MATERIAL 14: FOREIGN CURRENCY TRANSACTIONS WITH AND

WITHOUT HEDGING TRANSACTIONS

FOREIGN CURRENCY WITHOUT HEDGING

I - Importing Transactions

On December 1, 2009, Petra Corporation, ordered equipment FOB shipping point

from an American Company for US $ 10, 000. The equipment was shipped and
invoiced to Petra on December 16, 2009. Petra paid the invoice on January 15,
2010. Relevant spot rates for US dollars on the respective dates are as follows:

Selling Spot
Buying Spot Rate Rate
1-Dec-09 P 48.50 P 49.00
16-Dec-09 P 48.90 P 50.00
31-Dec-09 P 49.50 P 51.00
15-Jan-10 P 50.00 P 50.50
Required:

1. Prepare all the entries on Petra Corporation’s books to record the above
transactions.
2. Determine the following:
a. Foreign Exchange gain or loss on:
a.1 December 16, 2009
a.2 December 31, 2009
a.3 January 15, 2010
3. On December 31, 2009:
b.1 Accounts payable
b.2 Equipment

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II – Exporting Transactions

Conrada Exports Corporation, sold merchandise – metal crafts to a Canadian

Corporation for a 10, 000 Canadian dollars. Pertinent information on the exchange
conversion rates related to this transaction were as follows:

Buying Spot Selling Spot

Rate Rate
11/16/2009 - receipt of order P 51.50 P 52.00
12/16/2009 - date of shipment P 52.50 P 53.00
12/31/2009 - balance sheet date P 53.50 P 53.75
01/15/2010 - date of collection P 53.00 P 54.00
Required:

1. Prepare all the entries on Conrada Corporation’s books to record the above
transactions.
2. Determine the following:
a. Foreign Exchange gain or loss on:
a.1 December 16, 2009
a.2 December 31, 2009
a.3 January 15, 2010
3. On December 31, 2009:
b.1 Accounts receivable
b.2 Sales

III – Import

Ashar, a Philippine Corporation, bought inventory items from a foreign supplier in

US on November 5, 2009 for US $ 100, 000, when the spot rate was P41.00. At
Ashar’s December 31, 2009 year-end, the spot rate was P 40.50. On January 15,
2010, Ashar bought US $ 100, 000 at the spot rate of P 40.90 and paid the invoice.
How much should Ashar report in its income statements for 2009 and 2010 as
foreign exchange transaction gain or (loss)?

2009 2010 2009 2010

a. P (50, 000) P 40, 000 c. P0 P 10, 000

b. P 50, 000 P (40, 000) d. P 10, 000 P0

IV – Importing and Exporting

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Bon-Bon Corporation had the following foreign currency transactions during 2009:

 Merchandise was purchased from a foreign supplier on January 20, 2009 for
the Philippine peso equivalent of P 90, 000. The invoice was paid on March
20, 2009 at the Philippine peso equivalent of P 96, 000.
 On July 1, 2009, Bon-Bon borrowed from foreign corporation with a
Philippine Peso equivalent of P 500, 000 evidenced by a note that was
payable in the lender’s local currency on July 1, 2010. On December 31,
2009, the Philippine peso equivalents of the principal amount and accrued
interest were P 520,000 and P 26, 000, respectively. Interest on the note is
10% per annum.

In Bon-Bon’s 2009 income statement, what amount should be included as foreign

exchange loss?

a. P 0 c. P 21, 000
b. P 6, 000 d. P 27, 000

V – Export

On September 1, 2009, Rosan Corporation received an order for equipment from a

foreign customer for 300, 000 local currency units (LCU) when the Philippine peso
equivalent was P 96, 000. Rosan shipped the equipment on October 15, 2009, and
billed the customer for 300, 000 LCU when the Philippine peso equivalent was P
100,000. Rosan received the customer’s remittance in full amount on November
16, 2009, and sold the 300, 000 LCU for P 105, 000. In its income statement for
the year ended December 31, 2009, Rosan should report a foreign exchange
transaction gain of:

a. P 0 c. P 5, 000
b. P 4, 000 d. P 9, 000

VI – Lending

On July 1, 2009, Vir Company lent P 120,000 to a foreign supplier, evidenced by

an interest-bearing note due on July 1, 2010. The note is denominated in the
currency of the borrower and was equivalent to 840, 000 local currency units
(LCU) on that rate. The note principal was appropriately included at P 140,000 in
the receivable section of Vir’s December 31, 2009 balance sheet. The note
principal was repaid to Vir on July 1, 2010 due date when the exchange rate was 8
LCU to P 1. In its income statement for the year ended, December 31, 2010, what
amount should Vir include as a foreign currency transaction gain or loss?

