TEST BANK CHAPTER Foreign Currency Transactions and Hedging MULTIPLE CHOICE Topic: Valuation of forward contracts LO A U.S company invests in a forward purchase contract for 100,000,000 yen with a purchase price of $0.009/yen, for delivery in 45 days The spot rate at the time the contract is initiated is $0.0085/yen At the end of the accounting year, the forward contract is still outstanding The year-end spot rate is $0.0088/yen The year-end forward rate for delivery at the contract date is $0.0092/yen How is the forward contract reported on the U.S company’s balance sheet? a b c d $20,000 asset $20,000 liability $30,000 asset $30,000 liability ANS: a ($0.0092 - $0.009) x 100,000,000 = $20,000 Topic: Cash flow hedge LO On August 1, a U.S company enters into a forward contract, in which it agrees to buy 1,000,000 euros from a bank at a rate of $1.115 on December Changes in the value of the forward contract will be reported in other comprehensive income on the balance sheet in which one of the following situations? a b c d The U.S company has receivables denominated in euros, with payment to be received on December The U.S company sold merchandise to a customer in Belgium on August 1, and expects payment of 1,000,000 euros on December The U.S company plans to sell merchandise to a customer in Belgium on August 1, with payment of 1,000,000 euros expected on December The U.S company plans to purchase merchandise from a supplier in Belgium, with payment of 1,000,000 euros expected to be paid on December ANS: d Test Bank, Chapter ©Cambridge Business Publishers, 2010 Use the following information on the U.S dollar value of the euro to answer questions – below: October 30, 2010 December 31, 2010 April 30, 2011 Spot rate $ 1.25 1.28 1.26 Forward rate for April 30, 2011 delivery $ 1.30 1.32 1.26 On October 30, 2010, a company enters a forward contract to sell €100,000 on April 30, 2011 The company’s accounting year ends December 31 Topic: Hedge of export transaction LO The forward contract hedges an outstanding €100,000 account receivable due on April 30 What is the net effect on income in 2010 and 2011? a b c d 2010 $1,000 gain $1,000 loss $3,000 gain $2,000 loss 2011 $4,000 gain $4,000 gain $6,000 gain $6,000 gain ANS: a 2010: Gain on receivable, ($1.28 - $1.25) x €100,000 Loss on forward, ($1.32 - $1.30) x €100,000 Net gain = $3,000 = $2,000 $1,000 2011: Loss on receivable, ($1.28 - $1.26) x €100,000 Gain on forward, ($1.32 - $1.26) x €100,000 Net gain = $2,000 = $6,000 $4,000 ©Cambridge Business Publishers, 2010 Edition Advanced Accounting, 1st Topic: Hedge of firm commitment LO The forward contract hedges a sales order for €100,000, received October 30 The sale was made and the €100,000 collected on April 30, 2011 Sales revenue recorded on April 30 is: a b c d $126,000 $122,000 $130,000 $124,000 ANS: c (€100,000 x $1.26) + ($1.30 - $1.26) x €100,000 = $130,000 Topic: Hedge of firm commitment LO The forward contract hedges a sales order for €100,000, received October 30 The sale was made and the €100,000 collected on April 30, 2011 The net effect on 2010 income is: a b c d No effect $2,000 loss $3,000 gain $1,000 gain ANS: a The gain on the firm commitment and loss on the forward contract are ($1.32 - $1.30) x €100,000 = $2,000, and they offset for a zero effect on 2010 income Test Bank, Chapter ©Cambridge Business Publishers, 2010 Topic: Hedge of forecasted transaction LO The forward contract hedges a forecasted sale for €100,000, expected at the end of April 2011 The net effect on 2010 income is: a b c d No effect $2,000 loss $3,000 gain $1,000 gain ANS: a The loss on the forward contract is reported in other comprehensive income Topic: Hedge of forecasted transaction LO The forward contract hedges a forecasted sale for €100,000, expected at the end of April 2011 The sale takes place on April 30, 2011, €100,000 is collected, and the forward contract is closed Which statement is true, concerning the sale on April 30, 2011? a b c