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CHAPTER 9 FOREIGN CURRENCY TRANSACTIONS AND HEDGING FOREIGN EXCHANGE RISK

Answer to Discussion Question
Do we have a gain or what? This case demonstrates the differing kinds of information provided through application of current accounting rules for foreign currency transactions and derivative financial instruments. The Ahnuld Corporation could have received $200,000 from its export sale to Tcheckia if it had required immediate payment. Instead, Ahnuld allows its customer six months to pay. Given the future exchange rate of $1.70, Ahnuld would have received only $170,000 if it had not entered into the forward contract. This would have resulted in a decrease in cash inflow of $30,000. In accordance with SFAS 52, the decrease in the value of the tcheck receivable is recognized as a foreign exchange loss of $30,000. This loss represents the cost of extending credit to the foreign customer if the tcheck receivable is left unhedged. However, rather than leaving the tcheck receivable unhedged, Ahnuld sells tchecks forward at a price of $180,000. Because the future spot rate turns out to be only $1.70, the forward contract provides a benefit, increasing the amount of cash received from the export sale by $10,000. In accordance with SFAS 133, the change in the fair value of the forward contract (from zero initially to $10,000 at maturity) is recognized as a gain on the forward contract of $10,000. This gain reflects the cash flow benefit from having entered into the forward contract, and is the appropriate basis for evaluating the performance of the foreign exchange risk manager. (Students should be reminded that the forward contract will not always improve cash inflow. For example, if the future spot rate were $1.85, the forward contract would result in $5,000 less cash inflow than if the transaction were left unhedged.) The net impact on income resulting from the fluctuation in the value of the tcheck is a loss of $20,000. Clearly, Ahnuld forgoes $20,000 in cash inflow by allowing the customer time to pay for the purchase, and the net loss reported in income correctly measures this. The $20,000 loss is useful to management in assessing whether the sale to Tcheckia generated an adequate profit margin, but it is not useful in assessing the performance of the foreign exchange risk manager. The net loss must be decomposed into its component parts to fairly evaluate the risk manager’s performance. Gains and losses on forward contracts designated as fair value hedges of foreign currency assets and liabilities are relevant measures for evaluating the performance of foreign exchange risk managers. (The same is not true for cash flow hedges. For this type of hedge, performance should be evaluated by considering the net gain or loss on the forward contract plus or minus the forward contract premium or discount.)

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Answers to Questions
1. Under the two-transaction perspective, an export sale (import purchase) and the subsequent collection (payment) of cash are treated as two separate transactions to be accounted for separately. The idea is that management has made two decisions: (1) to make the export sale (import purchase), and (2) to extend credit in foreign currency to the foreign customer (obtain credit from the foreign supplier). The income effect from each of these decisions should be reported separately. Foreign currency receivables resulting from export sales are revalued at the end of accounting periods using the current spot rate. An increase in the value of a receivable will be offset by reporting a foreign exchange gain in net income, and a decrease will be offset by a foreign exchange loss. Foreign exchange gains and losses are accrued even though they have not yet been realized. Foreign exchange gains and losses are created by two factors: having foreign currency exposures (foreign currency receivables and payables) and changes in exchange rates. Appreciation of the foreign currency will generate foreign exchange gains on receivables and foreign exchange losses on payables. Depreciation of the foreign currency will generate foreign exchange losses on receivables and foreign exchange gains on payables. Hedging is the process of eliminating exposure to foreign exchange risk so as to avoid potential losses from fluctuations in exchange rates. In addition to avoiding possible losses, companies hedge foreign currency transactions and commitments to introduce an element of certainty into the future cash flows resulting from foreign currency activities. Hedging involves establishing a price today at which foreign currency can be sold or purchased at a future date. A party to a foreign currency forward contract is obligated to deliver one currency in exchange for another at a specified future date, whereas the owner of a foreign currency option can choose whether to exercise the option and exchange one currency for another or not. Hedges of foreign currency denominated assets and liabilities are not entered into until a foreign currency transaction (import purchase or export sale) has taken place. Hedges of firm commitments are made when a purchase order is placed or a sales order is received, before a transaction has taken place. Hedges of forecasted transactions are made at the time a future foreign currency purchase or sale can be anticipated, even before an order has been placed or received. Foreign currency options have an advantage over forward contracts in that the holder of the option can choose not to exercise if the future spot rate turns out to be more advantageous. Forward contracts, on the other hand, can lock a company into an unnecessary loss (or a reduced gain). The disadvantage associated with foreign currency options is that a premium must be paid up front even though the option might never be exercised. SFAS 133 requires an enterprise to recognize all derivative financial instruments as assets or liabilities on the balance sheet and measure them at fair value. The fair value of a foreign currency forward contract is determined by reference to changes in the forward rate over the life of the contract, discounted to the present value. Three pieces of information are needed to determine the fair value of a forward contract at any point in time during its life: (a) the contracted forward rate when the forward contract is entered into, (b) the
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current forward rate for a contract that matures on the same date as the forward contract entered into, and (c) a discount rate; typically, the company’s incremental borrowing rate. The manner in which the fair value of a foreign currency option is determined depends on whether the option is traded on an exchange or has been acquired in the over the counter market. The fair value of an exchange-traded foreign currency option is its current market price quoted on the exchange. For over the counter options, fair value can be determined by obtaining a price quote from an option dealer (such as a bank). If dealer price quotes are unavailable, the company can estimate the value of an option using the modified Black-Scholes option pricing model. Regardless of who does the calculation, principles similar to those in the Black-Scholes pricing model will be used in determining the value of the option. 10. Hedge accounting is defined as recognition of gains and losses on the hedging instrument in the same period as the recognition of gains and losses on the underlying hedged asset or liability (or firm commitment). 11. For hedge accounting to apply, the forecasted transaction must be probable (likely to occur), the hedge must be highly effective in offsetting fluctuations in the cash flow associated with the foreign currency risk, and the hedging relationship must be properly documented. 12. In both cases, (1) sales revenue (or the cost of the item purchased) is determined using the spot rate at the date of sale (or purchase), and (2) the hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate with a foreign exchange gain or loss recognized in net income. For a cash flow hedge, the derivative hedging instrument is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a change in Accumulated Other Comprehensive Income (AOCI). An amount equal to the foreign exchange gain or loss on the hedged asset or liability is then transferred from AOCI to net income; the net effect is to offset any gain or loss on the hedged asset or liability. An additional amount is removed from AOCI and recognized in net income to reflect (a) the current period’s amortization of the original discount or premium on the forward contract (if a forward contract is the hedging instrument) or (b) the change in the time value of the option (if an option is the hedging instrument). For a fair value hedge, the derivative hedging instrument is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a gain or loss in net income. The discount or premium on a forward contract is not allocated to net income. The change in the time value of an option is not recognized in net income. 13. For a fair value hedge of a foreign currency asset or liability (1) sales revenue (cost of purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate with a foreign exchange gain or loss recognized in net income. The forward contract is adjusted to fair value based on changes in the forward rate (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a gain or loss in net income. The foreign exchange gain (loss) and the forward contract loss (gain) are likely to be of different amounts resulting in a net gain or loss reported in net income. For a fair value hedge of a firm commitment, there is no hedged asset or liability to account for. The forward contract is adjusted to fair value based on changes in the forward rate (resulting in

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an asset or liability reported on the balance sheet), with a gain or loss recognized in net income. The firm commitment is also adjusted to fair value based on changes in the forward rate (resulting in a liability or asset reported on the balance sheet), and a gain or loss on firm commitment is recognized in net income. The firm commitment gain (loss) offsets the forward contract loss (gain) resulting in zero impact on net income. Sales revenue (cost of purchases) is recognized at the spot rate at the date of sale (purchase). The firm commitment account is closed as an adjustment to net income in the period in which the hedged item affects net income. 14. For a cash flow hedge of a foreign currency asset or liability (1) sales revenue (cost of purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the hedged asset or liability is adjusted to fair value based on changes in the spot exchange rate with a foreign exchange gain or loss recognized in net income. The forward contract is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a change in Accumulated Other Comprehensive Income (AOCI). An amount equal to the foreign exchange gain or loss on the hedged asset or liability is then transferred from AOCI to net income; the net effect is to offset any gain or loss on the hedged asset or liability. An additional amount is removed from AOCI and recognized in net income to reflect the current period’s allocation of the discount or premium on the forward contract. For a hedge of a forecasted transaction, the forward contract is adjusted to fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart recognized as a change in Accumulated Other Comprehensive Income (AOCI). Because there is no foreign currency asset or liability, there is no transfer from AOCI to net income to offset any gain or loss on the asset or liability. The current period’s allocation of the forward contract discount or premium is recognized in net income with the counterpart reflected in AOCI. Sales revenue (cost of purchases) is recognized at the spot rate at the date of sale (purchase). The amount accumulated in AOCI related to the hedge is closed as an adjustment to net income in the period in which the forecasted transaction was anticipated to occur. 15. In accounting for a fair value hedge, the change in the fair value of the foreign currency option is reported as a gain or loss in net income. In accounting for a cash flow hedge, the change in the entire fair value of the option is first reported in other comprehensive income, and then the change in the time value of the option is reported as an expense in net income. 16. The accounting for a foreign currency borrowing involves keeping track of two foreign currency payables—the note payable and interest payable. As both the face value of the borrowing and accrued interest represent foreign currency liabilities, both are exposed to foreign exchange risk and can give rise to foreign currency gains and losses.