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 a. P 0 c. P 15, 000 gain
b. P 15, 000 loss d. P 35, 000 loss

VII – Import and Export

During July 1, 2009, Petron Corporation had the following transactions with
foreign businesses:

Billing Exchange Rate

Date Nature of Transaction Currency (Direct)
Vendor
A:
Imported merchandise costing 100, 000
Rupees from Pakistan wholesaler
1-Jul-09 Rupee P .82
10-Jul-09 Paid 40% of amount owed P .83
31-Jul-09 Paid remaining amount owed P .78
Custome
r A:
Sold merchandise for 50, 000 pound to
15-Jul-09 Syrian wholesaler Syrian pound P .95
20-Jul-09 Received 20% payment P .90
30-Jul-09 Received the remaining amount owed P .91

1. What is the capitalized cost of inventory purchase from the Pakistan

wholesaler?
a. P 0 c. P 82, 000
b. P 78, 000 d. P 83, 000
2. What is the foreign exchange gain or loss on July 10, 2009 transaction
arising from the Pakistan wholesaler?
a. P 1, 000 loss c. P 400 gain

b. P 1, 000 gain d. P 400 loss

3. What is the foreign exchange gain or loss on July 31, 2009 transaction
arising from the Pakistan wholesaler?
a. P 4, 000 gain c. P 2, 400 loss
b. P 4, 000 loss d. P 2, 400 gain
4. What is the reportable sales amount in the income statement in 2009?
a. P 38, 000 c. P 45, 500
b. P 45, 000 d. P 47, 500
5. What is the foreign exchange gain or loss on July 20, 2009 transaction
arising from the Syrian wholesaler?
a. P 500 gain c. P 2, 500 gain
b. P 500 loss d. P 2, 500 loss

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 6. What is the foreign exchange gain or loss on July 30, 2009 transaction
arising from the Syrian wholesaler?
a. P 1, 600 loss c. P 2, 000 gain
b. P 1, 600 gain d. P 2, 000 loss

FOREIGN CURRENCY WITH HEDGING

The spot rates and forward rates for US $ on March 1, 2008, at various times are as
follows:
Dates Spot Rate Forward rates (for 2/1/2009)

March 1, 2008 P 55.00 P 56.00 (11 months)

December 31, 2008 P 55.60 P 56.50 (1 month)

February 1, 2009 P 55.10

 The firm’s fiscal year-end is December 31.

 On March 1, 2008, the Philippine firm entered into a forward contract to buy
us $10, 000 on February 1, 2009 for P 56.00
 For simplicity and focus on the main points of accounting for hedges,
interest was not considered noteworthy, thereby assume that the effects of
discounting are insignificant – thus, we ignore discounting or present value.

VIII - Hedging an Exposed Liability (“Undesignated Hedges” or Hedges does

not require Hedge Accounting)

A. On March 1, 2008 (date of transaction), a Philippine firm purchased inventory

for US $10, 000 payable on February 1, 2009 (settlement date).
1. The fair value (or nominal value) of the forward contract on March 1, 2008
should be:
a. P 0 c. P 560, 000
b. P 550, 000 d. P 565, 000

2. What is the notional value of the US $ 10, 000 forward contract?

a. P 0 c. P 560, 000
b. P 550, 000 d. P 565, 000
3. The December 31, 2008 profit and loss statement, foreign exchange gain or
loss due to hedged item (purchase of inventory) amounted to:
a. P 6, 000 gain c. P 5, 000 loss
b. P 6, 000 loss d. P 5, 000 gain
4. The December 31, 2008 profit and loss statement, foreign exchange gain or
loss due to hedging instrument (forward contract) amounted to:
a. P 6, 000 gain c. P 5, 000 loss
b. P 6, 000 loss d. P 5, 000 gain
5. What is the net impact on Philippine firm’s December 31, 2008 income as a
result of this hedged of an exposed liability?