d The $1,000 total loss on the forward contract is reclassified from other comprehensive income as an adjustment to sales revenue The $4,000 total gain on the forward contract is reclassified from other comprehensive income as an adjustment to sales revenue The 2011 $6,000 gain on the forward contract is recognized as a hedging gain on the 2011 income statement The 2010 $2,000 loss on the forward contract is recognized as a hedging loss on the 2010 income statement ANS: b The total gain on the forward contract is ($1.30 - $1.26) x €100,000 = $4,000 Changes in the value of the forward are reported in other comprehensive income until the hedged forecasted transaction is reported in income In this case, the forecasted transaction results in sales revenue, reported in 2011 ©Cambridge Business Publishers, 2010 Edition Advanced Accounting, 1st Topic: Export transaction LO On May 20, 2012, when the spot rate is $1.30/€, a company sells merchandise to a customer in Italy The spot rate is $1.31/€ on June 30, the company’s year-end Payment of €100,000 is received on July 30, 2012, when the spot rate is $1.28/€ What is the effect on fiscal 2012 and 2013 income? a b c d Fiscal 2012 $1,000 exchange loss $1,000 exchange gain No effect No effect Fiscal 2013 $3,000 exchange gain $3,000 exchange loss $2,000 exchange loss $2,000 exchange gain ANS: b Fiscal 2012 exchange gain = ($1.31 - $1.30) x €100,000 = $1,000 Fiscal 2013 exchange loss = ($1.31 - $1.28) x €100,000 = $3,000 Topic: Import transaction LO On May 20, 2012, when the spot rate is $1.30/€, a company purchases merchandise from a supplier in Italy The spot rate is $1.31/€ on June 30, the company’s year-end Payment of €100,000 is made on July 30, 2012, when the spot rate is $1.28/€ What is the effect on fiscal 2012 and 2013 income? a b c d Fiscal 2012 $1,000 exchange loss $1,000 exchange gain No effect No effect Fiscal 2013 $3,000 exchange gain $3,000 exchange loss $2,000 exchange loss $2,000 exchange gain ANS: a Fiscal 2012 exchange loss = ($1.31 – $1.30) x €100,000 = $1,000 Fiscal 2013 exchange gain = ($1.31 – $1.28) x €100,000 = $3,000 Test Bank, Chapter ©Cambridge Business Publishers, 2010 Data for questions 10 and 11 are as follows: On September 8, the Sealy Company purchased cotton at an invoice price of €20,000, when the exchange rate was $1.32/€ Payment was to be made on November On November 8, Sealy purchased the €20,000 for $1.30/€, and paid the invoice 10 Topic: Import transaction LO The cotton should be valued in Sealy's inventory at: a b c d $20,000 $25,600 $26,000 $26,400 ANS: d €20,000 11 x $1.32 = $26,400 Topic: Import transaction LO The exchange gain or loss recognized by Sealy as a result of this transaction is: a b c d No gain or loss $400 gain $400 loss $1,667 gain ANS: b €20,000 x ($1.32 - $1.30) = $400 gain ©Cambridge Business Publishers, 2010 Edition Advanced Accounting, 1st Data for questions 12 and 13 are as follows: On June 5, Teneco Corporation sold merchandise at an invoice price of €100,000, when the exchange rate was $1.36/€ Payment was to be received on August 16 On August 16, the customer paid the €100,000 The exchange rate on that date was $1.39/€ 12 Topic: Export transaction LO The sale should be reported on Teneco's books at: a b c d $136,000 $139,000 $ 73,530 $ 71,942 ANS: a €100,000 x $1.36 = $136,000 13 Topic: Export transaction LO The exchange gain or loss recognized by Teneco as a result of this transaction is: a b c d -0$3,000 gain $3,000 loss $3,919 loss ANS: b €100,000 x ($1.39 - 1.36) = $3,000 gain Test Bank, Chapter ©Cambridge Business Publishers, 2010 14 Topic: Analysis of foreign currency risks LO A U.S exporter has made a sale to a customer in another country The customer is obligated to remit payment in his local currency in 90 days The direct spot rate is now $1.54 The 90-day forward rate is $1.60 At which spot rate at the time the customer remits payment would the company have been better off not hedging the export transaction with a