Accounting for Derivatives and Hedging Transactions1
(Part 1)
Multiple Choice – Computational
Fair value hedge of a recognized asset
Use the following information for the next eight questions:
On December 15, 20x1, ABC Co. sold goods to a Japanese firm for 4,000,000
yens. ABC Co. was concerned about the fluctuation in the Japanese yen, so
on this date, ABC Co. entered into a 30-day forward contract to sell
4,000,000 yens for ₱1,880,000 to a bank at the forward rate of ₱0.47.
Relevant rates are shown below:
Dec. 15, 20x1
Spot rate
₱0.48
Forward rate
₱0.47
Dec. 31, 20x1
₱0.49
₱0.485
Jan. 15, 20x2
₱0.46
₱0.46
1. The entry to record the hedging instrument on December 15, 20x1 includes
a. a debit to accounts receivable for ₱1,880,000
b. a credit to sales for ₱1,880,000
c. both a and b
d. none
2. How much is the FOREX gain (loss) on foreign currency transaction on
December 31, 20x1?
a. 40,000
b. (40,000)
c. 60,0000
d. (60,000)
3. How much is the gain (loss) on change in fair value of the derivative on
December 31, 20x1?
a. 40,000
b. (40,000)
c. 60,0000
d. (60,000)
4. The derivative asset (liability) to be included in the December 31, 20x1
statement of financial position is
a. 1,960,000 b. (1,920,000) c. 60,0000
d. (60,000)
5. How much is the FOREX gain (loss) on foreign currency transaction on
January 15, 20x2?
a. 120,000
b. (120,000)
c. 100,0000
d. (100,000)
6. How much is the gain (loss) on change in fair value of the derivative on
January 15, 20x2?
a. 120,000
b. (120,000)
c. 100,0000
d. (100,000)
7. If the forward contract is settled on a net cash basis, how much is the
net cash settlement receipt (payment)?
a. 40,000
b. (40,000)
c. 100,000
d. 0
8. The total net effect of the two contracts in 20x1 and 20x2 profit or
loss is – gain (loss)
a. 40,000
b. (40,000)
c. 100,000
d. 0
No hedging designation (Held for speculation)
Use the following information for the next five questions:
ABC Co. expects the value of yens to decrease in the next 30 days.
Accordingly, on December 15, 20x1, ABC Co. enters into a 30-day forward
1
ADAPTED QUESTIONS FROM V. Z. MILLAN
1
contract to sell 4,000,000 yens at the forward rate of ₱0.47. On December
31, 20x1, the forward rate was ₱0.485 and by January 15, 20x2, the spot
rate moved to ₱0.46.
9. The entry to record the forward contract on December 15, 20x1 includes
a. a debit to forward contract for ₱60,000
b. a credit to forward contract for ₱60,000
c. a debit to loss on forward contract for ₱60,000
d. none
10.
on
a.
b.
How much is the gain (loss) on change in fair value of the derivative
December 31, 20x1?
60,000 in profit or loss c. (60,0000) in OCI
(40,000) in OCI
d. (60,000) in profit or loss
11. The derivative asset (liability) to be included in the December 31,
20x1 statement of financial position is
a. 1,960,000 b. (1,920,000) c. 60,0000
d. (60,000)
12. How much is the gain (loss) on change in fair value of the derivative
on January 15, 20x2?
a. 120,000
b. (120,000)
c. 100,000
d. (100,000)
13. How much is the net cash settlement receipt (payment) on January 15,
20x2?
a. 40,000
b. (40,000)
c. 1,840,000
d. (1,840,000)
Fair value hedge of a recognized liability
Use the following information for the next seven questions:
On December 15, 20x1, ABC Co. purchased goods from a Korean firm for
40,000 wons. ABC Co. was concerned about the fluctuation in the Korean
won, so on this date, ABC Co. entered into a 30-day forward contract to
buy 40,000 wons for ₱49,600 from a bank at the forward rate of ₱1.24.
Relevant rates are shown below:
Dec. 15, 20x1
Spot rate
1.20
Forward rate
1.24
Dec. 31, 20x1
1.26
1.27
Jan. 15, 20x2
1.30
1.30
14. The purchased inventory shall be recognized at
a. 48,000
b. 49,600 c. 50,400
d. 50,800
15. The derivative asset (liability) to be included in the December 31,
20x1 statement of financial position is
a. 2,400
b. (2,400)
c. 1,200
d. (1,200)
16. The adjustment to the inventory account on December 31, 20x1 is –
increase (decrease)
a. 2,400
b. (2,400)
c. 1,200
d. 0
17. How much is the FOREX gain (loss) on foreign currency transaction on
January 15, 20x2?
a. (2,400)
b. (1,600)
c. 1,200
d. (1,200)
18. How much is the gain (loss) on change in fair value of the derivative
on January 15, 20x2?
a. 1,200
b. (1,200)
c. 1,600
d. (1,600)
2
19. The total net effect of the two contracts on profit or loss in 20x2
is – gain (loss)
a. (1,600)
b. (400) c. 1,600
d. 0
20. Assuming the forward contract is settled on a net cash basis, how
much is the net cash settlement receipt (payment) on January 15, 20x2?
a. 1,600
b. (400) c. 2,400
d. (2,400)
No hedging designation (Held for speculation)
Use the following information for the next two questions:
ABC Co. expects the value of wons to increase in the next 30 days.
Accordingly, on December 15, 20x1, ABC Co. enters into a 30-day forward
contract to buy 40,000 wons at the forward rate of ₱1.24. On December 31,
20x1, the forward rate was ₱1.27 and by January 15, 20x2, the spot rate
moved to ₱1.30.
21. The derivative asset (liability) to be included in the December 31,
20x1 statement of financial position is
a. 2,400
b. (2,400)
c. 1,200
d. (1,200)
22. The total net effect of the transaction on profit or loss in 20x2 is
– gain (loss)
a. 2,400
b. (2,400)
c. 1,200
d. (1,200)
Fair value hedge of a firm sale commitment
Use the following information for the next six questions:
On December 15, 20x1, ABC Co. received a sale order from a Japanese firm
in the amount of 4,000,000 yens. The delivery of the goods sold is due on
January 15, 20x1. ABC Co. was concerned about the fluctuation in the
Japanese yen, so on this date, ABC Co. entered into a 30-day forward
contract to sell 4,000,000 yens for ₱1,880,000 to a bank at the forward
rate of ₱0.47.
Relevant rates are shown below:
Dec. 15, 20x1
Spot rate
₱0.48
Forward rate
₱0.47
Dec. 31, 20x1
₱0.49
₱0.485
Jan. 15, 20x1
₱0.46
₱0.46
23.
a.
b.
c.
d.
The entries on December 15, 20x1 include
a debit to accounts receivable for ₱1,880,000
a credit to sales for ₱1,880,000
both a and b
none
24.
a.
b.
c.
d.
The entry on December 31, 20x1 for the hedged item includes
debit to loss on forward contract for ₱60,000
debit to gain on forward contract for ₱60,000
a credit to firm commitment for ₱60,000
a debit to firm commitment for ₱60,000
25. The derivative asset (liability) on December 31, 20x1 is
a. 60,000
b. (60,000)
c. 40,000 d. (40,000)
26. The effectiveness of the hedging instrument as of December 31, 20x1
is
a. 60%
b. 80%
c. 100%
d. 125%
3
27.
a.
b.
c.
d.
The entry on January 15, 20x2 pertaining to the hedged item includes
a credit to sales for ₱1,880,000
a debit to cash (foreign currency) ₱1,880,000
a credit to gain for ₱100,000
a and b
28. Assuming the forward contract is settled on a net cash basis, how
much is the net cash settlement receipt (payment) on January 15, 20x2?
a. 40,000
b. (40,000)
c. 2,400
d. (2,400)
Fair value hedge of a firm purchase commitment
Use the following information for the next four questions:
On December 15, 20x1, ABC Co. entered into a firm commitment to purchase
goods from a Korean firm for 40,000 wons. If ABC Co. will not purchase the
goods from the Korean firm, it would be required to pay a penalty of
24,000 wons (i.e., ABC’s contract with the Korean firm is a firm
commitment).
ABC Co. was concerned about the fluctuation in the Korean won, so on this
date, ABC Co. entered into a 30-day forward contract to buy 40,000 wons
for ₱49,600 from a bank at the forward rate of ₱1.24.
Relevant rates are shown below:
Dec. 15, 20x1
Spot rate
1.20
Forward rate
1.24
Dec. 31, 20x1
1.26
1.27
Jan. 15, 20x2
1.30
1.30
29. The gain (loss) on the firm commitment on December 31, 20x1 is
a. (2,400)
b. (1,200)
c. (800)
d. 800
30. The derivative asset (liability) on December 31, 20x1 is
a. 60,000
b. (60,000)
c. 1,200
d. (1,200)
31. How much inventory is recognized on January 15, 20x2?
a. 49,600
b. 52,000
c. 50,400 d. 48,000
32. Assuming the forward contract is settled on a net cash basis, how
much is the net cash settlement receipt (payment) on January 15, 20x2?
a. 4,000
b. (4,000)
c. 2,400
d. (2,400)
Fair value hedge of a firm purchase commitment – Present value
Use the following information for the next six questions:
ABC Co. operates a chain of coffee shops nationally. On October 1, 20x1,
ABC Co. entered into a firm commitment to purchase 4,000 kilograms of
coffee beans for a contract price of ₱160 per kilogram on March 31, 20x2.
ABC Co. expects that there is a possible decrease in the price of coffee
beans, so on this date, ABC Co. entered into a six-month forward contract
with a bank to sell 4,000 kilograms of coffee beans at the current forward
rate of ₱160 per kilogram.
Information on fair values is shown below:
Fair value of
Fair value of
firm
Forward forward contract
commitment
Date
Spot price
price
(asset)
(liability)
Oct. 1, 20x1
155
160
27,727 a
Dec. 31, 20x1
151
153
(27,727)
52,000 b
Mar. 31, 20x2
147
147
(52,000)
4
[(160 – 153) x 4,000] x present value factor using 4%, assumed
appropriate rate, for three months (or 0.9902427).
b
[(160 – 147) x 4,000.
a
33. The entry on October 1, 20x1 to record the firm purchase commitment
includes a
a. debit to inventory for ₱640,000
b. credit to accounts payable for ₱640,000
c. both a and b
d. none
34. The entries on December 31, 20x1 includes a
a. a debit to loss on firm commitment for ₱27,727, recognized in profit
or loss
b. a debit to loss on firm commitment for ₱27,727, recognized in OCI
c. a credit to gain on firm commitment for ₱27,727, recognized in profit
or loss
d. a credit to gain on firm commitment for ₱27,727, recognized in OCI
35. The derivative asset (liability) on December 31, 20x1 is
a. 27,727
b. (27,728)
c. 1,200 d. (1,200)
36. The debit to inventory on March 31, 20x2 is
a. 640,000
b. 612,000
c. 588,000
d. 0
37. The gain (loss) on forward contract on March 31, 20x2 is
a. (24,273) b. 24,273 c. 52,000
d. (52,000)
38. The net cash settlement receipt (payment) on the forward contract on
March 31, 20x2 is
a. 52,000
b. (52,000)
c. (24,273)
d. 24,273
Fair value hedge of a firm purchase commitment – Present value
Use the following information for the next six questions:
ABC Co. supplies cabbage to various hotels and restaurants. On October 1,
20x1, ABC Co. entered into a firm commitment to purchase 4,000 kilograms
of cabbage for a contract price of ₱40 per kilogram on March 31, 20x2.
ABC Co. is worried about fluctuations in the price of cabbage. Therefore,
on October 1, 20x1, ABC Co. entered into a six-month, over-the-counter
(OTC) forward contract with a broker to sell 4,000 kilograms of cabbage at
the current forward rate of ₱40 per kilogram to be settled on a net cash
basis on March 31, 20x2.
Date
Oct. 1, 20x1
Dec. 31, 20x1
Mar. 31, 20x2
Spot price
41
32
50
Fair value of
forward contract
(asset)
39,608 a
(40,000)b
Forward
price
40
30
50
Fair value of firm
commitment
(liability)
(39,608)
40,000
[(40 – 30) x 4,000] x present value factor using 4%, assumed appropriate
rate, for three months (or 0.9902427).
b
[(50 – 40) x 4,000.
a
5
39. The fair value of the forward contract on Oct. 1, 20x1 is
a. 4,000
b. 164,000
c. 160,000
d. 0
40. The fair value of the firm commitment on Oct. 1, 20x1 is
a. 4,000
b. 164,000
c. 160,000
d. 0
41. The fair value of the forward contract on Dec. 31, 20x1 is – asset
(liability)
a. 39,608
b. (39,608)
c. 40,000 d. 0
42. The fair value of the firm commitment on Dec. 31, 20x1 is – asset
(liability)
a. 39,608
b. (39,608)
c. (40,000)
d. 0
43. The gain (loss) on the derivative on March 31, 20x2 is
a. 38,608
b. (40,000)
c. (79,608)
d. 79,608
44. The net cash settlement – receipt (payment) – on March 31, 20x2 is
a. (79,608) b. 79,608 c, 40,000 d. (40,000)
Cash flow hedge of a forecasted purchase transaction
Use the following information for the next eight questions:
ABC Co. produces potato chips. On December 15, 20x1, ABC Co. anticipates
purchasing 4,000 kilograms of potatoes on January 15, 20x2.
ABC Co. is concerned about the fluctuation in the price of potatoes, so on
December 15, 20x1, ABC Co. enters into a 30-day forward contract to
purchase 4,000 kilograms of potatoes at a forward rate of ₱45 per kilogram
(or ₱180,000). The forward contract will be settled net on January 15,
20x2.
Relevant prices per kilogram of potatoes are shown below:
Dec. 15, 20x1
Dec. 31, 20x1
Spot price
40
50
Forward price
45
55
Jan. 15, 20x1
60
60
45. The fair value of the hedging instrument on Dec. 15, 20x1 is
a. 20,000
b. 180,000
c. 160,000
d. 0
46. The fair value of the hedged item on Dec. 15, 20x1 is
a. 20,000
b. 180,000
c. 160,000
d. 0
47. The fair value of the hedging instrument on Dec. 31, 20x1 is
a. 40,000
b. (40,000)
c. 20,000 d. 0
48. The fair value of the hedged item on Dec. 31, 20x1 is
a. 40,000
b. (40,000)
c. 20,000 d. 0
49. The net effect of the derivative instrument on the 20x1 profit or
loss is – gain (loss)
a. 40,000
b. (40,000)
c. 20,000 d. 0
50. How much is the gain (loss) on the forward contract on January 15,
20x2?
a. 20,000 profit or loss
c. 20,000 OCI
b. (20,000) profit or loss
d. (20,000) OCI
6
51. The net cash settlement – receipt (payment) – on January 15, 20x2 is
a. 60,000
b. (60,000)
c. 40,000 d. (40,000)
52. Assume that all of the potatoes purchased were used to produce potato
chips at a total manufacturing cost of ₱400,000 and that all of the
potato chips were sold on February 14, 20x2 for ₱1,440,000, how much
cost of goods sold is recognized on February 14, 20x2?
a. 400,000
b. 460,000
c. 340,000
d. 420,000
Cash flow hedge of a forecasted sale transaction – Present value (Indirect
quotation)
Use the following information for the next five questions:
ABC Co. produces tomato paste. On October 1, 20x1, ABC Co. anticipates
selling goods worth DOP 59,400,000 (Dominican Peso) on April 1, 20x2. ABC
Co. enters into to a six-month forward contract to sell DOP 59,400,000 at
a forward rate of ₱1:DOP 140 or ₱424,284. The appropriate discount rate is
6% per annum. The following are the relevant exchange rates:
Date
Spot rate
Forward rate
Oct. 1, 20x1
₱1 : DOP 135
₱1 : DOP 140
Dec. 31, 20x1
₱1 : DOP 140
₱1 : DOP 142
Apr. 1, 20x2
₱1 : DOP 144
₱1 : DOP 144
53. How much is the gain (loss) on the forward contract on December 31,
20x1?
a. 5,887 profit or loss
c. (5,887) profit or loss
b. 5,887 OCI
d. (5,887) OCI
54.
a.
b.
55.
a.
How much is the gain (loss) on the hedged item on December 31, 20x1?
5,887 profit or loss
c. (5,887) OCI
(5,887) profit or loss
d. 0
How much sale revenue is recognized in 20x2?
424,286
b. 400,716
c. 406,772
d. 412,500
56. How much is the gain (loss) on the forward contract on April 1, 20x2?
a. 5,899 profit or loss
c. (5,899) profit or loss
b. 5,899 OCI
d. (5,899) OCI
57. The net cash settlement – receipt (payment) – on January 15, 20x2 is
a. 60,000
b. (60,000)
c. 11,786 d. (11,786)
Cash flow hedge of a recognized liability – Present value
Use the following information for the next seven questions:
On December 1, 20x1, ABC Co. purchased goods from a Korean firm for
400,000 wons. ABC Co. was concerned about the fluctuation in the Korean
won, so on this date, ABC Co. entered into a 2-month forward contract to
buy 400,000 wons for ₱496,000 from a bank at the forward rate of ₱1.24.
Relevant rates are shown below:
Dec. 1, 20x1
Spot rate
1.20
Forward rate
1.24
Dec. 31, 20x1
1.23
1.27
Jan. 31, 20x2
1.30
1.30
Additional information:
 ABC Co. chooses to account for the hedging instrument as a cash flow
hedge.
 The initial spot/forward difference (or ‘forward points’) amounts to
₱16,000 over the 2-month term of the forward contract [400,000 x (1.24
7


forward rate - 1.20 spot rate)]. This difference will be amortized as
interest expense using the effective interest method.
Given the spot/forward relationship above, the implicit interest rate is
19.84% per annum or 1.6530% per month.
The following are the relevant present value factors:
Dec. 31, 20x1: PV of ₱1, @ 0.5%, n=1 (1 month)………0.99502
Jan. 31, 20x2: PV of ₱1, @ 0.5%, n=0 (maturity date)…1
58. The inventory account is debited on December 1, 20x1 for
a. 400,000
b. 480,000
c. 496,000
d. 0
59. The FOREX gain (loss) on the hedged item on December 31, 20x1 is
a. (12,000) b. 12,000 c. 9,886
d.
