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Pdf - Intermediate accounting
Bs. Accountancy (Aklan State University)
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27
DERIVATIVES
Problem 27-1 (IAA)
On January 1, 2010, Pasay Company entered into a two-year P 3,000,000 variable
interest rate loan at the prevailing rate of 12%. In 2011, the interest rate is equal to the
prevailing interest rate at the beginning of the year.
The principal loan is payable on December 31, 2011 and the interest is payable on
December 31 of each year. On January 1, 2010, Pasay Company entered into a “receive
variable, pay fixed” interest swap agreement with a speculator bank designated as a cash
flow hedge.
The prevailing interest rate on January 1, 2011 is 4% and the present value of 1 at 14%
for one period is .877. How much should be reported as “interest rate swap receivable”
on December 31, 2010?
a.
b.
c.
d.
60,000
52,620
30,000
0
Solution 27-1 Answer b
Since the interest on January 1, 2011 is 14% which is 2% higher than the fixed rate of
12%, it means that Pasay Company shall receive P 60,000 from the bank on December
31, 2011. This receivable is recognized as a derivative asset on December 31, 2010 at
present value of P 52,620 as follows:
Interest rate swap receivable
Unrealized gain-interest swap
(60,000 x .877)
52,620
52,620
On December 31, 2011, when the amount of P 60,000 is received from the bank by Pasay
Company, the entry is:
Cash
60,000
Interest swap receivable
Unrealized gain-interest rate swap
52,620
7,380
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The unrealized gain on the interest rate swap is then offset against the interest expense for
2011 as follows:
Unrealized gain-interest rate swap
Interest expense
60,000
60,000
Actually, the entries to record the payment of annual interest for 2011 and the principal
payment are:
Interest expense (3,000,000 x 14%)
Cash
420,000
Loan payable
Cash
3,000,000
420,000
3,000,000
Accordingly, the net interest expense is P 420,000 minus P 60,000 or P360,000 which is
equal to the fixed rate of 12% times P3,000,000.
Problem 27-2 (IAA)
Imus Company received a two-year variable interest rate loan of P 5,000,000 on January
1, 2010. The interest on the loan is payable on December 31 of each year and the
principal is to be repaid on December 31, 2011.
On January 1, 2010, Imus Company entered into a “receive variable, pay fixed” interest
rate swap agreement with a speculator bank designated as a cash flow hedge.
The interest rate for 2010 is the prevailing interest rate of 10% and the rate in 2011 is
equal to the prevailing rate on January 1, 2011. The market rate of interest on January 1,
2011 is 7% and the present value of 1 at 7% for one period is .935.
How much should be reported by Imus Company on December 31, 2010 as “interest rate
swap payable”?
a.
b.
c.
d.
150,000
140,250
100,000
0
Solution 27-2 Answer b
Since the interest rate on January 1, 2011 is 7% which is 35 lower than the fixed rate of
10%, it means that Imus Company shall pay the bank P 150,000 on December 31, 2011
or P 5,000,000 times 3%.
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The interest rate swap payable is recognized as a derivative liability on December 31,
2010 as follows:
Unrealized loss-interest rate swap
Interest rate swap payable
(150,000 x .935)
140,250
140,250
On December 31, 2011, the pertinent entries are:
1. Payment of the loan:
Loan payable
Cash
5,000,000
5,000,000
2. Payment of annual interest:
Interest expense (5,000,000 x 7%)
Cash
350,000
350,000
3. Interest swap payment to the bank:
Interest rate swap payable
Unrealized loss- interest rate swap
Cash
140,250
9,750
150,000
4. Adjustment of the unrealized loss:
Interest expense
Unrealized loss- interest rate swap
150,000
150,000
Observe that the net interest expense for 2011 is equal to P 500,000 which is the fixed
rate of 10% times P 5,000,000.
Problem 27-3 (IAA)
On January 1, 2010, Taal Company received a 5-year variable interest rate loan of
P6,000,000 with the interest payment at the end of each year and the principal to be paid
on December 31, 2014. The interest rate for 2010is 8% and the rate in each succeeding
year is equal to market interest rate on January 1 of each.