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Answers to Problems 1. C An import purchase causes a foreign currency payable to be carried on the books. If the foreign currency depreciates, the dollar value of the foreign currency payable decreases, yielding a foreign exchange gain. 2. D SFAS 52 requires a two-transaction perspective, accrual approach. 3. B Foreign exchange gains related to foreign currency import purchases are treated as a component of income before income taxes. If there is no foreign exchange gain in operating income, then the purchase must have been denominated in U.S. dollars or there was no change in the value of the foreign currency from October 1 to December 1, 2009. 4. C The dollar value of the LCU receivable has decreased from $110,000 at December 31, 2009 to $95,000 at February 15, 2010. This decrease of $15,000 should be reported as a foreign exchange loss in 2010. The increase in the dollar value of the euro note payable represents a foreign exchange loss. In this case a $25,000 loss would have been accrued in 2009 and a $10,000 loss will be reported in 2010. A foreign currency receivable will generate a foreign exchange gain when the foreign currency increases in dollar value. A foreign currency payable will generate a foreign exchange gain when the foreign currency decreases in dollar value. Hence, the correct combination is franc (increase) and peso (decrease). The merchandise purchase results in a foreign exchange loss of $8,000, the difference between the U.S. dollar equivalent at the date of purchase and at the date of settlement. The increase in the dollar equivalent of the note’s principal results in a foreign exchange loss of $20,000. The total foreign exchange loss is $28,000 ($8,000 + $20,000). The Thai baht is selling at a premium (forward rate exceeds spot rate). The exporter will receive more dollars as a result of selling the baht forward than if the baht had been received and converted into dollars on April 1. Thus, the premium results in additional revenue for the exporter. The parts inventory will be recognized at the spot rate at the date of purchase (FC100,000 x $.23 = $23,000).

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will recognize a $1.000 discounted for two months ($2.000.000 x .000].0034 x 10 million).20). On December 31. The won receivable will be written down by $2.80. 12.000 = $5.500 $7.000 on the won receivable. 2009 Solutions Manual . 2009 that matures on March 31. 2009 balance sheet as a liability. Therefore. the premium results in an expense of $10.000 x . Barnum has locked-in to purchase ringgits at $0.20 gain on the forward contract and a foreign exchange loss of $2.037 per ringgit if it had waited until December 31 to enter into the forward contract.9803 = $4.10. 2010.941. 13. MNC Corp. the difference between the amount to be received from the forward contract actually entered into.000 at 12/31/09. D The forward contract must be reported on the December 31. and the amount that could be received by entering into a forward contract on December 31. $34.000 and a foreign exchange loss will be reported in 2009 income. causing Pimlico to pay more dollars to acquire kroner than if the kroner were purchased at the spot rate on March 1.037) x 1. The net impact on 2009 income is –$58.500 $2.12 – $.9706 = $1. The journal entries would be as follows: 3/1 6/1 no journal entries Premium Expense AOCI AOCI Forward Contract Foreign Currency Forward Contract Cash AOCI Adjustment to Net Income McGraw-Hill/Irwin 9-6 $10.000 [($.000 ($.000.042 – $. $32. The Adjustment to Net Income is the amount accumulated in Accumulated Other Comprehensive Income (AOCI) as a result of recognizing the premium expense and the fair value of the forward contract.500 $57. The fair value of the forward contract is the present value of $2. A The krona is selling at a premium in the forward market.500 $60. C The 10 million won receivable has changed in dollar value from $35.000 at 12/1/09 to $33. 2009 is a positive $2.50]. B The nominal value of the forward contract on December 31.0032 x 10 million).000 ($.000 $7. Inc.10) x 500.941. The forward contract must be reported at its fair value discounted for two months at 12% [($.500 © The McGraw-Hill Companies. 2009.901..000 $10. 11.000 $2.500 2.042 per ringgit but could have locked-in to purchase ringgits at $0.

70 Firm Commitment [($.30 $980. D The easiest way to solve problems 15 and 16 is to prepare journal entries for the option fair value hedge and the firm commitment. The journal entries are as follows: 9/1/09 Foreign Currency Option Cash 12/31/09 Foreign Currency Option Gain on Foreign Currency Option Loss on Firm Commitment Firm Commitment [($..30) 3/1/10 Foreign Currency Option Gain on Foreign Currency Option $700 $700 Loss on Firm Commitment $2. 9/e © The McGraw-Hill Companies. 2009 9-7 .000 $2.000 – $980. Inc.00 (980. Schaefer.70 $77.14.80) x 100.000 = $3.019.30) $(680.019.77 – $.30 $300.30 = $2.000 $300 $300 $980.000 3. C This is a cash flow hedge of a forecasted transaction.000 $3. B 16. Doupnik.30] Net impact on 2009 net income: Gain on Foreign Currency Option Loss on Firm Commitment $2.000 McGraw-Hill/Irwin Hoyle. The original cost of the option is recognized as an Option Expense over the life of the option.70] Foreign Currency (C$) Sales Cash Foreign Currency (C$) Foreign Currency Option Firm Commitment Adjustment to Net Income $77.80) x 100.000 $3.000 $77.000 x . 15.9803 = $980.79 – $.019. Advanced Accounting.000 $2.000 $80.000 = $1.

.77) Net increase in cash inflow 18 and 19. $78.250 $1.30 17.00 $78.16.000 $ 1.00 3.00 (2.250 McGraw-Hill/Irwin 9-8 © The McGraw-Hill Companies. The journal entries are as follows: 3/1 3/31 no journal entries Forward Contract Gain on Forward Contract ($1.250 – $0) Loss on Firm Commitment Firm Commitment Net impact on first quarter net income is $0. B Net cash inflow with option ($80.250 $1.000 – $2. (continued) Net impact on 2010 net income: Gain on Foreign Currency Option Loss on Firm Commitment Sales Adjustment to Net Income $ 700. $1. 2009 Solutions Manual .250 $1.000) Cash inflow without option (at spot rate of $.000.019.680.70) 77.000 77.000.000 The easiest way to solve problems 18 and 19 is to prepare journal entries for the forward contract fair value hedge of a firm commitment. Inc.

.000 1.000 $59. 2009 9-9 . (continued) 4/30 Loss on Forward Contract Forward Contract [Fair value of forward contract is ($. A 19.000.000 pesos x $.120 – $. Advanced Accounting. Inc.250 = $250] Firm Commitment Gain on Firm Commitment Foreign Currency (pesos) Sales [500. Doupnik.000 = $60.000 Net increase in cash flow from forward contract $ 1.18 and 19.118) x 500. B Cash inflow with forward contract [500.118] 59. 18.000 = $1.000 $1.000 – Loss on Forward Contract $250 + Gain on Firm Commitment $250 + Adjustment to Net Income $1.000 Net impact on second quarter net income is: Sales $59. $1.000 pesos x $.120] Foreign Currency (pesos) Forward Contract Firm Commitment Adjustment to Net Income $250 $250 $250 $250 $59.000 $1.000 – $1.000 pesos x $.000 $59.000 $60.000 McGraw-Hill/Irwin Hoyle.000 Cash inflow without forward contract [500. 9/e © The McGraw-Hill Companies. C 20.118] Cash [500.12] $60. Schaefer.000 x $.000.

500 – $1.000 x $.) Option Expense decreases net income by $400.100. Inc. and write-up option to fair value ($.000 McGraw-Hill/Irwin 9-10 © The McGraw-Hill Companies.000 $2.) Foreign Currency (BRL) [200. 2/1/10 Option Expense $1.000 – $1. The easiest way to solve problems 21 and 22 is to prepare journal entries for the option cash flow hedge of a forecasted transaction.100 – $0 = $1.100 = $900. The journal entries are as follows: 11/1/09 Foreign Currency Option Cash $1. 2009 Solutions Manual .21 and 22.100 Foreign Currency Option 900 Accumulated Other Comprehensive Income (AOCI) (Record expense for the decrease in time value of the option.500 $1. $1.000 x $.000 $2..000 $82. The decrease in time value of the option is recognized as an expense in net income.500 12/31/09 Option Expense $400 Foreign Currency Option $400 (The option has no intrinsic value at 12/31/09 so the entire change in fair value is due to a change in time value.40 – $.000 $2.000 $82.100 = $400 decrease in time value.40] Foreign Currency Option Parts Inventory (Cost-of-Goods-Sold) Foreign Currency (BRL) Accumulated Other Comprehensive Income (AOCI) Adjustment to Net Income $82.000 2.000 = $2.41] Cash [200. $1.41) x 200.000 $80.

000 $37. (10 minutes) (Foreign Currency Sale/Receivable) 9/15 Accounts Receivable (FCU) [100.000 x $.560 foreign exchange loss in 2010.40)] Foreign Exchange Loss Accounts Receivable (FCU) [100.000 9/30 10/15 $5.359 = $21.000 x $. Inc.37 – $..000 x ($.000 (50.000 x .000 foreign exchange loss in 2010.100) Cost-of-Goods-Sold (82. Advanced Accounting. The increase in the dollar value of the LCU payable from December 31 ($19.333 = $19.980) is recorded as a $720 foreign exchange gain in 2009.345 = $20.100) 21.540) is recorded as a $1. Schaefer. (10 minutes) (Foreign Currency Purchase/Payable) The decrease in the dollar value of the LCU payable from November 1 (60.42)] Cash Accounts Receivable (FCU) $40.500 in 2009.02) at December 31.000) Adjustment to Net Income 2.000 $37.000 at December 31 to $49. (10 minutes) (Foreign Currency Sale/Receivable) The ostra receivable decreases in dollar value from (50. The further decrease in dollar value of the ostra receivable from $51. (continued) Net impact on 2010 net income: Option Expense $ (1.000 x $1. 25. C 23.21 and 22. B 22. 24.000 $5.500 at December 20 to $51.700) to December 31 (60. resulting in a foreign exchange loss of $1.000 x . Doupnik.980) to January 15 (60.98) at January 10 results in an additional $2.000 x ($.05) $52.40] Sales Accounts Receivable (FCU) Foreign exchange Gain [100.000 Decrease in Net Income $ (81.000 (50. 2009 9-11 .000 McGraw-Hill/Irwin Hoyle.000 $2. 9/e © The McGraw-Hill Companies.000 $2.42 – $.000 $40.000 x $1.000 x .