60. How much is recognized in other comprehensive income on December 31,
20x1? debit (credit)
a. 19,876
b. (19,838)
c. 16,312 d. 0
61. The derivative asset (liability) recognized on December 31, 20x1 is
a. 19,876
b. (19,874)
c. 11,940 d. (11,940)
62. The FOREX gain (loss) on the hedged item on January 31, 20x2 is
a. (28,000) b. 28,000 c. 26,399 d. 0
63. How much is recognized in other comprehensive income on January 31,
20x2? debit (credit)
a. 20,126
b. (20,126)
c. 18,234
d. 0
64. The net cash settlement – receipt (payment) – on January 15, 20x2 is
a. (20,130) b. 20,130 c. (24,000)
d. 24,000
Accounting for Derivatives and Hedging Transactions2
(Part 2)
Multiple Choice – Computational
No hedging designation
Use the following information for the next four questions:
On December 1, 20x1, ABC Co. enters into a silver futures contract to
purchase 4,000 ounces of silver on February 1, 20x2 for ₱200 per ounce.
The broker requires an initial margin deposit of ₱80,000. The quoted
prices per ounce of silver are as follows:
Dec. 1, 20x1
Dec. 31, 20x1
Feb. 1, 20x2
200
190
185
1. The entries on December 1, 20x1 include
a. debit to “deposit with broker” for ₱80,000
b. credit to cash for ₱80,000
c. a and b
d. none
2. How much is the derivative asset (liability) as of December 31, 20x1?
a. 0
b. (34,668)
c. (40,000)
d. 40,000
2
ADAPTED QUESTIONS FROM V. Z. MILLAN
8
3. How much is the total net effect of the derivative on the 20x1 and 20x2
profit or loss? Gain (loss)
a. (60,000) b. 60,000 c. (40,000)
d. 40,000
4. How much is the net settlement on February 1, 20x2? – Receipt (payment)
a. 20,000
b. (20,000)
c. (60,000)
d. 60,000
Fair value hedge of a recognized asset – hedged item measured at fair
value
Use the following information for the next seven questions:
ABC Co. is a commodity trader. On December 1, 20x1, ABC Co. carries in its
inventory 400 troy ounces of gold valued at ₱4,800,000 (or ₱12,000 per
troy ounce). ABC Co. measures its inventory of gold at fair value less
costs to sell through profit or loss.
To protect the fair value of its inventory against a potential decline in
prices, ABC Co. enters into a “short” futures contract on December 1, 20x1
to sell 400 troy ounces of gold at ₱12,100 per troy ounce on February 1,
20x2 (the expected date of sale of the inventory). The futures contract
requires an initial margin deposit of ₱384,000.
We will assume that the fair values shown below already reflect costs to
sell.
Dec. 1, 20x1
Dec. 31, 20x1
Feb. 1, 20x2
Spot price
12,000
12,250
11,800
Futures price
12,100
12,300
11,800
5. The entries on December 1, 20x1 include
a. debit to “deposit with broker” for ₱384,000
b. credit to cash for ₱384,000
c. a and b
d. none
6. How much is the adjustment to the inventory account on December 31,
20x1? Increase (decrease)
a. 100,000
b. (100,000)
c. 80,000 d. 0
7. How much is the derivative asset (liability) as of December 31, 20x1?
a. (100,000)
b. 100,000
c. (80,000)
d. 80,000
8. How much is the gain (loss) on the futures contract on February 1, 20x2?
a. 0
b. (80,000)
c. (200,000)
d. 200,000
9. How much is the net settlement on February 1, 20x2? – Receipt (payment)
a. 120,000
b. (120,000)
c. 504,000
d. 504,000
10. How much is the total net cash receipt (payment)
contracts?
a. 4,840,000 b. (4,840,000) c. (504,000)
d. 504,000
on
the
two
Fair value hedge of a recognized asset – hedged item measured at lower of
cost or net realizable value (NRV)
Use the following information for the next five questions:
On December 1, 20x1, ABC Co. has a soybean inventory of 4,000 bushels
carried at a cost of ₱240 per bushel (or total cost of ₱960,000). ABC Co.
measures its inventory of soybeans at the lower of cost or net realizable
value (NRV).
9
ABC Co. intends to sell the whole inventory by February 1, 20x1. On
December 1, 20x1, ABC Co. enters into a futures contract to sell the whole
inventory on February 1, 20x1 at a price of ₱360 per bushel. The broker
requires a deposit of ₱80,000.
Information on fair values is as follows:
Dec. 1,
20x1
Dec. 31, 20x1
Spot price
Futures
price
Feb. 1, 20x2
354
371
338
360
374
338
11. How much is the adjustment to the inventory account on December 31,
20x1? Increase (decrease)
a. 100,000
b. 68,000 c. (68,000)
d. 0
12. How much is the derivative asset (liability) as of December 31, 20x1?
a. 0
b. (68,000)
c. (56,000)
d. 56,000
13. How much is the gain (loss) on the futures contract on February 1,
20x2?
a. 0
b. (56,000)
c. (144,000)
d. 144,000
14. How much is the net settlement on the derivative
February 1, 20x2? – Receipt (payment)
a. 168,000
b. (168,000)
c. 88,000 d. (88,000)
instrument
on
15. How much gross profit from sales is recognized on February 1, 20x2?
a. 0
b. 364,000
c. 388,000
d. 456,000
Fair value hedge of a firm sale commitment
Use the following information on the next five questions:
On December 1, 20x1, ABC Co. enters into a fixed-price contract to sell
4,000 ounces of silver on February 1, 20x2 for ₱210 per ounce. ABC Co.
prefers to have the sales contract settled at market value on delivery
date. Therefore, on December 1, 20x1, ABC Co. enters into a “long” futures
contract to purchase 4,000 ounces of silver at ₱200 per ounce. The futures
contract requires an initial margin deposit of ₱120,000.
Information on market values is shown below:
Dec. 1, 20x1
Dec. 31, 20x1
Spot price
210
240
Futures price
200
235
Feb. 1, 20x2
250
250
16. How much is the firm commitment asset (liability) on December 31,
20x1?
a. 120,000
b. (120,000)
c. (140,000)
d. (100,000)
17. How much is the derivative asset (liability) on December 31, 20x1?
a. 140,000
b. (140,000)
c. 120,000
d. (120,000)
18. How much is the sale revenue recognized on February 1, 20x2?
a. 1,000,000 b. 840,000
c. 800,000
d. 960,000
19. How much gain (loss) from firm commitment is recognized on February
1, 20x2?
10
a. 40,000
b. (40,000)
c. (60,000)
d. 60,000
20. How much is the net cash settlement on the derivative instrument on
February 1, 20x2?
a. 200,000
b. (200,000)
c. (320,000)
d. 320,000
Cash flow hedge of a forecasted purchase transaction – Assessment of Hedge
ineffectiveness
Use the following information for the next eleven questions:
On July 1, 20x1, ABC Co., a vegetable dealer, forecasts the purchase of
4,000 kilograms of broccoli in 6 months. Because ABC Co. is worried that
the price of broccoli will increase during the coming months, it enters
into 10 long cauliflower futures contracts on July 1, 20x1. Each futures
contract is based on the purchase of 400 kilograms of cauliflower at
₱92.98 per kilogram on July 1, 20x1.
Relevant prices per kilogram of commodity are shown below:
Broccoli
Cauliflower
Jan. 1
93.76
92.98
Mar. 31
95.18
94.52
June 30
96.20
95.36
21. What is the percentage of effectiveness of the hedging instrument on
March 31, 20x1 and June 30, 20x1, respectively?
March 31, 20x1
June 30, 20x1
a. 102%
96%
b. 95%
103%
c. 108%
98%
d. 97%
85%
22. How much is derivative asset (liability) on March 31, 20x1?
a. (6,160)
b. 6,160 c. (5,680)
d. 5,680
23. How much is the effective portion of the change in fair value of
derivative recognized in other comprehensive income on March 31, 20x1? –
Gain (loss)
a. 5,680
b. (5,680)
c. 6,160 d. (6,160)
24. How much is the ineffective portion of the change in fair value of
derivative recognized in profit or loss on March 31, 20x1? – Gain (loss)
a. 0
b. 560
c. 480
d. (480)
25. As of March 31, 20x1, the effect of the futures contract is referred
to as
a. overhedge b. underhedge c. middle hedge
d. bottom hedge
26. How much is the debit to inventory on June 30, 20x1?
a. 375,280
b. 371,920
c. 384,800
d. 381,440
27. How much is the effective portion of the change in fair value of
derivative recognized in other comprehensive income on June 30, 20x1? –
Gain (loss)
a. (3,840)
b. 3,840 c. (4,321)
d. 0
28. How much is the ineffective portion of the change in fair value of
derivative recognized in profit or loss on June 30, 20x1? – Gain (loss)
a. (480)
b. 480
c. (960) d. 960
11
29. How much is the net cash settlement
derivative instrument on June 30, 20x1?
a. 3,360
b. (3,360)
c. (9,520)
receipt
(payment)
on
the
d. 9,520
30. How much is the total net effect of the hedging instrument on profit
or loss? Favorable (unfavorable)
a. 3,840
b. (3,840)
c. (9,520)
d. 9,520
31. If all of the inventory purchased were sold on July 15, 20x1, how
much is the cost of goods sold?
a. 384,800
b. 375,280
c. 381,440
d. 371,920
Fair value hedge of a recognized asset – Put option
Use the following information for the next three questions:
On December 15, 20x1, ABC Co. sold goods to a Japanese firm for 4,000,000
yens. ABC Co. was concerned about the fluctuation in the Japanese yen, so
on this date, ABC Co. purchased a foreign currency put option for ₱30,000
to sell 4,000,000 yens at ₱0.47 on January 15, 20x2.
Dec. 15,
Dec. 31,
Jan. 15,
20x1
20x1
20x1
Spot rate
₱0.48
₱0.49
₱0.46
Fair values of the foreign
currency put option
30,000
20,000
32,000
32. How much is the gain (loss) on the put option on December 31, 20x1?
a. 0
b. 40,000
c. (10,000)
d. 10,000
33. How much is the net gain (loss) on the exercise of the put option on
January 15, 20x1?
a. (20,000)
b. 20,000
c. 12,000 d. 8,000
34. Assume that the spot rate on January 15, 20x2 is ₱0.48. How much is
the gain (loss) on the put option on January 15, 20x1?
a. (20,000)
b. 20,000
c. (32,000)
d. (40,000)
No hedging designation – Call option
Use the following information for the next three questions:
On April 1, 20x1, ABC Co. enters into a call option contract with an
investment banker which gives ABC Co. the option to purchase 4,000 XYZ,
Inc. shares of stocks at a strike price of ₱100 per share. The call option
expires on July 1, 20x1. ABC Co. pays the investment banker ₱2,400 for the
call option. The market price of the XYZ, Inc. shares on April 1, 20x1 is
₱100 per share.
Additional information:
April 1, 20x1
100/sh.
2,400
Market price of XYZ, Inc. shares
Time value
June 30, 20x1
106/sh.
1,600
35. How much is the gain (loss) on the call option on June 30, 20x1
arising from change in intrinsic value?
a. 24,000
b. (24,000)
c. 800
d. (800)
36. How much is the gain (loss) on the call option on June 30, 20x1
arising from change in time value?
a. 800
b. (800) c. 24,000 d. (24,000)
12
37. How much is the net cash settlement receipt (payment) on the call
option on July 1, 20x1?
a. 24,000
b. (24,000)
c. 23,200 d. (23,200)
Cash flow hedge of a forecasted sale transaction (Indirect quotation)
Use the following information for the next six questions:
ABC Co. forecasts a sale to an Indian customer of INR 1,120,000 (Indian
Rupee) in six months. On October 1, 20x1 when the spot rate is ₱1: INR
1.40, ABC Co. obtained an option to sell INR 1,120,000 for ₱783,216 (₱1 :
INR1.43). The option has a cost and fair value of ₱25,600 on inception
date.
ABC Co. chose to base effectiveness on the changes in the intrinsic value
of the option, as measured by the spot rate of the currency underlying the
option (e.g., “spot” intrinsic value). Changes in the fair value of the
option other than “intrinsic value” (e.g., time value, impact of
counterparty nonperformance risk) are excluded from the assessment of
effectiveness and will be reported in profit or loss as they occur.
The following information was determined:
Time value of
Date
Spot rate
option a
Oct. 1, 20x1
₱1 : INR 1.40
25,600
Dec. 31, 20x1
₱1 : INR 1.45
13,196
Apr. 1, 20x2
₱1 : INR 1.50
-
Fair value of
option a
25,600
24,000
36,552
a
These amounts are determined using an option pricing model. They are
provided in order to simplify the problem.
38. How much derivative asset (liability) is recognized on October 1,
20x1?
a. 23,664
b. (25,600)
c. 25,600 d. 0
39. The hedging instrument is most likely designated as a
a. fair value hedge
b. cash flow hedge c. a or b
d. none
40. The effective portion of the hedge recognized in other comprehensive
income on December 31, 20x1 is
a. 10,802
b. 25,746 c. 13,366 d. 0
41. How much derivative asset (liability) is recognized on December 31,
20x1?
a. 13,196
b. (24,000)
c. 24,000 d. 37,196
42. The effective portion of the hedge recognized in other comprehensive
income on April 1, 20x2 is
a. 10,802
b. 24,000 c. 12,404
d. 25,747
43. The adjusted sale revenue recognized on April 1, 20x2 is
a. 798,364
b. 788,312
c. 783,215
d. 776,325
Cash flow hedge of a variable-rate debt (Swap payment at maturity)
Use the following information for the next five questions:
On January 1, 20x1, ABC Co. obtained a two-year, ₱4,000,000 variable-rate
loan with interest payments due at each year-end and the principal due on
December 31, 20x2.
13
As protection from possible fluctuations in current market rates, ABC Co.
enters into an interest rate swap for the whole principal of the loan.
Under the agreement, ABC Co. shall receive variable interest and pay fixed
interest based on a fixed rate of 8%. The interest rate swap will be
settled net on maturity date.
The following are the current market rates:
Jan. 1, 20x1
8%
Jan. 1, 20x2
10%
44. The hedging instrument is most likely designated as a
a. fair value hedge
b. cash flow hedge c. a or b
d. none
45. How much derivative asset (liability) is recognized on December 31,
20x1?
a. 80,000
b. (72,728)
c. 72,728 d. 74,074
46. How much is the derivative gain (loss) recognized in profit or loss
on December 31, 20x1?
a. 74,074
b. (72,728)
c. 72,728 d. 0
47. The net cash settlement on the interest rate swap on December 31,
20x2 is – Receipt (payment)
a. 80,000
b. (80,000)
c. 72,728 d. 0
48. The interest expense recognized in profit or loss in 20x2 is
a. 320,000
b. 240,000
c. 335,728
d. 0
Cash flow hedge of a variable-rate debt (Swap payments at each year-end)
Use the following information for the next nine questions:
On January 1, 20x1, ABC Co. obtained a three-year, ₱4,000,000 variablerate loan with interest payments due at each year-end and the principal
due on December 31, 20x3.
As protection from possible fluctuations in current market rates, ABC Co.
enters into an interest rate swap for the whole principal of the loan.
Under the agreement, ABC Co. shall receive variable interest and pay fixed
interest based on a fixed rate of 9%. Swap payments shall be made at each
year-end.
The following are the current market rates:
Jan. 1, 20x1
9%
Jan. 1, 20x2
8%
Jan. 1, 20x3
12%
49. The net cash settlement on December 31, 20x1 is
a. 40,000
b. 37,037 c.36,697 d. 0
50. The derivative asset (liability) on December 31, 20x1 is
a. 37,037
b. (71,331)
c. 36,697 d. 40,000
51. The net cash settlement receipt (payment) on December 31, 20x2 is
a. 36,697
b. (71,331)
c. (40,000)
d. 0
52. The balance of accumulated OCI recognized on the hedging instrument
as of December 31, 20x2 is – Debit (credit)
a. (67,140) b. (107,141)
c. (138,472)
d. 0
14
53. The interest expense recognized in profit or loss in 20x2 is
a. 400,000
b. 387,542
c. 421,984
d. 0
54. The derivative asset (liability) on December 31, 20x2 is
a. 107,141
b. (107,141)
c. 138,472
d. (67,140)
55. How much is the derivative gain (loss) recognized in OCI on December
31, 20x2?
a. 138,472
b. (138,472)
c. 107,141
d. (107,141)
56. The net cash settlement – receipt (payment) – on the interest rate
swap on December’ 31, 20x3 is
a. 50,000
b. 120,000
c. 80,000 d. (120,000)
57. The interest expense recognized in 20x3 is
a. 400,000
b. 240,000
c. 520,000
d. 320,000
Fair value hedge of a fixed-rate debt
Use the following information for the next eight questions:
On January 1, 20x1, ABC Co. obtained a three-year, ₱4,000,000, 10% fixedrate loan with interest payments due at each year-end and the principal
due on December 31, 20x3.
ABC Co. expects that the current interest rates will decrease in the
future. Thus, ABC Co. enters into a “receive fixed, pay variable” interest
rate swap. Swap payments shall be made at each year-end.