On January 1, 2010, Taal Company entered into an interest rate swap agreement with a
financial institution to the effect that Taal will receive a swap payment if the interest on
January 1 is more than 8% and will make a swap payment if the interest is less than 8%.
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The swap payments are made at the end of the year. The interest rate swap agreement is
designated as a cash flow hedge.
On January 1, 2011, the market rate of interest is 9%. The present value of an ordinary
annuity of 1 at 9% for four periods is 3.24.
On December 31, 2010, how much should be reported by Taal Company as “interest rate
swap receivable”?
a.
b.
c.
d.
300,000
240,000
194,400
120,000
Solution 27-3 Answer c
The interest rate on January 1, 2011 is 9% which is 1% higher than the fixed rate of 8%.
This means that Taal Company shall receive an annual interest swap payment from the
financial institution of P 6,000,000 times 1% or P 60,000.
Since the term of the loan is 5 years and one year already expired, Taal Company shall
receive P 60,000 at the end of 2011 and can expect to receive P 60,000 at the end of
2012, 2013 and 2014.
Thus, the present value of the four annual payments of 60,000 is recognized as interest
rate swap receivable on December 31, 2010 or P 60,000 times 3.24 equals P 194,400.
Problem 27-4 (IAA)
On January 1, 2010, Trece Company borrowed P 5,000,000 from a bank at a variable rate
of interest for 4 years. Interest will be paid annually to the bank on December 31 and the
principal is due on December 31, 2013. Under the agreement, the market rate of interest
every January 1 resets the variable for that period and the amount of interest to be paid on
December 31. In conjunction with the loan, Trece Company entered into a “receivable
variable, pay fixed” interest rate swap agreement with another bank speculator.
The interest rate swap agreement was designated as a cash flow hedge. The market rates
of interest are:
January 1, 2010
January 1, 2011
January 1, 2012
January 1, 2013
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10%
14%
12%
11%
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The present value of an ordinary annuity of 1 is as follows:
At 14% for three periods
At 12% for two periods
At 11% for one period
2.32
1.69
0.90
1. What is the “notional” of the interest rate swap agreement?
a. 5,000,000
b. 2,000,000
c. 2,500,000
d.
500,000
2. What is the derivative asset or liability on December 31, 2010?
a.
b.
c.
d.
464,000 asset
464,000 liability
600,000 asset
600,000 liability
3. What is the derivative asset or liability on December 31, 2011?
a.
b.
c.
d.
200,000 asset
200,000 liability
169,000 asset
169,000 liability
4. What is the derivative asset or liability on December 31, 2010?
a.
b.
c.
d.
45,000 asset
45,000 liability
50,000 asset
50,000 liability
Solution 27-4
Question 1 Answer a
The “notional” of the interest rate swap agreement is equal to the principal amount of the
loan or P5, 000,000.
Question 2 Answer a
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The interest rate on January 1, 2011 is 14% which is higher than the underlying fixed rate
of 10%. This means that Trece Company shall receive a swap payment from the bank of
4% times P 5,000,000 or P200, 000 annually for 2011, 2012 and 2013. The present value
of the three annual payments is P 200,000 times 2.32 or P464, 000. This amount is
recognized on December 31, 2010 as interest rate swap receivable which is a derivative
asset.
Question 3 Answer c
The interest rate on January 1, 2012 is 12% which is higher than the underlying fixed rate
of 10%. This means that Trece Company shall receive a swap payment from the bank of
2% times P 5,000,000 or P 100,000 annually for 2012 and 2013. The present value of the
two annual payments is P 100,000 times 1.69 or P 169,000. This amount must be the
interest rate swap receivable on December 31, 2011.
Question 4 Answer a
The interest rate on January 1, 2013 is 11% which is higher than the underlying fixed rate
of 10%. This means that Trece Company shall receive a swap payment of 1% times
P5,000,000 or P 50,000 on December 31, 2013. The present value of P 50,000 payments
is P 50,000 times .90 or P 45,000. This amount must be the interest rate swap receivable
on December 31, 2012.
