Solution manual advanced accounting 2nd by hamlen CH08

Find more at www.downloadslide.com CHAPTER SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS MULTIPLE CHOICE d Fiscal 2013: ($1.25 - $1.28) x €100,000 = $3,000 gain on payable Fiscal 2014: ($1.32 – $1.25) x €100,000 = $7,000 loss on payable d Fiscal 2013: ($1.31 - $1.30) x €100,000 = $1,000 gain on receivable Fiscal 2014: ($1.28 - $1.31) x €100,000 = $3,000 loss on receivable b Entries are: November 15, 2013 Inventory 905,000 Accounts payable December 31, 2013 Exchange loss 905,000 60,000 Accounts payable $60,000 = ($0.965 - $0.905) x 1,000,000 Investment in forward 60,000 55,000 Exchange gain $55,000 = ($0.950 - $0.895) x 1,000,000 April 15, 2014 Accounts payable 55,000 25,000 Exchange gain $25,000 = ($0.940 - $0.965) x 1,000,000 Exchange loss 25,000 10,000 Investment in forward $10,000 = ($0.940 - $0.950) x 1,000,000 Accounts payable 940,000 Cash Investment in forward Solutions Manual, Chapter 10,000 895,000 45,000 ©Cambridge Business Publishers, 2013 Find more at www.downloadslide.com a See entries in above $15,000 gain = $25,000 gain - $10,000 loss d Entries are: December 31, 2013 Investment in forward 55,000 Exchange gain $55,000 = ($0.950 - $0.895) x 1,000,000 Exchange loss 55,000 55,000 Firm commitment March 1, 2014 Exchange loss 55,000 35,000 Investment in forward $35,000 = ($0.915 - $0.950) x 1,000,000 Firm commitment 35,000 35,000 Exchange gain Inventory Firm commitment 35,000 900,000 20,000 Accounts payable April 15, 2014 Exchange loss 920,000 20,000 Accounts payable $20,000 = ($0.940 - $0.920) x 1,000,000 Investment in forward 20,000 25,000 Exchange gain $25,000 = ($0.940 - $0.915) x 1,000,000 Accounts payable 940,000 Cash Investment in forward ©Cambridge Business Publishers, 2013 25,000 895,000 45,000 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com b See entries in above c Entries are: December 31, 2013 Investment in forward 55,000 OCI $55,000 = ($0.950 - $0.895) x 1,000,000 April 15, 2014 OCI 55,000 10,000 Investment in forward $10,000 = ($0.940 - $0.950) x 1,000,000 Foreign currency 10,000 940,000 Investment in forward Cash Inventory 45,000 895,000 940,000 Foreign currency 940,000 a Entry to record cost of goods sold is: Cost of goods sold OCI 895,000 45,000 Inventory 940,000 c ($0.940 - $0.915) x 1,000,000 = $25,000 loss 10 a Using the basis adjustment approach, IFRS nets the cash flow hedge gain against the equipment, reducing the equipment account Depreciation expense is unaffected whether the cash flow hedge gain is reclassified as an adjustment of the equipment or as an adjustment of depreciation expense Solutions Manual, Chapter ©Cambridge Business Publishers, 2013 Find more at www.downloadslide.com EXERCISES E8.1 Recording Import Transactions Purchases Inventories Accounts payable Payments Foreign currency Cash Accounts payable Exchange loss Exchange gain Foreign currency E8.2 Australia Dr Cr 204,000 204,000 Thailand Dr Cr 28,000 28,000 210,000 26,400 210,000 204,000 6,000 Indonesia Dr Cr 750 750 700 26,400 28,000 -210,000 Jordan Dr 710,000 710,000 710,000 700 750 1,600 26,400 Cr 710,000 710,000 50 700 -710,000 Recording Export Transactions Sales Accounts receivable Sales Collection Foreign currency Exchange loss Exchange gain Accounts receivable Cash Foreign currency Argentina Dr Cr 59,750 59,750 Canada Dr Cr 404,000 404,000 India Dr Cr 7,200 7,200 South Africa Dr Cr 14,100 14,100 62,750 410,000 6,600 600 13,700 400 3,000 59,750 62,750 6,000 404,000 410,000 62,750 ©Cambridge Business Publishers, 2013 -7,200 6,600 410,000 -14,100 13,700 6,600 Advanced Accounting, 2nd Edition 13,700 Find more at www.downloadslide.com E8.3 Recording Import and Export Transactions Import Transactions Transaction Transaction date: Inventory 3,300 Accounts payable Payment date: Accounts payable Exchange loss 3,300 3,300 500 Cash 3,800 Transaction Transaction date: Inventory 180,000 Accounts payable Payment date: Accounts payable 180,000 180,000 Exchange gain Cash 9,000 171,000 Export Transactions Transaction Transaction date: Accounts receivable 118,400 Sales Payment date: Cash Exchange loss 105,200 13,200 Accounts receivable Solutions Manual, Chapter 118,400 118,400 ©Cambridge Business Publishers, 2013 Find more at www.downloadslide.com Transaction Transaction date: Accounts receivable 