......000 – 40..............17]..000 x ($..800 12/31/09 Accounts Payable (LCU) [60...000 x ($.......000 pesos x 60% x $. Cash is reported at the spot rate when collected and the spot rate when paid..........000 27.....21] ........000 = 5.........000 pesos x $.... $1.600 McGraw-Hill/Irwin 9-12 © The McGraw-Hill Companies......600 Foreign Exchange Gain 1/28/10 Foreign Exchange Loss $4..82)] Accounts payable (LCU) Cash $54... $8. Dollar Balance for Foreign Currency Transactions) Inventory and Cost of Goods Sold are reported at the spot rate at the date the inventory was purchased.050 Accounts Payable [50...........................82 – $......800 $54.....100 Accounts Receivable [45......000 x $..... Sales are reported at the spot rate at the date of sale.000 pesos x $.......000 x $....600 $4..........000 x $.........................000 = 20....19) – (30..21] ...000 pesos x 40% x $............... Inventory [50...................... (15 minutes) (Determine U...... Accounts Receivable and Accounts Payable are reported at the spot rate at the balance sheet date............. Inc..........26.800 Accounts Payable (LCU) [60. $3......88)] $3........... $1.....800 $52.000 pesos x $.... (10 minutes) (Foreign Currency Purchase/Payable) 12/1/09 Inventory Accounts Payable (LCU) [60.20)]..S...100 Sales [45..88] $52.....17] .... 2009 Solutions Manual ...... $5..........400 COGS [50......200 Cash [(40....000 – 30..000 $3.....90 – $.18] ....... $4.

47)] Accounts receivable (L) [10.54] Accounts Receivable (L) [10.000 x ($.200 $9.47] Accounts Receivable (L) [40.000 $14.400 600 $10.100 x 2/3] Foreign Exchange Loss [20.600 $17.400 $5.000 x $.44] Accounts Payable (L) Foreign Exchange Loss Cash [40. (25 minutes) (Prepare Journal Entries for Foreign Currency Transactions) 2/1/09 Equipment Accounts Payable (L) [40.000 $500 $500 $400 $400 $5.600 400 $18.52] Foreign Exchange Gain Accounts Payable (L) [10.200 x 3/4] Foreign Exchange Gain Accounts Payable (L) [$14.700 $14.000 x $. 9/e © The McGraw-Hill Companies.500 4/1/09 6/1/09 8/1/09 11/1/09 12/31/09 Foreign Exchange Loss Accounts Payable (L) [10..000 x $.50] $17.000 x $.000 x $.200 $19.48] Sales Cost of Goods Sold Inventory [$14.55] 3/1/10 McGraw-Hill/Irwin Hoyle.200 300 $5.47)] Cash [20.400 300 $9.000 x $.000 x ($.48)] Foreign Exchange Gain 2/1/10 Cash [10.52 – $.52] Foreign Exchange Loss Cash [10. Schaefer.870 $14.870 $9. Inc.49] Accounts Receivable (L) [$19.100 $14.000 x $.100 $19. Advanced Accounting. Doupnik.52 – $.100 x 70%] 10/1/09 Cash [30.000 x $.200 200 $5.000 x $.45] Inventory Accounts Payable (L) [30.600 $17. 2009 9-13 .50 – $.28.000 x ($.000 x $.

46).800 – $70. By March 1. when the liability is paid. The increase in the dollar value of the liability creates a foreign exchange loss of $6. the liability had a dollar value of $70.000.200 ($70.000 x $. 2009 Solutions Manual . has a liability of AL 160.000 – $76.000 x $.48). The drop in the dollar value of the liability creates a foreign exchange gain of $3. Inc.400 (AL 160. On the date that this liability was created (September 1.000. Inc.000 x $.600 (AL 160. Inc. the dollar value has risen to $76.48). 2009).45) creating a foreign exchange gain of $4. On the date that this liability was created (December 1.44).400 – $73.400 (AL 160.800 – $73.46).000 (AL 160. has a liability of AL 160.200 ($76. On December 1. 2009. By March 1. McGraw-Hill/Irwin 9-14 © The McGraw-Hill Companies.000 x $.800 ($72.000 x $. 2009).600) in 2009. (20 minutes) (Determine Income Effect of Foreign Currency Purchase/Payable) a.800) to be reported in 2010.000 x $. b. The increase in the dollar value of the liability creates a foreign exchange loss of $3.000 (AL 160.400 ($76. when the liability is paid.45) creating a foreign exchange gain of $4. 2009). the liability had a dollar value of $73. 2010..000 – $76.800 (AL 160. On December 31.800 ($72. the liability had a dollar value of $73.000. On the date that this liability was created (September 1.600 (AL 160.800 (AL 160.000 x $. Benjamin. the dollar value has decreased to $70.800) to be reported in 2010.29.400) in 2009. Benjamin. the dollar value has dropped to $72. 2009. c. the dollar value has dropped to $72. Inc.000 x $. On December 31. 2010. when the liability is paid. has a liability of AL 160.44). the dollar value has risen to $76. Benjamin. 2009.600) in 2009.

10] (To record the note and conversion of 1 million dudeks into $ at the spot rate.12 – $.) $100. Doupnik.105 and record a foreign exchange loss.000 dudeks x ($. 9/30/09 Cash $100.000 Note Payable (dudek) [1 m x ($. Schaefer. record interest expense for the period 1/1 – 9/30/10.30.800 Interest Payable (dudek) 525 Foreign Exchange Loss [5.105)] 75 Cash [20.000 Note payable (dudek) [1 m x ($.000.125] (To accrue interest for the period 9/30 – 12/31/10.. 9/e © The McGraw-Hill Companies. and record a foreign exchange loss on the interest payable accrued at 12/31/09.000 dudeks x $. Advanced Accounting.000 x 2% x 3/12 = 5.000 12/31/09 Interest Expense $525 Interest Payable (dudek) [1.000 dudeks x $. (30 minutes) (Foreign Currency Borrowing) a.125 – $.105 spot rate] (To accrue interest for the period 9/30 – 12/31/09.12] (To record the first annual interest payment.400 12/31/10 Interest Expense $625 Interest Payable (dudek) [5.000 dudeks x $.105)] (To revalue the note payable at the spot rate of $.000 x $. 2009 9-15 .105 – $.12] $1.000 Note Payable (dudek) [1.000 dudeks x $.) $625 $20.000 $2.) 9/30/10 Interest Expense [15.) Foreign Exchange Loss $5.000 McGraw-Hill/Irwin Hoyle. Inc.10)] (To revalue the note payable at the spot rate of $.) $525 $5.) Foreign Exchange Loss $20.125 and record a foreign exchange loss.000.

250 25.525 / $100.15] (To record payment of the 1 million dudek note.000 dudeks x ($.375 / $100.5%. and record a foreign exchange loss on the interest payable accrued at 12/31/10.250 Interest Payable (dudek) 625 Foreign Exchange Loss [5. McGraw-Hill/Irwin 9-16 © The McGraw-Hill Companies.15] (To record the second annual interest payment. (continued) 9/30/11 Interest Expense [15.000 dudeks x $.000 dudeks x $.000 Cash [1 m dudeks x $. Inc.1% for 12 months $2.000 b.) $3.5% for 12 months Because of appreciation in the value of the dudek.525% for 3 months = = 22.125)] 125 Cash [20.000 Foreign Exchange Loss 25. record interest expense for the period 1/1 – 9/30/11.125 $27.) Note Payable (dudek) $125.000 = 22.000 = 27.5% for 12 months $2.500 / $100. 2009 Solutions Manual .000 = 5.15] $2.30.000 $5. the effective annual borrowing costs range from 22.15 – $. The effective cost of borrowing can be determined by considering the total interest expense and foreign exchange losses related to the loan and comparing this with the amount borrowed: 2009 Interest expense Foreign exchange loss Total 2010 Interest expense Foreign exchange losses Total 2011 Interest expense Foreign exchange losses Total $525 5.38% for 9 months = 36.000 $150.1% – 36.075 $22.425 20..

000 x $2.000) $ 55.075 – $2..10-$2. this results in an effective borrowing cost of approximately 27.450.000 AOCI $500 Premium Revenue [20.000 $155.500 x 1/3 = $500] $500 McGraw-Hill/Irwin Hoyle. Schaefer. 12/31/09 Accounts Receivable (K) Foreign Exchange Gain [20. 9/e © The McGraw-Hill Companies.00] Sales No entry for the forward contract. (40 minutes) (Forward Contract Hedge of Foreign Currency Receivable) a.450.000 x ($2. Advanced Accounting.500 x .00) = $1.75 [20.75 Forward Contract $2.4% over two years / 2 years = 27.000 $40.000 = 55.00)] $2.000 AOCI $2.9803 = $2.400 + $3.400 / $100.000) Principal $5.20) = $2. 2009 9-17 . Doupnik. 31.000 $2.000 x ($2.400 150. Cash Flow Hedge 12/1/09 Accounts Receivable (K) [20.000 x ($2.75] Loss on Forward Contract AOCI $2.000 $2. (continued) The net cash flow from this borrowing is: Cash outflows: Interest ($2. Inc.075 – $2.7% per year].400 Ignoring compounding.400 Cash inflow: Borrowing Net cash outflow (100.450.30.000 $40.7% per year [$55.