Problem 27-5 (IAA)
On January 1, 2010, Camry Company received a two-year P 500,000 loan. The loan calls
for interest payments to be made at the end of each year based on the prevailing market
rate at January 1 of each year. The interest rate at January 1, 2010 was 10 percent.
Fortuner Company also has a two-year P 500,000 loan but Fortuner’s loan carries a fixed
interest rate of 10 percent.
Camry Company does not want to bear the risk that interest rates may increase in the
second year of the loan. Fortuner Company believes that rates may decrease and it would
prefer to have variable debt. So the two entities enter into an interest rate swap agreement
whereby Fortuner agrees to make Camry’s interest payment in 2011 and Camry likewise
agrees to make Fortuner’s interest payment in 2011. The two entities agree to make
settlement payments, for the difference only, on December 31, 2011.
1. If the interest rate on January 1, 2011 is 8%, what will be Camry’s settlement with
Fortuner?
a. 10,000 payment
b. 10,000 receipt
c. 5,000 payment
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d.
5,000 receipt
2. What amount will Camry report as fair value of the interest rate swap on
December 31, 2010?
a. 500,000
b. 10,000
c.
9,259
d.
9,091
Solution 27-5
Question 1 Answer a
Since the interest rate of 8% on January 1, 2011 is lower than the underlying 10% rate,
Camry is required to pay Fortuner the difference of 2% times P 500,000 or P10, 000.
Question 2 Answer c
Since the P 10,000 payment is to be made on December 31, 2011, it is discontinued for
one year. The present value of 1 at8% for one period is .9259. Thus, the fair value of the
interest rate swap payable on December 31, 2010 is P 10,000 times .9529 or P 9,529.
Problem 27-6 (IAA)
Tagaytay Company is a golf course developer that constructs approximately 5 courses
each year. On January 1, 2010, Tagaytay Company has agreed to buy 5,000 trees on
January 31, 2011 to be planted in the course intends to build. In recent years, the price of
trees has fluctuated wildly. On January 1, 2010, Tagaytay Company entered into a
forward contract with a reputable bank. The price is set at P500 per tree.
The derivative forward contract provides that if the market price on January 31, 2011 is
more than P500, the difference is paid by the bank to Tagaytay. On the other hand, if the
market price is less than P500, Tagaytay will pay the difference to the bank. This
derivative forward contract was designated as a cash flow hedge. The market price on
December 31, 2010 and January 31, 2011 is P800. The appropriate discount rate is 8%
and the present value of 1 at 8% for one period is .926.
On December 31, 2010, what amount should be recognized by Tagaytay Company as
derivative asset or liability?
a.
b.
c.
d.
1,500,000 asset
1,389,000 liability
1,500,000 liability
1,389,000 asset
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Solution 27-6 Answer a
The entry on December 31, 2010 is:
Forward contract receivable
Unrealized gain-forward contract
(5,000 x P300)
1,500,000
1,500,000
The forward contract receivable is the derivative asset.
The amount is not discontinued anymore because it is to be received on January 31, 2011.
The entries on January 31, 2011 are:
Tree inventory (5,000 x P800)
Cash
4,000,000
Cash
1,500,000
4,000,000
Forward contract receivable
Unrealized gain-forward contract
Gain on forward contract
1,500,000
1,500,000
1,500,000
Problem 27-7 (IAA)
Carmona Grill operates a chain of seafood restaurants. On January 1, 2010, Carmona
Grill determined that it will need to purchase 100,000 kilos of tuna fish on February
1,011. Because of the volatile fluctuation in the price of tuna fish, on January 1, 2010,
Carmona negotiated a forward contract with a reputable financial institution for
Carmona Grill to purchase 100,000 kilos of tuna fish on February 1, 2011 at a price of P
8,000,000 or P80 per kilo. This forward contract was designated as a cash flow hedge.
On December 31, 2010 and February 1, 2011, the market price of tuna fish per kilo is
P75. The appropriate discount rate is 6% and the present value of 1 at 6% for one period
is .943.