712,500 Sales Payment date: Cash 712,500 746,700 Exchange gain Accounts receivable E8.4 Item 34,200 712,500 Adjusting Entry at Balance Sheet Date Book Balance ($) Dr (Cr.) $ 75,000 240,000 (550,000) (50,000) Dollar Equivalent, 12/31 Dr (Cr.) $ 80,000 = $.08 x 1,000,000 229,500 = $1.02 x 225,000 (540,000) = $1.35 x 400,000 (52,000) = $.26 x 200,000 Adjusting Entry Accounts payable ($10,000 - $2,000) Adjustment Needed Dr (Cr.) $ 5,000 gain 10,500 loss 10,000 gain 2,000 loss 8,000 Accounts receivable ($10,500 - $5,000) 5,500 Exchange gain 2,500 To record the net transaction loss on the receivables and payables at December 31; $2,500 gain = ($5,000 + $10,000) gain – ($10,500 + $2,000) loss ©Cambridge Business Publishers, 2013 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com E8.5 Hedging Foreign-Currency-Denominated Liability a March 15, 2014 Inventory 18,100 Accounts payable To record goods purchased; $18,100 = $.000905 x 20,000,000 18,100 April 14, 2014 Exchange loss 60 Accounts payable To restate payable at current spot rate; $60 = ($.000908 - $.000905) x 20,000,000 Investment in forward contract 60 160 Exchange gain To restate forward contract to current fair value; $160 = ($.000908 - $.000900) x 20,000,000 Foreign currency 160 18,160 Investment in forward contract 160 Cash 18,000 To record payment to the dealer, receipt of 20,000,000 won, valued at the current spot rate of $.000908/W, and fulfillment of the forward purchase contract Accounts payable 18,160 Foreign currency 18,160 b Dollars paid (to broker) with the hedge: Dollars that would have been paid at the current spot rate to purchase foreign currency for the supplier; (.000908 x 20,000,000): Cash gain (amount saved) from hedging: Solutions Manual, Chapter $18,000 -18,160 $ 160 ©Cambridge Business Publishers, 2013 Find more at www.downloadslide.com E8.6 a Hedging Foreign-Currency-Denominated Asset September 1, 2013 Accounts receivable 26,000,000 Sales To record sales made; $26,000,000 = $.65 x 40,000,000 26,000,000 September 30, 2013 Exchange loss 400,000 Accounts receivable 400,000 To restate receivable at current spot rate; $400,000 = ($.65 - $.64) x 40,000,000 Investment in forward contract 480,000 Exchange gain 480,000 To restate the forward contract to its current fair value; $480,000 = ($.652 - $.64) x 40,000,000 Foreign currency 25,600,000 Accounts receivable 25,600,000 To record receipt of currency from Brazilian customer; $25,600,000 = $.64 x 40,000,000 Cash 26,080,000 Foreign currency 25,600,000 Investment in forward contract 480,000 To record delivery of currency to the dealer, receipt of $26,080,000 as specified in the contract, and settlement of the forward contract b Dollars received (from broker) with the hedge: Dollars that would have been received from the customer's foreign currency at the current spot rate (.64 x 40,000,000): Cash gain (increased proceeds) from hedging: ©Cambridge Business Publishers, 2013 $26,080,000 - 25,600,000 $ 480,000 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com E8.7 Hedged Purchase Commitment and Foreign-Currency-Denominated Liability September 15, 2014 No entry November 15, 2014 Investment in forward contract 15,000 Exchange gain 15,000 To record change in fair value of the forward contract; $15,000 = ($.105 - $.104) x 15,000,000 Exchange loss 15,000 Firm commitment To record the loss on the firm purchase commitment Inventories 15,000 1,545,000 Accounts payable To record delivery of the goods at the current spot rate of $.103 Firm commitment 1,545,000 15,000 Inventories 15,000 To adjust the carrying value of the goods for the accumulated loss on the firm commitment during the commitment period December 31, 2014 Exchange loss 30,000 Accounts payable 30,000 To record loss due to increase in dollar value of accounts payable; $30,000 = ($.105 $.103) x 15,000,000 Investment in forward contract 30,000 Exchange gain 30,000 To record increase in value of forward purchase contract; $30,000 = ($.107 - $.105) x 15,000,000 January 15, 2015 Exchange loss 45,000 Accounts payable To record loss on accounts payable; $45,000 = ($.108 - $.105) x 15,000,000 Solutions Manual, Chapter 45,000 ©Cambridge Business Publishers, 2013 Find more at www.downloadslide.com Investment in forward contract 15,000 Exchange gain 15,000 To record increase in fair value