The following are the current market rates:
Jan. 1, 20x1
10%
Jan. 1, 20x2
12%
Jan. 1, 20x3
14%
58. The derivative asset (liability) on December 31, 20x1 is
a. 135,204
b. (135,204)
c. 80,000 d. (80,000)
59. Unrealized gain (loss) on the derivative instrument recognized in
profit or loss on December 31, 20x1 is
a. 135,204
b. (135,204)
c. 80,000 d. 0
60. Unrealized gain (loss) on the hedged item recognized in profit or
loss on December 31, 20x1 is
a. 135,204
b. (135,204)
c. 80,000 d. 0
61. The interest expense recognized in 20x2 is
a. 400,000
b. 264,796
c. 463,776
d. 535,204
62. The derivative asset (liability) on December 31, 20x2 is
a. 140,352
b. (140,352)
c. 168,342
d. (168,342)
63. Unrealized gain (loss) on the derivative instrument recognized in
profit or loss on December 31, 20x2 is
a. 140,352
b. (140,352)
c. (168,342)
d. 0
64. Unrealized gain (loss) on the hedged item recognized in profit or
loss on December 31, 20x2 is
a. 140,352
b. (140,352)
c. (168,342)
d. 0
15
65. The interest expense recognized in 20x3 is
a. 400,000
b. 540,351
c. 493,867
d. 565,304
Accounting for Derivatives and Hedging Transactions3
(Part 3)
Multiple Choice – Computational
Hedge of a net investment in foreign operation
Use the following fact pattern for the next eight questions:
Fact pattern
On July 1, 20x1, ABC Co. acquired 100% interest in XYZ, Inc., a company
situated in a foreign country. The currency of this country is the
Armenian Dram (AMD). The business combination did not result to any
goodwill. The year-end financial statements of the combining constituents
show the following information:
Assets
Investment in
subsidiary
Receivable from
XYZ, Inc.
Total assets
Liabilities
Payable to ABC Co.
Equity - Jan. 1,
20x1
Profit for the year
Total liabilities
and equity
July 1, 20x1
Date of acquisition
ABC Co.
XYZ, Inc.
(in pesos)
(in AMD)
40,000,000
24,000,000
8,000,000
-
Dec. 31, 20x1
Reporting date
ABC Co.
XYZ, Inc.
(in pesos)
(in AMD)
56,000,000
40,000,000
-
8,000,000
-
-
4,000,000
-
48,000,000
24,000,000
68,000,000
40,000,000
32,000,000
-
12,000,000
-
32,000,000
-
14,000,000
7,000,000
16,000,000
12,000,000
16,000,000
12,000,000
20,000,000
7,000,000
68,000,000
40,000,000
48,000,000
24,000,000
The following are the relevant exchange rates:
Spot rate at 7/1/20x1
Spot rate at 12/31/20x1
Average spot rate from 7/1/20x1 to 12/31/20x1
Twelve-month forward rate at 7/1/20x1
Six-month forward rate at 12/31/20x1
₱1
₱1
₱1
₱1
₱1
:
:
:
:
:
AMD
AMD
AMD
AMD
AMD
1.50
2.00
1.75
1.54
2.02
Case#1: No hedging instrument
1. How much is the FOREX gain (loss) arising from translation of intercompany accounts recognized in the subsidiary’s 20x1 separate financial
statements?
a. 2,400,000
b. (2,400,000)
c. (1,000,000) d. 1,000,000
2. How much is the subsidiary’s 20x1 adjusted separate profit immediately
before consolidation?
a. 6,000,000
b. 8,000,000
c. 6,362,524
d. 8,429,824
3. How much is the translation adjustment to be recognized in OCI in the
20x1 consolidated financial statements? - gain (loss)
a. (2,571,429)
b. 2,571,429
c. 2,428,571
d. (2,428,571)
3
ADAPTED QUESTIONS FROM V. Z. MILLAN
16
4. How much is the year-end consolidated total assets?
a. 76,000,000
b. 80,000,000 c. 74,362,428 d. 78,522,542
5. How much is the year-end consolidated total equity?
a. 37,571,428
b. 40,000,000 c. 37,000,000 d. 42,376,542
Case #2: With hedging instrument
Use the same fact pattern, except that ABC Co. decided on July 1, 20x1 to
limit its foreign currency exposure as it relates to the initial net
investment by entering into a forward contract to sell ADM 20,000,000 (tax
rate 40%) at a forward rate of 1.54 in 12 months and to designate it as a
hedge of the net investment. The appropriate discount factor is 0.971286.
6. How much is the translation adjustment to be recognized in OCI in the
20x1 consolidated financial statements? - gain (loss)
a. (630,124) b. 621,739
c. 428,571
d. (428,571)
7. How much is the year-end consolidated total assets?
a. 72,340,242
b. 80,000,000
c. 71,798,447
d. 78,000,000
8. How much is the year-end consolidated total equity?
a. 38,798,448
b. 40,000,000
c. 37,000,000
d. 42,376,542
Forward contract – Hedge of a recognized asset
Use the following information for the next three questions:
On March 1, 20x1, ABC Co. sold inventory to a foreign company for FC
4,000,000 (‘FC’ means foreign currency) when the spot exchange rate is FC
40: ₱1. The payment is due on April 1, 20x1.
ABC Co. is concerned about the possible fluctuation in exchange rates, so
on this date, ABC Co. entered into a forward contract to sell FC 4,000,000
for ₱100,000 to a broker. According to the terms of the forward contract,
if FC 4,000,000 is worth less than ₱100,000 on April 1, 20x1, ABC Co.
shall receive from the broker the difference; if it is worth more than
₱100,000, ABC Co. shall pay the broker the difference.
9. Case #1: If the exchange rate on April 1, 20x1 is FC35: ₱1, how much is
the net cash settlement? - Receipt / (Payment)
a. 14,286
b. (14,286)
c. 12,366 d. (12,366)
10. Case #2: If the exchange rate on April 1, 20x1 is FC50: ₱1, how much
is the net cash settlement? - Receipt / (Payment)
a. 23,478
b. (23,478)
c. 20,000 d. (20,000)
11. Case #3: If the exchange rate on April 1, 20x1 is FC45: ₱1, how much
is the fair value of the interest rate swap? – Asset / (Liability)
a. 11,111
b. (11,111)
c. 12,366
d. (12,366)
Forward contract – Hedge of a forecast transaction
Use the following information for the next two questions:
ABC Co. does printing jobs for various customers. On January 1, 20x1, ABC
Co. forecasted the purchase of 1,000 reams of paper in the next quarter.
The expected purchase date is on April 15, 20x1.
ABC Co. expects that the price of paper will fluctuate because of the
upcoming elections. Thus, on January 1, 20x1, ABC Co. enters into a
forward contract to purchase 1,000 reams of paper at a forward rate of
₱2,400 per ream. If the market price on April 15, 20x1 is more than
17
₱2,400, ABC Co. shall receive the difference from the broker. On the other
hand, if the market price is less than ₱2,400, ABC Co. shall pay the
difference to the broker. The forward contract will be settled net on
April 15, 20x1. The discount rate is 10%.
12. If the price of paper is ₱2,800 per ream on March 31, 20x1, how much
is the derivative asset (liability) to be recognized in ABC Co.’s first
quarter financial statements?
a. 367,338
b. (367,338)
c. 400,000
d. (400,000)
13. If the price of paper is ₱2,200 per ream on March 31, 20x1, how much
is the derivative asset (liability) to be recognized in ABC Co.’s first
quarter financial statements?
a. 187,333
b. (187,333)
c. 200,000
d. (200,000)
Forward contract – Present value
Use the following information for the next three questions:
ABC Co. produces feeds for hogs and chickens. In its long-term budget
completed on November 1, 20x1, ABC Co. forecasts a purchase of 100,000
kilos of corn on January 1, 20x3.
To protect itself from fluctuation in prices, ABC Co. enters into a
forward contract on November 1, 20x1 to purchase 100,000 kilos of corn for
₱20,000,000 (or ₱200 per kilo). The forward contract will be settled net
on January 1, 20x3.
14. What is the notional value of the forward contract?
a. 20,000,000
b. 30,000,000 c. 40,000,000 d. 50,000,000
15. If the current market price of corn is ₱260 per kilo on December 31,
20x1, what amount of derivative asset (liability) shall be reported in
ABC Co.’s 20x1 year-end financial statements? The appropriate discount
rate is 10%.
a. 5,454,545
b. (5,454,545)
c. 6,000,000
d. (6,000,000)
16. If the current market price of corn is ₱160 per kilo on December 31,
20x2, what amount of derivative asset (liability) shall be reported in
ABC Co.’s 20x2 year-end financial statements? The appropriate discount
rate is 10%.
a. 3,636,364
b. (3,636,364) c. 4,000,000
d. (4,000,000)
Futures contract
17. ABC Co. has the following futures contract:
Futures price
Quantity
- 1/1/x1
1. "Long" futures contract to
400
2,000
purchase gold
2. "Long" futures contract to
800
1,600
purchase silver
3. "Short" futures contract to
4,000
250
sell coffee beans
4. "Short" futures contract to
6,000
60
sell potatoes
Market price
- 12/31/x1
1,800
1,900
220
75
How much is the total net derivative asset (liability) on December 31,
20x1?
a. 220,000
b. (220,000)
c. 190,000
d. (190,000)
18
Call option
Use the following information for the next two questions:
On May 6, 20x1, ABC Co. entered into a firm commitment to purchase
equipment from a foreign company for FC 4,000,000 when the exchange rate
was FC 40: ₱1. Payment is due on June 1, 20x1.
ABC Co. is concerned about the possible fluctuation in exchange rates, so
on this date, ABC Co. entered into a call option to purchase FC 4,000,000
for ₱100,000 to a broker. ABC Co. paid ₱4,000 for the purchased option.
18. Case #1: If the exchange rate on June 1, 20x1 is FC 35: ₱1, how much
did ABC Co. save by purchasing the call option?
a. 14,286
b. (14,286)
c. (14,000)
d. 0
19. Case #2: If the exchange rate on June 1, 20x1 is FC 50: ₱1, how much
did ABC Co. save by purchasing the call option?
a. 20,000
b. (20,000)
c. (6,000)
d. 0
Put option
20. On March 31, 20x1, ABC Co. acquired for ₱40,000 a put option which
entitles ABC Co. to sell 20,000 units of a commodity for ₱880 per unit.
The option expires on July 1, 20x1. On July 1, 20x1, the current market
price of the commodity is ₱1,000 per unit. How much is the loss on the
put option to be recognized by ABC Co. in its 20x1 financial statements?
a. 40,000
b. 240,000
c. 280,000
d. 0
Call option – No hedging designation
Use the following information for the next four questions:
On October 1, 20x1, ABC Co. acquired for ₱40,000 a call option which
entitles ABC Co. to purchase 20,000 units of a commodity for ₱880 per
unit. The option is exercisable on March 31, 20x2. The call option was not
designated as a hedging instrument. The following are the current market
prices:
October 1, 20x1
880
December 31, 20x1
960
March 31, 20x1
1,000
21. How much is the derivative asset (liability) on December 31, 20x1?
a. (1,600,000)
b. 1,640,000
c. 1,600,000
d. (1,560,000)
22. How much is the unrealized gain (loss) on December 31, 20x1?
a. (1,560,000)
b. 1,560,000
c. 1,600,000
d. (1,600,000)
23. How much is the net cash settlement – receipt (payment) – on March
31, 20x2?
a. 2,440,000 b. 2,360,000
c. (2,400,000) d. 2,400,000
24. How much is the realized gain (loss) on the call option on March 31,
20x2?
a. 760,000
b. (840,000)
c. (800,000)
d. 800,000
Interest rate swap (swap payment at maturity)
Use the following fact pattern for the next four questions:
On January 1, 20x1 when the current market rate of interest was 10%, ABC
Co. obtained a two-year, ₱4,000,000, variable-rate loan. Interest payments
on the loan are due every year-end.
19
ABC Co. was worried about future fluctuations in interest rates. Thus, on
January 1, 20x1, ABC Co. entered into an interest rate swap wherein ABC
Co. shall receive interest at whatever the current market rate of interest
is at the beginning of the year and pay fixed interest at 10%. Swap
payment shall be made only at maturity date.
Case #1:
25. If the current market rate of interest on January 1, 20x3 is 8%, how
much is the net cash settlement at maturity date? – Receipt (Payment)
a. (80,000)
b. 80,000 c. (30,000)
d. 0
26. If the current market rate of interest on December 31, 20x2 is 8%,
how much is the fair value of the interest rate swap? - Asset
(Liability)
a. (74,072)
b. 74,072 c. (80,000)
d. (72,727)
Case #2:
27. If the current market rate of interest on January 1, 20x3 is 12%, how
much is the net cash settlement at maturity date? – Receipt (Payment)
a. (80,000)
b. 80,000 c. (30,000)
d. 0
28. If the current market rate of interest on December 31, 20x2 is 12%,
how much is the fair value of the interest rate swap? – Asset
(Liability)
a. (71,432)
b. 71,432
c. 80,000
d. 72,727
Interest rate swap (periodic swap payments)
Use the following information for the next three questions:
On January 1, 20x1, ABC Co. obtained a five-year, ₱4,000,000 variable-rate
loan with interest payments due at each year-end and the principal due on
December 31, 20x5.
As protection from possible fluctuations in current market rates, ABC Co.
enters into an interest rate swap for the whole principal of the loan.
Under the agreement, ABC Co. shall receive variable interest and pay fixed
interest based on a fixed rate of 8%. Swap payments shall be made at each
year-end.
The following are the current market rates:
Jan. 1, 20x1
8%
Jan. 1, 20x2
9%
Jan. 1, 20x3
12%
29. What is the “notional” amount of the interest rate swap agreement?
a. 4,000,000 b. 320,000
c. 4,320,000
d. 0
30. How much is the fair value of the interest rate swap on December 31,
20x1? – Asset (Liability)
a. 40,000
b. (36,697)
c. 36,697
d. 129,589
31. How much is the fair value of the interest rate swap on December 31,
20x2? – Asset (Liability)
a. 384,292
b. 202,806
c. 143,234
d. 36,697
20
Theory of Accounts Reviewer
1. In accordance with PFRS 7, which of the following best describes the
risk that an entity will encounter if it has difficulty in meeting
obligations associated with its financial liabilities?
a. Liquidity risk
b. Credit risk
c. Financial risk
d. Payment risk
2. In accordance with PFRS 7, which of the following best describes credit
risk?
a. The risk that one party to a financial instrument will cause a
financial loss for the other party by failing to discharge an
obligation
b. The risk that an entity will encounter difficulty in meeting
obligations associated with financial liabilities
c. The risk that the fair value associated with an instrument will vary
due to changes in the counterparty's credit rating
d. The risk that an entity's credit facilities will be withdrawn due to
cash flow sensitivities
3. Which of the following are types of hedging relationship?
I.
Cash flow hedge
II.
Credit risk hedge
III.
Interest rate hedge
IV.
Fair value hedge
a. I only
b. I and II
c. I and IV
d. All of these
4. In accordance with PFRS 7, which of the following are components of
market risk?
I.
Credit risk
II.
Currency risk
III.
Interest rate risk
IV.
Liquidity risk
a. I only
b. I and II
c. I and IV
d. All of these
5. Techniques such as hedging, forward contracts and options can:
a. Reduce risk.
c. Totally eliminate risk.
b. Increase risk.
d. Are purely for speculation.
6. Which of the following is the characteristic of a perfect hedge?
a. No possibility of future gain or loss
b. No possibility of future gain only
c. No possibility of future loss only
d. The possibility of future gain and no future loss
(AICPA)
7. It is a financial instrument which its return is based on the return of
some other underlying asset
a. FVPL
b. FVOCI
c. Amortized cost
d. Derivative
8. When an entity is unable to separate an embedded derivative from its
host contract, the entity should classify the hybrid instrument as
a. FVPL
b. FVOCI
21
c. Amortized cost
d. a or b
9. If a company having a floating-rate debt is concerned that interest
rates will rise causing interest costs to increase, it would most likely
to enter into a swap to
a. Pay-variable rate and receive-fixed rate.
b. Pay-fixed rate and receive-floating rate.
c. Swaps are not used for this purpose.
d. It would depend on whether the swap is in, at, or out-of-the money.
10. Arnold Co. purchased a call option on the rice field of Robert Co. on
January 1, 200A exercisable on or before January 1, 200B. On December
31, 200A, the fair market value of the rice field was below the call
option price, making the instrument “out of the money,” and Arnold Co.
decided not to exercise the call option. Which of the following
statements is correct?
a. The call option does not meet the definition of a derivative under
PFRSs regarding settlement at a future date.
b. The call option does not meet the definition of a derivative under
PFRSs regarding the absence of initial net investment or the presence
of a little initial net investment
c. The call option meets the definition of a derivative under PFRSs
regarding settlement at a future date since expiry at maturity is a
form of settlement even though there is no additional exchange of
consideration.
d. The call option meets the definition of a derivative; however, it
should be written off on December 31, 200A and a corresponding
financial liability should be recognized.
11. On January 1, 200A, Clifton Co. enters into a forward contract to
purchase 10,000 shares of stock from Jane Co. on December 31, 200A at a
forward price of ₱100 per share. Clifton Co. prepays the shares at ₱100
per share which is the current price of the shares on January 1, 200A.
Which of the following is correct?
a. The forward contract meets the definition of a derivative.
b. The forward contract fails the “underlying” test for a derivative
since the current price and forward price are equal on inception.
c. The forward contract fails the “future settlement” test for a
derivative since Clifton Co. prepaid the shares at inception at an
amount equal to settlement price. Prepayment at an amount equal to
settlement price is tantamount to settlement.
d. The forward contract fails the “no initial net investment or an
initial net investment that is smaller than would be required for
other types of contracts that would be expected to have a similar
response to changes in market factors” test for a derivative.
12. Which of the following may qualify as net investment in a foreign
operation, of a Philippine company, to be a hedged item for hedge
accounting purposes?
a. fish ball and kikyam operations in the US
b. investment in associate on a company operating in Canada
c. joint venture with McDonalds to sell Mcbalut in retail stores all
over the world
d. investment in subsidiary on a domestic corporation selling e-load and
auto load only within the Philippines.
22
13. To be considered highly effective, actual results of the hedge should
a. be 100% effective
c. result to no gain or loss
b. be within a range of 80 to 125%
d. be documented properly
14. Which of the following is not a derivative?
a.
Equity contracts
c.
Option Contract
b.
Futures contract
d.
