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With Answers
ACCT 5341 Examination 1 (Part 2)
Dr. Jensen
Spring 2001
Students are allowed to use the following examination aids:

The Green Book (FAS 133)

Calculator

Notes that you have written yourself

File 1 printouts

File 2 printouts
Students are not allowed to use the following in Part 1

Photocopies

Books
Notes or any other materials written by other students other than File 1 and File 2 printouts that were
joint efforts between you and a partner

Part 1 (Multiple Choice)
Choose the best answer to each question when more than one answer is correct.

Answers are to be recorded both on the question sheet and on the answer sheet.

The term “earnings” does not include “comprehensive earnings.”
Questions 1-20 Relate to Example in Appendix B of FAS 133
1. (03 Points) Page 102 of green book version of FAS 133: A careful reading of Paragraph 165 of 168 reveals
that the royalty commitment is a forecasted transaction rather than a firm commitment for DM3,000,000 to
be delivered on April 30. Does that distinction really matter in terms of being able to use FX hedge
accounting for the forward contract?
a. Yes, because the forward contract used as a hedge obligates DEF Company to a convert DM3,000,000
into U.S. dollars (USD) at a fixed rate of $0.6057 even if the actual royalties received are more than or less
than DM3,000,000? In that case, Paragraph 40e kicks in and hedge accounting should be denied. [Wrong
because the royalty agreement is not a recognized asset or liability]
b. No, because the royalty agreement is deemed probable and can be a hedged item as forecasted
transaction under Paragraph 36b at the top of Page 32 of your green book on FAS 133. [XXXXX]
c. No, because the royalty agreement qualifies as an unrecognized firm commitment under Paragraph 36b at
the top of Page 32 of your green book on FAS 133. [Wrong because the royalty agreement is not a firm
commitment]
d. Both answers b and c are correct.
2. (03 Points) Page 102 of green book version of FAS 133: A careful reading of Paragraph 165 of 168 reveals
that the royalty commitment is a forecasted transaction rather than a firm commitment for DM3,000,000 to
be delivered on April 30. Does that distinction really matter in terms of being able to sleep nights knowing
that the ultimate cash flows in U.S dollars (USD) are fixed in amount on April 30?
a. Yes, because the DEF Company is obligated under the forward contract to convert DM3,000,000 into
USD at the fixed rate of $0.6057 no matter whether the actual royalty cash received is greater than or less
than DM3,000,000 on April 30. [XXXXX]
b. No, because the royalty payments constitute an unrecognized firm commitment for DM3,000,000.
c. No, because the royalty payments constitute a recognized firm commitment for DM3,000,000.
d. No, because the royalty payments will be received at the April 30 USD/DM spot rates no matter what
happens with the actual royalty payments in deutsche (German) marks.
3. (03 Points) Page 102 of green book version of FAS 133: Suppose the DEF Company wants to guarantee its
$1,817,200 profit on April 40 no matter what the outcome of the royalty agreement? Is this possible and, if
so, would FAS 133 allow cash flow accounting?
a. Yes, because the forecasted transaction tests in Paragraph 29 are satisfied. Specifically, the royalty
agreement has a fixed notional (three units under Paragraph 166) with an uncertain price that could range
from DM0 to DM1 per unit. The probability test of Paragraph 29c is satisfied according to the last sentence
of Paragraph 166.
b. No, because this would be tantamount to a short sale in the functional currency (USD) and short sales are
not generally permitted to be cash flow hedges. [DEF Company owns the royalties and therefore cannot be
selling short on something that it does not own.]
c. Yes, but not under the original version of FAS 133 that did not permit the hedging of more than one type
of risk simultaneously. In this case there are two risks (risk that the DM3,000,000 will ever transpire and
the FX risk on that amount). However, under the FAS 138 amendments, simultaneous hedging of two risks
became possible. See Paragraph 25 of FAS 138 on Page 250 of your green book.
d. No, because if the hedge was contracted and fully guaranteed, there would be no cash flow risk to hedge.
[XXXXX]
4. (03 Points) Page 103 of green book version of FAS 133: There was a ($98,400) impact of the hedge versus
the alternative of not hedging in Example 10. When evaluating the impact of hedging versus ignoring the
FX risk by not hedging, choose the best answer below:
a. A January 1 spot rate greater than $0.6019 will increase the advantage of the hedge.
b. A January 1 forward rate greater than $0.6057 will decrease the advantage of the hedge.
c. An April 30 forward rate greater than $0.5729 will increase the advantage of the hedge
d. An April 30 spot rate greater than $0.5729 will decrease the advantage of the hedge [XXXXX]
5.
Page 105 of green book version of FAS 133: Suppose that the DM1,000,000 royalties had been
paid in cash on January 31, February 28, and March 31. Could the Problem 10 forward contract of $0.6057
on April 30 be entitled to FAS 133 hedge accounting even though the timing of the payments differ between