What amount should be recognized by Carmona Grill as derivative asset or liability o
December 31, 2010?
a.
b.
c.
d.
471,500 asset
500,000 asset
471,500 liability
500,000 liability
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Solution 27-7 Answer d
The entry on December 31, 2010 to recognize the reduction in the market price is:
Unrealized loss – forward contract
Forward contract payable
500,000
500,000
The forward contract payable is the derivative liability.
Because of the reduction in the market price on February 1, 2011, Carmona company
shall make a forward contract payment to the financial institution.
The entries on February 1, 2011 are:
Purchases
Cash (100,000 x P75)
7,500,000
7,500,000
Forward contract payable
Cash
500,000
Loss on forward contract
Unrealized loss – forward contract
500,000
500,000
500,000
Problem 27-8 (IAA)
Chavacano Company operates a seafood restaurant. On October 1, 2010, Chavacano
determined that it will need to purchase 50,000 kilos of Deluxe fish on March 1, 2011.
Because of the volatile fluctuation in the price of deluxe fish, on October 1, 2010,
Chavacano negotiated a forward contract with a reputable bank for Chavacano to
purchase 50,000 kilos of deluxe fish on March 1, 2011 at a price of P50 per kilo or
P2,500,000. This forward contract was designated as a cash flow hedge.
The derivative forward contract provides that if the market price of deluxe fish on March
1, 2011 is more than P50, the difference is paid by the bank to Chavacano. On the other
hand, if the market price on March 1, 2011 is less than P50, Chavacano will pay the
difference to the ban.
On December 31, 2010, the market price per kilo is P60 ad on March 1, 2011, the market
price is P58.
The appropriate discount rate is 8%. The present value of 1 at 85 for one period is .93.
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1. What is the fair value of the derivative asset or liability on December 3, 2010?
a.
b.
c.
d.
500,000 asset
500,000 liability
465,000 asset
465,000 liability
2. What is the fair value of the derivative asset or liability on March 1, 2011?
a.
b.
c.
d.
400,000 asset
400,000 liability
372,000 asset
372,000 liability
Solution 27-8
Question 1 Answer a
Market price – December 31, 2010
Underlying price
Derivative asset
Forward contract receivable-12/31/2010 (50,000 x 10)
60
50
10
500,000
Question 2 Answer a
Market price – March 1, 2011
Underlying price
Derivative asset
Forward contract receivable – 3/1/2011 (50,000 x 8)
58
50
8
400,000
The forward contract receivable recognized on December 31, 2010 is P 500,000. This
amount is reduced by P 100,000 on March 1, 2011, because the amount actually
collectible from bank is only P 400,000.
Problem 27-9 (IAA)
Seaside Company operates a five-star hotel. The entity makes very detailed long-term
planning. On October 1, 20101, Seaside Company determined that it would need to
purchase 8,000 kilos of Australian lobster on January 1, 2012.
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Because of the fluctuation in the price of Australian lobster, on October 1 ,2010, the
entity negotiated a forward contract with a bank for Seaside to purchase 8,000 kilos of
Australian lobster on January 1,2012 at a price of P9,6000,000. The price of Australian
lobster was P1, 200 per kilo on October 1, 2010. This forward contract was designated as
a cash flow hedge.
The bank has a staff of financial analysts who specialize in forecasting lobster prices.
These analysts are predicting a drop in worldwide lobster prices between October 1, 2010
and January 1, 2012.
On December 31, 2010, the price of a kilo of Australian lobster is P1, 500. on December
31, 2011 and January 1, 2012, the price of a kilo of Australian lobster is P1, 000. The
appropriate discount rate throughout this period is 10%. The present value of 1 at 10% for
one period is .91.
1. What is the notional value of the forward contract?
a. 12,000,000
b. 9,600,000
c. 7,200,000
d. 4,800,000
2. What is the derivative asset or liability on December 31, 2010?
a.
b.
c.
d.
