Chapter 11, Problem 11.28AP

a

To determine

Introduction:

Derivatives designed as hedge: To reduce risks, ASC 815 provides specific requirements for classifying derivative as a hedge. Hedge accounting offsets the gain or loss on the hedged instrument. Hedges can be used to offset foreign currency exchange rate risk, interest rate risk, and commodity risk. A derivative instrument in order to qualify as a hedge must have sufficient documentation at the beginning of the hedge term to identify the objective of the hedge. The hedge must be highly effective throughout its term. The effectiveness must be tested every three months and each time the financial instrument is prepared.

The entries for given transaction when forward contract is not designed as hedge.

Explanation of Solution

Date	Particulars	Debit $	Credit $
12/1/20X1	Purchases	60,000
	Accounts payable		60,000
	(Foreign currency payable on purchase transaction)
	Foreign currency receivable from exchange broker	60,900
	Dollars payable to exchange broker		60,900
	(Entered into foreign exchange contract to manage foreign currency exposer)
12/31/X1	Foreign currency transaction loss	1,000
	Accounts payable		1,000
	(Revaluation of foreign currency payable to equivalent U.S. dollar and loss on the same recognized)
	Foreign currency receivable from exchange broker	300
	Foreign currency transaction gain		300
	(Revaluation of foreign currency receivable and recognition of its gain)
03/31/20X2	Foreign currency transaction loss	1,000
	Foreign currency receivable from exchange broker		1,000
	(Revaluation of foreign currency receivable)
	Accounts payable	800
	Foreign currency transaction gain		800
	(Revaluation of foreign currency payable)
	Dollars payable to exchange broker	60,900
	Cash		60,900
	(Delivery of dollars to exchange broker as per the exchange contract)
	Foreign currency unit (A$)	60,200
	Foreign currency receivable from exchange broker		60,200
	(Received A$100,000 from exchange broker in accordance with contract)
	Accounts payable	60,200
	Foreign currency units		60,200
	(Foreign currency unit paid to creditor)

1. Foreign currency payable $60,000 = $A\$100,000\times \$.600$
2. Signed forward contract to manage foreign currency exposer

$60,900 = $A\$100,000\times \$.609$

3. Revaluation of Accounts payable at the end of the year and recognition of loss:

Spot rate on December 31 $A\$100,000\times \$.610$	$61,000
Less: Spot rate on December 1 $A\$100,000\times \$.600$	($60,000)
Foreign currency transaction loss	$1,000

4. Revaluation of foreign currency receivable from exchange broker

  $\$300=A\$100,000\times (\$.612-\$.609)$

5. Revaluation of foreign currency receivable from exchange broker on March 31

  $\$1,000=A\$100,000\times (\$.602-\$.612)$

6. Revaluation of foreign currency payable on March 31

  $\$800=A\$100,000\times (\$.602-\$.610)$

7. Received A$100,000 from exchange broker in accordance with forward contract

  $\$60,200=A\$100,000\times \$.602\text{}$ March 31 spot rate.

8. A$100,000 delivered to creditor.

b

To determine

Introduction:

Derivatives designed as hedge: To reduce risks, ASC 815 provides specific requirements for classifying derivative as a hedge. Hedge accounting offsets the gain or loss on the hedged instrument. Hedges can be used to offset foreign currency exchange rate risk, interest rate risk, and commodity risk. A derivative instrument in order to qualify as a hedge must have sufficient documentation at the beginning of the hedge term to identify the objective of the hedge. The hedge must be highly effective throughout its term. The effectiveness must be tested every three months and each time the financial instrument is prepared.

The entries for given transaction when forward contract designed for fair value hedge.

