Chapter 7, Problem 44E

a.

To determine

Prepare the journal entries to record the sale and all the adjustments required at

November 20, 2018, December 31, 2018 and February 20, 2019 for the forecasted sale

and forward contract accounts.

Explanation of Solution

A derivative instrument is a financial instrument or other contract with all three of the following features:

•    Has one or more underlying provisions and one or more notional amounts or payment provisions or both. These terms determine the settlement or settlement amount and, in some cases, whether a settlement is necessary or not.

•    It involves no initial net investment or a smaller initial net investment than would be required for other types of contracts that would be forced to respond to changes in market factors in a similar way.

•    Its terms allow or warrant net settlement, it can simply be net settled through means outside the deal or it allows for the distribution of an item that places the receiver in a role not substantially different from net settlement.

All derivatives must always be calculated and published at fair value on each interim and annual financial reporting date in the balance sheet. The fair value of financial instruments is the most relevant measure and the only valid factor for derivative instruments.

Gains and losses on fair value hedges on different types of derivatives are expressed in the statement of income offsetting losses and gains on hedged trades.

If a derivative instrument qualifies as a fair value hedge, at each statement date, both the derivative and the asset or liability to which it relates shall be reported at fair value. In the derivative financial instrument, gains or losses on the hedged assets or liabilities are offset (in whole or in part) by losses or gains.

Gains and losses on cash flow hedges are stationed in accrued other systematic earnings until the sales arise and then allocated to the income statement to offset the losses and benefits in those transactions.

Hedging the exposure of a recognized asset or liability or a forecast transaction to cash flow variability that is attributable to a particular risk (referred to as a cash flow hedge).

A futures contract is a deal to make a purchase or sale an asset at an agreed-upon price at a point in the future. Future contracts are streamlined, typically exchange-trading agreements. One partner agrees to purchase a specified set of securities or commodities, and take possession on a specific date.

A forward contract is a custom designed agreement between two parties to buy or sell an asset on a future date at a specified price. For hedging or speculation a forward contract may be used, although its non-standardized nature makes it particularly suitable for hedging.

Hedged Transaction
Date	Account title and Explanation		Debit	Credit
20 Nov-18	Must document hedging relationship and hedge effectiveness in accounting system. FV = 0 at inception, so no entry.
31-Dec-18	No entry
20 Feb 19	Cash		$\$13,000$
	Sales			$\$13,000$
	(To record sale of inventory at spot rate)
	Plant and equipment (asset)		$\$845,000$
	Cash			$\$845,000$
	(To record the purchase of fixed assets at spot rate)
	Plant and equipment (asset)		$\$39,000$
	Hedged firm commitment (asset)			$\$39,000$
	(To reclassify the firm commitment liability to the plant and equipment account when the purchase transaction is completed)

CF Hedge
Date	Account title and Explanation			Debit	Credit
20-Nov 18	Must document hedging relationship and hedge effectiveness in accounting system. FV = 0 at inception, so no entry.
31-Dec-18	OCI - Foreign currency transaction loss			$\$16,200$
	Forward contract (liability)				$\$16,200$
	(to record the increase in the value of the forward contract: [$1.22:€1 − $1.19:€1] of €540,000 = $16,200)
20-Feb 19	Sales			$\$10,800$
	Forward contract (liability)				$\$10,800$
	(to record the increase in the value of the forward contract: [$1.24:€1 − $1.22:€1] of €540,000 = $10,800)
	Forward contract (liability)			$\$27,000$
	Cash				$\$27,000$
	(To record the net settlement of the forward contract)
	Sales                                                                                 $\$16,200$
	AOCI - Foreign currency transaction loss                                      $\$16,200$
	(To record the reclassification of the AOCI FC transaction losses to sales in the period of the transaction)

b.

To determine

Compare with the forward rate at the beginning of the forward contract the net cash

received for both sale of goods and the settlement of the forward-contract derivatives.

Explanation of Solution

A futures contract is a deal to make a purchase or sale an asset at an agreed-upon price at a point in the future. Future contracts are streamlined, typically exchange-trading agreements. One partner agrees to purchase a specified set of securities or commodities, and take possession on a specific date.

Sale of goods	$669,600
Settle derivative	(27,000)
Net cash	$642,600
Forward rate of sales	$642,600

c.

To determine

Evaluate the amount of sales recognized in the quarter ending Dec 31, 2018; the quarter

ending Mar 31, 2019 and explain these amounts and also evaluate the total amount of

cost of goods sold recognized across the quarters ending Dec 31, 2018, and Mar 31,

2019.

Explanation of Solution

A futures contract is a deal to make a purchase or sale an asset at an agreed-upon price at a point in the future. Future contracts are streamlined, typically exchange-trading agreements. One partner agrees to purchase a specified set of securities or commodities, and take possession on a specific date.

A sale is a transaction between two or more parties in which the buyer receives goods, services and/or assets that are tangible or intangible in exchange for money. Other assets will in some cases be paid to a seller.

Sales recognized in Q4 2018:	$
Sales recognized in Q1 2019:	642,600
	$642,600