SEMINAR 2 DERIVATIVES & HEDGING R.F.

RAMOS

FORWARD CONTRACTS
Recognized asset or liability
On October 17, 2018, Frank, Inc. purchased from a Thailand firm inventory costing 10,000 baht.
Payment is due on January 15, 2019. Also on October 17, Frank entered into a foreign exchange
forward to buy 10,000 baht on January 15, 2019. Exchange rates are as follows:

10-17-2018 12-31-2018 1-15-2019

Spot rate (baht) P 1.30 P 1.42 P 1.40
Forward rate (baht) 1.36 1.43 1.40

1. In the year ended December 31, 2018 income statement, foreign exchange (FOREX) gain or loss
due to the purchase of inventory amounted to:
A. P200 gain
B. P1,000 loss
C. P1,200 gain
D. P1,200 loss

2. In the year ended December 31, 2018 income statement, FOREX gain or loss due to forward
contract amounted to:
A. P700 gain
B. P700 loss
C. P1,200 gain
D. P1,200 loss

3. The December 31, 2018 Accounts Payable amounted to:

A. P13,000
B. P13,600
C. P14,000
D. P14,200

4. The December 31, 2018 fair value of the forward contract amounted to:
A. P700 asset
B. P12,000 asset
C. P14,300 asset
D. P14,300 liability

5. On settlement date, January 15, 2019, FOREX gain or loss due to purchase of inventory amounted
to
A. P200 gain
B. P200 loss
C. P300 gain
D. P300 loss

6. On settlement date, January 15, 2019, FOREX gain or loss due to forward contract amounted to:
A. P200 loss
B. P300 gain
C. P300 loss
D. P600 gain

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On April 4, 2018, Paula, Inc. delivered to a Pakistan firm inventory it sold for 100,000 rupees. Payment
due is to be received on August 2, 2018. The company’s fiscal year ends on June 30. Also on April 4,
Paula Inc. entered into a foreign exchange forward to sell 100,000 rupees on August 2, 2018. Exchange
rates are as follows:

04-04-2018 06-30-2018 08-02-2018

Spot rate (rupee) P0.80 P0.84 P0.82
Forward rate (rupee) 0.77 0.83 0.82

7. In the year ended June 30, 2018 income statement, FOREX gain or loss due to sale of inventory
amounted to
A. P4,000 gain
B. P4,000 loss
C. P6,000 gain
D. P6,000 loss

8. In the year ended June 30, 2018 income statement, FOREX gain or loss due to forward contract
amounted to:
A. P4,000 gain
B. P4,000 loss
C. P6,000 gain
D. P6,000 loss

9. The June 30, 2018 Accounts Receivable amounted to:

A. P77,000
B. P80,000
C. P83,000
D. P84,000

10. The June 30, 2018 fair value of the forward contract amounted to:
A. P6,000 asset
B. P6,000 liability
C. P83,000 asset
D. P83,000 liability

11. On settlement date, August 2, 2018, FOREX gain or loss due to sale of inventory amounted to
A. P2,000 gain
B. P2,000 loss
C. P6,000 gain
D. P6,000 loss

12. On settlement date, August 2, 2018 FOREX gain or loss due to forward contract amounted to
A. P1,000 gain
B. P1,000 loss
C. P2,000 gain
D. P5,000 loss

Speculation
Monica Company expects the value of Korean won to increase in the next 30 days. Accordingly, on

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December 15, 2018, Monica enters into a 30-day forward contract to buy 40,000 wons at the forward
rate of P1.24. on December 31, 2018, the forward rate was P1.27 and by January 16, 2019, the spot rate
moved to P1.30.

13. The derivative asset (liability) to be included in the December 31, 2018 statement of financial
position is
A. P1,200
B. P2,400
C. P(1,200)
D. P(2,400)

14. The total net effect of the transaction on 2019 profit or loss is a gain (loss) of
A. P1,200
B. P2,400
C. P(1,200)
D. P(2,400)

Firm purchase commitment

On October 2, 2018, David Ball, Inc. ordered a custom-built passenger van from a Japanese firm. The
purchase order is non-cancelable. The purchase price is 1,000,000 yens with delivery and payment to
be on March 31, 2019. On October 2, 2018, David entered into a forward contract to buy 1,000,000 yens
on March 31, 2019 for P0.53. On March 31, 2019, the custom-built passenger van was delivered. The
relevant rates are as follows:

10/02/2018 12/31/2018 03/31/2019

Spot rate (yen) P 0.50 P 0.56 P 0.57
Forward rate (yen) 0.53 0.58 0.57

The forward contract is accounted for as a fair value hedge.