Explanation of Solution

Date	Particulars	Debit $	Credit $
12/1/20X1	Foreign currency receivable from exchange broker	60,900
	Dollars payable to exchange broker		60,900
	(Entered into foreign exchange contract to manage foreign currency exposer)
12/31/X1	Foreign currency transaction loss	300
	Firm commitment		300
	(Record the loss on the financial instrument aspect of the firm commitment)
	Foreign currency receivable from exchange broker	300
	Foreign currency transaction gain		300
	(Revaluation of foreign currency receivable to fair value and recognition of its gain)
1/30/20X2	Foreign currency transaction loss	700
	Foreign currency receivable from broker		700
	(revaluation of foreign currency receivable to current U.S. dollar equivalent)
	Firm commitment	700
	Foreign currency transaction gain		700
	(Recording of gain on the financial instrument aspect of the firm commitment)
	Purchases	61,200
	Firm commitment		400
	Accounts payable		60,800
	(Purchased furniture committed on December 1 X1
03/31/20X2	Foreign currency transaction loss	300
	Foreign currency receivable from exchange broker		300
	(Revaluation of foreign currency receivable)
	Accounts payable	600
	Foreign currency transaction gain		600
	(Revaluation of foreign currency payable)
	Dollars payable to exchange broker	60,900
	Cash		60,900
	(Delivery of dollars to exchange broker as per the exchange contract)
	Foreign currency unit (A$)	60,200
	Foreign currency receivable from exchange broker		60,200
	(Received A$100,000 from exchange broker in accordance with contract)
	Accounts payable	60,200
	Foreign currency units		60,200
	(Foreign currency unit paid to creditor)

1. Signed forward contract to manage foreign currency exposer

$60,900 = $A\$100,000\times \$.609$

2. Foreign currency transaction gain of revaluation of receivable on December 31

  $\$300=A\$100,000\times (\$.612-\$.609)$

3. Record the loss on the financial instrument aspect of the firm commitment on December 31 $\$300=A\$100,000\times (\$.612-\$.609)$
4. Revaluation of foreign currency receivable to current U.S. dollar

  $\$700=A\$100,000\times (\$.605-\$.612)$

5. Gain on financial instrument aspect of the firm commitment

  $\$700=A\$100,000\times (\$.605-\$.612)$

6. Purchase of furniture committed on December 1 20X1

  $\$60,800=A\$100,000\times \$.608$

7. Revaluation of foreign currency receivable from exchange broker

  $\$300=A\$100,000\times (\$.612-\$.609)$

8. Revaluation of foreign currency payable with change in spot from $.608 on January 30 to $.602 on March 31 $\$600=A\$100,000\times (\$.602-\$.608)$
9. Received A$100,000 in exchange of U.S. dollar

  $\$60,900=A\$100,000\times \$.609$

10. Received A$100,000 from exchange broker in accordance with forward contract

  $\$60,200=A\$100,000\times \$.602\text{}$ March 31 spot rate.

11. A$100,000 delivered to creditor.

c

To determine

Introduction:

Derivatives designed as hedge: To reduce risks, ASC 815 provides specific requirements for classifying derivative as a hedge. Hedge accounting offsets the gain or loss on the hedged instrument. Hedges can be used to offset foreign currency exchange rate risk, interest rate risk, and commodity risk. A derivative instrument in order to qualify as a hedge must have sufficient documentation at the beginning of the hedge term to identify the objective of the hedge. The hedge must be highly effective throughout its term. The effectiveness must be tested every three months and each time the financial instrument is prepared.

The entries when company uses the forward exchange rate to measure hedge effectiveness.