5
 a. P 1, 000 loss c. P 9, 000 gain
b. P 1, 000 gain d. P 9, 000 loss
6. The fair value (nominal value) of the forward contract on December 31,
2008 amounted to:
a. P 6, 000 asset c. P 5, 000 asset

b. P 6, 000 liability d. P 5, 000 liability

IX – Hedging an Unrecognized Foreign Currency Firm Commitment (Hedge

Accounting Applies)

B. On March 1, 2008, Philippine firm contracts to purchase equipment to a

foreign customer located in Boston for US $ 10, 000. The equipment is to be
delivered and the account is to be settled eleven months later on February 1,
2009. Thus, the transaction and the settlement date are both February 1,
2009.

7. The fair value (nominal value) of the forward contract on March 1, 2008
amounted to:
a. P 0 c. P 560, 000
b. P 550, 000 d. P 565, 000
8. The December 31, 2008 profit and loss statement, foreign exchange gain or
loss on hedged item/commitment amounted to:
a. P 1, 000 loss c. P 5, 000 loss
b. P 5, 000 gain d. P 9, 000 loss
9. The December 31, 2008 profit or loss statement, foreign exchange gain or
loss on the hedging instrument (forward contract) amounted to:
a. P 1, 000 loss c. P 5, 000 loss
b. P 5, 000 gain d. P 9, 000 loss
10.The Firm Commitment account as shown in the December 31, 2008 balance
sheet as:
a. P 5, 000 asset c. P 5, 000 equity
b. P 5, 000 liability d. None
11.What was the net impact on the Philippine firm’s December 31, 2008
income as a result of this fair value hedge of a firm commitment?
a. P 9, 000 asset c. P 9, 000 equity

b. P 9, 000 liability d. None, since it is a fair

value hedge

12.What is the amount of accounts payable that will be paid on February 1,

2009?
a. P 550, 000 c. P 560, 000
b. P 551, 000 d. P 565, 000

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 13.What is the net increase or decrease in cash flow from having entered into
this forward contract hedge? (NET METHOD)
a. Zero
b. P 9, 000 increase in cash flow
c. P 9, 000 decrease in cash flow
d. P 14, 000 increase in cash flow
14.The value of the equipment on February 1, 2009 if the firm commitment
account will be adjusted to asset acquired:
a. P 550, 000 c. P 560, 000
b. P 551, 000 d. P 565, 000
15.The value of the equipment on February 1,2 009 if the firm commitment
account will be a separate adjustment to net income:
a. P 550, 000 c. P 560, 000
b. P 551, 000 d. P 565, 000

X – Cash Flow Hedge: Forecasted Purchase Transaction

C. On March 1, 2008, a Philippine firm estimates or forecasted the purchase of

5, 000 units of inventory from the United States. The purchase would
probably occur on February 1, 2009 and require the payment of US $ 10,
000.

It is anticipated that the inventory could be further processed and delivered

to customers by early April 1, 2009. The company enters into a forward
contract to purchase US $ 10,000 on February 1, 2009 for P 56.

16.The December 31, 2007 foreign exchange gain of forward contract

amounted to:
a. P 14, 000 currently in earnings
b. P 5, 000 currently in earnings
c. P 14, 000 other comprehensive income
d. P 5, 000 other comprehensive income
17.On February 1, 2009, foreign currency exchange loss on forward contract
amounted to:
a. P 9, 000 other comprehensive income
b. P 14, 000 currently in earnings
c. P 5, 000 other comprehensive income
d. P 9, 000 currently in earnings
18.At what amount the inventory (purchase) is carried on the Philippine firm’s
books on February 1, 2009 if the exchange differential will be a separate
adjustment to net income?
a. P 550, 000 c. P 560, 000
b. P 551, 000 d. P 565, 000

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 19.Suppose that in April 2009, the inventory was sold for P 600, 000, what
would be the gross profit assuming any adjustments (if any) regarding
exchange differential will be thru Cost of Goods Sold account:
a. P 58, 000 c. P 40, 000
b. P 41, 000 d. P 31, 000
20.Suppose that premium or discount is allowed to be recognized by the firm,
what amount does Philippine firm report in net income as a result of this
cash flow hedge of a forecasted transaction/ the effects on net income from
these transactions?
a. P 10, 000 Discount Expense plus a P 9,000 negative Adjustment to Net
Income when the merchandise is received.
b. P 10, 000 Discount Expense plus a P 9,000 positive Adjustment to Net
Income when the merchandise is received.
c. P 10, 000 Premium Expense plus a P 9,000 negative Adjustment to Net
Income when the merchandise is received.
d. P 10, 000 Premium Expense plus a P 9,000 positive Adjustment to Net
Income when the merchandise is received.