forward contract? a b c d $1.52 $1.54 $1.59 $1.62 ANS: d Any rate above $1.60 leads to higher U.S dollar value of payment received than under the forward contract 15 Topic: Foreign currency options LO A company invests $200 in a foreign exchange option with the following terms: The company may purchase 1,000,000 zloty at a price of $.25/zloty on December 20, 2014 Which statement is true? a b c d If the spot price for zloty is $.36 on December 20, the company will gain $359,800 on the option If the spot price for zloty is $.24 on December 20, the company will lose $200 on the option If the spot price for zloty is $.27 on December 20, the company will lose $20,200 on the option If the spot price for zloty is $.30 on December 20, the company will gain $24,800 on the option ANS: b The option gives the holder the option to buy 1,000,000 zloty for $250,000 At a spot price of $.24/zloty, the option has no value and the holder loses its $200 investment ©Cambridge Business Publishers, 2010 Edition Advanced Accounting, 1st 16 Topic: Hedge of import transaction LO A U.S import company purchases boomerangs from an Australian supplier on October 1, 2013 for 100,000 Australian dollars (A$), payable February 1, 2014 On October 1, 2013, the company enters into a forward contract to hedge the foreign currency risk resulting from this purchase Exchange rates are as follows: October 1, 2013 December 31, 2013 February 1, 2014 Spot rate $0.89 0.88 0.82 Forward rate for 2/1 delivery $0.85 0.84 0.82 For the import company, what is the income statement effect of the above information? a b c d No effect in 2013, $4,000 gain in 2014 $1,000 gain in 2013, $6,000 gain in 2014 $1,000 loss in 2013, $6,000 loss in 2014 No effect in 2013, $4,000 loss in 2014 ANS: a 2013: forward contract: ($.85 - $.84) x A$100,000 = payable: ($.89 - $.88) x A$100,000 = 2014: forward contract: ($.84 - $.82) x A$100,000 = payable: ($.88 - $.82) x A$100,000 = Test Bank, Chapter $1,000 loss 1,000 gain -0$2,000 loss 6,000 gain $4,000 gain ©Cambridge Business Publishers, 2010 17 Topic: Hedge of firm commitment LO ABC Corporation issues a purchase order for 1,000,000 semiconductors to a foreign supplier The agreed upon total price is FC1,200,000, and the current spot rate is $1/FC Suppose a forward contract is taken out when the purchase order is issued, at a rate of $0.95/FC, for delivery when the semiconductors are received If the spot rate rises to $1.05 when the semiconductors are received and paid for by ABC, at what value will the semiconductors be reported on ABC’s books? a b c d $1,020,000 $1,140,000 $1,200,000 $1,260,000 ANS: b $1.05 x FC1,200,000 = ($1.05 - $.95) x FC1,200,000 = $1,260,000 (120,000) $1,140,000 Use the following information to answer questions 18 and 19 below A U.S company purchases a 60-day certificate of deposit from an Italian bank on October 15 The certificate has a face value of €1,000,000, costs $1,200,000 (the spot rate is $1.20/€), and pays interest at an annual rate of percent On December 14, the certificate of deposit matures and the company receives principal and interest of €1,010,000 The spot rate on December 14 is $1.18/€ The average spot rate for the period October 15 – December 14 is $1.19/€ 18 Topic: Foreign currency lending LO The exchange gain or loss on this investment is: a b c d $20,200 gain $20,200 loss $20,000 gain $20,000 loss ANS: d €1,000,000 x ($1.20 - $1.18) = $20,000 loss ©Cambridge Business Publishers, 2010 10 Edition Advanced Accounting, 1st May 1, 2013 Investment in forward 500 Other comprehensive income To mark the forward to market ($.1315 to $.132) Exchange loss 500 1,000 Accounts payable To mark accounts payable to market ($.131 to $.132) 1,000 Other comprehensive income 1,000 Exchange gain 1,000 To reclassify other comprehensive income to income to match against accounts payable loss Foreign currency 132,000 Investment in forward Cash 5,000 127,000 To close forward contract Accounts payable 132,000 Foreign currency 