15. The December 31, 2018 P&L FOREX gain or loss on the hedged item/commitment is
A. P50,000 gain
B. P50,000 loss
C. P60,000 gain
D. P60,000 loss

16. The December 31, 2018 P&L FOREX gain or loss on the hedging instrument (forward contract) is
A. P50,000 gain
B. P50,000 loss
C. P60,000 gain
D. P60,000 loss

17. The Firm Commitment account balance as shown in the December 31, 2018 SFP is
A. P50,000 asset
B. P50,000 liability
C. P60,000 liability
D. None, since it is a fair value hedge

18. The December 31, 2018 income statement net FOREX gain or loss is
A. Zero

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 B. P10,000 net gain
C. P10,000 net loss
D. Not applicable since hedge accounting does not apply

19. The December 31, 2018 balance of Accounts Payable is

A. P500,000
B. P530,000
C. P580,000
D. None, since there is no transaction yet

20. On March 31, 2019, FOREX gain or loss on the hedged item/commitment is
A. P4,000 loss
B. P7,000 loss
C. P10,000 gain
D. P10,000 loss

21. On March 31, 2019, FOREX gain or loss on the hedging instrument (forward contract) is
A. P4,000 gain
B. P7,400 gain
C. P10,000 gain
D. P10,000 loss

22. The Firm Commitment account balance on March 31, 2019 is

A. P10,000 asset
B. P40,000 asset
C. P40,000 liability
D. P50,000 liability

23. The value of the equipment on March 31, 2019 is

A. P530,000
B. P560,000
C. P570,000
D. P580,000

Firm sales commitment

On October 12, 2018, Joana Company obtained a non-cancelable sales order from a Thailand firm for a
custom-made statue of Fatima. The contract price was 100,000 baht. On October 12, 2018, Joana
entered into a foreign exchange forward contract to sell 100,000 baht in 100 days at the forward rate of
P3.15. The statue was delivered on December 11, 2018 and collection was made on January 20, 2019.
The relevant rates were as follows:

10/12/2018 12/11/2018 12/31/2018 01/20/2019

Spot rate (baht) P3.20 P3.00 P3.09 P2.97
Forward rate (baht) 3.15 2.98 3.08 2.97

24. What was the net impact on Joana’s December 11, 2018 P&L as a result of the fair value hedge?
A. Zero
B. P17,000 decrease
C. P17,000 increase
D. P20,000 decrease

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25. What is the reportable sales amount in the 2018 P&L?
A. P300,000
B. P308,000
C. P309,000
D. P317,000

26. On December 31, 2018, the FOREX gain or loss on the accounts receivable and firm commitment
amounted to

Accounts receivable Firm commitment

A. P9,000 gain Zero
B. P9,000 loss Zero
C. P9,000 gain P9,000 gain
D. Zero P9,000 loss

27. On December 31, 2018, FOREX gain or loss on the hedging instrument (forward contract)
amounted to
A. P7,000 gain
B. P7,000 loss
C. P9,000 gain
D. P11,000 loss

28. The net impact of the fair value hedge on January 2019 P&L was
A. Zero
B. P1,000 net gain
C. P1,000 net loss
D. P2,000 net gain

Angelica Company operates a chain of coffee shops nationally. On October 1, 2018, Angelica entered
into a firm commitment to purchase 4,000 kgs. of coffee beans for a contract price of P160 per kg on
March 31, 2019. Angelica expects that there is a possible decrease in the price of coffee beans, so on
this date, Angelica entered into a six-month forward contract with a bank to sell 4,000 kilograms of
coffee beans at the current forward rate of P160 per kg.