XI - Speculation

D. A Philippine firm entering into speculative purposes in anticipation for a

gain, enters into a contract on March 1, 2008 to acquire U $ 10, 000 on
February 1, 2009, a currency in which the company has no receivables,
payables or commitments.

21.The December 31, 2008 profit and loss statement, foreign exchange gain or
loss due to hedging instrument (forward contract) amounted to:
a. P 14, 000 loss c. P 5, 000 loss
b. P 5, 000 gain d. P 14, 000 gain
22.On February 1, 2009, foreign exchange gains or loss on forward contract
amounted to:
a. P 14, 000 loss c. P 5, 000 loss
b. P 5, 000 gain d. P 14, 000 gain

XII – With Present Value: Hedging an Exposed Liability

Stark, Inc. placed an order for inventory costing 500,000 foreign currency (FC)
with a foreign vendor on April 15 when the spot rate was 1 FC = P 0.683. Stark
received the goods on May 1 when the spot rate was 1 FC = P 0.687. Also, on May
1, Stark entered into 90-day forward contract to purchase 500,000 FC at a forward
rate of 1 FC = P 0.693. Payment was made to the foreign vendor on August 1 when
the spot rate was 1 FC = P 0.696. Stark has a June 30 year-end. In that date, the
spot rate was 1 FC = P 0.691, and the forward rate on the contract was 1 FC = P
0.695. Changes in the current value of the forward contract are measured as the

8
present value of the changes in the forward rates over time. The relevant discount
rate is 6%.

1. The foreign exchange gain on hedging instrument (forward contract) on June

30 amounted to:
a. P 2, 000 c. P 995
b. P 1, 000 d. Zero

2. The net income effect on June 30 amounted to:

a. P 2, 000 c. P 1, 005

b. P 1, 000 d. P 995

3. The foreign exchange gain due to hedging instrument (forward contract) on

August 1 amounted to:
a. P 2, 500 c. P 1, 500
b. P 2, 000 d. P 505

XIII – Call Option Contracts: Hedging an Exposed Liability

On December 31, 2008, Optix Company paid cash to purchase 90-day “at-the-
money” call option for 500, 000 Thailand baht. The option’s purpose is to protect
an exposed liability of 500 000 Thailand baht relating to an inventory purchase
receive on December 1, 2008 and to be paid on March 1, 2009.

12/1/200 12/31/200 3/1/200

8 8 9
Spot rate (market
price) P 1.20 P 1.28 P 1.27
Strike price
(exercise price) P 1.20 P 1.20 P 1.20
Fair value of call P 35,
option P 3, 000 P 42, 000 000

1. The notional amount of the option should be:

a. 500, 000 Thailand baht c. P 35, 000
b. P 3, 000 d. P 42, 000
2. The fair value of the call option on December 1, 2008?
a. P 0 c. P 35, 000
b. P 3, 000 d. P 42, 000
3. What is the intrinsic value (IV) and time value (TV) of option on December
1, 2008?
Intrinsic Value Time Value Intrinsic Value Time Value
a. P 0 P 0 c. P 35, 000 P 0
b. P 2, 000 P 40, 000 d. P0 P 3, 000

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 4. What is the intrinsic value (IV) and time value (TV) of option on December
31, 2008?
Intrinsic Value Time Value Intrinsic Value Time Value
a. P 40, 000 P 2, 000 c. P 3, 000 P0
b. P 2, 000 P 40, 000 d. P0 P 3, 000
5. What is the intrinsic value (IV) and time value (TV) of option on March 1,
2009?
Intrinsic Value Time Value Intrinsic Value Time Value
a. P 42, 000 P 0 c. P 35, 000 P 0
b. P 40, 000 P 2, 000 d. P0 P 35, 000
6. The foreign exchange gain or loss on option contract (hedging instrument)
on December 31, 2008 if changes in the time value will be included from
the assessment of hedge effectiveness (non-split accounting) should be:
a. P 1, 000 loss c. P 39, 000 gain
b. P 1, 000 gain d. P 40, 000 gain
7. The foreign exchange gain or loss on option contract (hedging instrument)
due to change in time value on December 31, 2008 if changes in the time
value will be excluded from the assessment of hedge effectiveness (split
accounting) should be:
a. P 1, 000 loss c. P 39, 000 gain
b. P 1, 000 gain d. P 40, 000 gain
8. The foreign exchange gain or loss on option contract (hedging instrument)
due to change in intrinsic value on December 31, 2008 if changes in the
time value will be excluded from the assessment of hedge effectiveness
(split accounting) should be:
a. P 1, 000 loss c. P 39, 000 gain