Swap contracts
(Adapted)
15. An interest rate swap in which company has fixed rate of interest and
pays a variable rate is called a :
a. cash flow hedge
b. fair value hedge
c. deferred hedge
d. hedge of foreign currency exposure of net investment in foreign
operations
(Adapted)
16. A derivative may be:
a.
an asset account
b.
a liability account
c.
an equity account
d. either an asset or liability account
17. The PFRSs require a company to recognize in its current net income
any gain or loss from a change in the fair value of the derivative for
a: (Item #1) Fair Value Hedge; (Item #2) Cash Flow Hedge
a. Yes, Yes
b. Yes, No
c. No, No d. No, Yes
18. Uncertainty about the future market value of an asset is referred to
as
a. price risk.
c. interest rate risk.
b. credit risk.
d. exchange rate risk.
19. Uncertainty that the party on the
abide by the terms of the agreement is
a. price risk.
c. interest
b. credit risk.
d. exchange
other side of an agreement will
referred to as
rate risk.
rate risk.
20. A contract, traded on an exchange, that allows a company to buy a
specified quantity of a commodity or a financial security at a specified
price on a specified future date is referred to as a(n)
a. interest rate swap.
c. futures contract.
b. forward contract.
d. option.
21. An agreement between two parties to exchange a specified amount of a
commodity, security, or foreign currency at a specified date in the
future with the price or exchange rate being set now is referred to as
a(n)
a. interest rate swap.
c. futures contract.
b. forward contract.
d. option.
22. If a cannery wanted to lock in the price they would pay for peaches
in August four months before harvest (in April of the same year), they
would be most likely to enter into which kind of agreement?
a. Interest rate swap
c. Futures contract
b. Fixed commodities contract
d. Option
23
23.
or
in
a.
b.
A contract giving the owner the right, but not the obligation, to buy
sell an asset at a specified price any time during a specified period
the future is referred to as a(n)
interest rate swap.
c. futures contract.
forward contract.
d. option.
24.
of
a.
b.
c.
d.
In exchange for the rights inherent in an option contract, the owner
the option will typically pay a price
only when a call option is exercised.
only when a put option is exercised.
when either a call option or a put option is exercised.
at the time the option is received regardless of whether the option
is exercised or not.
25. Which type of contract is unique in that it protects the owner
against unfavorable movements in the prices or rates while allowing the
owner to benefit from favorable movements?
a. interest rate swap.
c. futures contract.
b. forward contract.
d. option.
26. When gains or losses on derivatives designated as fair value hedges
exceed the gains or losses on the item being hedged, the excess
a. affects reported net income.
b. is recognized as an equity adjustment.
c. is recognized as part of comprehensive income.
d. is not recognized.
27. For which type of derivative are changes in the fair value deferred
and recognized as an equity adjustment?
a. Fair value hedge
c. Operating hedge
b. Cash flow hedge
d. Notional value hedge
(Adapted)
28. Which choice best describes the information that should be disclosed
related to derivative contracts?
a. Fair value
c. Both a and b
b. Notional amount
d. Neither a nor b
29. On February 1, Shoemaker Corporation entered into a firm commitment
to purchase specialized equipment from the Okazaki Trading Company for
¥80,000,000 on April 1. Shoemaker would like to reduce the exchange rate
risk that could increase the cost of the equipment in U.S. dollars by
April 1, but Shoemaker is not sure which direction the exchange rate may
move. What type of contract would protect Shoemaker from an unfavorable
movement in the exchange rate while allowing them to benefit from a
favorable movement in the exchange rate?
a. Interest rate swap
c. Call option
b. Forward contract
d. Put option
30. A company enters into a futures contract with the intent of hedging
an account payable of DM400,000 due on December 31. The contract
requires that if the U.S. dollar value of DM400,000 is greater than
$200,000 on December 31, the company will be required to pay the
difference. Alternatively, if the U.S. dollar value is less than
$200,000, the company will receive the difference. Which of the
following statements is correct regarding this contract?
24
a. The Deutsche mark futures contract effectively hedges against the
effect of exchange rate changes on the U.S. dollar value of the
Deutsche mark payable.
b. The futures contract is a contract to buy Deutsche marks at a fixed
price.
c. The futures contract is a contract to sell Deutsche marks at a fixed
price.
d. The contract obligates the company to pay if the value of the U.S.
dollar increases.
31. A company enters into a futures contract with the intent of hedging
an expected purchase of some equipment from a German company for
DM400,000 on December 31. The contract requires that if the U.S. dollar
value of DM800,000 is greater than $400,000 on December 31, the company
will receive the difference. Alternatively, if the U.S. dollar value is
less than $400,000, the company will pay the difference. Which of the
following statements is correct regarding this contract?
a. The Deutsche mark futures contract effectively hedges against the
effect of exchange rate changes on the U.S. dollar value of the
Deutsche mark commitment.
b. The futures contract exceeds the amount of the commitment and thus
hedges movements in the Deutsche mark exchange rate.
c. The futures contract is a contract to sell Deutsche marks at a fixed
price.
d. The extra DM400,000 would be accounted for as a speculative
investment.
32. A company enters into an interest rate swap in order to hedge a
$5,000,000 variable-rate loan. The loan is expected to be fully repaid
this year on June 10. The contract requires that if the interest rate on
April 30 of next year is greater than 11%, the company receives the
difference on a principal amount of $5,000,000. Alternatively, if the
interest rate is less than 11%, the company must pay the difference.
Which of the following statements is correct regarding this contract?
a. The swap agreement effectively hedges the variable interest payments.
b. The timing of the swap payment matches the timing of the interest
payments and, therefore, the variable interest payments are hedged.
c. The timing of the swap payment does not match the timing of the
interest payments and, therefore, the variable interest payments are
not hedged.
d. This swap represents a fair value hedge.
Use the following information for the next four questions:
Fact pattern
Hall, Inc., enters into a call option contract with Bennett Investment Co.
on January 2, 2016. This contract gives Hall the option to purchase 1,000
shares of WSM stock at $100 per share. The option expires on April 30,
2016. WSM shares are trading at $100 per share on January 2, 2016, at
which time Hall pays $100 for the call option.
33.
a.
b.
c.
d.
The call option would be recorded in the accounts of Hall as
an asset.
a liability.
a gain.
would not be recorded in the accounts (memorandum entry only).
25
34. Assume that the price of the WSM shares has risen to $120 per share
on March 31, 2016, and the Hall is preparing financial statements for
the quarter ending March 31. As regards this option, Hall, Inc., would
report which of the following?
a. A $20,000 realized gain.
b. A $20,000 unrealized gain.
c. a description of the change in price would be disclosed in the notes
to the financial statements, but would not be reflected in the
financial statements.
d. Nothing would be reported in the financial statements or the notes
thereto.
35. The 1,000 shares of WSM stock in this contract is referred to as
a. the collateral.
c. the option premium.
b. the notional amount.
d. the derivative.
(Adapted)
36. The $400 paid by Hall, Inc., to Baird Investment is referred to as
a. the option premium.
c. the strike price.
b. the notional amount.
d. the intrinsic value.
(Adapted)
37. Assume that the price per share of WSM stock is $120 on April 30,
2016, and that the time value of the option has not changed. In order to
settle the option contract, Hall, Inc., would most likely
a. pay Baird Investment $20,000.
b. purchase the shares of WSM at $100 per share and sell the shares at
$120 per share to Baird.
c. receive $20,000 from Baird Investment.
d. receive $400 from Baird Investment.
(Adapted)
38. Alpha Company purchases a call option to hedge an investment in
20,000 shares of Beta Company stock. The option agreement provides that
if the prices of a share of Beta Company stock is greater than $30 on
October 25, Alpha receives the difference (multiplied by 20,000 shares).
Alternatively, if the price of the stock is less than $30, the option is
worthless and will be allowed to expire. Which of the following
statements regarding this call option is correct?
a. The call option effectively hedges the investment in the shares of
Beta stock.
b. The call option is an option to sell Beta Company stock at a fixed
price.
c. The call option represents a speculative option rather than a hedge.
d. Alpha could have purchased a put option or a call option to
effectively hedge the investment in the shares of Beta stock.
(Adapted)
39. Which of the following statements about options and their underlying
assets is FALSE?
a. The value of an option, in comparison to its underlying asset, has
the potential of creating an arbitrage opportunity.
b. The owner of the option is legally required to engage in a
transaction involving the asset.
c. The holder of a long position on an option is the only party with the
right to initiate a transaction involving the asset.
d. The seller of the option is legally required to engage in a
transaction involving the asset.
26
(Adapted)
40. Which of the following statements about forward and future contracts
is FALSE?
a. A future requires the contract purchaser to receive delivery of the
good at a specified time.
b. A predetermined price to be paid for a good is a necessary
requirement in the terms of a forward contract.
c. The future value of a financial derivative depends on the value of
its underlying asset.
d. The primary difference between forwards and futures is that only
futures are considered financial derivatives.
(Adapted)
41. Futures contracts differ from forward contracts in which of the
following ways?
a. Performance of each party in a futures transaction is guaranteed by a
clearinghouse.
b. All of these choices are correct.
c. Futures contracts require a daily settling of any gains or loses.
d. Futures contracts are standardized.
(Adapted)
42. Which of the following statements accurately describes how futures
contracts differ from forward contracts?
a. Futures contracts are standardized.
b. Futures contracts require a daily settling of gains and losses.
c. All of these choices are correct.
d. The performance of counterparties to a futures contract is guaranteed
by a clearinghouse.
(Adapted)
43. When a call option on a future is exercised, the buyer receives:
a. a short position in the underlying future.
b. an option to purchase the underlying future.
c. the physical good.
d. a long position in the underlying future and a cash payment.
(Adapted)
44. Which of the following statements about swap agreements is FALSE?
a. They are standardized agreements, similar to futures.
b. Counterparties are the principles who engage in a swap agreement.
c. They allow for the exchange of different sets of future cash flows.
d. Interest rate and currency are common types of swaps.
(Adapted)
45. Which of the following requires the purchase of the underlying asset
at a specified price?
a. Purchasing a call option.
c. Writing a call option.
b. Writing a put option.
d. Purchasing a put option.
(Adapted)
46. Frank Jameson is a portfolio manager with 90 percent of the large-cap
diversified mutual fund he controls invested in common stocks. Jameson
is concerned the overall market will decline by a significant amount
over the next two months due to a slowing of the general economy. Which
of the following actions will provide a hedge for the mutual fund?
a. Selling interest rate future contracts.
27
b. Writing put options on the S&P 500.
c. Purchasing put options on the Standard and Poor's 500 Index (S&P
500).
d. Purchasing call options on the S&P 500.
(Adapted)
47. Ron Jensen is a speculator who does not currently own GHP Corporation
common stock but believes it will increase in market value by 25 percent
over the next month. Jensen can most likely achieve the highest
percentage return on the expected stock price increase by:
a. writing GHP put options.
c. buying GHP put options.
b. buying GHP call options.
d. buying GHP common stock.
(Adapted)
48. Which of the following statements about derivatives is TRUE?
a. Although forwards have terms that are not standardized, the
clearinghouse of that exchange still takes the opposite position of
each trade, thereby protecting the counterparties from default risk.
b. Although minimal, arbitragers face the risk of the market value of
the underlying asset declining by an amount greater then what was
protected with the hedge.
c. When a call option on a future is exercised, the seller receives a
short position in the underlying future plus pays cash to the holder
of the option.
d. The market value of a financial derivative is primarily a function of
the relative demand and supply for that contract.
(Adapted)
49. If an oil wholesaler expects to buy some gasoline for his customers
in the future and wants to hedge his risk, he needs to:
a. sell gasoline now.
c. do nothing.
b. sell crude oil futures contract.
d. buy crude oil futures contract.
(Adapted)
50. Which of the following statements about forward contracts is CORRECT?
A long trader agrees to:
a. take delivery, and a short trader agrees to take delivery
b. take delivery, and a short trader agrees to make delivery.
c. take delivery, and a short trader agrees to make delivery.
d. make delivery, and a short trader agrees to take delivery.
(Adapted)
51. If a farmer expects to sell his wheat in anticipation of a harvest
and wants to hedge his risk, he needs to:
a. sell wheat now.
c. buy wheat futures contracts now.
b. buy wheat now.
d. sell wheat futures contracts now.
(Adapted)
52. Which of the following statements about speculators and hedgers in
the futures market is TRUE?
a. Hedging can allow a business to guard against a price increase in a
commodity
without
sacrificing
profit
if
the
commodity
price
decreases.
b. A speculator would use futures to take a long position in a commodity
if its price is expected to decrease.
c. A speculator would use futures to take a short position in a
commodity if its price is expected to increase.
d. Hedgers guard against market price changes that would cause a
reduction in their operating profit.
28
(Adapted)
53. Standardized futures contracts are an aid to increased market
liquidity because:
a. standardization results in less trading activity.
b. uniformity of the contract terms broadens the market for the futures
by appealing to a greater number of traders.
c. standardization of the futures contract stabilizes the market price
of the underlying commodity.
d. non-standardized forward contracts are not allowed to trade.
(Adapted)
54. Futures have greater market liquidity than forward contracts, because
futures are:
a. developed with specific characteristics to meet the needs of the
buyer.
b. standardized contracts.
c. sold only for widely traded commodities, unlike forwards.
d. written for shorter periods of time.
(Adapted)
55. Standardization features of futures contracts do not include the:
a. quality of the good that can be delivered.
b. delivery time.
c. quantity of the good to be delivered.
d. delivery price of the commodity.
(Adapted)
56. What is the primary difference between an American and a European
option?
a. American and European options are never written on the same
underlying asset.
b. The European option can only be traded on overseas markets.
c. The American option can be exercised at any time on or before its
expiration date.
d. American and European options always have different strike prices
when written on the same underlying asset.
(Adapted)
57. American options are worth no less than European options with the
same maturity, exercise price, and underlying stock because:
a. purchasers of American options receive stock dividends, while
purchasers of European options do not.
b. American options are traded in U.S. exchanges where trading costs are
less than in European exchanges.
c. all of these choices are correct.
d. American options can be exercised before maturity, while European
options can be exercised only at maturity.
(Adapted)
58. Which of the following statements about European and American options
is FALSE?
a. European options offer more flexible trading opportunities for
speculators.
b. American options can be exercised at any time on or before the
expiration date.
c. European options are easier to analyze and value than American
options.
d. American options are far more common than European options.
(Adapted)
29
59. Which of the following statements regarding options is TRUE?
a. An American option is worth no less than a European option with the
same maturity, exercise price, and underlying stock.
b. European options are always worth the same as American options with
the same maturity, exercise price, and underlying stock.
c. European options are always worth more than American options with the
same maturity, exercise price, and underlying stock.
d. All of these choices are correct.
60. The writer of the put option has the:
a. obligation to sell the underlying asset in the future
conditions.
b. right to buy the underlying asset in the future
conditions.
c. right to sell the underlying asset in the future
conditions.
d. obligation to buy the underlying asset in the future
conditions.
under certain
under
certain
under
certain
under certain
61. The writer of an option has:
a. neither the right nor obligation. c. the right.
b. both the right and obligation.
d. the obligation.
62. John Elam has a position in an option in which Elam pays an upfront
fee to receive payments if the value of a stock is below $18 at
expiration. If the stock is not below $18 at expiration, Elam receives
nothing. Elam’s position in the option is:
a. short a put option.
c. long a call option.
b. short a call option.
d. long a put option.
63. James Anthony has a short position in a put
price of $94. If the stock price is below $94 at
happen to Anthony’s short position in the option?
a. The person who is long the put option will
option.
b. He will have the option exercised against him
who is long the put option.
c. He will exercise the option at $94.
d. He will let the option expire.
option with a strike
expiration, what will
not exercise the put
at $94 by the person
64. Which of the following represents a long position in an option?
a. Writing a call option.
c. Writing a naked call option.
b. Writing a put option.
d. Buying a put option.
65.
a.
b.
c.
The options market is a zero-sum game in that:
whatever the long call gains, the short call loses.
the short put position has limited gain but also has limited loss.
the long put position can gain infinitely, but the long call position
can only lose the premium.
d. the long put position has limited gain but also has limited loss.
66. The options market is a zero-sum game because:
a. there are no net profits or losses in the market.
b. the profits from the buyer and seller of a call option together are
always zero.
c. all of these choices are correct.
d. profits come only at the expense of another trader.
30
67. Which of the following statements regarding buyers of call and
options is TRUE?
a. Buyers of calls anticipate the value of the underlying asset
decrease, while the buyers of puts anticipate the value of
underlying asset to increase.
b. Buyers of calls anticipate the value of the underlying asset
decrease, and buyers of puts also anticipate the value of
underlying asset to decrease.
c. Buyers of calls anticipate the value of the underlying asset
increase, and buyers of puts also anticipate the value of
underlying asset to increase.
d. Buyers of calls anticipate the value of the underlying asset
increase, while the buyers of puts anticipate the value of
underlying asset to decrease.
put
to
the
to
the
to
the
to
the
68. Which of the following is a reason to use the swaps market rather
than the futures market? To:
a. maintain the firm's privacy.
b. increase the liquidity of the contract.
c. reduce the credit risk involved with the contract.
d. provide for a standardized contract.
69.
is
a.
b.
c.
d.
Which of the following statements about notional principal in swaps
TRUE?
Notional principal is used as a base for computation of payments.
Notional principal is useless in most swaps.
Notional principal is not actually exchanged.
Notional principal is not actually exchanged and notional principal
is used as a base for computation of payments.
70.
a.
b.
c.
d.
Parties agreeing to swap cash flows are:
dealers.
agents.
counterparties.
swap facilitators.
71. Consider a commercial bank that is about to make a large variablerate loan. Which of the following would be an appropriate position for
the bank to hedge its risk with this loan? Pay:
a. variable to a currency swap counterparty and receive fixed.
b. variable to an interest rate swap counterparty and receive fixed.
c. fixed to an interest rate swap counterparty and receive variable.
d. fixed to a currency swap counterparty and receive variable.
72. Consider a commercial bank that has many floating-rate liabilities
and has many fixed-rate assets. Which of the following would be an
appropriate position for the bank to hedge its risk? Pay:
a. variable to an interest rate swap counterparty and receive fixed.
b. fixed to a currency swap counterparty and receive variable.
c. variable to a currency swap counterparty and receive fixed.
d. fixed to an interest rate swap counterparty and receive variable.
