31/20x4 (inception date): Fair value of option (P0.006 x FC 1,000,000)………………………………………… P 6,000 3/1/20x4 (expiration date) : Fair value of option (P0.020 x FC 1,000,000)……………………………………….… 20,000 Impact on Net Income…………………………………………………….

20,000

14,000 P904,197

113. d – (150,000 FC x P.05 premium = P7,500) 114. a – (150,000 FC x P.04 premium = P6,000) 115. b – (150,000 FC x P.03 premium = P4,500) 116. c – (150,000 FC x P.97 = P145,500) 117. a Hedged Item/Commitment: 3/01/20x3: Spot rate……………………………………………..P .095 12/31/20x3: Spot rate…………………………………………….. .094 Foreign currency loss per unit…………………………………. P .001 x: No. of foreign currencies……………………………………... 2,000,000 Foreign currency loss due to hedged item/commitment..P 2,000 x: PV factor of an annuity of P1 @ for 12 periods………..… .9803 PV of foreign exchange loss due to hedged item/ commitment..………. ………………………………………. P 1,960.60 Hedging Instrument: 3/01/20x3: Fair value of Option………………………………..P 3,000 12/31/20x3: Fair value of Option6)……………………………... 3,200 Foreign currency gain on hedging transaction (option contract)………………………………………………………… 200.00 Net impact on 20x3 income – loss (decrease)……………………..……P1,760.60 118. d Sales (3/1/20x4 spot rate: P.089 x FC 2,000,000) …………………… P 178,000.00 Adjustment: Firm Commitment Account balance (credit balance) – since the P12,000 is a foreign currency loss then the firm commitment account is a credit balance 12,000.00* Adjusted Sales…………………………………………………………… P190,000.00 Foreign exchange loss on hedged item/ commitment, 3/31/2012: 5/01/20x3: Spot rate…………………………………………P .095 3/01/20x4 Spot rate…………………………………………. .089 Foreign currency loss…………………………………. ……P .006 x: No. of foreign currencies…..……………………………. 2,000,000 Foreign currency loss for the entire hedged item /commitment…………………………………………P 12,000* Less: PV of foreign loss due to hedged item /commitment………………………………………… 1,960.60 (10,039.40) Foreign currency gain on hedging instrument (option contract): 12/31/20x3 (balance sheet date): Fair value of option.P 3,200 3/01/20x4 (expiration date) : Fair value of option

[(P0.95 – P.089) x FC 2,000,000)..……………………… Net impact on 20x4 income – loss (decrease)………………..

12,000

119. c Net cash inflow with option (P190,000 – P3,000)…………………… Cash inflow without option (at spot rate of P.089 x 2,000,000 FC. Net increase in cash inflow

8,800.00 P188,760.60 P187,000 178,000 P 9,000

120. a Note: P1.40, OP < P1.368, Market/spot rate – Out-of-the-money (put option). Time value element only, therefore any gain or loss is charged to profit and loss or current earnings, not OCI. Refer to No. 99. Quiz - XX 1. a – the machine’s final recorded value should be the spot rate on the date of transaction since it is hedging that involves exposed liability (P.00781 x 200,000,000 = P1,562,000). 2. c – (P.1865 – P.1850) gain x 100,000 FC = P150 gain 3. using spot rate Accounts payable…………………………………………………………18,650 FC Units………………………………………………………………… 18,650 4. c – (P42 – P40) gain x 1,000 FC = P2,000 gain 5. 6. b

Accounts payable…………………………………………………………42,000 FC Units………………………………………………………………… 42,000 Hedging Instrument: Origininal forward rate on the date of hedging……………………………….P 0.90 Balance Sheet date: Remaining (current) forward rate – 12/3/1/20x4…… 0.93 Gain…………………………………………………………………………………….P .03 Multiplied by: No. of FCs……………………………………………………………. 200,000 FC Forward Contract Gain…………………………………………………………P 6,000 The entry would be as follows: Foreign Currency Receivable from Exchange Broker………………6,000 Foreign Currency Gain……………………………………………… 6,000

7. a

The entry on the date of expiration of the contract: Pesos Payable to Exchange Broker (P.90 x 200,000 FC)……………..180,000 Cash…………………………………………………………………….. 180,000 Foreign Currency Units or Investment in Foreign Currency (P.92)…184,000 Foreign Currency Loss – forward contract...………………………….. 2,000 Foreign Currency Receivable from Exchange Broker (.P93)… 186,000