2,400,000 asset
2,400,000 liability
2,184,000 asset
2,184,000 liability
3. What is the derivative asset or liability on December 31, 2011?
a. 1,600,000 asset
b. 1,600,000 liability
c.
800,000 asset
d.
800,000 liability
Solution 27-9
Question1 Answer b
The notional figure is 8,000 kilos and the notional value is 8,000 kilos times the
underlying fixed price of P1, 200 per kilo or P 9,600,000.
Question 2 Answer c
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Market price- December 31, 2010
Underlying fixed price
Derivative asset
1,500
1,200
300
Forward contract receivable (8,000 x 300)
2,400,000
Present value of derivative asset (2,400,000 x .91)
2,184,000
The present value of P2, 184,000 is recognized as forward contract receivable on
December 31, 2010 because the amount is collectible on January 1, 2012, one year from
December 31, 2010.
Forward contract receivable
Unrealized gain- forward contract
2,184,000
2,184,000
Question3 Answer b
Market price – December 31, 2011
Underlying fixed price
Derivative liability
1,000
1,200
200
Forward contract payable – 12/31/11 (8,000 x 200)
1,600,000
The pertinent entries in 2011 and 2012 are:
1.
To recognize the derivative liability on December 31, 2011:
Unrealized loss-forward contract
Forward contract payable
2.
2,184,000
2,184,000
To record the actual purchase on January 1, 2012 at P1,000 per kilo:
Purchases (8,000 x 1,000)
Cash
4.
1,600,000
To cancel the derivative basset that was recorded on December 31, 2010:
Unrealized gain-forward contract
Forward contract receivable
3.
1,600,000
8,000,000
8,000,000
To settle the derivative liability to the bank on January 1, 2012:
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Forward contract payable
Cash
5.
1,600,000
1,600,000
To close the unrealized loss on forward contract:
Loss on forward contract
Unrealized loss- forward contract
1,600,000
1,600,000
The loss on forward contract is an addition to the cost of goods in 2012. Accordingly, the
loss on forward contract can be charged directly to the purchases account.
Problem 27-10 (IAA)
Indang company requires 40,000 kilos of soya beans each month in its operation. To
eliminate the price risk associated with the purchase of soya beans, On December 1,
2010, Indang entered into a futures contract as a cash flow hedge to buy 40,000 kilos of
soya beans at P150 per kilo on March 1, 2011. The market price on December 31, 2010
and March 1, 2011 is P160 per kilo. The appropriate discount rate is 9% and the present
value of 1 at 9% for one period is .917.
What amount should be recognized by Indang Company on December 31, 2010 as
derivative asset or liability?
a.
b.
c.
d.
400,000 asset
400,000 liability
366,800 asset
366,800 liability
Solution 27-10 Answer a
The entry on December 31, 2010 is:
Futures contract receivable (40,000 x P10)
Unrealized gain- futures contract
400,000
400,000
The futures contract receivable is the derivative asset.
The entries on March 1, 2011 are:
Purchases
Cash (40,000 x P160)
Cash
6,400,000
6,400,000
400,000
Futures contract receivable
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400,000
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Unrealized gain – futures contract
Gain on futures contract
400,000
400,000
Problem 27-11 (IAA)
Naga Company produces bottled grape juice. Grape juice concentrate is typically bought
and sold by the pound. Naga uses 50,000 pounds of grape juice concentrate each month.
On November 1, 2010, Naga entered into a grape juice concentrate futures contract as a
cash flow hedge to buy 50,000 pounds of concentrate on February 1, 2011 at a price of
P50 per pound. The market price on December 31, 2010 and February 1, 2011 of the
grape juice concentrate is P38 per pound. The appropriate discount rate is 11%. The
periodic system is used.
What amount should be recognized by Naga Company on December 31, 2010 as
derivative asset or liability?
a.
b.
c.
d.
540,540 asset
540,540 liability
600,000 liability
600,000 asset
Solution 27-11 Answer c
The entry on December 31, 2010 is:
Unrealized loss-futures contract
Futures contract payable (50,000 x P 12)
600,000
600,000
The futures contract payable is the derivative liability.