of forward purchase contract; $15,000 = ($.108 - $.107) x 15,000,000 Foreign currency 1,620,000 Investment in forward contract Cash To record fulfillment of the forward contract Accounts payable 60,000 1,560,000 1,620,000 Foreign currency To record payment to the Mexican supplier E8.8 1,620,000 Hedged Sale Commitment and Foreign-Currency-Denominated Asset April 15, 2013 No entry April 30, 2013 Exchange loss 8,000 Investment in forward contract To record decline in fair value of the forward contract; $8,000 = ($.148 - $.140) x 1,000,000 Firm commitment 8,000 8,000 Exchange gain To record gain on U.S dollar value of the firm sale commitment 8,000 Accounts receivable 146,000 Sales revenue 146,000 To record delivery of goods to the South African customer; $146,000 = $.146 x 1,000,000 Sales revenue 8,000 Firm commitment To adjust the sales revenue for the change in value of the firm sales commitment ©Cambridge Business Publishers, 2013 10 8,000 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com P8.3 a Accounting for Forward Contracts—Hedging and Speculation December 31, 2012 Exchange loss 120,000 Investment in forward contract To record decline in value of forward sale contract #1; $120,000 = ($.165 - $.105) x 2,000,000 120,000 Firm commitment 120,000 Exchange gain To record increase in sales value of firm commitment related to contract #1 Investment in forward contract 120,000 180,000 Other comprehensive income To record increase in value of forward purchase contract #2; $60,000 = ($.165 - $.105) x 3,000,000 Exchange loss 180,000 60,000 Investment in forward contract 60,000 To record loss on speculative contract #3; $60,000 = ($.165 - $.105) x 1,000,000 January 29, 2013 Exchange loss 54,000 Investment in forward contract 54,000 To record decline in value of forward sale contract #1 since December 31; $54,000 = ($.192 - $.165) x 2,000,000 Firm commitment 54,000 Exchange gain To record increase in sales value of firm commitment related to contract #1 Foreign currency 54,000 384,000 Sales revenue To record sale to Danish customer; $384,000 = $.192 x 2,000,000 174,000 Firm commitment To adjust sales revenue for the accumulated balance in the firm commitment account 384,000 Sales revenue Solutions Manual, Chapter 174,000 ©Cambridge Business Publishers, 2013 19 Find more at www.downloadslide.com Cash Investment in forward contract 210,000 174,000 Foreign currency To record the settlement of forward sale contract #1 Investment in forward contract 384,000 81,000 Other comprehensive income To record increase in value of forward purchase contract #2; $81,000 = ($.192 - $.165) x 3,000,000 Foreign currency 81,000 576,000 Investment in forward contract Cash To record settlement of forward purchase contract #2 Inventory 261,000 315,000 576,000 Foreign currency To record purchase #2 at the current spot rate of $.192 Exchange loss 576,000 27,000 Investment in forward contract 27,000 To record loss on forward sale contract #3; $27,000 = ($.192 - $.165) x 1,000,000 Foreign currency 192,000 Cash 192,000 To record purchase of krone in the spot market, in anticipation of settlement of forward sale contract #3 Cash Investment in forward contract Foreign currency To record settlement of forward sale contract #3 ©Cambridge Business Publishers, 2013 20 105,000 87,000 192,000 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com b December 31, 2012 Balance Sheet: Investment in forward contracts has a net balance of zero Firm commitment has a net debit balance of $120,000 (current asset) Other comprehensive income is increased by $180,000 (stockholders= equity) 2012 Income Statement: Net exchange loss on speculative activity is $60,000 c P8.4 a Observe that the forward contracts entered into by Futura represented a perfect hedge That is, forward sale contracts #1 and #3 were hedged by forward purchase contract #2 One could argue that these forward exchange contracts were unnecessary, and whatever transaction costs were incurred by Futura in connection with the contracts represent an unnecessary loss to the firm Hedging, Leverage, Return on Assets Note that the December 31, 2012 spot rate is $.80 (= $400 million/C$500 million) and the forward rate in the contract is $.88 (= $440 million/C$500 million) If the exchange rate is $.83/C$ at the end of the first quarter, Cheesecake