73. A typical savings and loan association accept deposits (which is
floating rate in nature) and lend those funds on fixed rate terms. As a
result, it can be left with floating rate liabilities and fixed rate
31
assets. To escape this interest rate risk, the savings and loan might be
motivated to engage in:
a. a currency swap.
c. an interest rate swap.
b. an equity swap.
d. swaps can never help.
74. An interest rate swap:
a. all of these choices are correct.
b. allows a firm to convert outstanding fixed rate debt to floating rate
debt.
c. allows a firm to convert outstanding floating rate debt to fixed rate
debt.
d. obligates two counterparties to exchange cash flows at one or more
future dates.
75. The main motivation for engaging in swap transactions is:
a. commercial needs.
c. both of these choices are correct.
b. comparative borrowing advantages.
d. none of these choices are
correct.
76. Which of the following MUST be part of ANY swap transaction?
a. Swap dealers.
c. Counterparties.
b. Swap facilitators.
d. Counterparties and swap facilitators.
(Adapted)
77.
I.
A derivative
Specifically
unrecognized
II.
Expected to
value of the
a. I only.
nor II.
(AICPA)
designated as a fair value hedge must be:
identified
to
the
hedged
asset,
liability
or
firm commitment.
be highly effective in offsetting changes in the fair
hedged item.
b. II only.
c. Both I and II.
d.
Neither
I
78. In order for a financial instrument to be a derivative for accounting
purposes, the financial instrument must:
I.
Have one or more underlyings.
II.
Require an initial net investment.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor
II.
(AICPA)
79. The determination of the value or settlement amount of a derivative
involves a calculation which uses:
I.
An underlying.
II.
A notional amount.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor
II.
(AICPA)
80. On December 31, 199X, the end of its fiscal year, Smarti Company held
a derivative instrument which it had acquired for speculative purposes
during November, 199X. Since its acquisition the fair value of the
derivative had increased materially. On December 31, how should the
increase in fair value of the derivative instrument be reported by
Smarti in its financial statements?
a. Recognized as a deferred credit until the instrument is settled.
32
b. Recognized in current net income for 199X.
c. Recognized as a component of other comprehensive income for 199X.
d. Disregarded until the instrument is settled.
(AICPA)
81. Gains and losses from changes in the fair value of a derivative
designated and qualified as a fair value hedge should be:
a. Disregarded until the derivative is settled.
b. Recognized as a deferred debit or deferred credit in the balance
sheet until the derivative is settled.
c. Recognized in current net income in the period in which the fair
value of the derivative changes.
d. Recognized as a component of other comprehensive income in the period
in which the fair value of the derivative changes.
(AICPA)
82. Qualified derivatives may be used to hedge the cash flow associated
with an/a: (Item #1) Forecasted; (Item #2) Asset transaction
a. Yes Yes
b. Yes No c. No Yes d. No No
(AICPA)
83. A change in the fair value of a derivative qualified as a cash flow
hedge is determined to be either effective in offsetting a change in the
hedged item or ineffective in offsetting such a change. How should the
effective and ineffective portions of the change in value of a
derivative which qualifies as a cash flow hedge be reported in financial
statements?
Effective portion in
Ineffective portion in
a. Current income
Current income
b. Current income
Other comprehensive income
c. Other comprehensive income
Current income
d. Other comprehensive income
Other comprehensive income
(AICPA)
84. Which of the following risks are inherent in an interest rate swap
agreement?
I.
The risk of exchanging a lower interest rate for a higher interest
rate.
II.
The risk of nonperformance by the counterparty to the agreement.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor
II.
(AICPA)
85. Which of the following financial instruments is not considered a
derivative financial instrument?
a. Interest-rate swaps.
c. Stock-index options.
b. Currency futures.
d. Bank certificates of deposit.
(AICPA
86. Derivatives that are not hedging instruments are always classified in
which category of financial instruments?
a. Financial assets or liabilities with fair values through profit or
loss
b. Held-to-maturity investments.
c. Loans and receivables originated by the enterprise.
d. Available-for-sale financial assets.
(AICPA)
33
87. Which of the following is the best description of a financial
instrument?
a. Any monetary contract denominated in a foreign currency.
b. Cash, an investment in equities, and any contract to receive or pay
cash.
c. Any form of a company’s own capital stock.
d. Any transaction with a bank or other financial institution.
(Adapted)
88. On November 1, Year One, the Jeter Company signs a contract to
receive one million Japanese yen on February 1, Year Two, for $10,000
based on the three-month forward exchange rate at that time of $1 for
100 Japanese yen (1,000,000 x 1/100 or $10,000). Why would Jeter obtain
this contract?
a. Jeter believes the value of the Japanese yen will be increasing in
relation to the value of the US dollar.
b. Jeter believes the value of the Japanese yen will be decreasing in
relation to the value of the US dollar.
c. Jeter believes that the economy of Japan will be growing at a rate
faster than that of the US economy.
d. Jeter could be hedging a future need to make a payment in Japanese
yen or it could be speculating that the Japanese yen will become more
valuable.
(Adapted)
89. On November 1, Year One, the Haynie Company signs a contract to
receive one million Japanese yen on February 1, Year Two, for $10,000
based on the three-month forward exchange rate at that time of $1 for
100 Japanese yen (1,000,000 x 1/100 or $10,000). This contract is a
derivative because its value is derived from the future value of the
Japanese yen in relation to the US dollar. On December 31, Year One, the
Haynie Company is producing financial statements. How is this forward
exchange contract reported?
a. It is shown as an asset or a liability at its fair value.
b. It is shown only as an asset at its fair value.
c. It is shown only as a liability at its fair value.
d. It is only disclosed in the notes to the financial statements because
it is a future transaction.
(Adapted)
90. On December 1, Year One, a company acquires two three-month financial
instruments that qualify as derivatives. Financial instrument A was
bought to serve as a fair value hedge. Financial instrument B was bought
to serve as a cash flow hedge. By the end of Year One, both of these
financial instruments have increased in value by $1,000. How should
these gains in value be reported by the company on the Year One
financial statements?
a. Both gains are reported within net income.
b. Both gains are reported within accumulated other comprehensive
income.
c. The gain on the fair value hedge is reported within net income
whereas the gain on the cash flow hedge is reported within
accumulated other comprehensive income.
d. The gain on the fair value hedge is reported within accumulated other
comprehensive income whereas the gain on the cash flow hedge is
reported within net income.
(Adapted)
34
91. Some financial instruments qualify as derivatives. Which of the
following is the best description of a derivative?
a. A contract denominated in two different currencies.
b. A contract that derives its value from some other index, item, or
security.
c. A contract that may happen but is not guaranteed to happen.
d. A contract made by two parties but which directly impacts a third
party.
(Adapted)
92. The functional currency of Nash, Inc.’s subsidiary is the French
franc. Nash borrowed French francs as a partial hedge of its investment
in the subsidiary. In preparing consolidated financial statements,
Nash’s translation loss on its investment in the subsidiary exceeded its
exchange gain on the borrowing. How should the effects of the loss and
gain be reported in Nash’s consolidated financial statements?
a. The translation loss less the exchange gain is reported separately as
other comprehensive income.
b. The translation loss less the exchange gain is reported in the income
statement.
c. The translation loss is reported separately in the stockholders’
equity section of the balance sheet and the exchange gain is reported
in the income statement.
d. The translation loss is reported in the income statement and the
exchange gain is reported separately in the stockholders’ equity
section of the balance sheet.
(AICPA)
93. A gain in the fair value of a derivative may be included in
comprehensive income if the derivative is appropriately designated as a
a. Speculation in Foreign Currency.
b. Hedge of a Foreign Currency exposure of an available-for-sale
security.
c. Hedge of a Foreign Currency exposure of a forecasted foreign currency
denominated transaction.
d. Hedge of a foreign currency firm commitment.
(AICPA)
94. Shore Co. records its transactions in US dollars. A sale of goods
resulted in a receivable denominated in Japanese yen, and a purchase of
goods resulted in a payable denominated in euros. Shore recorded a
foreign exchange transaction gain on collection of the receivable and an
exchange transaction loss on settlement of the payable. The exchange
rates are expressed as so many units of foreign currency to one dollar.
Did the number of foreign currency units exchangeable for a dollar
increase or decrease between the contract and settlement dates?
(Item #1) Yen exchangeable for ₱1; (Item #2) Euros exchangeable for ₱1
a. Increase Increase
c. Decrease Increase
b. Decrease Decrease
d. Increase Decrease
(AICPA)
95. On October 1, 2016, Mild Co., a US company, purchased machinery from
Grund, a German company, with payment due on April 1, 2017. If Mild’s
2016 operating income included no foreign exchange transaction gain or
loss, then the transaction could have
a. Resulted in an extraordinary gain.
35
b. Been denominated in US dollars.
c. Caused a foreign currency gain to be reported as a contra account
against machinery.
d. Caused a foreign currency translation gain to be reported as other
comprehensive income.
(AICPA)
96. On October 1, 2016, Velec Co., a US company, contracted to purchase
foreign goods requiring payment in Qatari rials, one month after their
receipt at Velec’s factory. Title to the goods passed on December 15,
2016. The goods were still in transit on December 31, 2016. Exchange
rates were one dollar to twenty-two rials, twenty rials, and twenty-one
rials on October 1, December 15, and December 31, 2016, respectively.
Velec should account for the exchange rate fluctuation in 2016 as
a. A loss included in net income
c. An extraordinary gain.
b. A gain included in net income
d. An extraordinary loss.
(AICPA)
97. Derivatives are financial instruments that derive their value from
changes in a benchmark based on any of the following except
a. Stock prices.
c. Commodity prices.
b. Mortgage and currency rates.
d. Discounts on accounts
receivable.
(AICPA)
98. Derivative instruments are financial instruments or other contracts
that must contain
a. One or more underlyings, or one or more notional amounts.
b. No initial net investment or smaller net investment than required for
similar response contacts.
c. Terms that do not require or permit net settlement or delivery of an
asset.
d. All of the above.
(AICPA)
99. The basic purpose of derivative financial instruments is to manage
some kind of risk such as all of the following except
a. Stock price movements.
c. Currency fluctuations.
b. Interest rate variations.
d. Uncollectibility of accounts
receivables.
(AICPA)
100. Which of the following statements is(are) true regarding derivative
financial instruments?
I.
Derivative financial instruments should be measured at fair value and
reported in the balance sheet as assets or liabilities.
II.
Gains and losses on derivative instruments not designated as hedging
activities should be reported and recognized in earnings in the
period of the change in fair value.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor
II.
(AICPA)
101. Which of the following is an underlying?
a. A credit rating.
c. An average daily temperature.
b. A security price.
d. All of the above could be underlyings.
(AICPA)
36
102. If
price
a. At
b. In
(AICPA)
the price of the underlying is greater than the strike or exercise
of the underlying, the call option is
the money.
c. On the money.
the money.
d. Out of the money.
103. Which of the following is not a distinguishing characteristic of a
derivative instrument?
a. Terms that require or permit net settlement.
b. Must be “highly effective” throughout its life.
c. No initial net investment.
d. One or more underlyings and notional amounts.
(AICPA)
104. An example of a notional amount is
a. Number of barrels of oil.
c. Currency swaps.
b. Interest rates.
d. Stock prices.
(AICPA)
105. Disclosures related to financial instruments, both
nonderivative, used as hedging instruments must include
a. A list of hedged instruments.
b. Maximum potential accounting loss.
c. Objectives and strategies for achieving them.
d. Only a. and c.
(AICPA)
derivative
and
106. Which of the following financial instruments or other contracts is
not specifically excluded from the definition of derivative instruments
in PAS 39?
a. Leases.
c. Adjustable rate loans.
b. Call (put) option.
d. Equity securities.
(AICPA)
107. Which of the following is not a derivative instrument?
a. Futures contracts.
c. Interest rate swaps.
b. Credit indexed contracts.
d. Variable annuity contracts.
(AICPA)
108. Which of the following criteria must be met for bifurcation to occur?
a. The embedded derivative meets the definition of a derivative
instrument.
b. The hybrid instrument is regularly recorded at fair value.
c. Economic characteristics and risks of the embedded instrument are
“clearly and closely” related to those of the host contract.
d. All of the above.
(AICPA)
109. Financial instruments sometimes contain features that separately meet
the definition of a derivative instrument. These features are classified
as
a. Swaptions.
c. Embedded derivative instruments.
b. Notional amounts.
d. Underlyings.
(AICPA)
110. The process of bifurcation
a. Protects an entity from loss by entering into a transaction.
37
b. Includes entering into agreements between two counterparties to
exchange cash flows over specified period of time in the future.
c. Is the interaction of the price or rate with an associated asset or
liability.
d. Separates an embedded derivative from its host contract.
(AICPA)
111. Hedge accounting is permitted for all
hedges except
a. Trading securities.
b. Unrecognized firm commitments.
c. Available-for-sale securities.
d. Net investments in foreign operations.
(AICPA)
of
the
following
types
of
112. Which of the following is a general criterion for a hedging
instrument?
a. Sufficient documentation must be provided at the beginning of the
process.
b. Must be “highly effective” only in the first year of the hedge's
life.
c. Must contain a nonperformance clause that makes performance probable.
d. Must contain one or more underlyings.
(AICPA)
113. For an unrecognized firm commitment to qualify as a hedged item it
must
a. Be binding on both parties.
b. Be specific with respect to all significant terms.
c. Contain a nonperformance clause that makes performance probable.
d. All of the above.
(AICPA)
114. A hedge of the exposure to changes in the fair value of a recognized
asset or liability, or an unrecognized firm commitment, is classified as
a
a. Fair value hedge.
c. Foreign currency hedge.
b. Cash flow hedge.
d. Underlying.
(AICPA)
115. Gains and losses on the hedged asset/liability and the hedged
instrument for a fair value hedge will be recognized
a. In current earnings.
b. In other comprehensive income.
c. On a cumulative basis from the change in expected cash flows from the
hedged instrument.
d. On the balance sheet either as an asset or a liability.
(AICPA)
116. Gains and losses of
will be recognized in
which of the following?
hedge
a. Yes No
b. Yes
(AICPA)
the effective portion of a hedging instrument
current earnings in each reporting period for
(Item #1) Fair value hedge; (Item #2) Cash flow
Yes
c. No No
d. No Yes
117. Which of the following risks are inherent in an interest rate swap
agreement?
38
I.
The risk of exchanging a lower interest rate for a higher interest
rate.
II.
The risk of nonperformance by the counterparty to the agreement.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor
II.
(AICPA)
118. Which of the following meet the definition of assets and/or
liabilities?
(Item #1) Derivative instruments; (Item #2) G/L on the fair value of
derivatives
a. Yes No b. No Yes c. Yes Yes
d. No No
(AICPA)
119. The risk of an accounting loss from a financial instrument due to
possible failure of another party to perform according to terms of the
contract is known as
a. Off-balance-sheet risk.
c. Credit risk.
b. Market risk.
d. Investment risk.
(AICPA)
120. Examples of financial instruments with off-balance sheet risk include
all of the following except
a. Outstanding loan commitments written.
c. Warranty obligations
b. Recourse obligations on receivables.
d. Futures contracts.
(AICPA)
121. Off-balance-sheet risk of accounting loss does not result from
a. Financial instruments recognized as assets entailing conditional
rights that result in a loss greater than the amount recognized in
the balance sheet.
b. Financial instruments not recognized as either assets or liabilities
yet still expose the entity to risk of accounting loss.
c. Financial instruments recognized as assets or liabilities where the
amount recognized reflects the risk of accounting loss to the entity.
d. Financial instruments recognized as liabilities that result in an
ultimate obligation that is greater than the amount recognized in the
balance sheet.
(AICPA)
122. Are there any circumstances when a contract that is not a financial
instrument would be accounted for as a financial instrument under PAS 32
and PAS 39 (and PFRS 9)?
a. No. Only financial instruments are accounted for as financial
instruments.
b. Yes. Gold, silver, and other precious metals that are readily
convertible to cash are accounted for as financial instruments.
c. Yes. A contract for the future purchase or delivery of a commodity or
other nonfinancial item (e.g., gold, electricity, or gas) generally
is accounted for as a financial instrument if the contract can be
settled net.
d. Yes. An entity may designate any nonfinancial asset that can be
readily convertible to cash as a financial instrument.
(Adapted)
123. All of the following are characteristics of a derivative except:
a. It is acquired or incurred by the entity for the purpose of
generating a profit from short-term fluctuations in market factors.
39
b. Its value changes in response to the change in a specified underlying
(e.g., interest rate, financial instrument price, commodity price,
foreign exchange rate, etc.).
c. It requires no initial investment or an initial net investment that
is smaller than would be required for other types of contracts that
would be expected to have a similar response to changes in market
factors.
d. It is settled at a future date.
(Adapted)
124. Is a derivative (e.g., an equity conversion option) that is embedded
in another contract (e.g., a convertible bond) accounted for separately
from that other contract?
a. Yes. PFRSs require all derivatives (both freestanding and embedded)
to be accounted for as derivatives.
b. No. PFRSs preclude entities from splitting financial instruments and
accounting for the components separately.
c. It depends. PFRSs require embedded derivatives to be accounted for
separately as derivatives if, and only if, the entity has embedded
the derivative in order to avoid derivatives accounting and has no
substantive business purpose for embedding the derivative.
d. It depends. PFRSs require embedded derivatives to be accounted for
separately if, and only if, the economic characteristics and risks of
the embedded derivative and the host contract are not closely related
and the combined contract is not measured at fair value with changes
in fair value recognized in profit or loss.
(Adapted)
125. Which of the following is not a condition for hedge accounting?
a. Formal designation and documentation of the hedging relationship and
the entity’s risk management objective and strategy for undertaking
the hedge at inception of the hedging relationship.
b. The hedge is expected to be highly effective in achieving offsetting
changes in fair value or cash flows attributable to the hedged risk,
the effectiveness of the hedge can be reliably measured, and the
hedge is assessed on an ongoing basis and determined actually to have
been effective.
c. For cash flow hedges, a forecast transaction must be highly probable
and must present an exposure to variations in cash flows that could
ultimately affect profit or loss.
d. The hedge is expected to reduce the entity’s net exposure to the
hedged risk, and the hedge is determined actually to have reduced the
net entity-wide exposure to the hedged risk.