132,000 To pay the supplier May 31, 2013 Cost of goods sold Other comprehensive income 127,000 1,500 Inventory 128,500 Note: Remaining other comprehensive income balance is $4,000 - $2,000 + $500 - $500 + $500 - $1,000 = $1,500 gain ©Cambridge Business Publishers, 2010 46 Edition Advanced Accounting, 1st 14 Topic: Cash flow hedge accounting versus regular accounting LO 3, Following is information on exchange rates for the euro: October 1, 2011 December 31, 2011 January 31, 2012 March 31, 2012 April 30, 2012 Spot rate $1.45 1.50 1.52 1.56 1.60 Forward rate for 4/30/12 delivery $1.48 1.53 1.55 1.58 1.60 On October 1, 2011, a U.S company forecasts that it will buy merchandise from a supplier in Portugal for €10,000,000 around the end of March, 2012, with payment expected to be made, in euros, about one month later The company closes its books on December 31 The following events occur: October 1, 2011: The company enters a forward purchase agreement for delivery of €10,000,000 on April 30, 2012 No initial investment is required December 31, 2011: The company closes its books January 31, 2012: The company issues a purchase order to the supplier for €10,000,000 in merchandise, to be delivered March 31, 2012 March 31, 2012: The company takes delivery of the merchandise April 30, 2012: The company closes the forward contract and pays the supplier €10,000,000 May 15, 2012: The company sells the merchandise to a U.S customer for $22,500,000 Required Fill in the schedule below, showing the amounts related to the above events that will be reported in the company’s annual reports for 2011 and 2012 Show related journal entries in the next schedule Show liabilities and gains in parenthesis Test Bank, Chapter ©Cambridge Business Publishers, 2010 47 ANS: Account title Forward contract qualifies as a hedge of the forecasted transaction 2011 Investment in forward (balance sheet) Other comprehensive income (Balance sheet) 2012 $ 500,000 (500,000) 2011 2012 $ 500,000 (Gains) and losses (income statement) Cost of goods sold (income statement) $14,800,000 ©Cambridge Business Publishers, 2010 48 Edition The forward contract does not qualify as a hedge (500,000) $ (200,000) (300,000) (200,000) 400,000 $ (300,000) $15,600,000 Advanced Accounting, 1st Forward contract is a qualified hedge December 31 Investment in forward 500,000 OCI 500,000 January 31 Investment in forward OCI 200,000 200,000 March 31 Investment in forward 300,000 OCI 300,000 Exchange loss 300,000 Firm commitment 300,000 OCI 300,000 Gain 300,000 Inventory 15,300,000 Firm commitment 300,000 A/P 15,600,000 April 30 Investment in forward 200,000 OCI 200,000 Exchange loss 400,000 A/P 400,000 OCI 400,000 Exchange gain 400,000 Foreign currency 16,000,000 Cash 14,800,000 Investment in for 1,200,000 A/P 16,000,000 Foreign currency 16,000,000 May 15 CGS OCI Inventory Test Bank, Chapter 14,800,000 500,000 Forward contract is not a qualified hedge Investment in forward Exchange gain 500,000 Investment in forward Exchange gain 200,000 Investment in forward Exchange gain 300,000 500,000 200,000 300,000 -Inventory A/P 15,600,000 15,600,000 Investment in forward Exchange gain 200,000 Exchange loss A/P 400,000 200,000 400,000 Foreign currency Cash 14,800,000 Investment in for A/P Foreign currency 16,000,000 CGS Inventory 15,600,000 15,600,000 1,200,000 16,000,000 16,000,000 15,300,000 ©Cambridge Business Publishers, 2010 49 15 Topic: Cash flow hedge accounting versus regular accounting LO 3, Following are exchange rates for the Canadian dollar October 31, 2011 December 31, 2011 March 31, 2012 Spot rate $ 0.80 0.84 0.82 Forward rate for March 31, 2012 delivery $ 0.81 0.86 0.82 A U.S company enters a forward contract on October 31, 2011 to hedge a forecasted purchase of merchandise for C$1,000,000 on March 31, 2012 On March 31 it takes delivery of the merchandise, closes the forward and pays for the merchandise It sells the merchandise in May The company’s accounting year ends December 31 Required What