The entries on February 1, 2011 are:
Purchases
Cash (50,000 x P38)
1,900,000
1,900,000
Futures contract payable
Cash
600,000
Loss on futures contract
Unrealized loss – futures contract
600,000
600,000
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600,000
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Problem 27-12 (IAA)
Taal Company requires 25,000 pounds of copper each month in its operations. To
eliminate the price risk associated with copper purchases, on December 1, 2010, Taal
entered into a futures contract as a cash flow hedge to buy 25,000 pounds of cooper on
June 1, 2011. The futures price is P50 per pound.
The futures contract is managed through an exchange, so Taal does not know the party on
the other side of the contract. As with most derivative contracts, this futures contract is
settled by an exchange of cash on June 1, 2011 based on the price of copper on that date.
The market price per pound is P45 on December 31, 2010 and P42 on June 1, 2011.
What is the derivative asset or liability on December 31, 2010?
a.
b.
c.
d.
125,000 asset
125,000 liability
200,000 asset
200,000 liability
Solution 27-12 Answer b
Market price – December 31, 2010
Underlying fixed price
Derivative liability
Futures contract payable-12/31/2010 (25,000 x 5)
Market price – June 1, 2011
Underlying fixed price
Derivative liability
Futures contract payable – June 1, 2011
Futures contract payable – December 31, 2010
Increase in derivative liability on June 1, 2011
45
50
5
125,000
42
50
8
200,000
125,000
75,000
Problem 27-13 (IAA)
Janina Company regularly hedges its purchases requirements and the sale of its finished
products in the futures market. On December 1, 2010, Janina Company entered into the
following three contracts designated as cash flow hedge:
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Type of contract
Purchase sugar
Purchase milk
Sell ice cream
Quantity
20,000
50,000
30,000
Futures price
1/1/2010
60
100
220
Market price
12/31/2010
75
91
195
All three contracts are to be settled on January 1, 2011.
What is the derivative asset or liability on December 31, 2010?
a.
300,000 asset
b.
600,000 asset
c.
900,000 liability
d. 1,050,000 liability
Solution 27-13 Answer b
Sugar-“purchase”
Milk-“purchase”
Ice cream-“sell”
(20,000 x 15)
(50,000 x 9)
(30,000 x 25)
Futures contract receivable- 12/31/2010
300,000
(450,000)
750,000
600,000
Problem 27-14 (IAA)
Legaspi Company produces colorful 100% cotton T-shirts that are very popular among
the youth. The entity uses 150,000 kilos of cotton each month in its production process.
In accordance with the entity’s long-term planning, the entity normally procures one
month supply of cotton to be used in its production process.
On December 31, 2010, Legaspi Company purchased a call option as a cash flow hedge
to buy 150,000 kilos of cotton on July 1, 2011. The call option price is P30 per kilo. The
entity paid P50, 000 for call option. The market price of cotton on July 1, 2011 is P 35
per kilo.
What amount should be recognized by Legaspi Company as a gain on call option in
2011?
a.
b.
c.
d.
750,000
700,000
375,000
350,000
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Solution 27-14 Answer b
Fair value of call option on 7/1/2011 (150,000 x P5)
Call option payment
Gain on call option
750,000
(50,000)
700,000
The entry on December 31, 2010 for the payment of the call option is:
Call option
Cash
50,000
50,000
The entries on July 1, 2011 are:
Call option
Unrealized gain-call option
700,000
Cash
750,000
700,000
Call option
Purchases
Cash
750,000
5,250,000
5,250,000
Unrealized gain-call option
Gain on call option
700,000
700,000
Problem 27-15 (IAA)
Bicol Company uses approximately 200,000 units of raw material in its manufacturing
operations. On December 31, 2010, Bicol Company purchased a call option to buy
200,000 units of raw materials on July 1, 2011 at a price of P25 per unit. The entity paid
P20, 000 for the call option. Bicol designated the call option as a cash flow hedge against
price fluctuation for its July purchase. The market price of the raw material on July 1,
2011 is P22 per unit.