8. b – refer to No. 7 9. d – refer to No.7

10. c P1,000 = 50,000 FCs x (P.74 - P.72). The loss is calculated using only forward rates. On September 30, 20x4, the loss is the difference between the 60-day forward rate of P.74 on September 1 and the 30-day forward rate of P.72 on September 30, 20x4. 11. d Date of transaction: 9/1/20x4: Spot rate………………………………………..P 1.46 Balance Sheet date: Sept. 30, 20x4: Spot rate………………………………… 1.50 Gain…………………………………………………………………………………….P .04 Multiplied by: No. of FCs……………………………………………………………. 250,000 FC Transaction Loss………..…………………………………………………………P 10,000 The question refers to foreign currency transaction loss which indicates that only the exposed liability had a loss, while the the forward contract transaction results in a gain computed as follows: Original forward rate on the date of hedging…………………………………P 1.47 Balance Sheet date: Remaining (current) forward rate – Sept. 30, 20x4… 1.48 Gain…………………………………………………………………………………….P .01 Multiplied by: No. of FCs……………………………………………………………. 250,000 FC Forward Contract Gain…………………………………………………………P 2,500 If the question is the net impact on the net income the loss on exposed liability and the gain of forward contract should be offsetted, thereby resulting a net effect of P7,500 decrease in net income. 12. b – speculation (gain or loss – income statement) Original forward rate on the date of hedging…………………………………P 1.47 Balance Sheet date: Remaining (current) forward rate – Sept. 30, 20x4… 1.48 Gain…………………………………………………………………………………….P .01 Multiplied by: No. of FCs……………………………………………………………. 250,000 FC Forward Contract Gain…………………………………………………………P 2,500 13. b Receivable balance: P162,000 (spot rate on the balance sheet date, P.81 x 200,000 FCU) Gain or loss: P4,000 loss [(P.83 – P.81) x 200,000 FCU] 14.

Date of transaction: 8/1/20x4: Spot rate………………………………………..P 1.16 Balance Sheet date: 4/30/20x4: Spot rate……………………………………… 1.20 Gain…………………………………………………………………………………….P .04 Multiplied by: No. of FCs……………………………………………………………. 300,000 FC Transaction Loss………..…………………………………………………………P 12,000 The question refers to foreign currency transaction loss which indicates that only the exposed liability had a loss, while the the forward contract transaction results in a gain computed as follows: Original forward rate on the date of hedging…………………………………P Balance Sheet date: Remaining (current) forward rate – Sept. 30, 20x4… Gain…………………………………………………………………………………….P

1.17 1.18 .01

Multiplied by: No. of FCs……………………………………………………………. 300,000 FC Forward Contract Gain…………………………………………………………P 3,000 If the question is the net impact on the net income the loss on exposed liability and the gain of forward contract should be offsetted, thereby resulting a net effect of P9,000 decrease in net income. 15. P12,000 Date of transaction: 8/1/20x4: Spot rate………………………………………..P 1.16 Balance Sheet date: 4/30/20x4: Spot rate……………………………………… 1.20 Gain…………………………………………………………………………………….P .04 Multiplied by: No. of FCs……………………………………………………………. 300,000 FC Transaction Loss………..…………………………………………………………P 12,000 The question refers to foreign currency transaction loss which indicates that only the exposed liability had a loss, while the the forward contract transaction results in a gain computed as follows: Original forward rate on the date of hedging…………………………………P 1.17 Balance Sheet date: Remaining (current) forward rate – Sept. 30, 20x4… 1.18 Gain…………………………………………………………………………………….P .01 Multiplied by: No. of FCs……………………………………………………………. 300,000 FC Forward Contract Gain…………………………………………………………P 3,000 If the question is the net impact on the net income the loss on exposed liability and the gain of forward contract should be offsetted, thereby resulting a net effect of P9,000 decrease in net income. 16. P3,000 Original forward rate on the date of hedging…………………………………P 1.17 Balance Sheet date: Remaining (current) forward rate – Sept. 30, 20x4… 1.18 Gain…………………………………………………………………………………….P .01 Multiplied by: No. of FCs……………………………………………………………. 300,000 FC Forward Contract Gain…………………………………………………………P 3,000 17. d PAS 32 and 39 requires the FCU payable be recorded at the forward rate on the date of hedging. Letter (d) is the required entry under the old practice wherein the FCU payable are recorded using the spot rate on the date of hedging. 18. d – no adjustment required on the date of transaction. 19. (P1.47 x 600,000 FC) the original (60-day) forward rate on the date of hedging (i.e., November 30, 20x4) 20. since no forward contract was entered into, the only effect on income statement is only the foreign currency exchange gain on exposed asset position. Spot rate on the date of transaction: 12/16/20x4…………………………….P 0.00090 Balance Sheet date: Spot rate – December 31, 20x4………………………. 0.00092 Gain……………………………………………………………………………………P 0.00002

Multiplied by: No. of FCs…………………………………………………………… Foreign Currency Exchange Gain……………………………………………….P