are the balances for the following accounts, assuming the forward contract qualifies as a hedge of the forecasted transaction for the period October 31, 2011 to March 31, 2012, and also if the forward contract does not qualify as a hedge? a b c d Other comprehensive income balance, December 31, 2011 Gain/loss on forward contract, 2011 income statement Gain/loss on forward contract, 2012 income statement 2012 cost of goods sold ANS: Qualifies as hedge Other comprehensive income, December 31, 2011 (gain) 2011 income statement gain on forward contract 2012 income statement loss on forward contract 2012 cost of goods sold ©Cambridge Business Publishers, 2010 50 Edition $ 50,000 Does not qualify $ 0 50,000 810,000 40,000 820,000 Advanced Accounting, 1st 16 Topic: Hedge of firm commitment, import transaction, speculation LO 2, 5, Electronic Importers, a U.S company, has the following outstanding balances as of December 31, 2011, its accounting year-end Forward purchase contract dated December 1, 2011 for 20,000,000 yen to hedge a firm commitment to purchase computer hardware for 20,000,000 yen in 90 days ending on March 1, 2012 Account payable for 70,000,000 yen for unpaid merchandise acquired on December 16, 2011 and due on January 15, 2012 Forward sale contract dated December 16, 2011 for 30,000,000 yen to speculate in exchange rate changes and due on January 15, 2012 Exchange rates quoted in the U.S for Japanese yen are: Spot rate 90-day forward 60-day forward 30-day forward 15-day forward 12/1/11 $.00620 00630 00620 00610 00615 12/16/11 12/31/11 $.00610 $.00600 00620 00610 00610 00603 00600 00590 00605 00595 1/15/12 $.00593 00600 00590 00580 00585 3/1/12 $.00580 00590 00580 00570 00575 Required a Calculate the gain or loss on Electronic Importers' 2011 income statement due to the above items Specify the amount and whether it is a gain or loss b Calculate the balances at which the forward purchase contract and the forward sale contract would be reported in the December 31, 2011 balance sheet c At what amount (U.S dollars) should the computer hardware be valued on March 1, 2012? Test Bank, Chapter ©Cambridge Business Publishers, 2010 51 ANS: a Forward purchase contract: no income effect due to offsetting gain and loss on contract and firm commitment Accounts payable 70,000,000 x ($.00610 - $.00600) = Forward sale 30,000,000 x ($.00600 - $.00595) = b $7,000 gain 1,500 gain $8,500 gain Forward purchase contract: ($.0063 - $.00603) x 20,000,000 = $5,400 current liability Forward sale contract: ($.006 - $.00595) x 30,000,000 = $1,500 current asset c ($.0058 x 20,000,000) = Plus firm commitment balance: ($.0063 - $.0058) x 20,000,000 Hardware balance, 3/1/12 ©Cambridge Business Publishers, 2010 52 Edition $116,000 10,000 $126,000 Advanced Accounting, 1st 17 Topic: Import transactions, hedge of firm commitment, hedge of forecasted transaction, speculation LO 2, 5, 6, Each of the following situations is independent of the others Acme Importers is a U.S company with a December 31 year-end Use the following information on exchange rates (US$/$Canadian) to answer each question September 1, 2012 October 1, 2012 December 31, 2012 February 1, 2013 Spot rate $.80 78 75 69 Forward rate for delivery on 2/1/13 $.82 79 74 69 Required For each situation, (1) make the journal entries necessary to record the events, including year-end adjustments, and (2) calculate the effect on Acme's income in the year 2012, and in the year 2013 Show the amounts and whether they are gains or losses a b c d e On September 1, 2012 Acme Importers agrees to buy merchandise from Montreal Suppliers Delivery will take place on October 1, 2012, and Acme will pay Montreal Suppliers C$5,000 on February 1, 2013 On September 1, 2012, Acme Importers makes a firm commitment to buy merchandise from Montreal Suppliers Delivery will take place on October 1, 2012, and Acme will pay Montreal Suppliers C$5,000 on February 1, 2013 On October 1, 2012, Acme enters into a forward purchase