Factory incurs a net loss on the forward contract of $25 million, since the C$ could be bought for $.83 instead of the $.88 forward rate; ($25 million) = ($.83 - $.88) x 500 million The contract requires purchase of C$ for $440 million when the expected prevailing market price is $415 million Concurrently there is a $15 million [= ($.83- $.80) x 500 million] exchange loss on the payable that increases liabilities Without the hedge, Cheesecake Factory's payable to the international supplier increases by $15 million and the $15 million exchange loss decreases equity There is no change in total assets Using the data in the problem, measured leverage rises to 715 [= ($700 + $15)/$1,000] With the hedge, the payable still increases by $15 million The forward contract is shown as a current liability of $25 million Using the data in the problem, measured leverage becomes 74 [= ($700 + $15 + $25)/$1,000] b If Cheesecake Factory did not use the forward contract, it could borrow $400 million now and buy the needed foreign currency This would cost $412 million, including 12% interest for months The forward contract costs $440 million In addition, if the company borrows, it could invest the C$ in short-term international investments until required by the international supplier This alternative seems to dominate the forward contract Solutions Manual, Chapter ©Cambridge Business Publishers, 2013 21 Find more at www.downloadslide.com c As above, there is a $15 million exchange loss on the payable which decreases operating income The forward rate implied by the contract is $.81 (= $405 million/$500 million) Thus there is a $10 million gain on the forward purchase contract that increases assets, since the exchange rate increases from $.81 to $.83 at the end of the quarter Without the hedge, and assuming an annual ROA of 16 (.04 quarterly), at current exchange rates projected operating income for the first quarter is $44 million [= 04 ($1,000 + $1,200)/2] Without the hedge, the $15 million exchange loss due to the increasing exchange rate reduces operating income to $29 million and the quarterly ROA to 026 [ = $29/($1,000 + $1,200/2)] With the hedge, operating income is again reduced by the $15 million loss on the payable, but increases by the $10 million gain on the forward purchase contract Operating income is $39 million = ($44 million - $5 million) and the quarterly ROA is 035 [= $39/($1,000 + $1,200 + $10)/2] P8.5 a Transaction Exposure and Credit Analysis Using the information given, we can compute Poole's cash flow from operations as follows (in millions): Net income $ 150 + Depreciation expense 50 - Increase in noncash working capital (40) - Unrealized transaction gains on long-term debt (22) Cash flow from operations $ 138 Because earnings overstate cash from operations by $12 million, "nearness to cash" could be improved b Sales generate cash flows When sales are denominated in a foreign currency, however, the amount of cash ultimately collected is affected by changes in the exchange rate, as well as by the general risk of default Although we not know Poole's 2014 projected sales to these international customers, we know that onethird of the ending inventory is designated to be sold to them Wide variations in the exchange rate will likely have material effects on dollar cash flows from these sales The suggested analysis involves calculating the dollars lost on sale of the designated inventory if customers pay Poole when the dollar strengthens and the exchange rate falls to $.20/peso In this case, the 500 million pesos will produce $75 million (= $175 - $.20 x 500) less, more than half of Poole's 2013 operating cash flow ©Cambridge Business Publishers, 2013 22 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com c P8.6 a Poole seems to have considerable exposure to exchange rate risk, with foreign currency denominated claims in receivables, payables and long-term debt, and susceptible revenue-driven cash flow streams First, you would like more information on the extent of this exposure and whether any of it represents natural hedges Second, you want to know management's plans to minimize this risk and the relative cost of different strategies, such as forward contracts, international loans and investments, and accelerated payment and collection policies