(Adapted)
126. What is the accounting treatment of the hedging instrument and the
hedged item under fair value hedge accounting?
a. The hedging instrument is measured at fair value, and the hedged item
is measured at fair value with respect to the hedged risk. Changes in
fair value are recognized in profit or loss.
b. The hedging instrument is measured at fair value, and the hedged item
is measured at fair value with respect to the hedged risk. Changes in
fair value are recognized directly in equity to the extent the hedge
is effective.
c. The hedging instrument is measured at fair value with changes in fair
value recognized directly in equity to the extent the hedge is
effective. The accounting for the hedged item is not adjusted.
40
d. The hedging instrument is accounted for in accordance with the
accounting requirements for the hedged item (i.e., at fair value,
cost or amortized cost, as applicable), if the hedge is effective.
(Adapted)
127. What is the accounting treatment of the hedging instrument and the
hedged item under cash flow hedge accounting?
a. The hedged item and hedging instrument are both measured at fair
value with respect to the hedged risk, and changes in fair value are
recognized in profit or loss.
b. The hedged item and hedging instrument are both measured at fair
value with respect to the hedged risk, and changes in fair value are
recognized directly in equity.
c. The hedging instrument is measured at fair value, with changes in
fair value recognized directly in equity to the extent the hedge is
effective. The accounting for the hedged item is not adjusted.
d. The hedging instrument is accounted for in accordance with the
accounting requirements for the hedged item (i.e., at fair value,
cost or amortized cost, as applicable), if the hedge is effective.
(Adapted)
Suggested answers to Theory of accounts questions
1. A
21. B
41. B
61. D
81. C
2. A
22. C
42. C
62. D
82. A
3. C
23. D
43. D
63. B
83. C
4. B
24. D
44. A
64. D
84. C
5. A
25. D
45. B
65. A
85. D
6. A
26. A
46. C
66. C
86. A
7. D
27. B
47. B
67. D
87. B
8. A
28. C
48. C
68. A
88. D
9. B
29. C
49. D
69. D
89. A
10. C
30. C
50. B
70. C
90. C
11. D
31. D
51. D
71. B
91. B
12. A
32. C
52. D
72. D
92. A
13. B
33. A
53. B
73. C
93. C
14. A
34. C
54. B
74. A
94. B
15. B
35. B
55. D
75. C
95. B
16. D
36. A
56. C
76. C
96. B
17. B
37. C
57. D
77. C
97. D
18. A
38. C
58. A
78. A
98. B
19. B
39. B
59. A
79. C
99. D
20. C
40. D
60. D
80. B
100. C
41
101.
102.
103.
104.
105.
106.
107.
108.
109.
110.
111.
112.
113.
114.
115.
116.
117.
118.
119.
120.
D
B
B
A
D
B
D
A
C
D
A
A
D
A
A
A
C
A
C
C
121.
122.
123.
124.
125.
126.
127.
C
C
A
D
D
A
C
Accounting for Derivatives and Hedging Transactions (Part 1)
Multiple Choice – Computational
Answers at a glance:
1. D
11. D
21. C
31. A
41. A
51. A
2. A
12. C
22. C
32. C
42. B
52. C
3. D
13. A
23. D
33. D
43. C
53. B
4. D
14. A
24. D
34. A
44. D
54. D
5. B
15. C
25. B
35. A
45. D
55. A
6. C
16. D
26. C
36. C
46. D
56. B
7. A
17. B
27. A
37. B
47. A
57. C
8. B
18. A
28. A
38. A
48. D
58. B
9. D
19. B
29. B
39. D
49. D
59. A
10. D
20. C
30. C
40. D
50. C
60. E
61. C
62. A
63. A
64. D
Solutions:
1. D
Solution:
Hedged item –
Account receivable
Dec. 15, 20x1
Accounts
receivable……1.92M
Hedging instrument –
Forward contract (Derivative)
Dec. 15, 20x1
No entry
(4M yens x 0.48 spot rate)
Sales…………………….1.92M
2. A
Solution:
Hedged item –
Account receivable
Dec. 31, 20x1
Accounts
receivable……40K
[(0.49 - 0.48) x 4M]
FOREX gain……………....40K
to adjust accounts receivable for the
increase in spot rate
Hedging instrument –
Forward contract (Derivative)
Dec. 31, 20x1
Loss on forward contract….60K
Forward contract (liability)...60K
[(0.485 - 0.47) x 4M]
to record the value of the derivative
3. D (See entries above)
4. D (See entries above)
5. B
Solution:
Hedged item –
Account receivable
Hedging instrument –
Forward contract (Derivative)
Jan. 15, 20x2
Cash – foreign currency…1.84M
Jan. 15, 20x2
Cash – local currency……1.88M
(4M x 0.46 current spot rate)
(4M x 0.47 agreed rate)
FOREX loss………………...120K
Accounts receivable……...1.96M
(1.92M + 40K)
to record the receipt of 1M yens from the
customer
Forward contract (liability)….60K
Cash – foreign currency…1.84M
Gain on forward contract ...100K
to record the remittance of 4M yens to the
bank in exchange for the pre-agreed sale
price of ₱1,880,000
6. C (See entries above)
7. A (1.88M debit to cash – 1.84 credit to cash) = 40,000 net cash
receipt (See entry above)
8. B 20x1: (40,000 gain – 60,000 loss) - 20x2: (120,000 loss –
100,000 gain) = 40,000 net loss (See entries above)
9. D
Solution:
Hedged item – None
Forward contract (Derivative)
Dec. 15, 20x1
No entry
10. D
Solution:
Hedged item – None
Forward contract (Derivative)
Dec. 31, 20x1
Loss on forward contract…..60K
Forward contract (liability)....60K
[ (0.485 - 0.47) x 4M]
to record the value of the derivative
11. D (See entry above)
12. C
Solution:
Hedged item – None
Forward contract (Derivative)
Jan. 15, 20x2
Cash – local currency…...1.88M
(4M x 0.47 agreed rate)
Forward contract (liability). 60K
Cash – foreign currency. 1.84M
Gain on forward contract…100K
to record the remittance of 4M yens to the
bank in exchange for the pre-agreed sale
price of ₱1,880,000
13. A (1.88M debit to cash – 1.84 credit to cash) = 40,000 net cash
receipt (See entry above)
14. A
Solution:
Hedged item –
Account payable
Dec. 15, 20x1
Inventory……………48,000
Hedging instrument –
Forward contract (Derivative)
Dec. 15, 20x1
No entry
(40K wons x 1.20 spot rate)
Accounts payable…48,000
15. C
Solution:
Hedged item –
Account payable
Dec. 31, 20x1
FOREX loss ………… 2,400
[40K x (1.26 – 1.20)]
Accounts payable…. 2,400
16. D
Hedging instrument –
Forward contract (Derivative)
Dec. 31, 20x1
Forward contract (asset).. 1,200
Gain on forward contract.. 1,200
[(1.27 forward rate – 1.24 forward rate) x
40K]
17. B
Solution:
Hedged item –
Account payable
Hedging instrument –
Forward contract (Derivative)
Jan. 15, 20x2
Accounts
payable…….50,400
Jan. 15, 20x2
Cash - foreign currency...52,000
(48K + 2.4K)
(40K x 1.30)
FOREX loss…………… 1,600
[(1.30 -1.26) x 40K]
Cash - foreign currency…...52,000
to record the payment of 40,000 wons to
the supplier
Cash - local currency….….49,600
Forward contract (asset)… 1,200
Gain on forward contract.....1,200
[(1.30 – 1.27) x 40K]
to record the purchase of 40,000 wons
from the bank at the pre-agreed purchase
price of ₱49,600
18. A (See entries above)
19. B (1,600 loss – 1,200 gain) = 400 net loss (See entries above)
20. C (52,000 debit to cash – 49,600 credit to cash) = 2,400 net cash
receipt (See entries above)
21. C
Solutions:
Hedged item – None
Forward contract (Derivative)
Dec. 15, 20x1
No entry
Dec. 31, 20x1
Forward contract (asset).. 1,200
Gain on forward contract.. 1,200
[(1.27 forward rate – 1.24 forward rate) x
40K]
Jan. 15, 20x2
Cash - foreign currency.. .52,000
(40K x 1.30)
Cash - local currency….….49,600
Forward contract (asset)… 1,200
Gain on forward contract.... 1,200
[(1.30 – 1.27) x 40K]
22. C (See entries above)
23. D
Solution:
Hedged item –
Firm sale commitment
Dec. 15, 20x1
No entry
24. D
Solution:
Hedged item –
Firm sale commitment
Hedging instrument –
Forward contract (Derivative)
Dec. 15, 20x1
No entry
Hedging instrument –
Forward contract (Derivative)
Dec. 31, 20x1
Firm commitment (asset)..60K
Gain on firm
commitment……………60K
Dec. 31, 20x1
Loss on forward contract..60K
Forward contract (liability)..60K
to recognize the change in the fair value
of the firm commitment
to recognize the change in the fair value
of the forward contract
[(0.485 – 0.47) x 4M yens
25. B (See entry above)
26. C (60,000 loss ÷ 60,000 gain) = 100%
27. A
Solution:
Hedged item –
Firm sale commitment
Jan. 15, 20x2
Cash (foreign currency)… 1.84M
(4M yens x 0.46 spot rate)
Loss on firm commitment...100K
Sales…………………… 1.88M
Hedging instrument –
Forward contract (Derivative)
Jan. 15, 20x2
Cash (local currency)….....1.88M
Forward contract (liability)… 60K
Gain on forward contract…100K
Cash (foreign currency)….1.84M
(4M yens x 0.47 forward rate)
Firm commitment (asset).. 60K
to record the actual sale transaction, to
recognize the change in the fair value of
the firm commitment, and to derecognize
the firm commitment
to record the remittance of 4M yens to the
bank in exchange for the pre-agreed sale
price of ₱1,880,000
28. A (1,880,000 debit to cash – 1,840,000 credit to cash) = 40,000
net cash receipt (See entries above)
29. B
Solution:
Hedged item –
Firm purchase commitment
Dec. 15, 20x1
No entry
Hedged item –
Firm purchase commitment
Hedging instrument –
Forward contract (Derivative)
Dec. 15, 20x1
No entry
Hedging instrument –
Forward contract (Derivative)
Dec. 31, 20x1
Loss on firm commitment .. 1,200
Firm commitment (liability).. 1,200
Dec. 31, 20x1
Forward contract (asset)… 1,200
to recognize the change in the fair value
of the firm commitment
to recognize the change in the fair value
of the forward contract
[(1.27 – 1.24) x 40K yens
Gain on forward contract… 1,200
30. C (See entry above)
31. A
Solution:
Hedged item –
Firm purchase commitment
Jan. 15, 20x2
Inventory…………………..49.6K
(40K wons x 1.24 forward rate)
Loss on firm commitment... 1.2K
Firm commitment (liability).. 1.2K
Cash (foreign currency)……52K
Hedging instrument –
Forward contract (Derivative)
Jan. 15, 20x2
Cash (foreign currency)…...52K
Gain on forward contract.. 1.2K
Forward contract (asset)… 1.2K
Cash (local currency)…. 49.6K
(40K wons x 1.30 spot rate)
to record the payment of 40,000 wons to
the supplier
to record the purchase of 40,000 wons
from the bank at the pre-agreed purchase
price of ₱49,600
32. C (52,000 debit to cash – 49,600 credit to cash) = 2,400 net cash
receipt (See entries above)
33. D
Solution:
Hedged item –
Firm purchase commitment
Oct. 1, 20x1
No entry
Hedging instrument –
Forward contract (Derivative)
Oct. 1, 20x1
No entry
34. A
Solution:
Hedged item –
Firm purchase commitment
Hedging instrument –
Forward contract (Derivative)
Dec. 31, 20x1
Dec. 31, 20x1
Loss on firm commitment ..27,727
Forward contract (asset)..27,727
Firm commitment (liability).. 27,727
Gain on forward contract 27,727
to recognize the change in the fair value
of the firm commitment
to recognize the change in the fair value
of the forward contract
35. A (See entries above)
36. C
Solution:
Hedged item –
Firm purchase commitment
Mar. 31, 20x2
Inventory (147 x 1,000).588,000
Loss on firm commitment
(52,000 – 27,727)……… 24,273
Firm commitment
(liability)………………...27,727
Cash ………………………640,000
Hedging instrument –
Forward contract (Derivative)
Mar. 31, 20x2
Cash [(160 - 147) x 4,000]...52,000
Gain on forward
contract (52,000 – 27,727).
l24,273beoForward contract
(asset)…27,727
(160 fixed contract price x 4,000)
to record the actual purchase transaction,
to recognize the change in the fair value
of the firm commitment, and to
derecognize the firm commitment
to recognize the change in forward rates
during the period and to record the net
cash settlement of the forward contract.
37. B (See entries above)
38. A (See entries above)
39. D
Solutions:
Hedged item –
Firm purchase commitment
Oct. 1, 20x1
No entry
Hedging instrument –
Forward contract (Derivative)
Oct. 1, 20x1
No entry
Dec. 31, 20x1
Dec. 31, 20x1
Loss on firm commitment 39,608
Forward contract (asset) 39,608
Firm commitment (liability). 39,608
Gain on forward contract. 39,608
to recognize the change in the fair value
of the firm commitment
to recognize the change in the fair value
of the forward contract
Mar. 31, 20x2
Inventory (50 x 4,000) 200,000
Firm commitment
(liability)……………….39,608
Cash…………………… 160,000
Gain on firm
commitment……………… 79,608
Mar. 31, 20x2
Loss on forward contract..79,608
[40,000 minus (negative 39,608)]
Forward contract (asset)…39,908
Cash………………………. 40,000
[(50 – 40) x 4,000]
[40,000 minus (negative 39,608)]
to record the actual purchase transaction,
to recognize the change in the fair value
of the firm commitment, and to
derecognize the firm commitment
to recognize the change in forward rates
during the period and to record the net
cash settlement of the forward contract.
40. D (See entries above)
41. A (See entries above)
42. B (See entries above)
43. C (See entries above)
44. D (See entries above)
45. D
Solution:
Hedged item – Highly probable
forecast transaction
Dec. 15, 20x1
No entry
Hedging instrument –
Forward contract (Derivative)
Dec. 15, 20x1
No entry
46. D (See entries above)
47. A
Solution:
Hedged item – Highly probable
forecast transaction
Dec. 31, 20x1
No entry
Hedging instrument –
Forward contract (Derivative)
Dec. 31, 20x1
Forward contract (asset)… 40K
[(55 –45) x 4,000
Accumulated OCI… ……. 40K
to recognize the change in the fair value
of the forward contract
48. D (See entries above)
49. D (See entries above)
50. C
Solution:
Hedged item – Highly probable
forecast transaction
Jan. 15, 20x2
Inventory………………….240K
(4,000 x 60 current spot rate)
Cash (foreign currency)….240K
to record the actual purchase transaction
Hedging instrument –
Forward contract (Derivative)
Jan. 15, 20x2
Forward contract (asset)… 20K
[(60 –55) x 4,000
Accumulated OCI… ……. 20K
to recognize the change in the fair value
of the forward contract
Jan. 15, 20x2
Cash [(60 – 45) x 4,000]…. 60K
Forward contract (asset)…60K
to record the net settlement of the
forward contract.
51. A (See entries above)
52. C
Solution:
Feb. 14, 20x2
Cash…………………….1.44M
Cost of goods sold………400K
Inventory……………………400K
Sales……………………….1.44M
Feb. 14, 20x2
Accumulated OCI… ……. 60K
(40K + 20K)
Cost of goods sold…………..60K
to record the sale of inventory
to reclassify accumulated gains on
forward contract to profit or loss as a
reduction to cost of goods sold.
Net cost of goods sold = 400,000 debit – 60,000 credit = 340,000
53. B
Solutions:
The fair values of the forward contract are determined as follows:
Translation using forward
Cumulative changes
Date
rates
since inception date
10/1/0x1 (DOM 59.400M ÷ 140) = ₱424,286
12/31/x1 (DOM 59.400M ÷ 142) = ₱418,310 (418,310 – 424,286) = 5,976
4/1/x2 (DOM 59.400M ÷ 144) = ₱412,500 (412,500 – 424,286) = 11,786
Fair value of
Date
Cumulative
PV of 1*
changes
PV
forward
factors
contract -
asset (liability)
10/1/0x1
12/31/x1
4/1/x2
5,976
11,786
@ .5% n=3
0.98515
@ .5% n=0
1
5,887
11,786
Changes in
fair values –
gain (loss)
5,887
5,899
* (6% ÷ 12 months = .5% per month); n= 3 is three months, Dec. 31 to Apr. 1
The measurements resulted to assets and gains because the forward
prices were ₱418,310 and ₱412,500 on December 31 and April 1,
respectively, but ABC Co. can sell at a higher price of ₱424,286.
These conditions are favorable to ABC.
54. D – None, the actual sale have not yet taken place.
55. A
Solutions:
Hedged item – Highly probable
forecast transaction
Oct. 1, 20x1
No entry
Dec. 31, 20x1
No entry
Hedging instrument –
Forward contract (Derivative)
Oct. 1, 20x1
No entry
Dec. 31, 20x1
Forward contract (asset).. 5,887
Accumulated OCI… ……. 5,887
to recognize the change in the fair value
of the forward contract
April 1, 20x2
Accounts receivable..412,500
Sales……………………412,500
April 1, 20x2
Forward contract (asset)..5,899
Accumulated OCI… ……. 5,899
(59.4M ÷ 144 spot rate)
to record the actual sale transaction
April 1, 20x2
Accumulated OCI……. 11,786
(5,887 + 5,899)
Sales……………………...11,786
to reclassify the gain accumulated in OCI
to profit or loss.
to recognize the change in the fair value
of the forward contract
April 1, 20x2
Cash (5,887 + 5,899)……11,786
Forward contract (asset)…11,786
to record the net settlement of the
forward contract.