Explanation of Solution

Date	Particulars	Debit $	Credit $
12/1/20X1	Foreign currency receivable from exchange broker	60,900
	Dollars payable to exchange broker		60,900
	(Entered into foreign exchange contract to manage foreign currency exposer)
12/31/X1	Foreign currency receivable from exchange broker	300
	Other comprehensive income		300
	(Revaluation of foreign currency receivable to fair value and recognized as other comprehensive income)
1/30/20X2	Other comprehensive income	700
	Foreign currency receivable from broker		700
	(Revaluation of foreign currency receivable to current U.S. dollar equivalent and recognized as other comprehensive income)
	Purchases	60,800
	Accounts payable		60,800
	(Purchased furniture committed on December 1 X1)
03/31/20X2	Other comprehensive income	300
	Foreign currency receivable from exchange broker		300
	(Revaluation of foreign currency receivable recognized as other comprehensive income)
	Accounts payable	600
	Foreign currency transaction gain		600
	(Revaluation of foreign currency payable)
	Foreign currency transaction loss	600
	Other comprehensive income		600
	(Reclassify amount from OCI to offset the foreign currency transaction on foreign currency payable)
	Dollars payable to exchange broker	60,900
	Cash		60,900
	(Delivery of dollars to exchange broker as per the exchange contract)
	Foreign currency unit (A$)	60,200
	Foreign currency receivable from exchange broker		60,200
	(Received A$100,000 from exchange broker in accordance with contract)
	Accounts payable	60,200
	Foreign currency units		60,200
	(Foreign currency unit paid to creditor)

1. Signed forward contract to manage foreign currency exposer

$60,900 = $A\$100,000\times \$.609$

2. Foreign currency transaction gain of revaluation of receivable on December 31

  $\$300=A\$100,000\times (\$.612-\$.609)$

3. Revaluation of foreign currency receivable to current U.S. dollar equivalent and recording of other comprehensive income for effective change in fair value on December 31 $\$700=A\$100,000\times (\$.605-\$.612)$
4. Purchase of furniture valued at spot rate

  $\$60,800=A\$100,000\times \$.608$

5. Revaluation of foreign currency receivable to current U.S. dollar and recognized as Other comprehensive income $\$300=A\$100,000\times (\$.602-\$.605)$
6. Revaluation of foreign currency payable using spot rate and recognizing the change

  $\$600=A\$100,000\times (\$.602-\$.608)$

7. Purchase of furniture committed on December 1 20X1

  $\$60,900=A\$100,000\times \$.609$

8. Received A$100,000 from exchange broker in accordance with forward contract

  $\$60,200=A\$100,000\times \$.602\text{}$ March 31 spot rate.

9. A$100,000 delivered to creditor.

d

To determine

Introduction:

Derivatives designed as hedge: To reduce risks, ASC 815 provides specific requirements for classifying derivative as a hedge. Hedge accounting offsets the gain or loss on the hedged instrument. Hedges can be used to offset foreign currency exchange rate risk, interest rate risk, and commodity risk. A derivative instrument in order to qualify as a hedge must have sufficient documentation at the beginning of the hedge term to identify the objective of the hedge. The hedge must be highly effective throughout its term. The effectiveness must be tested every three months and each time the financial instrument is prepared.

The entries when forward contract was for speculations only.

Explanation of Solution

Date	Particulars	Debit $	Credit $
12/1/20X1	Foreign currency receivable from exchange broker	60,900
	Dollars payable to exchange broker		60,900
	(Entered into foreign exchange contract to manage foreign currency exposer)
12/31/X1	Foreign currency receivable from exchange broker	300
	Other comprehensive income		300
	(Revaluation of foreign currency receivable to fair value and recognized as other comprehensive income)
3/31/20X2	Foreign currency transaction loss	1,000
	Foreign currency receivable from broker		1,000
	(Revaluation of foreign currency receivable)
	Dollars payable to exchange broker	60,900
	Cash		60,900
	(Delivery of dollars to exchange broker as per the exchange contract)
	Foreign currency unit (A$)	60,200
	Foreign currency receivable from exchange broker		60,200
	(Received A$100,000 from exchange broker in accordance with contract)

1. Signed forward contract to manage foreign currency exposer

$60,900 = $A\$100,000\times \$.609$

2. Foreign currency transaction gain of revaluation of receivable on December 31

  $\$1,000=A\$100,000\times (\$.602-\$.612)$

3. Purchase of furniture committed on December 1 20X1

  $\$60,900=A\$100,000\times \$.609$

4. Received A$100,000 from exchange broker in accordance with forward contract

  $\$60,200=A\$100,000\times \$.602\text{}$ March 31 spot rate.