Information on fair values is shown below:

Fair value of Fair value of firm

forward contract commitment
Date Spot price Forward price (asset) (liability)
Oct. 1, 2018 P155 P160
Dec. 31, 2018 151 153 P27,727 (1) P(27,727)
Mar. 31, 2019 147 147 52,000 (2) (52,000)
1 (160 – 153) x 4,000 x 0.9902427

2 (160 – 147) x 4,000

The appropriate interest rate for three months is 4%

29. The entry on October 1, 2018 to record the firm purchase commitment
A. includes a debit to Inventory for P640,000

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 B. Includes a credit to Accounts Payable for P640,000
C. includes both A and B
D. none

30. The entries on December 31, 2018 include

A. a credit to Gain on Firm Commitment for P27,728 which is recognized in P&L
B. a credit to Gain on Firm Commitment for P27,728 which is recognized in OCI
C. a debit to Loss on Firm Commitment for P27,728 which is recognized in P&L
D. a debit to Loss on Firm Commitment for P27,728 which is recognized in OCI

31. The derivative asset (liability) on December 31, 2018 is

A. P1,200
B. P27,727
C. P(1,200)
D. P(27,727)

32. The debit to Inventory on March 31, 2019 is

A. Zero
B. P588,000
C. P612,000
D. P640,000

33. The gain (loss) on forward contract on March 31, 2019 is

A. P24,273
B. P52,000
C. P(24,273)
D. P(52,000)

34. The net cash settlement receipt (payment) on the forward contract on March 31, 2019 is
A. P24,273
B. P52,000
C. P(24,273)
D. P(52,000)

HEDGE OF A NET INVESTMENT IN FOREIGN OPERATION

On December 31, 2018, Hazel Company, the parent of the 100%-owned Japanese subsidiary, expected
the yen to weaken by the end of 2019. Accordingly, Hazel Company, the parent, contracted with a
foreign exchange trader on December 31, 2018, to sell 2,300,000 yens (the subsidiary’s net asset
position at that date) in 365 days at the forward rate of P0.435. The following direct exchange rates are
available:

12/31/2019
12/31/2018 (the expiration date and
(the inception date) financial reporting date)
Spot rate P 0.440 P 0.400
Forward rate (selling forward) 0.435 0.400

The January 31, 2019 cumulative debit balance of the translation reserve amounted to P129,000 and
the translation reserve loss for 2019 was P100,000.

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35. The December 31, 2019 FOREX gain or loss on forward contract to be charged is
A. P80,500 gain - earnings
B. P80,500 gain - equity
C. P80,500 loss - equity
D. P92,000 gain - equity

36. The December 31, 2019 translation reserve balance (cumulative translation adjustment) is
A. P148,500 debit
B. P148,500 credit
C. P229,500 debit
D. P309,500 debit

Translation gain or loss

Irish Corporation uses the closing-rate method of translation for its wholly-owned foreign subsidiary
Richard, Inc. which was established in 2018. For 2019, Richard’s net income was FC100,000 which
translated into P33,000. Earnings occurred evenly throughout the year and were remitted to Irish
monthly. A debit translation adjustment of P64,000 resulted in 2019. At December 31, 2018, the
cumulative translation adjustment had a credit balance of P18,000.

On December 31, 2018, in expectation that the foreign currency would weaken throughout 2019,
Irish’s management entered into a one-year forward exchange contract to sell FC600,000 on December
31, 2019 at the forward rate of P0.40. Richard’s net asset position at December 31, 2018 was FC600,000.
There was no hedging in 2018. Richard prepares its annual financial statements on June 30 and
quarterly financial statements on December 31.

The following direct exchange rates prevailed:

12/31/ 2018 06/30/ 2018 12/31/2019

Spot rate P0.42 P0.37 P0.30
Forward rate 0.40 0.36 0.30

37. The June 30, 2019 FOREX gain or loss on forward contract amounted to:
A. P24,000 gain - earnings
B. P24,000 gain - equity
C. P24,000 loss - equity
D. P30,000 gain - equity

38. The June 30, 2019 cumulative translation adjustment balance amounted to
A. P22,000 credit
B. P22,000 debit
C. P24,000 credit
D. P42,000 credit

39. The December 31, 2019 FOREX gain or loss on the forward contract amounted to
A. P36,000 gain - earnings
B. P36,000 gain - equity
C. P36,000 loss - equity
D. P42,000 gain - equity

40. The December 31, 2019 cumulative translation adjustment balance amounted to

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 A. P14,000 credit
B. P14,000 debit
C. P22,000 debit
D. P36,000 credit

OPTION CONTRACTS
Recognized liability
On November 1, 2018, Sheila Philippines took delivery from a Thailand firm of inventory costing
100,000 baht. Payment is due on January 30, 2019. Concurrently, Sheila Philippines paid P900 cash to
acquire a 90-day call option for 100,000 Thailand baht. The following rates and other information are
available:

11/01/2018 12/31/2018 01/30/2019

Spot rate (market price) P 1.20 P 1.22 P 1.23
Exercise price 1.20 1.20 1.20
Fair value of call option P 900.00 P 2,200.00 P 3,000.00

41. The notional amount is

A. P900
B. P200
C. P3,000
D. 100,000 baht

42. What is the intrinsic value (IV) and time value (TV) of option at December 31, 2018?
Intrinsic value Time value
A. P2,000 P200
B. P2,200 Zero
C. P200 P2,000
D. Zero P2,200

43. The FOREX gain or loss on option contract (hedging instrument) due to change in time value on
December 31, 2018 (if changes in the time value will be excluded from the assessment of hedge
effectiveness) should be
A. P700 loss
B. P1,300 gain
C. P2,000 gain
D. P2,000 loss

44. The FOREX gain or loss on option contract (hedging instrument) due to change in intrinsic value
on December 31, 2018 (if changes in the time value will be excluded from the assessment of hedge
effectiveness) should be
A. P700 gain
B. P700 loss
C. P1,300 gain
D. P2,000 gain

45. The FOREX gain or loss on option contract (hedging instrument) on December 31, 2018 (if
changes in the time value will be included from the assessment of hedge effectiveness) should be
A. P700 gain
B. P700 loss

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 C. P1,300 gain
D. P2,000 gain

46. The December 31, 2018 net FOREX gain or loss is

A. P700 net gain
B. P700 net loss
C. P1,300 net gain
D. P2,000 net loss

47. The January 30, 2019 expiration date net FOREX gain or loss is
A. P200 net gain
B. P200 net loss
C. P800 net gain
D. P1,000 net loss

Forecasted export transaction

On January 1, 2018, Irene Company paid P16,000 cash to acquire a put foreign exchange option for
1,000,000 Thailand Baht, with an expiration date of December 31, 2018. The option hedges 2018’s first
six months forecasted export sales of 1,000,000 baht. Irene’s fiscal year ends on June 30, 2018.

Relevant data include:

01/01/2018 06/30/2018 12/31/2018

Spot rate (market price) P 1.20 P 1.12 P 1.15
Exercise price 1.19 1.19 1.19
Fair value of put option at 06/30/11 P 81,000

48. The option’s time value at inception is

A. P81,000
B. P16,000
C. P10,000

49. The option’s intrinsic value at inception is

A. P16,000
B. P10,000
C. P6,000
D. Zero

50. The June 30, 2018 Foreign Currency Contract Value – Option is
A. P6,000
B. P10,000
C. P16,000
D. P81,000

51. The June 30, 2018 FOREX gain or loss is

A. P65,000 loss - equity
B. P81,000 gain - equity
C. P65,000 gain - equity
D. P65,000 gain - earnings

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52. The December 31, 2018 FOREX gain or loss to be recognized in current earnings (if there is no
export sale in 2018) is
A. Zero
B. P26,000
C. P39,000
D. P65,000

53. The December 31, 2018 FOREX gain or loss to be recognized in current earnings (if export sales of
1,000,000 baht all occurred in December 2018) is
A. Zero
B. P26,000
C. P39,000
D. P65,000

54. The December 31, 2018 FOREX gain or loss to be recognized in current earnings (if 2018’s export
sales is 1,000,000 baht, 60% of which occurred in the first six months) is
A. Zero
B. P26,000
C. P39,000
D. P65,000

Forecasted import transaction

On January 1, 2018, Kent Company paid P17,000 cash to acquire a call foreign currency option for
1,000,000 Thailand Baht, with an expiration date of December 31, 2018. The option hedges 2018’s
forecasted import sales of 1,000,000 baht. At June 30, 2018, import purchases totaled 750,000 baht, of
which 600,000 baht had been resold to Philippine customers. Kent’s fiscal year ends on June 30, 2018.