Sales at current spot rate (59.4M ÷ 144)
Reclassification of accumulated OCI to P/L
Total sales
56. B (See entries above)
57. C (See entries above)
412,500
11,786
424,286
58. B
Solution:
Hedged item –
Account payable
Dec. 15, 20x1
Inventory……………480,000
Hedging instrument –
Forward contract (Derivative)
Dec. 15, 20x1
No entry
(400K wons x 1.20 spot rate)
Accounts payable…480,000
59. A
Solution:
The amortization table is prepared as follows:
Interest expense
Discount
a = b x 1.6530%
Total
7,934
8,066
16,000
IGNORED
Dec. 1, 20x1
Dec. 31, 20x1
Jan. 31, 20x2
Present value
b = prev. bal. + a
480,000*
487,934
496,000
*400,000 notional amount x 1.20 spot rate
The fair values of the forward contract are computed as follows:
Fair value
Change
of forward
in fair
contract
values
Dec. 1, 20x1
11,940
11,940
Dec. 31, 20x1: (1.27 - 1.24) x 400,000 x .99502
24,000
12,060
Jan. 31, 20x2: (1.30 - 1.24) x 400,000 x 1
Hedged item –
Account payable
Dec. 31, 20x1
FOREX loss ………… 12,000
[400K x (1.23 – 1.20)]
Accounts payable… 12,000
to recognize FOREX loss on the increase
in exchange rates.
Hedging instrument –
Forward contract (Derivative)
Dec. 31, 20x1
Interest expense……….. 7,934
Forward contract (asset)...11,904
Accumulated OCI ………19,838
to recognize the change in the fair value
of the derivative and to record the
effective portion in OCI, taking into
account the interest expense implicit in
the forward contract.
Dec. 31, 20x1
Accumulated OCI …12,000
Gain on forward contract 12,000
to reclassify an amount out of OCI to
offset the transaction loss on the
account payable.
60. B
The CORRECT ANSWER is 19,838. (See entries above)
61. C (See entries above)
62. A
Solutions:
Hedged item –
Account payable
Jan. 31, 20x2
FOREX loss ………… 28,000
[400K x (1.30 – 1.23)]
Accounts payable….28,000
to recognize FOREX loss on the increase
in exchange rates.
Accounts payable…520,000
Cash - foreign currency…520,000
to record the settlement of the account
payable
Hedging instrument –
Forward contract (Derivative)
Jan. 31, 20x2
Interest expense……….. 8,066
Forward contract (asset)...12,060
Accumulated OCI ………20,126
to recognize the change in the fair value
of the derivative and to record the
effective portion in OCI, taking into
account the interest expense implicit in
the forward contract.
Cash – foreign currency..520K
Cash – local currency… 496K
Forward contract………
24K
to record the settlement of the forward
contract.
Accumulated OCI …… 27,964
(19,838 – 12,000 + 20,126)
Gain on forward contract 27,964
to reclassify the remaining amount of
accumulated OCI.
63. A (See entries above)
64. D (520,000 debit – 496,000 credit) = 24,000 net cash receipt
Accounting for Derivatives and Hedging Transactions (Part 2)
Multiple Choice – Computational
Answers at a glance:
1. C
11. B
21. C
31.
B
41. C
51.
C
2.
C
12. C
22. B
32.
C
42. D
52.
B
3.
4.
A
A
13. D
14. A
23. A
24. C
33.
34.
B
A
43. C
44. B
53.
54.
E
A
5.
C
15. D
25. A
35.
A
45. C
55.
A
6.
A
16. B
26. C
36.
B
46. D
56.
B
7.
8.
C
D
17. A
18. A
27. B
28. A
37.
38.
A
C
47. A
48. A
57.
58.
E
B
9.
D
19. B
29. D
39.
B
49. D
59.
B
10.
A
20. D
30. D
40.
A
50. B
60.
A
61.
C
62.
B
63.
E
64.
65.
E
B
Solutions:
1. C
Solution:
Hedged item – None
Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker ……..80K
Cash………………………..80K
to record the initial margin deposit with
the broker
2. C
Solution:
Hedged item – None
Futures contract (Derivative)
Dec. 31, 20x1
Loss on futures contract…..40K
Futures contract (liability)...40K
[(200 - 190) x 4,000]
to record the value of the derivative
computed as the change in the underlying
multiplied by the notional amount.
3. A
Solution:
Hedged item – None
Futures contract (Derivative)
Feb. 1, 20x2
Loss on futures contract… 20K
[(190 - 185) x 4,000]
Futures contract (liability)..40K
Cash – local currency…… 20K
Deposit with broker…….....80K
to recognize loss on the change in the fair
value of the futures contract and to record
the net cash settlement of the futures
contract.
40,000 loss in 20x1 + 20,000 loss in 20x2 = 60,000 total loss
4. A (See entry above)
5. C
Solution:
Hedged item – Inventory
Dec. 1, 20x1
No entry
Hedging instrument –
Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker …….384K
Cash………………………...384K
to record the initial margin deposit with
the broker
6. A
Solution:
Hedged item – Inventory
Dec. 31, 20x1
Inventory………….……100K
Gain on fair value change...100K
[(12,250 – 12,000) x 400]
to recognize the change in the fair value
less costs to sell of the gold inventory.
7. C (See entries above)
Hedging instrument –
Futures contract (Derivative)
Dec. 31, 20x1
Loss on futures contract….80K
Futures contract (liability)...80K
[(12,300 -12,100) x 400]
to recognize the change in the fair value
of the futures contract.
8. D
Solution:
Hedged item – Inventory
Feb. 1, 20x2
Loss on fair value change…180K
[(12,250 – 11,800) x 400]
Inventory……………………180K
Futures contract (Derivative)
Feb. 1, 20x2
Futures contract (asset).. 200K
Gain on futures contract…200K
[(12,300 – 11,800) x 400]
to recognize the change in the fair value
less costs to sell of the gold inventory.
to recognize the change in the fair value
of the futures contract.
Feb. 1, 20x2
Cash……………………..4.72M
Sale (11.8 spot price x 400).. 4.72M
Feb. 1, 20x2
Cash……………………….504K
Cost of goods sold……. 4.72M
Inventory (4.8M +100K – 180K) 4.72M
to recognize the sale of the gold
inventory.
[(12.1K – 11.8K) x 400] + 384K
Futures contract (asset)......120K
(200K asset – 80K liability)
Deposit with broker………..384K
to record the net cash settlement of the
futures contract.
9. D (See entries above)
10. A
Solution:
Outflow on deposit with broker - Dec. 1, 20x1
Cash receipt from sale
Net cash receipt on settlement of futures contract
Net cash receipt (equal to the pre-agreed sale price)
(384,000)
4,720,000
504,000
4,840,000
11. B
Solutions:
Hedged item –
Inventor
y
Dec. 1, 20x1
No entry
Hedging instrument –
Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker ……..80K
Cash………………………..80K
to record the initial margin deposit with
the broker
Dec. 31, 20x1
Inventory………….……68K
Gain on fair value change.....68K
[(371 – 354) x 1,000]
to recognize the change in the fair value
of the inventory due to changes in the
hedged risk.
Dec. 31, 20x1
Loss on futures contract....56K
Futures contract (liability).. 56K
[(374 -360) x 4,000]
to recognize the change in the fair value
of the futures contract.
12. C (See entries above)
13. D (See entries above)
14. A
Solution:
Hedged item – Inventory
Feb. 1, 20x2
Loss on fair value change…132K
[(371 – 338) x 4,000]
Inventory……………………132K
Futures contract (Derivative)
Feb. 1, 20x2
Futures contract (asset).. 144K
Gain on futures contract… 144K
[(374 – 338) x 4,000]
to recognize the change in the fair value
of the inventory due to changes in the
hedged risk.
to recognize the change in the fair value
of the futures contract.
Feb. 1, 20x2
Cash (338 spot price x 4K)..1.352M
Sales……………………..….1.352M
Feb. 1, 20x2
Cash……………………….168K
Cost of goods sold……….896K
Inventory (960K + 68K –132K) 896K
to recognize the sale of the soybean
inventory.
[(360 – 338) x 4K] + 80K deposit
Futures contract (asset) ........88K
(144K asset – 56K liability)
Deposit with broker…………80K
to record the net cash settlement of the
futures contract.
15. D (1,352,000 sales less 896,000 cost of sales) = 456,000 (See
entries above)
16. B
Solution:
Hedged item –
Firm sale commitment
Dec. 1, 20x1
No entry
Hedging instrument –
Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker …….120K
Cash……………………….120K
to record the initial margin deposit with
the broker
Dec. 31, 20x1
Loss on firm commitment.. 120K
[(240 – 210) x 4,000]
Firm commitment (liability) 120K
to recognize the change in the fair value
of the firm commitment
17.
A (See entries above)
Dec. 31, 20x1
Future contract (asset)… 140K
[(235 – 200) x 4,000]
Gain on futures contract…..140K
to recognize the change in the fair value
of the futures contract
18. A
Solution:
Hedged item –
Firm sale commitment
Feb. 1, 20x2
Firm commitment (liability)..120K
Loss on firm commitment.... 40K
Hedging instrument –
Futures contract (Derivative)
Feb 1, 20x2
Cash
……………………….320K
[(250 – 200) x 4,000] + 120K deposit
Deposit with broker ………120K
Futures contract (asset)….140K
Gain on futures contract….. 60K
[(250 – 240) x 4,000]
Cash……………………….. 840K
(210 contract price x 4,000)
[(250 – 235) x 4,000]
Sale (250 spot price x 4,000)... 1M
to record the actual sale transaction
to record the net settlement of the futures
contract.
19. B (See entries above)
20. D (See entries above)
21. C
Solution:
The changes in the expected cash flows on the forecasted
transaction and the changes in the fair values of futures contract are
computed as follows:
Hedging
Hedged item:
instrument:
Forecasted
Futures
transaction
contracts
(Broccoli)
(Cauliflower)
Mar. 31, 20x1
Current prices – Mar. 31
95.18
94.52
Previous prices – Jan. 1
93.76
92.98
Increase (Decrease)
1.42
1.54
a
4,000
Multiplied by: Kilograms of commodity
4,000
Changes during the period – 3/31/x1
(5,680)
6,160
Fair value - 1/1/x1
Cumulative changes – 3/31/x1
(5,680)
6,160
June 30, 20x1
Current prices – June 30
Previous prices – Mar. 31
Increase (Decrease)
Multiplied by: Kilograms of commodity
Changes during the period – 6/30/x1
Fair value - 3/31/x1
Cumulative changes – 6/30/x1
96.20
95.18
1.02
4,000
(4,080)
(5,680)
(9,760)
95.36
94.52
0.84
4,000
3,360
6,160
9,520
a
No. of futures contracts x Kilograms covered by each contract = (10 x 400) = 4,000.
Cumulative changes in:
Fair values of futures contract
Expected cash flows of forecasted transaction
Ratio
March 31
6,160
5,680
108%
June 30
9,520
9,760
98%
22. B (See solutions above)
23. A
Solution:
To determine the ineffectiveness of the hedge, the following
procedures are performed:
Step 1: Determine the cumulative changes in the expected cash
flows on the forecasted transaction.
Step 2: Determine the cumulative changes in the fair values of the
hedging instrument.
Step 3: Determine the lower of the amounts computed in Step 1
and Step 2, in absolute values.
Step 4: The amount determined in Step 3 is the effective portion
which is recognized in other comprehensive income. The
difference between the change in the fair value of the
hedging instrument and the effective portion represents the
ineffective portion which is recognized in profit or loss.
The steps above are applied as follows:
Forecasted
Futures
transaction contract
Broccoli Cauliflower
Cumulative Cumulative
Dates
1/1/x1
3/31/x1
6/30/x1
Effective portion - OCI
(Step 3)
Lower of a
and b –
Cumulative
OCI
change in
cash flows
(Step 1)
change in
fair values
(Step 2)
a
b
c
6,160
9,520
5,680
9,520
(5,680)
(9,760)
Ineffective portion P/L (Step 4)
OCI
during
the
period
d=cprev. bal.
5,680
3,840
P/L
Cumulative
P/L
during
the
period
f=e-
e=b-c
prev. bal.
-
480
-
480
(480)
24. C (See table above)
25. A - On March 31, 20x1, the effect of the hedge is “overhedge”
(the increase in the cash inflows from the hedging instrument is
greater than the increase in the expected cash outflows on the
hedged item).
26. C
Solution:
Hedged item – Highly probable
forecast transaction
Hedging instrument –
Futures contract (Derivative)
Jan. 1, 20x1
No entry
Jan. 1, 20x1
No entry
Mar. 31, 20x1
No entry
Mar. 31, 20x1
Futures contract…..6,160
Accumulated OCI……… 5,680
Gain on futures contract…. 480
to recognize the change in the fair value
of the effective portion of the futures
contract in OCI and the ineffective
portion in profit or loss.
June 30, 20x1
Inventory……………384,800
June 30, 20x1
(4,000 x 96.20)
Loss on futures contract.. 480
Cash…………………….384,800
to record the purchase of broccoli at the
current price.
Futures contract……. 3,360
Accumulated OCI………. 3,840
to recognize the change in the fair value
of the effective portion of the futures
contract in OCI and the ineffective
portion in profit or loss.
June 30, 20x1
Cash…………………9,520
Futures contract……….. 9,520
(6,160 + 3,360)
to record the net settlement of the futures
contract.
27. B (See table above)
28. A (See table above)
29. D (See entry above)
30. D – This amount is reclassified to profit or loss when the related
inventory is sold.
31. B (384,800 cost of inventory – 9,520 reclassification adjustment of
OCI) = 375,280
32. C
Solution:
Hedged item –
Account receivable
Dec. 15, 20x1
Accounts receivable…… 1.92M
(4M yens x 0.48 spot rate)
Hedging instrument –
Put option (Derivative)
Dec. 15, 20x1
Put option ……..…….. 30K
Cash………..……………… 30K
Sales……………………...1.92M
Dec. 31, 20x1
Dec. 31, 20x1
Accounts
receivable……40K
Loss on put option…..…..10K
[4M x (0.49 - 0.48)]
Put option…………………..10K
FOREX gain……………....40K
(30K – 20K)
to adjust the accounts receivable for the
increase in spot exchange rate
to recognize loss on the decrease in the
fair value of the option.
Jan. 15, 20x2
Cash – foreign currency.. 1.84M
Jan. 15, 20x2
Cash – local currency…1.88M
(4M x 0.46 current spot rate)
(4M x 0.47 option price)
FOREX loss…………….. 120K
Accounts receivable……….1.96M
(1.92M + 40K)
to record the receipt of 4M yens from
customer
Put option (30K – 10K)…….. 20K
Cash – foreign currency. 1.84M
Gain on put option….…… 20K
to record the exercise of the put option
which is in the money.
33. B (See entries above)
34. A 20,000 - carrying amount of the option
35. A
Solution:
Hedged item – None
Call option (Derivative)
April 1, 20x1
April 1, 20x1
Call option
……..…….. 2,400
Cash………..……………… 2,400
June 30, 20x1
June 30, 20x1
Call option ……..…….. 24,000
[(106 – 100) x 4,000]
Gain on call option………. 24,000
to record the increase in the fair value of
the call option due to the increase in
intrinsic value (excess of market value of
shares over exercise price).
June 30, 20x1
Loss on call
option……….800
(2,400 – 1,600)
Call option……………………..800
to record the decrease in the fair value of
the call option due to the decrease in
1
time value.
July 1, 20x1
July 1, 20x1
Cash……………
[(106 – 100) x 4,000]
24,000
Loss on call option….1,600
Call option ……..……..….. 25,600
(2,400 + 24,000 – 800)
to record the net settlement of the call
option contract.
36. B (See entries above)
37. A (See entries above)
38. C
Solution:
Hedged item – Highly probable
forecast transaction
Oct. 1, 20x1
No entry
Hedging instrument –
Put option (Derivative)
Oct. 1, 20x1
Put option ……..……..25.6K
Cash………..…………… 25.6K
to record the purchase of option contract
39. B – Cash flow hedge because the hedged item is a highly
probable forecasted transaction.
40. A
Solution:
The gain or loss on December 31, 20x1 is computed as follows:
Change in:
Change in
Intrinsic value
Time value fair value of
(OCI)
(P/L)
option
10.1.x1 (see table above)
25,600
25,600
12.31.x1
10,802
13,196
24,000
(1.12M ÷ 1.45) – 783,216
Gain (Loss)
10,802
(12,404)
(1,600)
41. C (See table above)
42. D
Solution:
12.31.x1(see table above)
4.1.x2
(1.12M ÷ 1.50) – 783,216
Gain (Loss)
Change in:
Intrinsic value Time value
(OCI)
(P/L)
10,802
13,196
36,549
25,747
43. C 746,667 + 36,550 = 783,217
Solution:
Hedged item – Highly probable
forecast transaction
191
(13,196)
Change in
fair value of
option
24,000
36,549
12,549
April 1, 20x2
Accounts receivable….746,667
Sales………………………746,667
(1,120,000 ÷ 1.50 spot rate)
to record the actual sale transaction
April 1, 20x2
Accumulated OCI……..36,550
(10,802 + 25,748)
Sales……………………… 36,550
to reclassify accumulated OCI to profit or
loss
44. B
45. C
Solution:
Receive variable
20x1
320,000
320,000
-
a
Pay 8% fixed
Net cash settlement - receipt
20x2
400,000
320,000
80,000
a
The interest rates used are the current rates as at the beginning of
the year (i.e., 4M x 8% = 320,000) & (4M x 10% = 400,000).
There is no cash settlement in 20x1 because the variable and fixed
rates are the same (i.e., 8% and 8%, respectively).