b. P 1, 000 gain d. P 40, 000 gain

9. The December 31, 2008 foreign exchange gain or loss amounted to:
a. P 0 c. P 1, 000 loss
b. P 1, 000 gain d. P 40, 000 gain
10.The March 1, 2009 expiration date, foreign exchange gain or loss amounted
to:
a. P 0 c. P 2, 000 loss
b. P 2, 000 gain d. P 5, 000 gain

XIV – Put Option Contracts: Hedging a Foreign Currency Firm Commitment

On September 1, 2009, Jensen Company received an order to sell a machine to a

customer in Japan at a price of 100, 000 yens. Jensen shipped the machine and
received payment on March 1, 2010. On September 1, 2009, Jensen purchased a
put option giving it the right to sell 100, 000 yens on March 1, 2010, at a price of P

10
80, 000. Jensen properly designated the option as a fair value hedge of the
Japanese yen firm commitment. The option cost P 2, 000 and had a fair value of P
2, 300 on December 31, 2009. The fair value of the firm commitment was
measured by referring to changes in the spot rate. The following spot exchange
rates apply:

Philippine Peso per

Dates Japanese Yen
Sept. 1,
2009 P 0.80
Dec. 31,
2009 P 0.79
March. 01,
2010 P 0.77

1. The notional amount of the put option should be:

a. 100, 000 yens c. P 2, 300
b. P 80, 000 d. P 2, 000
2. The fair value (nominal value) of the put option on September 1, 2009?
a. P 0 c. P 2, 300
b. P 2, 000 d. P 3, 000
3. What is the intrinsic value (IV) and time value (TV) of option on September
1, 2009?
Intrinsic Value Time Value Intrinsic Value Time Value
a. P 0 P 2, 300 c. P 2, 300 P 2, 000
b. P 2, 000 P0 d. P0 P 2, 000
4. What is the intrinsic value (IV) and time value (TV) of option on December
31, 2009?
Intrinsic Value Time Value Intrinsic Value Time Value
a. P 1, 000 P 1, 300 c. P 1, 300 P 1, 000
b. P 2, 300 P 1, 000 d. P0 P 2, 300
5. What is the intrinsic value (IV) and time value (TV) of option on March 1,
2010?
Intrinsic Value Time Value Intrinsic Value Time Value
a. P 3, 000 P0 c. P 2, 300 P0
b. P 0 P 3, 000 d. P 2, 000 P0
6. What was the net impact on Jensen Company’s 2009 income as a result of
this fair value hedge of a firm commitment?
a. P 0
b. P 680.30 decrease in income
c. P 300 increase in income
d. P 980.30 increase in net income

11
 7. What was the net impact on Jensen Company’s 2010 income as a result of
this fair value hedge of a firm commitment?
a. P 0
b. P 1, 319.70 decrease in income
c. P 77, 980.30 increase in income
d. P 78, 680.30 increase in net income
8. What was the net increase or decrease in cash flow from having purchased
the foreign currency option to hedge this exposure to foreign exchange risk?
a. P 0
b. P 1, 319.70 decrease in income
c. P 77, 980.30 increase in income
d. P 78, 680.30 increase in net income

XV – Put Option Contracts: Hedging a Forecasted Transaction – Hedge

Accounting Applies

(Split Accounting: Exclude the time value element in assessing hedge

effectiveness)

On June 1, the company forecasted the purchase the purchase of 5, 000 units of
inventory from a foreign vendor. The purchase would probably occur on
September 1 and require the payment of 100, 000 foreign currencies (FC).

It is anticipated that the inventory could be further processed and delivered to

customers by early October.

On June 1, the company purchased a call option to buy 100, 000 FC at a strike
(option) price of 1 FC = P 0.55 during September. An option premium of P 900
was paid. Changes in the time value of the option will be excluded from the
assessment of hedge effectiveness.. Spot rates, strike price and option values are as
follows:

1-Jun 30-Jun 31-Jul Sept. 1

Spot rate (market
price) P 0.53 P 0.552 P 0.57 P 0.575
Strike price (exercise
price) P 0.55 P 0.55 P 0.55 P 0.55
Fair value of call P 1, P 2, P 2,
option P 900 350 400 600

On September 1, the company purchased 5, 000 units of inventory at a cost of 103,

000 FC. The option was settled/sold on September 1 at its fair value of P 2, 600.
After incurring further processing costs of P 20, 000, the inventory was sold for P
95, 000 on October 5.