contract with ABC Exchange Dealers for the purchase of C$5,000, to be delivered February 1, 2013 On September 1, 2012, Acme Importers makes a firm commitment to buy merchandise from Montreal Suppliers Delivery will take place on October 1, 2012, and Acme will pay Montreal Suppliers C$5,000 on February 1, 2013 On September 1, 2012, Acme enters into a forward purchase contract with ABC Exchange Dealers for the purchase of C$5,000, to be delivered February 1, 2013 The merchandise remains in Acme's inventory as of December 31, 2013 The CFO at Acme Importers believes that the U.S dollar will continue to strengthen with respect to the Canadian dollar On October 1, 2012, he enters into a speculative forward sale contract with ABC Exchange Dealers for delivery of C$5,000 on February 1, 2013 On September 1, 2012, Acme Importers forecasts that it will buy merchandise from a Canadian supplier Delivery and payment of C$5,000 is expected to take place on October 1, 2012 On September 1, 2012, Acme enters into a forward purchase contract with ABC Exchange Dealers for the purchase of C$5,000 for $0.76, to be delivered October 1, 2012 The merchandise purchase occurs as forecasted, and the merchandise remains in Acme’s inventory as of December 31, 2013 Test Bank, Chapter ©Cambridge Business Publishers, 2010 53 ANS: 1a 10/1 Merchandise 3,900 Accounts payable 3,900 (5,000 x $.78) 12/31 10/1 Accounts payable 150 Exchange gain 150 [($.78 - $.75) x 5,000] 2/1 Accounts payable 300 Exchange gain 300 [($.75 - $.69) x 5,000] 2/1 Accounts payable 3,450 Cash 3,450 (5,000 x $.69) b 10/1 Merchandise 3,900 Accounts payable 12/31 3,900 Accounts payable 150 Exchange gain 12/31 150 Exchange loss 250 Investment in forward 250 [($.79 - $.74) x 5,000] 2/1 Accounts payable 300 Exchange gain 2/1 300 Exchange loss 250 Investment in forward 250 [($.74 - $.69) x 5,000] 2/1 Foreign currency Investment in forward 3,450 500 Cash 2/1 Accounts payable 3,450 Foreign currency ©Cambridge Business Publishers, 2010 54 Edition 3,950 3,450 Advanced Accounting, 1st c 10/1 Exchange loss 150 Investment in forward 150 [($.82 - $.79) x 5,000] 10/1 Firm commitment 150 Exchange gain 10/1 150 Merchandise 3,900 Accounts payable 10/1 Merchandise 3,900 150 Firm commitment 12/31 Exchange loss 150 250 Investment in forward 12/31 Accounts payable 250 150 Exchange gain 2/1 150 Exchange loss 250 Investment in forward Accounts payable 250 300 2/1 Exchange gain 2/1 2/1 300 Foreign currency 3,450 Investment in forward 500 Cash 3,950 Accounts payable 3,450 2/1 Foreign currency Test Bank, Chapter 3,450 ©Cambridge Business Publishers, 2010 55 d 12/31 Investment in forward 250 Exchange gain 250 [($.79 - $.74) x 5,000] 2/1 Investment in forward 250 Exchange gain 250 [($.74 - $.69) x 5,000] 2/1 Foreign currency 3,450 Cash 3,450 Cash 3,950 2/1 Foreign currency Investment in forward e 10/1 Investment in forward 3,450 500 100 Other comprehensive income 100 [($.78-.76) x 5,000] 10/1 Foreign currency 3,900 Investment in forward Cash Merchandise 100 3,800 3,900 10/1 Foreign currency (a) (b) (c) (d) (e) 3,900 Income effects: 2012 $150 gain 100 loss 100 loss 250 gain -0- ©Cambridge Business Publishers, 2010 56 Edition 2013 $300 gain 50 gain 50 gain 250 gain -0- Advanced Accounting, 1st 18 Topic: Borrowing in foreign currency LO A U.S company purchases a 60-day certificate of deposit from a German bank on October 15 The certificate has a face value of €10,000,000, costs $13,800,000 (the spot rate is $1.38/€ on October 15), and pays interest at an annual rate of percent On December 14, the certificate of deposit matures and the company receives principal and interest due to it The spot rate on December 14 is $1.40/€ The average spot rate for the period October 15 - December 14 is $1.39/€ Required Prepare all necessary journal entries to record the above events on the U.S company's books ANS: 10/15 Temporary investments 13,800,000 Cash 12/14 Temporary investments 13,800,000 200,000 Exchange gain $200,000 = ($1.40 - $1.38) x €10,000,000 Foreign currency Temporary investments Interest income $186,667 = (10,000,000 x 8% x 2/12) x $1.40 Test Bank, Chapter 200,000 14,186,667 14,000,000 186,667 ©Cambridge Business Publishers, 2010 57 19 Topic: Speculation in forward contracts LO On November 1, 2013, a U.S company thinks the exchange rate for the euro will fall, so it enters into a forward contract in the amount of €1,000,000, for delivery on March 15, 2014 This is a speculative contract The company’s accounting year ends December 31 The company closes the contract on February 1, 2014 Exchange rates are as follows ($/ €): November 1, 2013 December 31, 2013 February 1, 2014 March 15, 2014 Spot rate $ 1.42 1.46 1.47 1.50 Forward rate for March 15, 2014 delivery $ 1.43 1.45 1.48 1.50 Required a Does the company enter a forward purchase or a forward sale contract? Explain b Prepare the journal entries necessary on December 31, 2013 and February 1, 2014 to record the above events ANS: a A forward sale locks in the selling price If the rate falls, as the company expects, it will gain by buying euros at the lower price and selling at the higher contract price b December 31, 2013 Loss 20,000 Investment in forward To adjust the forward contract to fair value; $20,000 = ($1.45 - $1.43) x €1,000,000 20,000 February 1, 2014 Loss 30,000 Investment in forward To adjust the forward contract to fair value; $30,000 = ($1.48 - $1.45) x €1,000,000 30,000 The company closes the forward by entering a forward purchase for delivery on March 15, 2014, at $1.48/€ So the company sells at $1.43 and buys at $1.48, for a net cash outflow of ($1.48 - $1.43) x €1,000,000 = $50,000 Investment in forward Cash To close the forward contract on February 1, 2014 ©Cambridge Business Publishers, 2010 58 Edition 50,000 50,000 Advanced Accounting, 1st 20 Topic: IFRS for hedging forecasted transactions LO On February 15, 2011, an Italian company, with a June 30 year-end, enters a forward purchase contract for $1,000,000 to be delivered on August 1, 2011 The contract hedges a forecasted purchase of equipment The forward is closed and the equipment purchased on August The equipment has a 2-year life, and is straight-line depreciated Following is information on exchange rates (€/$): February 15, 2011 June 30, 2011 August 1, 2011 Spot rate €0.80 0.74 0.72 Forward rate for August 1, 2011 delivery €0.81 0.76 0.72 The company follows IFRS and uses the basis adjustment approach to reporting cash flow hedges Required Prepare the journal entries to record the following events: a b c d June 30, 2011 adjusting entry August 1, 2011 adjusting entries and transactions June 30, 2012 adjusting entry for the equipment If the company followed U.S GAAP, how would the June 30, 2012 entry differ? Test Bank, Chapter ©Cambridge Business Publishers, 2010 59 ANS: a June 30, 2011 Other comprehensive income 50,000 Investment in forward 50,000 To adjust the forward contract to fair value; €50,000 = (€.81 - €.76) x $1,000,000 b August 1, 2011 Other comprehensive income 40,000 Investment in forward 40,000 To adjust the forward contract to fair value; €40,000 = (€.76 - €.72) x $1,000,000 Foreign currency Investment in forward 720,000 90,000 Cash 810,000 To close the forward contract Equipment 720,000 Foreign currency 720,000 To purchase the equipment Equipment 90,000 Other comprehensive income To adjust the equipment for the accumulated loss on the forward 90,000 c June 30, 2012 Depreciation expense 371,250 Equipment, net 371,250 To record depreciation expense for fiscal 2012; €371,250 = (€810,000/2) x 11/12 d June 30, 2012 Depreciation expense 330,000 Equipment, net 330,000 To record depreciation expense for fiscal 2012; €330,000 = (€720,000/2) x 11/12 Depreciation expense 41,250 Other comprehensive income 41,250 To reclassify other comprehensive income as an adjustment of depreciation expense for fiscal 2012; €41,250 = (€90,000/2) x 11/12 ©Cambridge Business Publishers, 2010 60 Edition Advanced Accounting, 1st