Relevant data include:

01/01/2018 06/30/2018 12/31/2018
Spot rate (market price) P 1.15 P 1.18 P 1.17
Exercise price 1.14 1.14 1.14
Fair value of call option at 06/30/12 P 44,000

55. The option’s time value at inception is

A. Zero
B. P7,000
C. P10,000
D. P17,000

56. The option’s intrinsic value at inception is

A. Zero
B. P7,000
C. P10,000
D. P17,000

57. The June 30, 2018 FOREX gain or loss to be recognized in equity is
A. P5,400 gain
B. P5,400 loss
C. P27,000 gain
D. Zero

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58. The June 30, 2018 FOREX gain or loss to be recognized in current earnings is
A. P5,400 gain
B. P21,000 loss
C. P21,600 gain
D. P27,000 gain

59. The December 31, 2018 FOREX gain or loss to be recognized in current earnings is
A. P5,400 gain
B. P8,600 gain
C. P8,600 loss
D. P21,600 gain

60. What is the intrinsic value and time value of the option, respectively, on December 31, 2018?
A. P40,000;P 4,000
B. P4,000; P44,000
C. P30,000; zero
D. Zero; P30,000

INTEREST RATE SWAP

On January 1, 2012, Alexandra Company received a two-year, P5-million loan with interest payments
due at the end of each year based on the prevailing market rate at January 1 of each year. The interest
rate on January 1, 2012 was 10%. Venus Company also has a two-year P5 million loan, but Venus’s
loan carries a fixed interest rate of 10%.

Alexandra Company doesn’t want to bear the risk that interest rates may increase in 2013. Venus
Company believes that rates may decrease and it would prefer to have variable debt.

The two entities entered into an interest rate swap whereby Venus agreed to make Alexandra’ interest
payment in 2013 and Alexandra likewise agreed to make Venus’s interest payment in 2013. The two
entities agreed to make settlement payment -- for the difference only -- on December 31, 2013.

The interest rate on January 1, 2013 is 8%.

The present values of 1 for one period are 0.926 and 0.909 at 8% and 10%, respectively. The present
values of an ordinary annuity for two periods are 1.783 and 1.736 at 8% and 10%, respectively.

61. What will be Alexandra’ settlement with Venus?

A. P50,000 payment
B. P50,000 receipt
C. P100,000 payment
D. P100,000 receipt

62. What amount will Alexandra report as fair value of the interest rate swap payable on December
31, 2012?
A. P90,900
B. P92,600
C. P100,000
D. P5,000,000

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On January 1, 2018, Chelsea Ventures, Inc., received a two-year, P0.6 million loan with interest
payments due at the end of each year and the principal to be repaid on December 31, 2019. The
interest rate for the first year is the prevailing market rate of 8 percent, and the rate each succeeding
year will be equal to the prevailing market rate on January 1 of that year.

Chelsea Ventures also entered into an interest rate swap agreement related to this loan. Under the
terms of the swap agreement, in the years 2019 and 2020, Chelsea Ventures will receive a swap
payment based on the principal amount of P0.6 million. If the January 1 interest rate is greater than 8
percent, Chelsea Ventures will receive a swap payment for the difference. If the January 1 interest rate
is less than 8 percent, Chelsea Ventures will make a swap payment for the difference. The swap
payments are made on December 31, 2019. On December 31, 2018 (January 1, 2019), the interest rate is
7 percent.

63. The fair value of the swap contract on January 1, 2018 should be
A. P0
B. P5,607
C. P6,000
D. P600,000

64. The interest expense on December 31 of each year would be as follows:

2018 2019
A. P42,000 P42,000
B. P42,000 P48,000
C. P48,000 P42,000
D. P48,000 P48,000

65. What amount will Chelsea report as the fair value of the interest rate swap (obligation under
swap contract -- a liability account) at December 31, 2018 (answers rounded to the nearest peso)?
A. P5,241
B. P5,555
C. P5,607
D. P6,000

66. The amount to be debited/credited to OCI on December 31, 2018 due to the swap agreement
would be
A. P5,241 debit
B. P5,607 debit
C. P5,607 credit
D. P6,000 credit

67. What will be Chelsea’s settlement payment to/from?

A. P5,241 payment from
B. P5,607 payment from
C. P5,607 payment to
D. P6,000 payment to

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Hedge of a highly probable forecast sale transaction
Connoisseur Company is engaged in the clothing business. On December 16, 2018, the entity
anticipates selling 1,000 meters of thread on January 15, 2019. To safeguard from a possible decrease
in the future price of thread, the entity entered into a 30-day forward contract with a bank to sell 1,000
meters of thread at the current forward rate of P100 per meter. The forward contract will be settled
net on January 15, 2019.

Information on fair values is shown below:

Date Spot price Forward price

December 16, 2018 97 100
December 31, 2018 94 96
January 15, 2019 92 92

The actual sale on COD basis took place on January 15, 2019.

Required
Provide the journal entries on December 16, 2018, December 31, 2018 and January 15, 2019

End of Handouts

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