What amount should be recognized by Bicol Company as loss on call option in 2011?
a. 600,000
b. 550,000
c. 650,000
d. 20,000
Solution 27-15 Answer d
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The loss on call option is equal only to the payment of P20, 000. Since the market price
decreased on July 1, 2011, the call option is not exercised but simply ignored. Remember
that a call option a right and not an obligation.
The entry to record the payment of the option on December 31, 2010 is:
Call option
Cash
20,000
20,000
The entries on July 1, 2011 are:
Raw material purchases
Cash (200,000 x P22)
4,400,000
4,400,000
Loss on call option
Call option
20,000
20,000
Problem 27-16 (IAA)
Sorsogon Company uses approximately 300,000 units of raw material in its
manufacturing operations. On December 1, 2010, Sorsogon Company purchased a call
option to buy 300,000 units of the raw material on March 1, 2011 at a price of P25 per
unit.
Sorsogon paid P50, 000 for the call option and designated the call option as a cash flow
hedge against price fluctuation for its March purchase.
On December 31, 2010, the market price of the raw material is P27 per unit and on
March 1, 2011, the market price is P28.
What is the derivative asset or liability on December 31, 2010?
a.
b.
c.
d.
600,000 asset
600,000 liability
900,000 asset
900,000 liability
Solution 27-16 Answer a
Market price – December 31, 2010
Underlying fixed price
Derivative asset
Call option – December 31, 2010 (300,000 x 2)
27
25
2
600,000
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Market price – March 1, 2011
Underlying fixed price
Derivative asset
Call option – March 1, 2011(300,000 x 3)
Call option – December 31, 2010
Increase in fair value in 2011
28
25
3
900,000
600,000
300,000
Problem 27-17 (IFRS)
Vivien Company purchases approximately 500,000 bushels of oats each month. On
December 1, 2010, Vivien purchased an option to purchase 500,000 bushels of oats on
March 1, 2011 at a price of P100 per bushels which is the market price of bushel on
December 1, 2010. Vivien had to pay P100, 000 to purchase the call option which it
designated as a cash flow hedge against price increases for its March 1, 2011 purchase of
oats.
On December 31, 2010, the price of oats is P95 per bushel. Because there is still time for
the price of oats to potentially rise above P100 per bushel before the option expires, the
option has a value of P40, 000 on December 31, 2010. On March 1, 2011, the price of
oats is P104 per bushel.
What is the gain on call option that should be reported in the 2011 statement of
comprehensive income?
a.
b.
c.
d.
2,000,000
1,900,000
1,960,000
1,940,000
Solution 27-17 Answer b
Call option – December 1, 2010
Fair value of call option – December 31, 2010
Unrealized loss on call option in 2010
100,000
40,000
60,000
Fair value of call option – 3/1/2011 (500,000 x 4)
Fair value of call option – December 31, 2010
2,000,000
( 40,000)
Gain on call option in 2011
1,960,000
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Unrealized loss on call option in 2010
Net gain on call option in 2011
( 60,000)
1,900,000
Problem 27-18 (IAA)
Hazel Company enters into a call option contract with a bank on January 1, 2010. This
contract gives the entity the option to purchase 10,000 shares at P100 per share. The
option expires on April 30, 2010. The shares are trading at P100 per share on January 1,
2010, at which time Hazel pays P10, 000 for the call option. The market price per share is
P120 on April 30, 2010, and the time value of the option has not changed.
In order to settle the option contract, what would Hazel most likely do?
a. Pay the bank P200, 000.
b. Purchase the shares at P100 per share and sell the shares at P120 per share to the
bank.
c. Receive P200, 000 from the bank.
d. Receive P190, 000 from the bank.
Solution 27-18 Answer c
Market price per share
Option price
Fair value of call option
Call option receipt (10,000 x 20)
120
100
20
200,000
Problem 27-19 (IAA)
On June 30 of the current year, Ester Company entered into a firm commitment to
purchase specialized equipment from Nagasaki Company for ¥80,000,000 on August 31.