1. What is the intrinsic value (IV) and time value (TV) of option on June 1?

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 Intrinsic Value Time Value Intrinsic Value Time Value
a. P 0 P0 c. P 900 P0
b. P 0 P 900 d. P 200 P 700

2. What is the intrinsic value (IV) and time value (TV) of option on June 30?
Intrinsic Value Time Value Intrinsic Value Time Value
a. P 200 P 1, 150 c. P 250 P 450
b. P 1, 150 P 200 d. P0 P 1, 350
3. What is the intrinsic value (IV) and time value (TV) of option on July 31?
Intrinsic Value Time Value Intrinsic Value Time Value
a. P 2, 000 P 400 c. P 250 P 450
b. P 400 P 2,000 d. P0 P 1, 350
4. What is the intrinsic value (IV) and time value (TV) of option on September
1?
Intrinsic Value Time Value Intrinsic Value Time Value
a. P 0 P0 c. P 100 P 2, 500
b. P 2, 500 P 100 d. P 2, 600 P0
5. The foreign exchange gain on option contact (hedging instrument) on June
30: (OCI-Other Comprehensive Income)
OCI Option Expense/Earnings OCI Option Expense/Earnings
a. P 450 P0 c. P 250 P 200

b. P 0 P 450 d. P200 P 250

6. The foreign exchange gain on option contact (hedging instrument) on July

31: (OCI-Other Comprehensive Income)
OCI Option Expense/Earnings OCI Option Expense/Earnings
a. P 1, 800 P (750) c. P 2, 000 P (750)
b. P (1, 800) P 750 d. P2, 000 P 1, 500
7. The foreign exchange gain on option contact (hedging instrument) on
September 1:
OCI Option Expense/Earnings OCI Option Expense/Earnings
a. P 500 P (800) c. P 2, 000 P (750)

b. P 200 P 750 d. P2, 500 P (300)

8. The cost of inventory that was sold on October 5:

a. P 56, 650 c. P 76, 725
b. P 59, 225 d. P 79, 225
9. The cost of sales on October 5, assume that adjustments were made as part
of cost of goods sold:

a. P 56, 650 c. P 76, 725

b. P 59, 225 d. P 79, 225

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 10.What is the adjusted gross profit on October 5 arising from the above
transactions; assume that adjustments were made as part of cost of goods
sold?

a. P 35, 775 c. P 17, 475

b. P 18, 275 d. P 15, 775
11.What is the net impact on the company’s net income on October 5 as a result
of this hedge of a forecasted foreign currency purchase? Assume that
adjustments were made part of the cost of goods sold.
a. P 35, 775 c. P 17, 475
b. P 18, 275 d. P 15, 775

12.What is the net impact on company’s July 31 net income (assume fiscal year
ends July 31) as a result of this hedge of a forecasted foreign currency
purchase?
a. P 0
b. P 250 increase in net income
c. P 500 decrease in net income
d. P 750 decrease in net income

XVI – Futures: Hedging an Exposed Asset – “Undesignated Hedges” or Hedge

does not require Hedge Accounting

On December 1, 2008, Lorien Company made a credit sale to a Korean company.

The amount of sale was 100, 000 Korean won. Lorien will collect the account on
January 1, 2009. On December 1, the exchange rate of 40 Korean won for 1
Philippine peso. On December 1, Lorien entered into a futures contract to sell
100,000 Korean won for 1 Philippine peso.

1. If the exchange rate for 1 Philippine peso on December 31, 2008 is 50

Korean won, compute the foreign exchange gain or loss on hedged item:
a. P 0 c. P 500 gain
b. P 500 loss d. Not applicable, since it is a non-derivative contract

2. Compute the gain or loss on hedging instrument-future contract:

a. P 0 c. P 500 gain
b. P 500 loss d. Not applicable, since it is a non-derivative contract

3. Compute the net (total) foreign exchange gain or loss/ the effect on net
income would be:
a. P 0 c. P 500 gain
b. P 500 loss d. Not applicable, since it is a non-derivative contract

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XVII – Futures with Present Value: Hedging an Exposed Asset –
“Undesignated Hedges” or Hedge does not require Hedge Accounting

On January 1, 2008, Randolf Company sold equipment to Jang Company for 20,
000, 000 Korean won, with payment to be received in 2 years on January 1, 2010.
The exchange rate on January 1, 2008, is 800 won = P 1. On the same date,
Randolf enters into a futures contract and agrees to sell 20, 000,000 won on
January 1, 2010,a t the rate of 800 won = P 1.