000 Impact on net income over both periods: $40.000 (2.000 (3.500 3. McGraw-Hill/Irwin 9-18 © The McGraw-Hill Companies.25] Accounts Receivable (K) Cash [20.500 + $1. (continued) Impact on 2009 income: Sales Foreign Exchange Gain Loss on Forward Contract Premium Revenue Total 3/1/10 $40.000) 500 $40.450.31.049.000 $1.000 x $2.000 x $2.049.25 Loss on Forward Contract AOCI AOCI Premium Revenue [$1.000 $1.075) = $3.000 $3.000 $3.000 $45.500 $45.500 x 2/3 = $1.500 – 2.000 $41.000 = $(41.000 x ($2.000 Accounts Receivable (K) Foreign Exchange Gain [20.000 x ($2.500). 2009 Solutions Manual . equal to cash inflow.000 2.075] Forward Contract Foreign Currency (K) Impact on 2010 income: Foreign Exchange Gain Loss on Forward Contract Premium Revenue Total $3.000] Foreign Currency (K) [20.75] = $1.25 – $2.000 $1.500 $3.049.000 $45. Inc.25 – $2.000 $3..25 [20.25 Forward Contract $1.000) 1.10)] AOCI $1.

000 x $2.75) $39.000 Loss on Forward Contract $2..9803 = $2.500.25] Foreign Currency (K) [20.000.000 x $2. Fair Value Hedge 12/1/09 Accounts Receivable (K) [20.75] Impact on 2009 income: Sales Foreign exchange gain Loss on forward contract Total 3/1/10 $2.10 – $2. 12/31/09 Accounts Receivable (K) Foreign Exchange Gain [20.500 $45.25) $1.000 $41.00 (2. Advanced Accounting.000 $3.049.25] Accounts Receivable (K) Cash [20.10)] Loss on Forward Contract $1.000 $40.25 Forward Contract $1. (continued) b.75 = $1.450.950.75 Forward contract [20. Inc.000 x (2.075] Forward Contract Foreign Currency (K) Impact on 2010 income: Foreign Exchange Gain Loss on Forward Contract Total $45.000 Accounts Receivable (K) Foreign Exchange Gain [20.75 = $41.000 x ($2.075) = $3.25 $3.31.25 – $2.000 x ($2.549.000.000.000 $3.000 $45.450.500 3.049.75 $40.75 Impact on net income over both periods: $39.950. equal to cash inflow.049. Doupnik. McGraw-Hill/Irwin Hoyle.500 – 2.00 (1.000 x $2.000 x ($2.000 $2.049.000 $40.00] Sales No entry for the forward contract. 9/e © The McGraw-Hill Companies. 2009 9-19 .00)] $2.549.075 – $2. Schaefer.450.25 + $1.450.25 [20.450.00 2.20) = $2.500 x .25 – $2.

450.10 – $2.75 AOCI $2. Inc.500) McGraw-Hill/Irwin 9-20 © The McGraw-Hill Companies.500 x 1/3 = $500] Impact on 2009 income: Parts Inventory (COGS) Foreign Exchange Loss Gain on forward contract Premium Expense Total $500 $(40..000 Premium Expense $500 AOCI [20.075 – $2.00)] $2.000 Forward Contract $2.00) = $1.500 x .000 $2.32.000 $2. Cash Flow Hedge 12/1/09 Parts Inventory (COGS) Accounts Payable (K) [20.000 $40.000 x $2.450.000 x ($2.000) (2.20) = $2. 12/31/09 Foreign Exchange Loss Accounts Payable (K) [20.075 – $2.000 x ($2.000 $40.75 [20. 2009 Solutions Manual .000 (500) $(40. (40 minutes) (Forward Contract Hedge of Foreign Currency Payable) a.00] No entry for the Forward Contract.9803 = $2.75] AOCI Gain on Forward Contract $2.450.000 x ($2.000) 2.

000) Impact on net income over both periods: $(40.000 $1.000 $3.25 [20. (continued) 3/1/10 Foreign Exchange Loss Accounts Payable (K) [20.000 (1.000 $(3.25 – $2.000) $(1.10)] $3.049.000] Foreign Currency (K) [20.500) + $(1.25 AOCI $1.500 3.000 $41. 9/e © The McGraw-Hill Companies.25] AOCI Gain on Forward Contract Premium Expense AOCI [$1.000) 3. Inc.25 – $2. McGraw-Hill/Irwin Hoyle.75 = $1..000 x ($2.500 $45.075) = $3.450.000) = $(41.500 x 2/3 = $1. 2009 9-21 .32.000 x ($2.000 $1.049. Schaefer.000 x $2. Advanced Accounting. Doupnik.000 $45.500 – 2.000 $45.25] Cash Forward Contract Accounts Payable (K) Foreign currency (K) Impact on 2010 income: Foreign Exchange Loss Loss on Forward Contract Premium revenue Total $3.049.500).000 Forward Contract $1. equal to cash outflow.000 $3.

25) 3/1/10 Foreign Exchange Loss Accounts Payable (K) [20.500 x .000 Forward Contract $2.75 Gain on Forward Contract $2. Inc.500 – 2.000.75 $(39.25 – $2.049.10)] $3.450. 2009 Solutions Manual .000 x ($2.00) 2.049.000 $40.549.000 McGraw-Hill/Irwin 9-22 © The McGraw-Hill Companies.500 3.049.450.000 x $2.00)] $2.25 Gain on Forward Contract $1.500 $45.9803 = $2. 12/31/09 Foreign Exchange Loss Accounts Payable (K) [20. Fair Value Hedge 12/1/09 Parts Inventory (COGS) Accounts Payable (K) [20.00) (2.25 – $2. (continued) b.25] Cash Forward Contract Accounts Payable (K) Foreign currency (K) $45.000 x ($2.75 [20.450.075) = $3.25] Foreign Currency (K) [20.32.000 $2.000 $41.450.000 Forward Contract $1.75 = $1.000 $40..450.000.000 $3.00] No entry for the forward contract.000 x ($2.075 – $2.10 – $2.75] Impact on 2009 income: Parts Inventory (COGS) Foreign Exchange Loss Gain on forward contract Total $(40.20) = $2.000 $45.25 [20.000 x ($2.000 x $2.

549.950.25 $(1. Cash Flow Hedge 6/1 Accounts Receivable (P) Sales [$.500.75) = $(41.000 $1. Doupnik.000 Time Value $2. 33.0020) x 1.000 Intrinsic Value $0 $0 $1.045) x 1.000.0018 – $.000 $3..000 $2. (30 minutes) (Option Hedge of Foreign Currency Receivable) a.048 – $. 9/e © The McGraw-Hill Companies. equal to cash outflow.049.75) Impact on net income over both periods: $(39.800 $1.000 $1. Advanced Accounting. Inc.00). 2009 9-23 .000.000 $200 $200 Change in Time Value – –$ 200 –$1.000.000] Loss on Foreign Currency Option Accumulated Other Comprehensive Income (AOCI) Option Expense Accumulated Other Comprehensive Income (AOCI) Date 6/1 6/30 9/1 Fair Value $2.000 $200 $200 $3.25) + $(1. (continued) Impact on 2010 income: Foreign Exchange Loss Gain on Forward Contract Total $(3.000 $3.000.045 x 1.000 $45.000 $3.000] Accumulated Other Comprehensive Income (AOCI) Foreign Currency Option [($.950.00) 1.000 pesos] Foreign Currency Option Cash 6/30 Accounts Receivable (P) Foreign Exchange Gain [($.000 $2. Schaefer.32.800 McGraw-Hill/Irwin Hoyle.800 $0 $45.

800 Accumulated Other Comprehensive Income (AOCI) (Change in time value of option recognized as expense) Foreign Currency (P) Accounts Receivable (P) Cash Foreign Currency (P) Foreign Currency Option $44.000.000] Accumulated Other Comprehensive Income (AOCI) Foreign Currency Option [$1.045) x 1. Net increase in cash is $43.000 $1.000 and Option Expense is $2.000 Over the two accounting periods.800 $44.048) x 1.045 x 1.000 $800 $800 $4. 2009 Solutions Manual .000 $1.000 $44.000 $3.000 $2.800 – $1.33.000.000] Loss on Foreign Currency Option Foreign Currency Option $45.000.000 $45. Inc.000] Foreign Currency Option Cash 6/30 Accounts Receivable (P) Foreign Exchange Gain [($. Fair Value Hedge 6/1 Accounts Receivable (P) Sales [$.000 $3. b.000.000.044 – $.000 Option Expense $1.000 $4. (continued) 9/1 Foreign Exchange Loss Accounts Receivable (P) [($.048 – $..000 $2.000 $45. Sales are $45.000 $4.000] Accumulated Other Comprehensive Income (AOCI) Gain on Foreign Currency Option $4.000 $200 $200 McGraw-Hill/Irwin 9-24 © The McGraw-Hill Companies.