The exchange rate on June 30 is ¥100=$1. To reduce the exchange rate risk that could
increase in the cost of the equipment in U.S. dollars, Ester pays $12,000 for a call option
contract. This contract gives Ester the option to purchase ¥80,000,000 at an exchange rate
of ¥100=$1 on August 31. On August 31, the exchange rate ¥93=1
How much in U.S dollars did Ester Company save by purchasing the call option?
a.
b.
c.
d.
12,0000
48,215
60,215
Ester Company would have been better off not to have purchased the call option.
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Solution 27-19 Answer b
Dollar equivalent – August 31 (80,000,000/ 93 )
Dollar equivalent – June 30
(80,000,000/100)
Total saving
Payment for call option
Net saving – gain on call option
860,215
800,000
60,215
12,000
48,215
Problem 27-20 (IFRS)
Oriental Company has the Philippine peso as its functional currency. The entity expects
to purchase goods from USA for $50,000 on March 31, 2011.
Accordingly, the entity is exposed to a foreign currency risk. If the dollar increases before
the purchase takes place, the entity will have to pay more pesos to obtain the $50,000 that
it will have to pay for the goods.
On October 1, 2010, Oriental Company entered into a foreign currency forward contract
with a bank speculator to purchase $50,000 in six months for a fixed amount of P2,
250,000 or P45 to $1. This forward contract is designated as cash flow hedge of the
entity’s exposure to increase in dollar exchange rate. On December 31, 2010, the
exchange rate is P46 to $1 and on March 31, 2011, the exchange rate is P48 to $1.
What is the derivative asset or liability on December 31, 2010?
a. 150,000 asset
b. 150,000 liability
c. 50,000 asset
d. 50,000 liability
Solution 27-20 Answer c
Peso equivalent – December 31, 2010 ($50,000 x 46)
Peso equivalent – October 1, 2010
Forward contract receivable – December 31, 2010
2,300,000
2,250,000
50,000
Peso equivalent – March 31, 2011 ($50,000 x 48)
Peso equivalent – December 31, 2010
Increase in Derivative Asset
2,400,000
2,300,000
100,000
1.
To recognize the derivative asset on December 31, 2010:
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Forward contract receivable
Unrealized gain – forward contract
50,000
50,000
An unrealized gain on forward contract is recognized because the foreign currency
forward contract is designated as a cash flow hedge.
2.
To recognize the increase in derivative asset on March 31, 2011:
Forward contract receivable
Unrealized gain – forward contract
100,000
100,000
3.
To record the cash settlement of the derivative contract from the bank on March
31, 2011:
Cash
150,000
Forward contract receivable
4.
To record the purchase of goods on March 31, 2011:
Purchases ($50,000 x 48)
Cash
5.
150,000
2,400,000
2,400,000
To close the unrealized gain on forward contract:
Unrealized gain – forward contract
Purchases
150,000
150,000
Problem 27-21 (IAA)
On November 1, 2010, Cassandra Company sold some limited edition art prints to
Noritake Company for ¥47,850,000 to be paid on January 1, 2011. The current exchange
rate on November 1, 2010 was ¥110=$1, so the total payment at the current exchange
rate would be equal to $435,000. Cassandra entered into a forward contract with a large
bank to guarantee the number of dollars to be received. According to the terms of the
contract, if ¥47,850,000 is worth less than $435,000, the bank will pay Cassandra the
difference in cash. Likewise, if ¥47,850,000 is worth more than $435,000, Cassandra
must pay the bank the difference in cash. The exchange rate on December 31, 2010 is
¥120 = $1.
What amount in U.S. dollar will Cassandra report as derivative asset or liability on
December 31, 2010?
a. 398,750 asset
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b. 308,750 liability
c. 36,250 asset
d. 36,250 liability
Solution 27-21 Answer c
Dollar equivalent – November 1, 2010
Dollar equivalent – 12/31/2010 (47,850,000/120)
Forward contract receivable – December 31, 2010
Prepared by: Mise, Jenifer H.
BSA-3
(TTh/8:00-9:30pm)
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435,000
398,750
36,250