The net cash settlement in 20x2 is discounted to determine the fair
value of the derivative on Dec. 31, 20x1:
Net cash settlement – receipt (due on Dec. 31, 20x2)
PV of 1 @ 10%, n=1
Fair value of derivative - 12/31/x1 (asset)
80,000
0.90909
72,727
46. D – the gain is recognized in OCI not in P/L
Solution:
Hedged item –
Hedging instrument –
Variable interest payments
Interest rate swap (Derivative)
Dec. 31, 20x1
Interest expense… 320,000
Cash (4M x 8%)….……... 320,000
Dec. 31, 20x1
Interest rate swap…..72,727
Accumulated OCI……….72,727
to recognize interest expense on the
variable-rate loan
to recognize the change in the fair value
of the interest rate swap
47. A (See computation in #45)
192
48. A (400,000 – 80,000) = 320,000 (See entries below)
Solution:
Hedged item –
Hedging instrument –
Variable interest payments
Interest rate swap (Derivative)
Dec. 31, 20x2
Interest expense….400,000
Cash (4M x 10%) ……..….400,000
Dec. 31, 20x2
Cash…………………80,000
Interest rate swap……....72,727
Accum. OCI (squeeze)……7,273
to recognize interest expense on the
variable-rate loan
to record the net cash settlement of the
interest rate swap
Dec. 31, 20x2
Loan payable……….4M
Cash……………………………4M
Dec. 31, 20x2
Accumulated OCI…..80,000
Interest expense……….80,000
to record the settlement of the loan
to reclassify accumulated OCI to profit or
loss
49. D
Solution:
Receive variable
a
(4M x 9%) & (4M x 8%)
Pay 9% fixed
Net cash settlement – payment
a
20x1
360,000
360,000
-
20x2
320,000
360,000
(40,000)
Based on the current rates as at the beginning of the year.
The net cash settlement is discounted to determine the fair value of
the derivative on Dec. 31, 20x1.
Net cash payment (due annually starting on Dec. 31, 20x2)
PV of ordinary annuity of 1 @8%, n=2
Fair value of derivative - 12/31/x1 (liability)
(40,000)
1.783265
(71,331)
50. B (See computation above)
51. C (See computation above)
52. B – The fair value of the derivative on this
date. Solution:
Receive variable (4M x 12%)
Pay 9% fixed
Net cash settlement – receipt
20x3
480,000
360,000
120,000
The net cash settlement is discounted to determine the fair value of
the derivative on Dec. 31, 20x2.
Net cash receipt (due on Dec. 31, 20x3 – maturity date)
Multiply by: PV of 1 @12%, n=1
Fair value of derivative - 12/31/x2 (asset)
120,000
0.892857
107,143
53. E
The CORRECT ANSWER is 360,000 (320,000 + 40,000) (See
entries below)
Solution:
Hedged item –
Variable interest payments
Hedging instrument –
Interest rate swap (Derivative)
Dec. 31, 20x2
Interest expense…320,000
Cash (4M x 8%)…...……320,000
Dec. 31, 20x2
Interest rate
swap…..40,000
Cash…………………….40,000
to recognize interest expense on the
variable-rate loan
to record the periodic net cash settlement
on the interest rate swap - (see previous
computation)
Dec. 31, 20x2
Interest expense……...40,000
Accumulated OCI……40,000
to record a piecemeal reclassification of
accumulated OCI to profit or loss
54. A (See computations in #52)
55. A
Solution:
The change in the fair value of the interest rate swap is determined as
follows:
Fair value of interest rate swap – Dec. 31, 20x2 - (asset) 107,143
Less: Carrying amount of interest rate swap – Dec. 31, 20x2
(71,331 liability – 40,000 net cash settlement) - (liability)
(31,331)
Change in fair value – gain
138,474
56. B
Solution:
Receive variable (1M x 12%)
Pay 9% fixed
Net cash settlement – receipt
20x3
480,000
360,000
120,000
57. E
The CORRECT ANSWER is 360,000 (See solution below)
Interest expense (4M x 12%)
Reclassification of accum. OCI
Net interest expense - 20x3
480,000
(120,000)
360,000
58. B
Solutions:
Hedging instrument:
The net cash settlement on the swap is determined as follows:
20x1
20x2
Receive 10% fixed
400,000
400,000
a
Pay variable (4M x 10%) & (4M x 12%)
400,000
480,000
Net cash settlement – payment
(80,000)
a
Based on the current rates as at the beginning of the year.
The net cash settlement is discounted to determine the fair value of
the derivative on Dec. 31, 20x1.
Net cash payment (due annually starting on Dec. 31, 20x2)
PV of ordinary annuity of 1 @12%, n=2
Fair value of derivative - 12/31/x1 (liability)
(80,000)
1.69005
(135,204)
PV of ordinary annuity is used because swap payments are made at each yearend (i.e., Dec. 31, 20x2 and Dec. 31, 20x3; ‘n=2’). A liability is recognized
because the net cash settlement is a payment.
59. B
Solution:
Fair value of derivative - 12/31/x1 (liability)
Fair value of derivative - 12/1/x1
Unrealized loss on the derivative instrument
(135,204)
(135,204)
60. A
Solution:
Hedged item:
The fair value of the loan payable on Dec. 31, 20x1 is determined as
follows:
PVF @12%
current rate,
Future cash flows:
Present
n=2
value
Principal
4,000,000 0.797193878
3,188,776
Interest at 10% fixed rate
400,000 1.69005102
676,020
3,864,796
Fair value of loan payable - Dec. 31, 20x1
Carrying amount of loan payable - Dec. 31, 20x1
Gain on decrease in liability
3,864,796
4,000,000
135,204
61. C
Solution:
Date
Interest
payments
Interest
expense @ 12%
Amortization
12/31/x1
12/31/x2
400,000
463,776
63,776
Present
value
3,864,796
3,928,572
62. B
Solution:
Hedging instrument:
The net cash settlement in 20x3 is determined as a basis for adjusting
the fair value of the interest rate swap on Dec. 31, 20x2.
20x3
Receive 10% fixed
400,000
Pay variable (4M x 14%)
560,000
Net cash settlement – payment
(160,000)
The net cash settlement is discounted to determine the fair value of
the derivative on Dec. 31, 20x2.
Net cash payment (due on Dec. 31, 20x3 – maturity date)
Multiply by: PV of 1 @14%, n=1
Fair value of derivative - 12/31/x2 (liability)
(160,000)
0.877192982
(140,351)
63. E
The CORRECT ANSWER is (85,147) (See solution below)
Fair value of interest rate swap – Dec. 31, 20x2 - (liability)
Carrying amount of interest rate swap – Dec. 31, 20x2
(135,204 liability – 80,000 net cash settlement) - (liability)
Change in fair value – loss (increase in liability)
140,351
(55,204)
85,147
64. E
The CORRECT ANSWER is (68,923) (See solution below)
Solution:
Hedged item:
The fair value of the loan payable on Dec. 31, 20x2 is determined as
follows:
PVF @14%
current rate,
Future cash flows:
Present
n=1
value
Principal
4,000,000 0.877192982
3,508,772
Interest at 10% fixed rate
400,000 0.877192982
350,877
3,859,649
The gain or loss on the change in the fair value of the loan payable is
determined as follows:
Fair value of loan payable - Dec. 31, 20x2
3,859,649
Carrying amt. - Dec. 31, 20x2 (see amortization table above)
3,928,572
Gain on decrease in liability – Dec. 31, 20x2
68,923
65. B
Solution:
Date
Interest
payments
Interest
expense @ 14%
400,000
540,351
Amortization
12/31/x2
12/31/x3
140,351
Present
value
3,859,649
4,000,000
Accounting for Derivatives and Hedging Transactions (Part 3)
Multiple Choice – Computational
Answers at a glance:
1. C
6. A
11. A
16. D
21. C
26. A
2. A
7. E
12. C
17. C
22. B
27. B
3. D
4. A
8. A
9. B
13. D
14. A
18. E
19. D
23. D
24. D
28. B
29. A
5. C
10. C
15. A
20. A
25. A
30. D
31. A
Solutions:
1. C
Solution:
Receivable from XYZ, Inc. (in pesos)
Multiply by: Closing rate, Dec. 31, 20x1
Adjusted balance of Payable to ABC Co. (in AMD)
Payable to ABC Co. (in AMD) - unadjusted
Payable to ABC Co. (in AMD) - adjusted
FOREX loss in subsidiary's P/L (in AMD)
2. A
Solution:
XYZ's separate profit before FOREX loss (in
AMD) FOREX loss (in AMD)
XYZ's separate profit after FOREX loss (in AMD)
3. D
Solution:
₱4,000,000
2
8,000,000
7,000,000
8,000,000
(1,000,000)
7,000,000
(1,000,000)
6,000,000
1) Translation of XYZ's opening net assets:
Net assets of sub., July 1 - at opening rate
Net assets of sub., July 1 - at closing rate
Decrease in opening net assets - loss
(12M ÷ 1.50)
(12M ÷ 2.00)
8,000,000
6,000,000
(2,000,000)
Cumulative translation difference - Jan. 1
2) Translation of changes in net assets during the period:
Profit of subsidiary at average rate
(6M ÷ 1.75)
Profit of subsidiary at closing rate
(6M ÷ 2.00)
Decrease in profit – loss
3) Translation of goodwill: Goodwill, Dec.
31 - at opening rate Goodwill, Dec. 31 - at
closing rate Increase (Decrease) in
goodwill -gain (loss)
Total translation loss – OCI
4. A
Solution:
-
3,428,571
3,000,000
(428,571)
(2,428,571)
Receivable from XYZ
Total assets
XYZ, Inc.
ABC Co.
(in AMD) - Adjustments
(in pesos) unadjusted
56,000,000
40,000,000
8,000,000
4,000,000
68,000,000 40,000,000
Liabilities
Payable to ABC Co.
Total liabilities
32,000,000
32,000,000
14,000,000
7,000,000 1,000,000
21,000,000
14,000,000
8,000,000
22,000,000
Equity - July 1, 20x1
Profit for the year
16,000,000
12,000,000
12,000,000
Assets
Investment in subsidiary
Translation loss – OCI
Total equity – Dec. 31
Total liabilities & equity
(1,000,000)
XYZ, Inc.
(in AMD) adjusted
40,000,000
40,000,000
20,000,000
7,000,000
6,000,000
36,000,000
19,000,000
18,000,000
68,000,000
40,000,000
40,000,000
Rates
2
XYZ, Inc. (in Consolidation
pesos)
20,000,000 (56M + 20M)
(eliminated)
(eliminated)
20,000,000
2
2
1.75
76,000,000
76,000,000
7,000,000 (32M + 7M)
4,000,000 (eliminated)
11,000,000
39,000,000
(omitted) (parent only)
3,428,571 (20M+
16,000,000
23,428,571
3,428,571)
(see above)
2
Consolidated
39,000,000
9,000,000
(2,428,571)
37,000,000
20,000,000
76,000,000
The 1,000,000 adjustments pertain to the FOREX loss on the intercompany payable which is recognized in the subsidiary’s separate profit or
loss. Notice that the even though the intercompany accounts have been eliminated, the FOREX loss remains in the consolidated total equity
5. C (See solution above)
6. A
Solution:
Hedging instrument:
The fair value of the forward contract on July 1, 20x1 is zero.
The fair value of the forward contract on December 31, 20x1 is
computed as follows:
Sale price at 6-month forward rate - 12/31/20x1 (20M ÷ 2.02)
9,900,990
Sale price at the pre-agreed forward rate (20M ÷ 1.54)
12,987,013
Difference
3,086,023
Multiply by: PV factor (given)
0.971286
Fair value of forward contract - Dec. 31, 20x1 (asset)
2,997,411
An asset is recognized because the sale price at the six-month
forward rate is ₱9,900,990 but ABC can sell at a higher price of
₱12,987,013 – a condition that is favorable to ABC.
The gain (loss) on the forward contract is computed as follows:
Fair value of forward contract - July 1, 20x1
2,997,411
Fair value of forward contract - Dec. 31, 20x1
Increase in fair value - Unrealized gain in OCI (gross of tax) 2,997,411
(1,198,964)
Less: Deferred tax liability (2,997,411 x 40%)
1,798,447
Unrealized gain in OCI (net of tax)
The net translation gain (loss) to be recognized in other
comprehensive income is computed as follows:
Total translation loss – OCI (without hedging - see Case #1)
Unrealized gain in OCI - net of tax
Total FOREX translation loss - OCI (with hedging)
(2,428,571)
1,798,447
(630,124)
7. E
The CORRECT ANSWER is 78,997,411 (See solution below)
Solution:
Hedging instrument –
Forward contract (Derivative)
July 1, 20x1
No entry
Dec. 31, 20x1
Forward contract….2,997,411
Deferred tax liability….... 1,198,964
Accumulated OCI……… 1,798,447
to recognize the change in the fair value of the forward
contract
Consolidated
(without
hedging)
Journal entry
on hedging
instrument
Consolidated
(with hedging)
Total assets
76,000,000
2,997,411
78,997,411
Total liabilities
39,000,000
1,198,964
40,198,964
Equity - July 1, 20x1
16,000,000
16,000,000
Profit for the year
23,428,571
23,428,571
Translation loss – OCI
(2,428,571)
Total equity – Dec. 31
37,000,000
38,798,447
Total liab. & equity
76,000,000
78,997,411
1,798,447
(630,124)
8. A (See solution above)
9. B
Solution:
Fixed selling price
Selling price at current spot rate (4M ÷ 35)
Excess – payment to broker
100,000
114,286
(14,286)
10. C
Solution:
Fixed selling price
Selling price at current spot rate (4M ÷ 50)
Deficiency - receipt from broker
100,000
80,000
20,000
223
11. A
Solution:
Fixed selling price
Selling price at current spot rate (4M ÷ 45)
Fair value of forward contract – receivable (asset)
100,000
88,888
11,111
12. C
Solution:
Fixed purchase price (₱2,400 x 1,000)
Purchase price at current mkt. price (₱2,800 x 1,000)
Derivative asset - receivable from broker
2,400,000
2,800,000
400,000
13. D
Solution:
Fixed purchase price (₱2,400 x 1,000)
Purchase price at current mkt. price (₱2,200 x 1,000)
Derivative liability - payable to broker
2,400,000
2,200,000
(200,000)
14. A ₱20,000,000 (100,000 kilos notional figure x ₱200 forward price)
15. A
Solution:
Fixed purchase price (100,000 x ₱200)
Purchase price at current mkt. price (100,000 x ₱260)
Receivable from broker
Multiply by: PV of 1 @10%, n=1
Fair value of forward contract (asset)
20,000,000
26,000,000
6,000,000
0.90909
5,454,540
16. D
Solution:
Fixed purchase price (100,000 x ₱200)
Purchase price at current mkt. price (100,000 x ₱160)
Payable to broker
Multiply by: PV of 1 @10%, n=0
Fair value of forward contract (liability)
20,000,000
16,000,000
(4,000,000)
1
(4,000,000)
17. C
Solution:
"Long" futures contract to purchase gold:
Fixed purchase price (₱2,000 x 400)
Purchase price at current market price (₱1,800 x 400)
800,000
720,000
Payable to broker
(80,000)
"Long" futures contract to purchase silver:
Fixed purchase price (₱1,600 x 800)
224
1,280,000
Purchase price at current market price (₱1,900 x 800)
1,520,000
Receivable from broker
"Short" futures contract to sell coffee beans:
Fixed selling price (₱250 x 4,000)
Selling price at current market price (₱220 x 4,000)
Receivable from broker
240,000
1,000,000
880,000
"Short" futures contract to sell potatoes:
Fixed selling price (₱60 x 6,000)
Selling price at current market price (₱75 x 6,000)
Payable to broker
120,000
360,000
450,000
Net derivative asset
(90,000)
190,000
18. E
The CORRECT ANSWER is 10,286 (See solution below)
Solution:
Purchase price using the option
100,000
Purchase price without the option (4M ÷ 35)
114,286
Savings from exercising the option - gross
14,286
Less: Cost of purchased option
(4,000)
Net savings from call option
10,286
19. D
20. A 40,000 – the cost of option
21. C
Solution:
Fixed purchase price (₱880 x 20,000)
Purchase price at current market price (₱960 x 20,000)
Derivative asset - receivable from broker
22. B
Solution:
Fair value of call option - July 1, 20x1 (cost)
Fair value of call option - Dec. 31, 20x1 (see above)
Unrealized gain - increase in fair value
23. D
Solution:
Fixed purchase price (₱880 x 20,000)
Purchase price at current market price (₱1,000 x 20,000)
17,600,000
19,200,000
1,600,000
40,000
1,600,000
1,560,000
17,600,000
20,000,000
Net cash settlement - receipt
24. D
Solution:
March. Cash (see above)
Call option (see above)
31,
20x2
2,400,000
2,400,000
Gain on call option (squeeze)
1,600,000
800,000
to record the net settlement of the call
option
25. A
Solution:
20x1
400,000
400,000
Net cash settlement - (payment) (due on Dec. 31, 20x3)
20x2
320,000
400,000
(80,000)
26. A
Solution:
Net cash settlement - (payment) (due on Dec. 31, 20x3)
Multiply by: PV of 1 @8%, n=1
Fair value of interest rate swap - liability
(80,000)
0.9259
(74,072)
Receive variable (at Jan. 1 current rates)
Pay 10% fixed
27. B
Solution:
20x1
Receive variable (at Jan. 1 current rates)
400,000
Pay 10% fixed
400,000
Net cash settlement – receipt (due on Dec. 31, 20x3)
28. B
Solution:
Net cash settlement - receipt (due on Dec. 31, 20x3)
Multiply by: PV of 1 @12%, n=1
Fair value of interest rate swap - asset
20x2
480,000
400,000
80,000
80,000
0.8929
71,432
29. A 4,000,000 – the principal amount of the loan
30. D
Solution:
Receive variable (4M x 9%)
Pay 8% fixed
Net cash settlement - receipt (due annually for the next 4 yrs.)
Multiply by: PV ordinary annuity @9%, n=4
360,000
320,000
40,000
3.23972
Fair value of forward contract – asset
129,589
31. A
Solution:
Receive variable (4M x 12%)
Pay 8% fixed
Net cash settlement - receipt (due annually for the next 4 yrs.)
Multiply by: PV ordinary annuity @12%, n=3
Fair value of forward contract - receivable
480,000
320,000
160,000
2.40183
384,293