000 $800 $800 $44.33.000 $4.000 $44. Doupnik. Inc.000) = Net cash inflow Impact on Net Income $43.000 $44.000.048) x 1.044 – $.000 Foreign Exchange Loss (4.000 Impact on Net Income over the Two Accounting Periods: Sales $45.000) Loss on Foreign Currency Option (1. Advanced Accounting.000 McGraw-Hill/Irwin Hoyle.000 $45. 2009 9-25 . 9/e © The McGraw-Hill Companies.000 $1. (continued) 9/1 Foreign Exchange Loss Accounts Receivable (P) [($. Schaefer.000 Foreign Exchange Gain 3.000] Loss on Foreign Currency Option Foreign Currency Option Foreign Currency (P) Accounts Receivable (P) Cash Foreign Currency (P) Foreign Currency Option $4..

085 x 1.000 $0 $85.000** McGraw-Hill/Irwin 9-26 © The McGraw-Hill Companies.000] Foreign Currency Option Accumulated Other Comprehensive Income (AOCI) [$4.000 Intrinsic Value $0 $3.000 $4.000 $2.000 $2.000 $85.000 $3. (30 minutes) (Option Hedge of Foreign Currency Payable) a.000 $5.000 $5.000 Change in Time Value -$1.000 Time Value $2. 2009 Solutions Manual .34.000* -$1.000 $1. Inc.000* $1.000] Accumulated Other Comprehensive Income (AOCI) Gain on Foreign Currency Option Option Expense Accumulated Other Comprehensive Income (AOCI) Date 6/1 6/30 9/1 Fair Value $2.000 – $2.000 $3.000.000 $3.085) x 1.000] Accounts Payable (M) Foreign Currency Option Cash 6/30 Foreign Exchange Loss Accounts Payable (M) [($.000 $2..000 $1.000 $2. Cash Flow Hedge 6/1 Inventory [$.088 – .000.000 $3.

000 $1..000 $87.000 $1.000 $90.000 85. Advanced Accounting.000 McGraw-Hill/Irwin Hoyle.000 $2.000] Foreign Currency Option Accumulated Other Comprehensive Income (AOCI) [$5.000.000 $2.000 $90.000 $2.000 – $4.000** $1. Schaefer. Doupnik. Inc.000 $1.000 $5.000 $90. 9/e © The McGraw-Hill Companies.000 $85. 2009 9-27 .09 – $.088) x 1.000 $ 2.000] Accumulated Other Comprehensive Income (AOCI) Gain on Foreign Currency Option Option Expense Accumulated Other Comprehensive Income (AOCI) Foreign Currency (M) Cash Foreign Currency Option Accounts Payable (M) Foreign Currency (M) Impact on net income: Option Expense Inventory (Cost of Goods Sold) Cash outflow $2. (continued) 9/1 Foreign Exchange Loss Accounts Payable (M) [($.34.

000 $2.000) 85.000.000 $90.000 $85.09 – $. Inc.000. Fair Value Hedge 6/1 Inventory Accounts Payable (M) [$.000 $2. 2009 Solutions Manual .085 x 1.000 $1.000) 3. (continued) b.000 $2.000] Foreign Currency Option Cash 6/30 Foreign Exchange Loss Accounts Payable (M) [($.000 $90.000 $2.000 $1.000 $90.000.000 – $2.000] Foreign Currency Option Gain on Foreign Currency Option [$4.000 $87..000 $2.000 $85.000] Foreign Currency (M) Cash Foreign Currency Option Accounts Payable (M) Foreign currency (M) Impact on net income: Foreign Exchange Loss Gain on Foreign Currency Option Impact on net income Inventory Cash Outflow $85.34.000] 9/1 Foreign Exchange Loss Accounts Payable (M) [($.000] Foreign Currency Option Gain on Foreign Currency Option [$5.000 ($5.085) x 1.000 – $4.088 – $.000 ($2.000 $3.000 $2.000 $3.088) x 1.000 McGraw-Hill/Irwin 9-28 © The McGraw-Hill Companies.000 $5.

000 -$3.000 $3. 12/31/09 Foreign Exchange Loss Accounts Receivable (FCU) Accumulated Other Comprehensive Income (AOCI) Gain on Forward Contract Forward Contract Accumulated Other Comprehensive Income (AOCI) $3.844 $3.0002 . Inc. 9/e © The McGraw-Hill Companies.000.000 = $3.961 = $3.961 is the present value factor for four months at an annual interest rate of 12% (1% per month) calculated as 1/1.33 Accumulated Other Comprehensive Income (AOCI) $333.000 $.48 $49.000 $3. where .844.000 – $48. Advanced Accounting.53 – $. 2 $52. Dollar Change in U.000 x ($.000 -$1.49 Account Receivable (FCU) Forward U. 2009 Journal Entries 11/01/09 Accounts Receivable (FCU) Sales There is no entry for the forward contract.666.000 $3.53 $.$ 844 Date 11/01/09 12/31/09 4/30/10 1 $52.35.S.50 $.000 = $(4.000 $.000. (30 minutes) (Forward Contract Cash Flow Hedge of Foreign Currency Denominated Asset) Spot Rate $.000.000 Discount Expense $333.844 +$3.000 x 2/6 = $333.000 $.00 0.52 $50. Rate to Value Dollar Value 4/30/10 $53.000 $3.000 $53.014.000) x .52) = $1.49 Forward Contract Change in Fair Value Fair Value $0 1 $3.33] The impact on net income for the year 2009 is: Sales Foreign Exchange Loss Gain on Forward Contract Net gain (loss) Discount Expense Impact on net income $53.67 McGraw-Hill/Irwin Hoyle. Doupnik.33) $52.000 – $49.844 $3.00 (3.000.844 $53.S.00 (333.00) 3.33 [100. Schaefer. 2009 9-29 ..

00) 1.67 Foreign Currency (FCU) Accounts Receivable (FCU) Cash Foreign Currency (FCU) Forward Contract The impact on net income for the year 2010 is: Foreign Exchange Loss Gain on Forward Contract Net gain (loss) Discount Expense Impact on net income $(1.000 $49.00 (666.67) $(666.000.000 $1. (continued) 2010 Journal Entries 4/30/10 Foreign Exchange Loss Accounts Receivable (FCU) Accumulated Other Comprehensive Income (AOCI) Gain on Forward Contract Accumulated Other Comprehensive Income (AOCI) Forward Contract $1.00 0.67 Accumulated Other Comprehensive Income (AOCI) $666.000.000 $844 $844 Discount Expense $666. Inc.35. 2009 Solutions Manual .000 $52.000 $1.000 McGraw-Hill/Irwin 9-30 © The McGraw-Hill Companies.000 $3.000 $1.67) $49..000 $49.

.000 $265.000 $9.000 mongs] There is no formal entry for the Forward Contract.000 $15.0002 .000) $. Inc.000 (-$9.000 $7.000) $.52 12/31/09 $250. 12/31 Foreign Exchange Loss Accounts Receivable (mongs) Accounts Payable (mongs) Foreign Exchange Gain Forward Contract Gain on Forward Contract The impact on net income for the year 2009 is: Sales Net Foreign Exchange Loss $ (6.000.9901 is the present value factor for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.$1.921 $7. Schaefer.000 (-$3. Advanced Accounting. Dollar Value Dollar Value 1/31/10 11/30/09 $265.000 ($147.000 $15.000 – $98.48 1/31/10 $245.921.S.921 $265. 2009 9-31 .36.921 Net gain (loss) Impact on net income $265. (30 minutes) (Forward Contract Fair Value Hedge of Net Foreign Currency Denominated Asset) Account Receivable (Payable) (mongs) Forward Change in U.000 $159.000 $9.9901 = $7.921 +$7.000 – $96. Doupnik.000 = $(8.53 x 300. where .921 McGraw-Hill/Irwin Hoyle.S. 2009 Journal Entries 11/30 Accounts Receivable (mongs) Sales [$.921 $6.53 x 500.921 $266. 9/e © The McGraw-Hill Companies.000) Gain on Forward Contract 7.000 $159.000) -$15.49 1 Forward Contract Change in Fair Value Fair Value $0 1 $7.000) x .000 ($150.000) $.000 = $6.000 ($159.000 mongs] Inventory Accounts Payable [$. 2 $104.921 $104.01. Rate to Date U.000 1.000) -$ 5.

(continued) 2010 Journal Entries 1/31 Foreign Exchange Loss Accounts Receivable (mongs) Accounts Payable (mongs) Foreign Exchange Gain Loss on Forward Contract Forward Contract Foreign Currency (mongs) Accounts Receivable (mongs) Accounts Payable (mongs) Foreign Currency (mongs) Cash Foreign Currency (mongs) Forward Contract The impact on net income for the year 2010 is: Net Foreign Exchange Loss Loss on Forward Contract Impact on net income $(2.000 $245.000 ($266.000 $3.921 – $3..921) $5.000 $1.921 $245.921) $(3.000 $6.36.000 $98. Inc. 2009 Solutions Manual . McGraw-Hill/Irwin 9-32 © The McGraw-Hill Companies.000 $5.921 $1.000 with a corresponding increase in retained earnings of $263.000 and an increase in inventory of $159.921).000 $104.000 $147.000 The net effect on the balance sheet is an increase in cash of $104.000 $3.000 $147.000) (1.