the hedge and the hedged item?
(03 Points)
a. Yes, but the hedged portions must be transferred from OCI to current earnings in a manner similar to
what is illustrated on Paragraph 170 of FAS 133.
b. Yes, but the hedged portions must be deferred fully in OCI until April 30 when the forward contract
expires.
c. No [XXXXX because the hedged items have different risk exposures than the DM3,000,000 being
hedged.]
d. No, but the cash flow from each DM1,000,000 royalty payment may be deferred in OCI until the forward
contract expires on April 30.
6. (03 Points) Page 105 of green book version of FAS 133: The foreign currency (FX) transaction losses of
($53,900) listed in Paragraph 172 arise due to which of the following:
a. Dedesignation of a portion of the FX risk hedge when each DM1 million becomes a firm commitment.
Each firm commitment is, thereby, subject to FX risk between the dates of dedesignation and April 30.
b. Failure of the DEF Company to negotiate a better deal in which each DM1 would be paid in cash at the
moment a unit of the product is sold by ZYX Company in Germany.
c. Ineffectiveness of the forward contract in hedging the FX risk of the DM3 million on April 30..
d. Both answers a and b are correct. [XXXXX]
7. (03 Points) Page 105 of green book version of FAS 133: Prior to FAS 133, the re “Total Amount Reported
in Earnings” of $605,627 would have been reported as follows on Page 105:
a. $605,627
b. $605,627+$6,100
c. $605,627+$6,100-$6,063-$10,891-$3,873 [XXXXX]
d. $605,627
-$6,063-$10,891-$3,873.
8. (03 Points) Page 105 of green book version of FAS 133: Prior to FAS 133, the re “Total Amount Reported
in Earnings” of $1,817,100 would have been reported as follows on Page 105:
a. $1,817,100 [XXXXX]
b. $1,817,100+$53,900
c. $1,817,100+$53,900-$54,178-$32,822-$11,400
d. $1,817,100
-$54,178-$32,822-$11,400.
9. (03 Points) Page 101 of green book version of FAS 133: The losses due to changes in time value posted to
Earnings in Paragraph 163 are excluded from OCI because of which of the following:
a. Time value tends to decline and drop to zero, thereby leaving zero for the time value portion in OCI even
if the option is settled for a cash gain when it expires.
b. Changes in time value do not per se change the value of a hedge. For example, a call or put option that
never goes into the money has changes in time value. [XXXXX]
c. Time value changes are too unstable to serve as a hedge.
d. Time value changes are posted to OCI and are changed into earnings when earned.
10. (03 Points) Page 94 of green book version of FAS 133: If Example 7 had used forward rather than futures
contracts as a hedge of the forecasted purchase of corn on May 20, choose the most accurate statement
below:
a. The hedge derivative would have to be estimated using a non-zero time value of money to discount
present Chicago forward prices back to the present time from May 20.
b. The hedge derivative contract would have to be estimated using a zero time value of money to discount
present Chicago forward prices back to the present time from May 20.
c. The hedge derivative would have to be estimated using a non-zero time value of money to discount
present Minneapolis forward prices back to the present time from May 20. [XXXXX]
d. The hedge derivative contract would have to be estimated using a zero time value of money to discount
present Minneapolis forward prices back to the present time from May 20
11. (03 Points) Page 94 of green book version of FAS 133: If Example 7 had used forward rather than futures
contracts as a hedge of the forecasted purchase of corn on May 20, choose the most accurate statement
below:
a. The hedged item (forecasted transaction) should be valued using a zero time value of money on present
Chicago spot prices.
b. The hedged item (forecasted transaction) should be valued using a non-zero time value of money to
discount present Chicago forward prices back to the present time from May 20. [XXXXX]
c. The hedged item (forecasted transaction) should be valued using a zero time value of money on present
Minneapolis spot prices.
d. The hedged item (forecasted transaction) should be valued using a non-zero time value of money to
discount present Minneapolis forward prices back to the present time from May 20
12. (03 Points) Page 94 of green book version of FAS 133: In Paragraph 152, the FASB explains that there is
no hedging ineffectiveness because the difference between Chicago and Minneapolis futures prices was
always $0.05 in Paragraph 150 for every repricing date. Choose the most correct statement below:
a. There's no hedge ineffectivness since the futures contracts hedge, when valued with forward prices in the
Minneapolis market, will generate the same journal entries as the journal entries derived in Paragraph 152
using forward prices in Chicago (provided that the price differences remain constant at $0.05). [XXXXX]
b. The OCI balance change would have been zero on every date where the forward price differences hedge
between Chicago and Minneapolis did not remain constant at $0.05 per bushel, thereby giving rise to
ineffectiveness. [Depends upon DELTA level.]
c. The OCI balance change would have been non-zero on every date where the forward price differences