5. A$100,000 delivered to creditor.

e

To determine

Introduction:

Derivatives designed as hedge: To reduce risks, ASC 815 provides specific requirements for classifying derivative as a hedge. Hedge accounting offsets the gain or loss on the hedged instrument. Hedges can be used to offset foreign currency exchange rate risk, interest rate risk, and commodity risk. A derivative instrument in order to qualify as a hedge must have sufficient documentation at the beginning of the hedge term to identify the objective of the hedge. The hedge must be highly effective throughout its term. The effectiveness must be tested every three months and each time the financial instrument is prepared.

The entries assuming that interest is significant and the time value of money is considered in valuing forward contract.

Explanation of Solution

Date	Particulars	Debit $	Credit $
12/1/20X1	Purchases	60,000
	Accounts payable		60,000
	(Foreign currency payable on purchases)
	Foreign currency receivable from exchange broker	60,900
	Dollars payable to exchange broker		60,900
	(Entered into foreign exchange contract to manage foreign currency exposer)
12/31/X1	Foreign currency receivable from exchange broker	291
	Foreign currency transaction gain		291
	(Revaluation of foreign currency receivable)
	Foreign currency transaction loss	1,000
	Accounts payable		1,000
	(Revaluation of foreign currency payable)
03/31/20X2	Foreign currency transaction loss	991
	Foreign currency receivable from exchange broker		991
	(Revaluation of foreign currency receivable recognized )
	Accounts payable	800
	Foreign currency transaction gain		800
	(Revaluation of foreign currency payable)
	Dollars payable to exchange broker	60,900
	Cash		60,900
	(Delivery of dollars to exchange broker as per the exchange contract)
	Foreign currency unit (A$)	60,200
	Foreign currency receivable from exchange broker		60,200
	(Received A$100,000 from exchange broker in accordance with contract)
	Accounts payable	60,200
	Foreign currency units		60,200
	(Foreign currency unit paid to creditor)

1. Foreign currency payable on purchases $\$60,000=A\$100,000\times \$.600$
2. Signed forward contract to manage foreign currency exposer

$60,900 = $A\$100,000\times \$.609$

3. Revaluation of foreign currency payable to equivalent U.S. dollar value

  $\$1,000=A\$100,000\times (\$.610-\$.600)$

4. Revaluation of foreign currency receivable

  $\$300=A\$100,000\times (\$.612-\$.609)$

5. To adjust with Net present value $291 = $(\$300\times .12)\times \frac{3}{12}$
6. Revaluation of foreign currency receivable to current U.S. dollar equivalent and recording of other comprehensive income for effective change in fair value on December 31 $\$700=A\$100,000\times (\$.605-\$.612)$
7. Purchase of furniture valued at spot rate

  $\$60,800=A\$100,000\times \$.608$

8. Revaluation of foreign currency receivable to current U.S. dollar and recognized

Spot rate March 21, 20X2 $A\$100,000\times \$.602$	$60,200
Forward rate December 1, 20X1 $A\$100,000\times \$.609$	$60,900
Undiscounted loss on forward contract	($700)
Less gain previously recognized on December 31, 20X1	($291)
Change in fair value	$991

9. Revaluation of foreign currency payable using spot rate and recognizing the change

  $\$800=A\$100,000\times (\$.602-\$.610)$

10. Purchase of furniture committed on December 1 20X1

  $\$60,900=A\$100,000\times \$.609$

11. Received A$100,000 from exchange broker in accordance with forward contract

  $\$60,200=A\$100,000\times \$.602\text{}$ March 31 spot rate.

12. A$100,000 delivered to creditor.