Schaefer. Inc.000 $69.000 LCUs x $.000 x .000 $7.00 (8.000 $72.9901 = $ 8.65) x 100.71 – $. Foreign Currency Receivable 10/01 Accounts Receivable (LCU) Sales (100. 9/e © The McGraw-Hill Companies.000 = $ 9.000] $2.90] 1/31 Accounts Receivable (LCU) Foreign Exchange Gain [($.910.90 [($.000 There is no formal entry for the forward contract.000 loss – 8.90 $65.000] $1.000.000 McGraw-Hill/Irwin Hoyle.90 $1.90 Gain on Forward Contract $ 1. 12/31 Accounts Receivable (LCU) Foreign Exchange Gain [($.000 $8. 2009 9-33 ..69) $69.71) x 100. Advanced Accounting.000 Loss on Forward Contract $8.90 gain] Foreign Currency (LCU) Accounts Receivable (LCU) Cash Forward Contract Foreign Currency (LCU) The impact on net income: Sale Foreign Exchange Gain Loss on Forward Contract Gain on Forward Contract Impact on net income $69.910.000 $65.910.000 = $ 7.910.000. (40 minutes) (Forward Contract Fair Value Hedge) a.000 Forward Contract $ 1.90 Forward Contract [($.90) 1.72 – $. Doupnik.000 $72.910.000.00 = Cash Inflow $72.910.910.37.69) x 100.74 – $.72 – $.65) x 100.90 = $ 1.000 $2.00 3.910.910.

90 $8.000) $65.000 $72.000 $7.37.910.910.910.000 Impact on Net Income: Sales Net loss on Forward Contract Net gain on Firm Commitment Adjustment to Net Income $72.90 $1. Loss on Forward Contract Forward Contract Firm Commitment Gain on Firm Commitment $8.90 12/31 1/31 Forward Contract Gain on Forward Contract Loss on Firm Commitment Firm Commitment Foreign Currency (LCU) Sales Cash Forward Contract Foreign Currency (LCU) Adjustment to Net Income Firm Commitment $1. Inc. 2009 Solutions Manual ..000 (7.90 $1.90 $1.90 $8.910.000) 7.90 $72.000 = Cash Inflow McGraw-Hill/Irwin 9-34 © The McGraw-Hill Companies.000 $72.000 $7.910.000 $65.000 $7.910.90 $8.910. (continued) b.000 (7. Foreign Currency Firm Sales Commitment 10/01 There is no entry to record either the sales agreement or the forward contract as both are executory contracts.910.

8/1 There is no entry to record either the purchase agreement or the forward contract as both are executory contracts. (30 minutes) (Forward Contract Fair Value Hedge of a Foreign Currency Firm Purchase Commitment) Forward Rate to 10/31 $.000) McGraw-Hill/Irwin Hoyle.50 $4.000 $(60.30 $. Inc.950.325 $.50) – $4.000)2 + $ 950.320 (spot) Forward Contract Change in Fair Value Fair Value $0 1 $4.000 4.9901 is the present value factor for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.50 $950. 9/e © The McGraw-Hill Companies.38.000) = $5.000 – $60.0002 – $ 950.950.50 $4.50 Firm Commitment Change in Fair Value Fair Value $0 $0 1 $(4.950. where .000 $4. Schaefer. 2009 9-35 .000 – $60.50 $950..000.000) = $4.50 $4.50 Date 8/1 9/30 10/31 1 ($65.5. Forward Contract Gain on Forward Contract Loss on Firm Commitment Firm Commitment $4.000 x .000 9/30 10/31 Loss on Forward Contract Forward Contract Firm Commitment Gain on Firm Commitment Foreign Currency (rupees) Cash Forward Contract Inventories (Cost-of-goods-sold) Foreign Currency (rupees) Firm Commitment Adjustment to Net Income The net cash outflow is $60. Assuming the inventory is sold in the fourth quarter.950.950.50 + $4.000 $4.000: Cost of goods sold Adjustment to net income Net impact on net income $(64. the net impact on net income is negative $60.50 $64.50 $950.950. Doupnik.50 $4.950.000 $64.950.950.50 $950.50 $(4.000) 4.000 $60.9901 = $4.000 $64.000. Advanced Accounting. 2 ($64.01.

6/1 Foreign Currency Option Cash There is no entry to record the sales agreement because it is an executory contract.000 = $(15.50 2 $(15.901.50)1 – $ 4.000 + $7.000 – $500.901.000) – $10. $5.50) McGraw-Hill/Irwin 9-36 © The McGraw-Hill Companies. (30 minutes) (Option Fair Value Hedge of a Foreign Currency Firm Sale Commitment) Spot Rate Firm Commitment Change in Fair Value Fair Value Option Premium for 9/1 Option Change in Fair Value Fair Value Date 6/1 6/30 9/1 1 $1..000 $5.99 $0.000 + $3.9803 = $(4.010 $0. where .97 $( 4. Inc.901.000 $3.00 $(1.5).50 $3.901.50 $4.39.000 = $(5.000. 2 $485.50) 3.9803 is the present value factor for two months at an annual interest rate of 12% (1% per month) calculated as 1/1.000 $15.000).016 $0.901.000 6/30 Loss on Firm Commitment Firm Commitment Foreign Currency Option Gain on Foreign Currency Option $4.000) x .901.000 – $500.00 $0.000 $495.098.50 $0. 2009 Solutions Manual .012.030 $5.000 $8.901.000 The impact on net income for the second quarter is: Loss on Firm Commitment Gain on Foreign Currency Option Impact on net income $(4.

901. 2009 9-37 .50 $10.50 $7.50) 7. Inc.901. Doupnik. (continued) 9/1 Loss on Firm Commitment Firm Commitment Foreign Currency Option Gain on Foreign Currency Option Foreign Currency (lek) Sales Cash Foreign Currency (lek) Foreign Currency Option Firm Commitment Adjustment to Net Income The impact on net income for the third quarter is: Sales Loss on Firm Commitment Gain on Foreign Currency Option Adjustment to Net Income Impact on net income $485.000 ($496.000.00 (10.000 – $5.098.000 $15.000 $500.000 The impact on net income over the second and third quarters is: $495.000 = $495.000 $485.00 $496.000.098.000 $7..000 $485.50 $10.098.39.000 15.000.000 $485. Advanced Accounting.000 McGraw-Hill/Irwin Hoyle. 9/e © The McGraw-Hill Companies.000 $15. Schaefer.50) The net cash inflow resulting from the sale is: $500.00 15.901.50 – $1.

21 b) 12/20 $.000 $400 $500 $0 + $100 – $400 $10.18. 3 The premium on 12/20 for an option that expires on that date is equal to the option’s intrinsic value.20 has no intrinsic value – the premium on 12/20 is $.21.500 $500 Firm Commitment $500 Adjustment to Net Income (Note that this last entry is not made until the period when the parts inventory affects net income through cost of goods sold. Inc.000 500 $10. Big Arber will exercise its option.000 – $10. $10. Given the spot rate on 12/20 of $. The option strike price ($.000..000 – $500 + $1.008 $. the date the parts are to be paid for.000 – $9. The journal entries are as follows: 11/20 Foreign Currency Option Cash $400 $400 There is no entry to record the purchase agreement because it is an executory contract. 4 The premium on 12/20 for an option that expires on that date is equal to the option’s intrinsic value. (20 minutes) (Option Fair Value Hedge of a Foreign Currency Firm Purchase Commitment) Spot Rate Firm Commitment Change in Fair Value Fair Value Option Premium for 12/20 Option Change in Fair Value Fair Value Date 11/20 $.500 $10.500 $10.) McGraw-Hill/Irwin 9-38 © The McGraw-Hill Companies.000 = $1.21) on December 20. Therefore.500 = $(500). a call option with a strike price of $. a.20) is less than the spot rate ($.20 has an intrinsic value of $. 2009 Solutions Manual .18 1 2 $(500)1 2 $1.000 $. a call option with a strike price of $.000.01 per mark. Given the spot rate on 12/20 of $. 12/20 Loss on Firm Commitment Firm Commitment Foreign Currency Option Gain on Foreign Currency Option Foreign Currency (pijio) Cash Foreign Currency Option Parts Inventory Foreign Currency (pijio) $500 $500 $100 $100 $10.40.0103 4 $.20 a) 12/20 $.

Advanced Accounting. Big Arber will allow the option to expire unexercised.000 $9.000 $9.000 Firm Commitment (Note that this last entry is not made until the period when the parts inventory affects net income through cost of goods sold.) McGraw-Hill/Irwin Hoyle. Therefore. 9/e © The McGraw-Hill Companies. The option strike price ($.20) is greater than the spot rate ($. Doupnik..18) on December 20. 2009 9-39 .000 $400 $400 $9.40. The journal entries are as follows: 11/20 Foreign Currency Option Cash $400 $400 There is no entry to record the purchase agreement because it is an executory contract. Foreign currency will be acquired at the spot rate on December 20. 12/20 Firm Commitment Gain on Firm Commitment Loss on Foreign Currency Option Foreign Currency Option Foreign Currency (pijio) Cash Parts Inventory Foreign Currency (pijio) $1. (continued) b. Schaefer.000 $9.000 $1. Inc.000 Adjustment to Net Income $1.000 $1. the date the parts are to be paid for.

000 Foreign Currency (marks) To record the purchase of parts and payment of 1 million marks to the supplier. [($.000 $5.000] 3/15/10 Foreign Currency Option AOCI To recognize the increase in the value of the foreign currency option with the counterpart recorded in AOCI.000 $4. Option Expense AOCI To recognize the decrease in the time value of the option as expense.58) x 1.000 $2.000.000 $3.41.005] No journal entry related to the forecasted transaction.000 Parts Inventory $590.000 $580. Option Expense $1.000 – $3. (20 minutes) (Option Cash Flow Hedge of Forecasted Transaction) 12/15/09 Foreign Currency Option Cash [1 million marks x $.000 $590..58 and close out the foreign currency option account.000 = $1. $590.000 AOCI To recognize the decrease in the time value of the option as expense. 12/31/09 Foreign Currency Option $3.000 McGraw-Hill/Irwin 9-40 © The McGraw-Hill Companies. Foreign Currency (marks) Cash Foreign Currency Options To record exercise of the foreign currency option at the strike price of $.000 $4. $2. 2009 Solutions Manual . Inc.000 10.584 – $.000 = $4.000 $1.000 AOCI To recognize the increase in the value of the foreign currency option with the counterpart recorded in AOCI.000 $5.