Hedging a Foreign Currency Commitment—Effects on Income November 30, 2013 Exchange loss 21,000 Investment in forward contract 21,000 To record decline in value of forward sale contract; $21,000 = ($1.310 - $1.268) x 500,000 Firm commitment 21,000 Exchange gain To record increase in sales value of the agreement with the Swiss customer 625,000 Sales revenue To record delivery of the motors to the Swiss customer; $625,000 = $1.25 x 500,000 21,000 Accounts receivable 21,000 Firm commitment To adjust sales revenue for the accumulated balance in the firm commitment account 625,000 Sales revenue December 31, 2013 Exchange loss 5,000 Accounts receivable To adjust accounts receivable balance to the new spot rate; $5,000 = ($1.25 - $1.24) x 500,000 Investment in forward contract 21,000 5,000 10,000 Exchange gain 10,000 To record increase in value of forward sale contract; $10,000 = ($1.31 - $1.29) x 500,000 Solutions Manual, Chapter ©Cambridge Business Publishers, 2013 23 Find more at www.downloadslide.com January 31, 2014 Accounts receivable 20,000 Exchange gain To adjust accounts receivable balance to the new spot rate; $20,000 = ($1.28 - $1.24) x 500,000 20,000 Investment in forward contract 5,000 Exchange gain To record increase in value of forward sale contract; $5,000 = ($1.29 - $1.28) x 500,000 5,000 Foreign currency 640,000 Accounts receivable 640,000 To record payment by Swiss customer to Ellis Corporation; $640,000 = $1.28 x 500,000 Cash Investment in forward contract 634,000 6,000 Foreign currency To record settlement of the forward sale contract 640,000 b Exchange loss Exchange gain Sales revenue Net effect on income 2013 $ ( 5,000) 10,000 604,000 $ 609,000 2014 $ -25,000 -$ 25,000 Note that the income effects for the two years sum to $634,000, the U.S dollar amount received from the sale and forward contract c With the forward contract, Ellis received $634,000 from the sale Without the contract, CHF500,000 would have been exchanged for $640,000 = $1.28 x 500,000 Therefore Ellis lost $6,000 due to hedging However, Ellis did gain peace of mind in knowing the $634,000 was locked in ©Cambridge Business Publishers, 2013 24 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com P8.7 Hedging a Forecasted Transaction December 31, 2013 Investment in forward contract 21,000 Other comprehensive income To record increase in value of forward purchase contract; $21,000 = (1.441 - $1.420) x 1,000,000 January 29, 2014 Inventory 21,000 1,450,000 Accounts payable To record delivery of merchandise at current spot rate of $1.45 1,450,000 March 1, 2014 Exchange loss 10,000 Accounts payable To adjust the account payable to the current spot rate; $10,000 = ($1.46 - $1.45) x 1,000,000 10,000 Investment in forward contract 19,000 Other comprehensive income To record increase in value of forward purchase contract; $19,000 = ($1.46 - $1.441) x 1,000,000 Other comprehensive income 19,000 10,000 Exchange gain To reclassify OCI to earnings to offset loss on accounts payable Foreign currency 10,000 1,460,000 Investment in forward contract Cash To record settlement of the forward contract Accounts payable 40,000 1,420,000 1,460,000 Foreign currency 1,460,000 To record payment to the supplier April 8, 2014 Cash 1,600,000 Sales revenue 1,600,000 To record sale to U.S customer Solutions Manual, Chapter ©Cambridge Business Publishers, 2013 25 Find more at www.downloadslide.com Cost of goods sold 1,450,000 Inventory To record cost of merchandise sold 1,450,000 Other comprehensive income 30,000 Cost of goods sold To transfer remaining gain in OCI on forward purchase contract to current income P8.8 a Analyzing the Performance of an Import/Export Department This problem is approached by evaluating the profit contributions of the import and export departments separately and then by reviewing the reasonableness of the forward contracts Although the ultimate measure of profitability is cash received minus cash paid out, we are also interested in the change in the dollar equivalents of Bush's overseas purchases and sales between the transaction dates and the payment/collection dates This may have some implications for credit and payment policies (1) Profit Contribution of the Import Transactions (2) (3) (4)=(3)-(1) (5)=(1)-(2) Part # $ Cost When Purchased $ Cost When Paid Total Net Revenue K14 