10 M 200

21. P695.05 increase Hedged Item: Exposed Asset: Spot rate on the date of transaction: 12/16/20x4…………………………….P 0.00090 Balance Sheet date: Spot rate – December 31, 20x4………………………. 0.00092 Gain……………………………………………………………………………………P 0.00002 Multiplied by: No. of FCs……………………………………………………………. 10 M Foreign Currency Exchange Gain……………………………………………….P 200 Hedging Instrument: Original forward rate on the date of hedging: 12/16/20x4…………………P 0.00098 Balance Sheet date: Remaining (current) forward rate – 12/31/20x4…… 0.00093 Gain…………………………………………………………………………………….P .00005 Multiplied by: No. of FCs……………………………………………………………. 10,000,000 FC Forward Contract Gain…………………………………………………………P 500 Multiplied by: PV of P 1 at 12%............……………………………………………. .9901 FC Forward Contract Gain…………………………………………………………P 495.50 Net impact on 20x4 income statement…………………………………………..P 695.05 22. P100 increase Hedged Item: Exposed Asset: Balance Sheet date: Spot rate – December 31, 20x4……………………….P 0.00092 Date of Settlement: Spot rate – January 15, 20x5……………………………. 0.00095 Gain……………………………………………………………………………………P 0.00003 Multiplied by: No. of FCs……………………………………………………………. 10 M Foreign Currency Exchange Gain……………………………………………….P 300 Hedging Instrument: Balance Sheet date: Remaining (current) forward rate – 12/31/20x4……P 0.00093 Date of expiration: Spot rate – January 15, 20x5……………………………… 0.00095 Loss……………………………………………………………………………………..P .00002 Multiplied by: No. of FCs…………………………………………………………… 10,000,000 FC Forward Contract Loss………………………………………………………….P 200 Net impact on 20x5 income statement…………………………………………..P 100 23. c – (forward rate > spot rate – premium) buyer’s point of view considered as premium expense since it was purchase at a higher rate plus a loss on firm commitment (i.e., P1.21 – P1.20) Theories Completion Statements 1. hedging 2. existing assets and liabilities, firm commitments, forecasted transactions 3. firm commitment 4. forecasted 5. hedged item 6. hedging instrument 7. FX forwards, FX options 8. two-sided, counterbalanced 9. one-sided, counterbalanced 10. Hedge accounting 11. exchange rate, specified period

12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51.

call, put option holder option writer premium “in the money” time value element, intrinsic value element exchange rate, future date fulfill, obligation take executory unrealized the net position, setoff premium, discount, time value premium, decrease split accounting designated, effective, firm speculating firm commitment, forecasted transaction market, credit, liquidity market, credit market, liquidity unlimited “on-balance-sheet,” “off-balance-sheet” rights, obligations, assets, liabilities fair values assets, liabilities undesignated, fair value, cash flow, net investment asset, liability, firm commitment forecasted transaction. fair value cash flow net investment earnings other comprehensive income, earnings earnings, earnings forward valuing, reporting hedging effectiveness time value ineffective

True or False 52. False 53. False 54. False 55. False 56. True 57. True 58. False 59. True 60. True 61. False

68. 69. 70. 71. 72. 73. 74. 75. 76. 77.

False False True False False False True True True True

84. 85. 86. 87. 88. 89. 90. 91. 92. 93.

True False True True False False False True False True

100. 101. 102. 103. 104. 105. 106. 107. 108. 109.

False True True False True True True True False True

116. 117. 118. 119. 120 121. 122. 123. 124. 125.

True False False True True False False False False True

132. 133. 134. 135. 136. 137. 138. 139. 140. 141.

True False True False False False False False True False

148. 149. 150 151. 152.

False True False True False

62. 63. 64. 65 66. 67.

True False False True False False

78. 79 80. 81. 82. 83.

True False False False False True

94. 95. 96. 97. 98. 99.

False True False False False False

Multiple Choice Questions (theories) 153. E 161. C 171. 154. B 162. B 172. 155. A 163. B 173. 156. E 164. B 174. 157. E 165 A 175. 158. D 166. E 176. 159. B 167. E 177. 160. D 168. A 178. 169. A 179 170. D 180. Note for: 197. 199. 202.

E C B C A A A C A D

110. 111. 112. 113. 114. 115. 181. 182. 183. 184. 185. 186. 187. 188. 189. 190.

False False False False True False E C A D D B A B A C

126. 127. 128. 129. 130. 131. 191. 192. 193. 194. 195. 196. 197. 198. 199. 200.

False True False True False False C A C B B B d c c a

142. 143. 144. 145. 146. 147. 201. 202. 203. 204. 205. 206. 207. 208. 209. 210.

True False True False True False b c d d b c d c d b

An underlying is a financial or physical variable. The net investment must be less than that required for other types. Trading securities do not qualify for hedge accounting. Under PFRS 9, there is no more classification as to trading and available-for-sale instead it is now classified either as FVTPL and FVTOCI.

211. 212. 213. 204. 215. 216. 217. 218. 219. 220

c c b b b b c d d a