000 $10.000) $(590. Unhedged Foreign Currency Liability 9/15 Inventory Accounts Payable (euro) Foreign Exchange Loss Accounts Payable (euro) Foreign Exchange Loss Accounts Payable (euro) Foreign Currency (euro) Cash Accounts Payable (euro) Foreign Currency (euro) $200. Inc. Forward Contract and Option Hedge of Foreign Currency Firm Commitment) a.000) Net cash outflow for parts: $585.000 $220.000 $200. Forward Contract and Option Hedge of Foreign Currency Liability.41. (60 minutes) (Foreign Currency Transaction.000) (4.000 $10. Advanced Accounting. 9/e © The McGraw-Hill Companies.000 + $580.000) 10.000 $220. (continued) AOCI Adjustment to Net Income To transfer the amount accumulated in AOCI as an adjustment to net income in the period in which the forecasted transaction occurs. Impact on net income: 2009 – Option expense 2010 – Cost of Goods Sold Option Expense Adjustment to Net Income $10.000 $10..000 $10. Schaefer.000 = ($5.000) 42.000 9/30 10/31 McGraw-Hill/Irwin Hoyle. Doupnik.000 $(584.000 $220.000 $220.000 $10. 2009 9-41 .000 $(1.

000 $210.S.000 $200.000 10/31 Foreign Exchange Loss Accounts Payable (euro) Forward Contract Gain on Forward Contract Foreign Currency (euro) Cash Forward Contract Accounts Payable (euro) Foreign Currency (euro) McGraw-Hill/Irwin 9-42 © The McGraw-Hill Companies. where .940.000 $10.40 $220.940.940.9901 is the present value factor for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.000 – $212.000 – $212.60 $10.60 $5.000 Forward Rate to 10/31 $1.000 $10. 9/15 Inventory Accounts Payable (euro) There is no formal entry for the forward contract.000 = $8.06 $1.60 $8.000 $220. Inc.000 $8.059. (continued) b.000 x .000 $2.10 Forward Contract Change in Fair Value Fair Value $0 1 $5.00 $1.000 9/30 Foreign Exchange Loss Accounts Payable (euro) Forward Contract Gain on Forward Contract $10. 2 $220.000 $220.059.000 $220.40 Date 9/15 9/30 10/31 1 $218.000 = $6.9901 = $5.940. Value Dollar Value $200.940.09 $1.000 +$10.05 $1.000.000 $5.002 +$2..10 Accounts Payable (C) U.01.059.40 $2.42. $200.000.000 $212. Dollar Change in U.S. Forward Contract Fair Value Hedge of a Recognized Foreign Currency Liability Spot Rate $1.60 +$5.000 +$10.60. 2009 Solutions Manual .

(continued) c.000 (Note that this last entry is not made until the period when the inventory affects net income through cost of goods sold.) McGraw-Hill/Irwin Hoyle.000 $212..40 $2.000 $220.60 $5.940. 2009 9-43 . 9/e © The McGraw-Hill Companies.000 Adjustment to Net Income $8.940.000 Firm Commitment $8.40 $2. Forward Contract Gain on Forward Contract Loss on Firm Commitment Firm Commitment 10/31 Forward Contract Gain on Forward Contract Loss on Firm Commitment Firm Commitment Foreign Currency (euro) Cash Forward Contract Inventory Foreign Currency (euro) $5. Schaefer.940.40 $2. Doupnik.60 $5.059.059.940.059.000 $220. Advanced Accounting.42. Inc.40 $220. Forward Contract Fair Value Hedge of a Foreign Currency Firm Commitment 9/15 9/30 There is no formal entry for the forward contract or the purchase order.000 $8.60 $2.059.60 $5.

Inventory Accounts Payable (euro) Foreign Currency Option Cash $200.000 $7.42.070 $14.000 $3.0001 2 $4.000 Time Value $7. Inc.000.000 .000 of fair value is attributable to time value.000 $10.000 $20.000 Intrinsic Value $0 2 $10.$3.000 + $6. The remaining $4. Option Cash Flow Hedge of a Recognized Foreign Currency Liability The following schedule summarizes the changes in the components of the fair value of the euro call option with a strike price of $1.035 $7.000 Accumulated Other Comprehensive Income (AOCI) Accumulated Other Comprehensive Income (AOCI) $10.000 $.000 $10.00 for October 31. With a spot rate of $1. Fair value is attributable solely to the time value of the option.05 and a strike price of $1.000 McGraw-Hill/Irwin 9-44 © The McGraw-Hill Companies.000 $7. (continued) d.000 $10.10 1 Option Fair Premium Value $.100 $20. the option has no intrinsic value.000 Change in Time Value .000 $03 2 3 Because the strike price and spot rate are the same. the option has an intrinsic value of $10.000 Accumulated Other Comprehensive Income (AOCI) $7. 2009 Solutions Manual . The time value of the option at maturity is zero.00.00 09/30 $1.000 9/15 9/30 Foreign Exchange Loss Accounts Payable (euro) Foreign Currency Option $7.000 $.000 Gain on Foreign Currency Option Option Expense $3.. Change in Fair Value + $7.$4.000 Spot Date Rate 09/15 $1.05 10/31 $1.000 $200.

000 $20.000 $220.000 McGraw-Hill/Irwin Hoyle.000 $220.000 $4.000 Accumulated Other Comprehensive Income (AOCI) Foreign Currency (euro) Cash Foreign Currency Option Accounts Payable (euro) Foreign Currency (euro) $220.000 $10.000 Gain on Foreign Currency Option Option Expense $4. Inc. 2009 9-45 .42.000 $6. 9/e © The McGraw-Hill Companies. Schaefer.000 Foreign Currency Option $6.000 Accumulated Other Comprehensive Income (AOCI) Accumulated Other Comprehensive Income (AOCI) $10. Advanced Accounting. (continued) 10/31 Foreign Exchange Loss Accounts Payable (euro) $10..000 $10.000 $200. Doupnik.

where .000 $14.901).05 $1.099 $10.9901 = $(9.10 Firm Commitment Change in Fair Value Fair Value $0 $ (9.000 9/30 10/31 Foreign Currency Option Gain on Foreign Currency Option Loss on Firm Commitment Firm Commitment Foreign Currency (euro) Cash Foreign Currency Option Inventory Foreign Currency (euro) Firm Commitment Adjustment to Net Income (Note that this last entry is not made until the period when the inventory affects net income through cost of goods sold.099 $220. Inc.000) –$10.000 $9.901 $6. (continued) e.901) –$ 9.000 +$7.000 – $200. Option Fair Value Hedge of a Foreign Currency Firm Commitment Spot Rate $1.000 $7.901 $9.00 $1.) McGraw-Hill/Irwin 9-46 © The McGraw-Hill Companies..000 $20.9011 $(20. 9/15 Foreign Currency Option Cash Foreign Currency Option Gain on Foreign Currency Option Loss on Firm Commitment Firm Commitment $7.099 Option Premium for 10/31 $.000 $20.9901 is the present value factor for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.000 $7.000 20.000 $20.000 $220.000 +$6.100 Foreign Currency Option Change in Fair Value Fair Value $ 7.000 $200.000 $220.000) x .42.000 $7.070 $.000 Date 9/15 9/30 10/31 1 $210.000 = $(10.000 $10.01. 2009 Solutions Manual .035 $.000 $6.

. Financial Instruments (same disclosure as in MD&A). 2. In Note 15.S.” c. and Japan. 1. IFF provided information in the annual report related to its management of foreign exchange risk in the following locations: a. IFF uses foreign currency forward contracts to reduce exposure to cash flow volatility arising from foreign currency fluctuations associated with certain foreign currency receivables and payables (hedges of foreign currency denominated assets and liabilities) and anticipated purchases of raw materials (hedges of forecasted transactions). The company also uses a Japanese Yen.U. Note 15. Advanced Accounting. In 2005. Dollar swap to hedge monthly sale and purchase transactions between the U. 3. Quantitative and Qualitative Disclosures about Market Risk. b. Item 7. Item 1A. Management Discussion and Analysis of Financial Condition and Results of Operations under “Market Risk. Risk Factors. IFF indicates that the notional amount and maturity dates of its forward contracts match those of the underlying transactions. The following responses are based on IFF’s 2005 annual report. Doupnik. b. 2009 9-47 . Item 7A.S. Inc. Schaefer. 9/e © The McGraw-Hill Companies. McGraw-Hill/Irwin Hoyle.Answers to Develop Your Skills Cases Research Case—International Flavors and Fragrances The responses to this assignment might change over time as the company changes its use of foreign currency derivatives or changes the manner in which it discloses its foreign currency hedging activities in the annual report.