KR08 L16 M29Q Total $ 10,624 83,300 46,330 93,240 $233,494 $10,240 98,600 50,020 80,640 $239,500 $ 15,500 102,000 50,000 92,000 $259,500 (1) Part # A24 DD2 A27 B23 Total 30,000 Gross Contribution $ 4,876 18,700 3,670 (1,240) $26,006 Exchange Gain (Loss) $ 384 (15,300) (3,690) 12,600 $ (6,006) Profit Contribution of the Export Transactions (2) (3) (4)=(1)-(3) (5)=(2)-(1) $ Revenue When Sold $ Revenue When Collected Total Cost $ 31,752 150,000 220,000 9,198 $410,950 $ 34,104 144,000 232,000 8,468 $418,572 $ 27,720 144,000 178,000 8,500 $358,220 ©Cambridge Business Publishers, 2013 26 Gross Contribution $ 4,032 6,000 42,000 698 $52,730 Exchange Gain (Loss) $ 2,352 (6,000) 12,000 (730) $ 7,622 (6)=(4)+(5) Total Contribution $ 5,260 3,400 (20) 11,360 $20,000 (6)=(4)+(5) Total Contribution $ 6,384 54,000 (32) $ 60,352 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com Review of Forward Contracts Overall, the contracts entered for hedging purposes produced a net gain of $2,700 The forward purchase contract cost $130,200 (= 210,000 x $.62) while at maturity the foreign currency could have been purchased for $123,900 (= 210,000 x $.59), yielding a loss of $6,300 (= $130,200 - $123,900) The forward sale contract produced revenue of $270,000 (= 300,000 x $.90) while at maturity the same amount of foreign currency could have been sold on the spot market for $261,000 (= 300,000 x $.87), yielding a gain of $9,000 (= $270,000 - $261,000) The net gain amounted to $2,700 (= $9,000 - $6,300) Note that had the hedging not been undertaken, exchange rate movements would have produced losses on both the purchase and sale transactions Ignoring interest rate effects, and considering spot rates only, the cost of the foreign currency to be purchased increased by $4,200 (=($.59 - $.57) x 210,000) between inception and maturity while the value of the foreign currency to be sold decreased by $3,000 (= ($.88 - $.87)300,000) between inception and maturity In contrast, the speculative contracts were mistakes The foreign currency acquired for $250,000 (= 1,000,000 x $.25) in the purchase contract could be sold for only $220,000 (= 1,000,000 x $.22) in the spot market at maturity, generating a loss of $30,000 Likewise, the currency sold for $740,000 (= 1,000,000 x $.74) in the sale contract had to be purchased in the spot market at maturity for $850,000 (= 1,000,000 x $.85) and a loss of $110,000 resulted b Memorandum TO: FROM: SUBJECT: Top Management, Bush Specialty Products Mr X, Consultant Review of William Johnston's Import/Export Department Mr Johnston is doing a reasonable job in the import/export business Both import and export transactions provided positive contributions toward fixed costs and profits of Bush The export business has been the most successful with a much higher ratio of profit contribution to sales Unfortunately, these reasonably satisfactory results have been wiped out by Mr Johnston's activities in the forward markets for foreign exchange Johnston entered into two speculative forward contracts which produced losses of $140,000, almost $60,000 more than the total profit contribution provided by the import/export transactions I not know whether he has been cautioned against speculating with the firm's capital and cannot recommend outright that Johnston be fired At a minimum, he should be prohibited from entering into speculative forward contracts on behalf of the import/export department Solutions Manual, Chapter ©Cambridge Business Publishers, 2013 27 Find more at www.downloadslide.com Mr Johnston's credit and payment policies should be reviewed Several of the import and export transactions resulted in large exchange gains and losses Although there was a net exchange gain, several of the currencies Mr Johnston transacts in seem to be quite volatile Hence the timing of payments and collections should be closely monitored along with movements in the exchange rates While hedging in the forward market eliminates this risk, there may be a more cost-effective solution P8.9 Recording a Hedged International Loan December 16, 2014 Cash 84,000,000 Loan payable 84,000,000 To record the dollar equivalent of £50 million borrowed from a London bank; $84,000,000 = $1.68 x 50,000,000 December 31, 2014 Loan payable 1,000,000 Exchange gain To accrue the exchange gain on the