between Chicago and Minneapolis did not remain constant at $0.05 per bushel, thereby giving rise to
hedging ineffectiveness.[Depends upon DELTA level.]
d. None of the above.
13. (03 Points) Page 94 of green book version of FAS 133: If the futures contracts had not been terminated
early on May 1, the 20 futures contracts are a perfect hedge that will lock in the purchase price of 100,000
bushels of corn at a contracted price of $2.7375 no matter what the spot price changes to on May 20. Which
of the following statements is the most correct assuming the Paragraph 145 hedge qualifies for hedge
accounting?
a. FAS 133 did not create any major changes in reported earnings in March 31 since FAS 80 required daily
cash adjustments to the derivative contracts under FAS 80.
b. FAS 133 hedge accounting results in less earnings volatility during the hedging period such as on March
31. [XXXXX due to OCI booking instead current earnings]
c. FAS 133 results in more earnings volatility during the hedging period such as on March 31.
d. FAS 133 hedge accounting increased the assets of JKL on March 31 relative to FAS 80 accounting for
futures contracts. [This would be correct for forward contracts, but it is not correct for futures
contracts.]
14. (03 Points) Page 74 of green book version of FAS 133: The value change in the forward contract is
$22,500 in Paragraph 109 of FAS 133. Assume the ABC Company follows the lower-of-cost-or market
inventory method. Under the 80%-125% DELTA(t) rule, what would this forward contract value increase
have to be in order to disallow hedge accounting due to hedge ineffectiveness in Period 1?
a. Any forward contract value change of less than $20,000 would be deemed overly ineffective, and the
entire forward contract value change could not be booked in Period 1..
b. Any forward contract value change of more than $31,250 would be deemed overly ineffective, and the
entire forward contract value change could not be booked in Period 1.
c. Any forward contract value change of more than $25,000 would be deemed ineffective and any excess
change in value above $25,000 would not be offset an earnings decline due to write-down of the inventory
to fair value. [XXXXX]
d. Both Answers a and b are correct..
15. (03 Points) Page 74 of green book version of FAS 133: How would the “Total” row in Paragraph 109 have
appeared if the economic hedge failed to qualify for hedge accounting? Assume the ABC Company follows
the lower-of-cost-or market inventory method.
a. $1,097,500
periods]
$0
$(1,000,000) $(97,500) [XXXXX --- Hedge accounting only affects interim
b. $1,097,500
$0
$(997,500)
$(120,000)
c. $1,097,500
$0
$(975,000)
$(122,500)
d. None of the above.
16. (03 Points) Page 74 of green book version of FAS 133: How would the “Total” row in Paragraph 109 have
appeared prior to FAS 133? Assume the ABC Company follows the lower-of-cost-or market inventory
method.
a. $1,097,500
periods]
$0
$(1,000,000) $(97,500) [XXXXX --- Hedge accounting only affects interim
b. $1,097,500
$0
$(997,500)
$(120,000)
c. $1,097,500
$0
$(975,000)
$(122,500)
d. None of the above.
17. (03 Points) Page 74 of green book version of FAS 133: How would the “Total” row in Paragraph 109 have
if ABC Company had not hedged? Assume the ABC Company follows the lower-of-cost-or market
inventory method.
a. $1,097,500
$0
$(1,000,000) $(97,500)
b. $1,097,500
$0
$(997,500)
c. $1,075,000
$0
$(1,000,000) $(75,000) [XXXXX]
d. None of the above.
$(120,000)
18. (03 Points) Page 86 of green book version of FAS 133: The value change in the forward contract is
$25,000 in Paragraph 129 of FAS 133. Under the 80%-125% DELTA(t) rule, what would this forward
contract value increase have to be in order to disallow hedge accounting due to hedge ineffectiveness in
Period 1?
a. Any forward contract value change of less than $20,000 would be deemed overly ineffective, and the
entire forward contract value change could not be booked in Period 1..
b. Any forward contract value change of more than $31,250 would be deemed overly ineffective, and the
entire forward contract value change could not be booked in Period 1.
c. The forward contract value change would always be booked, but OCI change would be booked at zero if
the forward contract value change was less than $20,000 or greater than $31,250. [XXXXX]
d. Both Answers a and b are correct.
19. (03 Points) Page 86 of green book version of FAS 133: How would the “Total” row in Paragraph 129
change if ABC Company had the economic hedge described in Example 4, but for some reason the hedge
failed to qualify for FAS 133 hedge accounting as a cash flow hedge? Assume the ABC Company follows
the lower-of-cost-or market inventory method.
a. $1,100,000
$0
$0
$(1,100,000) [XXXXX]
b. $1,075, 000
$0
$0
$(1,075,000)
c. $1,050,000
$0
$0
$(1,050,000)
d. None of the above.
20.
(03 Points) Page 86 of green book version of FAS 133: How would the “Total” row in Paragraph 129
change if ABC Company had not hedged? Assume the ABC Company follows the lower-of-cost-or market
inventory method.
a. $1,100,000
$0
$0
$(1,100,000)
b. $1,075,000
$25,000
$(25,000)
$(1,075,000)
c. $1,050,000
$0
$0
$(1,050,000)
d. None of the above. [XXXXX $1,075,000
$0
$0
$(1,075,000) ]