Using the advanced query function in FARS to search for the phrase “forecasted foreign currency transaction” returns two hits: SFAS 131. parent cannot apply hedge accounting for the foreign currency option acquired to hedge the French subsidiary’s foreign exchange risk. The DIG’s response to Issue H4 is that a company may not treat foreigncurrency-denominated fixed-rate interest payments as an unrecognized firm commitment that may be designated as a hedged item in a foreign currency fair value hedge. paragraphs 485 and 487.S. paragraph 487 indicates that for a hedge of a forecasted foreign currency transaction to qualify for hedge accounting. 2. the French subsidiary) must be a party to the hedging transaction. those fixed-rate interest payments could be designated as the hedged transaction in a cash flow hedge. Note: Include the hyphen between currency and denominated and the “s” in payments (plural). Using the advanced query function in FARS to search for the phrase “foreign currency-denominated interest payments” returns two hits.” provides an answer to the question. 2009 Solutions Manual . 2. the U. the component of the entity that has the foreign currency exposure (i. In other words.. FARS Case 2—Foreign Currency-Denominated Debt 1. “Hedging Foreign-CurrencyDenominated Interest Payments. Statement 133 Implementation Issue No. Paragraph 487 provides an answer to the question.. H4. However. McGraw-Hill/Irwin 9-48 © The McGraw-Hill Companies. SFAS 131. Inc.e.FARS Case 1—Hedge of Forecasted Foreign Currency Transaction 1.

700.144092 50.607.000. and 3.84 6.90 7/1/2004 1.40) 8/2/2004 0.93 (27.500 4/1/2004 1.049.400) 8/2/2004 1.085.94) 4/30/2004 0.81) 641.045.200 4/30/2004 0.83 (2.796.163666 56.600) 3/1/2004 0.02) 11/1/2004 1.00) (57.000) 7/1/2004 0.066.74 11/1/2004 0. Note that all transactions had a $ value on transaction date of approximately $50.900 6/1/2004 0.83) 12/1/2004 0.73) 10/1/2004 0. Doupnik.32) (5.2358 50.120821 50.824.02) (137.64 0.770179 (48. Advanced Accounting. 2009 9-49 .Excel Case—Determine Foreign Exchange Gains and Losses 1.90 (810.983.0244918 (50.000868056 (50.086.8273 (50.03 Import/Export Company reported a net foreign exchange gain of $4.8323 (50.418.03 in 2004 income.327815 (48.787216 (50.49) $4.000) 8/31/2004 0. 9/e © The McGraw-Hill Companies.025.. Exchange Rate at $ Value at Transaction Transaction Date Date Exchange Rate at Settlement Date Foreign Currency Type of Transaction Amount in Foreign Currency Transaction Date Settlement Date $ Value at Settlement Date Foreign Exchange Gain (Loss) Brazilian real (BRL) Swiss franc (CHF) Euro (EUR) South African rand (ZAR) Chinese yuan (CNY) Thai baht (THB) British pound (GBP) South Korean won (KRW) Total Net Foreign Exchange Gain (Loss) Import purchase Import purchase Export sale Export sale Export sale Import purchase Import purchase Import purchase (147.000956938 (55.054. the large appreciation in value of the ZAR coupled with the asset exposure in that currency generated a large foreign exchange gain.120823 50.008.00) 347.12 (63.. At one extreme.054.205. Schaefer. The size of the foreign exchange gains and losses reported in the last column differs substantially across transactions because of different rates of change in the exchange rates across the currencies in which Import/Export Company had exposures. Spreadsheet for the calculation of the foreign exchange gains (losses) related to Import/Export Company’s foreign currency transactions for the year 2004.38) 1.215. Inc.239.700) 2/2/2004 0. a similar dollar value asset exposure in CNY resulted in a negligible gain as a result of the very small change in the $/CNY exchange rate over the relevant period.128.28) $1.083.55 40.338696 (50.443.0241779 (49. 2.81 8/31/2004 0.2158 49. On the other hand. McGraw-Hill/Irwin Hoyle.09 413.028.007.068.

06 per euro under the forward contract.03.06 [($1. Given that the cost of goods sold is $103. If Linber had purchased 100.Analysis Case—Cash Flow Hedge 1.06 – $1.980 ($2. the forward rate must have been $1.000 euros = $2.00 euros]. the forward rate at 3/31/09 must have been $1. The negative adjustment to net income reflects this economic loss.000 euros on 2/1/09 at the spot rate of $1. the spot rate on 5/1/09 must have been $1..000 reflects the increase in cost for the parts from the date the transaction was forecasted until the date of purchase.000].06 – $1. The premium expense of $6. 3. McGraw-Hill/Irwin 9-50 © The McGraw-Hill Companies.000 euros = $6. Given the $6.04 – $1. 2009 Solutions Manual .000.000 total premium expense. so the forward contract results in an economic loss of $3. Linber must pay $1.000.00.000 [($1. The fact that the forward contract is a liability signals that the forward rate at 3/31 is less than the forward rate on 2/1. Given that the forward contract is reported as a liability of $1. 4.9901).03) x 100.000]. 2.04 [($1.00 spot) x 100.06) x 100. it could have saved $6.000 x . Inc.

00 1.690.730. Dollar Value on 12/15/06 $32.00 1.430. Spreadsheets for the calculation of the foreign exchange gains (losses) related to Pier Ten Company’s foreign currency account receivables. Advanced Accounting.158.00 34.660.2982 0.257.602.000.00) (92. 2009 9-51 . Inc.000 50.50 $132.001116 0.000 Foreign Exchange Gain (Loss) on 12/31/06 $(240.00 32.S.50 McGraw-Hill/Irwin Hoyle.863.50 32.00 32.6521 0.150. Doupnik.02805 U.000 50.000.195.282 0.001099 0.00 32.50 $130.00 32.000 115.00) $2.00) (494.50) $(335.970.2835 0.00 32.6483 0.530. Foreign Currency Account Receivable 30.000 Exchange Rate on 12/15/06 0.00 32.Internet Case—Historical Exchange Rates 1.470.S.150. Schaefer. 9/e © The McGraw-Hill Companies.415.000 1.000 1.000 Exchange Rate on 1/15/07 0.. Dollar Value on 12/31/06 $32.605.353.50) $1.50 (190. Dollar Value on 1/15/07 $33.00) 172.00 (55.823.000 50.150.00 Currency South Korean won (KRW) Malaysian ringgit (MYR) Singapore dollar (SGD) Thai baht (THB) Foreign Currency Account Receivable 30.293.000 1.00) Foreign Exchange Gain (Loss) on 1/15/07 $ 750.000.6494 0.00 Foreign Currency Account Receivable 30.165.50 Currency South Korean won (KRW) Malaysian ringgit (MYR) Singapore dollar (SGD) Thai baht (THB) Total Currency South Korean won (KRW) Malaysian ringgit (MYR) Singapore dollar (SGD) Thai baht (THB) Total Exchange Rate on 12/31/06 0.000 115.S.00 (402.000 115.50 135.02797 U.50 Net Foreign Exchange Gain (Loss) $ 510.00 $130.00 32.001091 0.480.0284 U.

The put option in SGD would have had a value of $55. indicating that it would not have been beneficial to acquire the SGD option.2. 2009 Solutions Manual .50 loss avoided less $100. The transaction denominated in Thai baht resulted in a net foreign exchange loss of $494.00 cost of option).00 on 1/15/07 and would have been exercised. Inc.50 greater ($494. resulting in a decrease in net cash inflow to Pier Ten of $200.00 cost of option) if a put option had been acquired.158.. Assuming a strike price equal to the December 15.00 ($55.00 fair value less $100. Put options in KRW and MYR would have had no value at 1/15/07.50 and would have been the most important to hedge. the only foreign currency transaction for which the purchase of a put option would have been beneficial is the transaction in Thai baht.50 in 2007 related to these foreign currency receivables. there would have been a net loss on the SGD option of $45.00 (the cost of the options). McGraw-Hill/Irwin 9-52 © The McGraw-Hill Companies. However.00 in 2006 and a net foreign exchange gain of $2. 3. Net cash inflow from the THB receivable would have been $394. 2006 spot rate. Pier Ten would have reported a net foreign exchange loss of $335.

this may or may not be advantageous for the company. Exporters sometimes use forward contracts to hedge export sales (import purchases) when the foreign currency is selling at a forward premium (discount) as this locks in premium revenue (discount revenue). In this case. The advantage is that the company is not required to exchange foreign currency for dollars at the option strike price if it is disadvantageous to do so. Inc. it which case the forward contract provides PBEC with foreign currency for which it has no current use. The disadvantage is that the company is obligated to exchange foreign currency for dollars at the contracted forward rate. McGraw-Hill/Irwin Hoyle. The risk associated with this strategy is that the customer may or may not pay on time. and the customer does not pay on time. the exporter will need to purchase foreign currency at the spot rate to settle the forward contract. there is always the risk that the supplier does not deliver on time. This is essentially the same as speculation. Depending upon the future spot rate. Advanced Accounting. a gain or loss could arise. 2009 9-53 . However. If an exporter enters into a forward contract to sell foreign currency. In that case. Doupnik.. The disadvantage of using options is that there is an up-front cost incurred. 9/e © The McGraw-Hill Companies. it has more control over the timing of when it will need foreign currency. The bottom line is that there is no right or wrong answer to the question which hedging instrument should be used to hedge the Swiss franc exposure to foreign exchange risk. Since PBEC is making import purchases.Communication Case—Forward Contracts and Options The advantage of using forward contracts is that there is no cost to enter them. The exporter can simply allow the option to exercise if it has not received foreign currency from the customer by the expiration date. Schaefer. the exporter might be better off by purchasing a foreign currency put option. it should be safe to enter into a forward contract to purchase foreign currency on the date when PBEC plans to pay for its purchases.