loan payable; $1,000,000 = ($1.68 - $1.66) x 50,000,000 Exchange loss 1,000,000 1,010,000 Investment in forward contract To accrue the loss on the forward purchase contract; $1,010,000 = ($1.71 - $1.69) x 50,500,000 Interest expense 1,010,000 415,000 Interest payable 415,000 To accrue interest expense on the loan payable from December 16 - December 31, 2014; $415,000 = $1.66 x 250,000 January 15, 2015 Loan payable Exchange gain To accrue the exchange gain on the loan payable; $1,500,000 = ($1.66 - $1.63) x 50,000,000 ©Cambridge Business Publishers, 2013 28 1,500,000 1,500,000 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com Exchange loss 3,030,000 Investment in forward contract To accrue the exchange loss on the forward purchase contract; $3,030,000 =($1.69 - $1.63) x 50,500,000 3,030,000 Interest payable 7,500 Exchange gain To accrue the gain on the interest payable; $7,500 = ($1.66 - $1.63) x 250,000 Interest expense 7,500 407,500 Interest payable 407,500 To accrue interest expense on the loan payable from January - January 15, 2015; $407,500 = $1.63 x 250,000 Foreign currency Investment in forward contract 82,315,000 4,040,000 Cash To record settlement of the forward purchase contract Loan payable Interest payable 86,355,000 81,500,000 815,000 Foreign currency 82,315,000 To record repayment of the loan and interest to the London Bank with the foreign currency P8.10 Interpretation of Financial Statement Disclosures a Forward contracts lock in the U.S dollar value of other currencies to be received or paid To lock in the dollar value of royalties to be received, IBM enters forward sale contracts that allow it to sell the currency received from franchisees and others at a fixed price To lock in the dollar value of cost transactions, IBM enters forward purchase contracts that allow it to buy the currency needed to pay for supplies, salaries, etc at a fixed price b Forward sales hedge net foreign currency inflows Therefore if the hedges are effective, the anticipated foreign currency royalty and cost transactions involve a net inflow of currency to IBM, locking in the future selling price of the currency to be received Solutions Manual, Chapter ©Cambridge Business Publishers, 2013 29 Find more at www.downloadslide.com c Because IBM incurred losses on the hedges, the U.S dollar must have weakened in 2010 and 2009 with respect to the hedged currencies (the $/FC rate increased) The hedge investments lock in the future selling price of the currency Losses occur when the market selling price increases, since the company is locked in to a lower selling price d When the royalties are received, related losses on the hedge investments are reclassified from AOCI to offset the royalty revenue The journal entry debits royalty revenue and credits OCI The accounts that IBM adjusts when cost transactions are recorded depend on the type of cost In general, the journal entry debits an expense or loss and credits OCI, increasing the reported expense or loss IBM’s 2010 footnotes indicate that selling and administrative expense, cost of goods sold, and other income/expense are adjusted for reclassifications from AOCI P8.11 Hedge of Forecasted Transaction, Firm Commitment, and Foreign-CurrencyDenominated Liability December 31, 2013 Investment in forward 100,000 Other comprehensive income To record gain on forward; $100,000 = ($1.42 - $1.41) x 10,000,000 January 15, 2014 Investment in forward 100,000 Other comprehensive income To record gain on forward; $100,000 = ($1.43 - $1.42) x 10,000,000 February 1, 2014 Investment in forward Firm commitment To record loss on firm commitment established on January 15 100,000 200,000 Other comprehensive income To record gain on forward; $200,000 = ($1.45 - $1.43) x 10,000,000 Exchange loss 100,000 200,000 200,000 200,000 Other comprehensive income 200,000 Exchange gain 200,000 To reclassify AOCI to income to exactly offset the loss on the firm commitment ©Cambridge Business Publishers, 2013 30 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com Inventory Firm commitment 14,100,000 200,000 Accounts payable 14,300,000 To record delivery of the merchandise and the payable at the spot rate, and close the firm commitment against the inventory balance March 1, 2014 Exchange loss 200,000 Accounts payable To record loss on payable; $200,000 = ($1.45 - $1.43) x 10,000,000 200,000 NOTE: No adjustment is needed for the forward, since the forward rate did not change between February and March Other comprehensive income 200,000 Exchange gain To reclassify AOCI to income to exactly offset the loss on the payable Foreign currency 200,000 14,500,000 Investment in forward Cash To close the forward contract Accounts payable 400,000 14,100,000 14,500,000 Foreign currency 14,500,000 To pay the supplier March 15, 2014 Cash 25,000,000 Sales revenue To record the sale of the merchandise Cost of sales 25,000,000 14,100,000 Inventory 14,100,000 To record cost of sales Note: There is no remaining balance in AOCI to reclassify as an adjustment to cost of sales Solutions Manual, Chapter ©Cambridge Business Publishers, 2013 31 Find more at www.downloadslide.com P8.12 Evaluation of Domestic and International Investments Domestic Investment $1,000,000 (1.03) = $1,030,000, for an effective annual yield of 6% U.K Investment $1,000,000 can be invested in a CD worth £625,000 [=$1,000,000/$1.60] The value of the CD at the end of months is (£625,000) x 1.035 = £646,875 To avoid exchange risk, the company would enter into a forward contract locking in the sale of £646,875 at $1.63, which will yield $1,054,406 The annual effective yield is ($54,406/$1,000,000) x = 10.88% German Investment $1,000,000 can be invested in a CD worth €689,655 [=$1,000,000/$1.45] The value of the CD at the end of months is (€689,655) x 1.025 = €706,897 To avoid exchange risk, the company would enter into a forward contract locking in the sale of €706,897 at $1.50, which will yield $1,060,346 The annual effective yield is ($60,346/$1,000,000) x = 12.07% Recommendation: Purchase the German certificate as it has the highest effective annual yield P8.13 Hedge of Net Investment in an International Subsidiary a 1) If the functional currency of the subsidiaries is the U.S dollar, PriceSmart’s exposed position is the assets reported at fair value less total liabilities, typically a net liability position As the direct exchange rate increases (the U.S dollar weakens against the quetzal), PriceSmart incurs a remeasurement loss Hedge investments that provide a gain when the direct exchange rate increases include forward purchases or call options in quetzals, or investments in quetzal-denominated financial assets, such as notes receivable 2) If the value of the quetzal increases, in U.S dollar terms, PriceSmart reports gains on forward purchases or call option hedges and losses on its net liability exposure to foreign currency risk 3) The gains and losses are both reported on PriceSmart’s income statement ©Cambridge Business Publishers, 2013 32 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com b 1) If the functional currency of the subsidiaries is the quetzal, PriceSmart’s exposed position is the net assets of the subsidiaries, typically a positive net asset position As the direct exchange rate increases (the U.S dollar weakens against the quetzal), PriceSmart incurs a translation gain Hedge investments that provide a loss when the direct exchange rate increases include forward sales or put options in quetzals, or borrowings in quetzaldenominated financial liabilities, such as loans from Guatemalan banks 2) If the value of the quetzal increases, in U.S dollar terms, PriceSmart reports losses on forward sales and put options used as hedges of net asset exposure, and gains on its net asset exposure to foreign currency risk 3) The gains and losses affect OCI, and are reported in the cumulative translation adjustment component of PriceSmart’s AOCI, part of stockholders’ equity on the balance sheet Solutions Manual, Chapter ©Cambridge Business Publishers, 2013 33 ... Business Publishers, 2013 18 60,000 1,080,000 1,080,000 1,080,000 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com P8.3 a Accounting for Forward Contracts—Hedging and Speculation December... 62,750 ©Cambridge Business Publishers, 2013 -7,200 6,600 410,000 -14,100 13,700 6,600 Advanced Accounting, 2nd Edition 13,700 Find more at www.downloadslide.com E8.3 Recording Import and Export... ($5,000 + $10,000) gain – ($10,500 + $2,000) loss ©Cambridge Business Publishers, 2013 Advanced Accounting, 2nd Edition Find more at www.downloadslide.com E8.5 Hedging Foreign-Currency-Denominated