On December 31, 2008, the exchange rate is 790 won = P 1. On December 31,
2009, the exchange rate is 830 won = P1. The appropriate discount rate throughout
this period is 10%. For purposes of estimating future settlement payments under
the futures contract, assume that the current exchange rate is the best forecast of
the future exchange rate.

1. What is the notional value of the Korean Won futures contract?

a. P 20, 661 c. P 25, 000

b. P 22, 727 d. P 25, 316

2. What is the value of won receivable on December 31, 2008?

a. P 20, 661 c. P 25, 000
b. P 22, 727 d. P 25, 316
3. What is the fair value of the futures contract on December 31, 2008?
a. P 284 c. P 904
b. P 316 d. P 2, 066
4. What is the fair value of the futures contract on January 1, 2010?
a. P 284 c. P 904
b. P 316 d. P 2, 066

Derivatives as Hedging Instruments in Managing Commodity Exposures

XVIII – Forward Contracts: Hedging a Forecasted Transaction

Megan Rose Cuisine operates a chain of fine seafood restaurants. The company
makes very detailed long-term planning. On October 1, 2008, Megan Rose
determined it would need to purchase 1, 000, 000 pounds of deluxe fish on January
1, 2010. Because of the fluctuations in the price of deluxe fish, on October 1, the
company negotiated a special forward contract with Angela Investment bank for
Megan Rose to purchase 1, 000, 000 pounds of deluxe fish on January 1, 2010, at a
price of P 16, 000,000. The price of the deluxe fish was P 16 per pound on October
1. Angela Investment Bank has a staff of financial analysts who specialize in
forecasting fish prices. These analysts are predicting a drop in worldwide fish
prices between October 1, 2008, and January 1, 2010. On December 31, 2008, the
price of a pound of deluxe fish is P20. On December 31, 2009, the price of a pound
of deluxe fish is P 11. The appropriate discount rate throughout this period is 10%.
15
 1. What is the notional value of fish forward contract?
a. P 20, 000, 000 c. P 11, 000, 000
b. P 16, 000, 000 d. P 4, 000,000

2. What is the fair value of the forward contract on December 31, 2008?
a. P 4, 000, 000 c. P 5, 000, 000
b. P 3, 636, 364 d. P 4, 545,454

3. The value of fish inventory on January 1, 2010 should be:

a. P 20, 000, 000 c. P 11, 000, 000
b. P 16, 000, 000 d. P 4, 000,000

XIX – Futures Contracts: Hedging a Forecasted Transaction

Quincy Bottlers produces bottled juice. Orange Juice concentrate is typically

bought and sold by the pound, and Quincy uses 100, 000 pounds of orange juice
concentrate each month. On December 1, 2008, Quincy entered into an orange
juice concentrate futures contract to buy 100, 000 pounds of concentrate on
January 1 at a price of P 0.85 per pound, which is also the market price of
concentrate on December 1. Quincy designates the futures contract as a hedge of
the forecasted purchase of orange juice concentrate on January.

On December 31, 2008, and January 1, 2009, the market price of the concentrate is
P 0.75 per pound.

1. What is the notional value of the orange juice concentrate future contract?
a. Zero c. P 75, 000
b. P 10,000 d. P 85, 000
2. What is the fair value of the futures contract on December 31, 2008?
a. Zero c. P 75, 000
b. P 10,000 d. P 85, 000
3. What is the value of the orange juice inventory on January 1, 2009?
a. Zero c. P 75, 000

b. P 10,000 d. P 85, 000

4. What is the loss on futures contract-earnings on January 1, 2009?

a. Zero c. P 75, 000
b. P 10,000 d. P 85, 000

XX – Option Contracts: Hedge a Forecasted Purchase

A Pampanga food processor forecasts purchasing 300,000 pounds of soybean oil in

May. On February 20, the company acquires an option to buy 300, 000 pounds of

16
soybean oil in May at a strike price of P 1.60 per pound. Information regarding
spot prices and option values at selected date is as follows:

20-Feb 28-Feb 31-Mar 20-Apr

Spot rate ( market price) per
pound P 1.61 P 1.59 P 1.62 P 1.64
Strike price (exercise price)
per pound P 1.60 P 1.60 P 1.60 P 1.60
Fair value of call option P 3, 800 P 1, 200 P 6, 800 P 12, 500

The company settled the option on April 20 and purchased 300, 000 pounds of
soybean oil on May 3 at a spot price of P 1.63 per pound. During May, the soybean
oil was used to produce food. One-half of the resulting food was sold in June. The
change in the option’s time value is excluded from the assessment of hedge
effectiveness.

1. The foreign exchange gain (or loss) on option contract (hedging instrument)
on February 28:
OCI Option Expense/Earnings OCI Option Expense/Earnings

a. P (1, 600) P 400 c. P (3, 000) P 400

b. P 3, 000 P (400) d. P0 P0

2. The foreign exchange gain (or loss) on option contract (hedging instrument)
on March 31:

OCI Option Expense/Earnings OCI Option Expense/Earnings

a. P 6,000 P (400) c. P (3, 000) P 400

b. P 3,000 P (400) d. P 0 P 0
3. The foreign exchange gain (or loss) on option contract (hedging instrument)
on April 20:
OCI Option Expense/Earnings OCI Option Expense/Earnings
a. P 9,000 P (300) c. P (9, 000) P 300
b. P 6,000 P (300) d. P 6, 000 P 300
4. The cost of inventory that was acquired on May 3:
a. P 480, 000 c. P 489, 000
b. P 483, 000 d. P 492, 000
5. The cost of sales assuming that adjustments were made as part of cost of
goods sold during June:
a. P 240, 000 c. P 244, 500
b. P 241, 500 d. P 246, 000

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 6. What is the adjusted gross profit arising from the above transactions
assuming the sales of P 300, 000?

a. P 60, 000 c. P 55, 500

b. P 58, 500 d. P 54, 000
7. What is the net income effect of the above transactions?

a. P 63, 300 c. P 59, 700

b. P 60, 000 d. P 59, 500

Special Topics

XXI

On January 1, 2008, Cougar Company received a two-year P 500, 000 loan. The
loan calls for payments to be made at the end of each year based on the prevailing
market rate at January 1 of each year. The interest rate at January 1, 2008 was 10
percent. Aggie Company also has a two-year P 500, 000 loan, but Aggie’s loan
carries a fixed interest rate of 10 percent. Cougar Company does not want to bear
the risk that interest rates may increase in year two of the loan. Aggie Company
believes that rates may decrease and they would prefer to have variable debt. So
the two companies enter into an interest rate swap agreement whereby Aggie
agrees to make Cougar’s interest payment in 2009 and Cougar likewise agrees to
make Aggie’s interest payments in 2009. The two companies agree to make
settlement payments, for the difference only, on December 31, 2009. If the interest
rate on January 1, 2009, is 12 percent, what will be Cougar’s settlement payment to
/from Aggie?

a. P 5, 000 payment c. P 10, 000 receipt

b. P 10, 000 receipt d. P 12, 000 receipt

XXII

On January 1, 2008, Cougar Company received a two-year P 500, 000 loan. The
loan calls for payments to be made at the end of each year based on the prevailing
market rate at January 1 of each year. The interest rate at January 1, 2008 was 10
percent. Aggie Company also has a two-year P 500, 000 loan, but Aggie’s loan
carries a fixed interest rate of 10 percent. Cougar Company does not want to bear
the risk that interest rates may increase in year two of the loan. Aggie Company
believes that rates may decrease and they would prefer to have variable debt. So
the two companies enter into an interest rate swap agreement whereby Aggie
agrees to make Cougar’s interest payment in 2009 and Cougar likewise agrees to
make Aggie’s interest payments in 2009. The two companies agree to make
settlement payments, for the difference only, on December 31, 2009. If the interest

18
rate on January 1, 2009, is 12 percent, what will be Cougar’s settlement payment to
/from Aggie?

a. P 5, 000 payment c. P 10, 000 payment

b. P 5, 000 receipt d. P 10, 000 receipt

XXIII

On January 1, 2008, Cougar Company received a two-year P 500, 000 loan. The
loan calls for payments to be made at the end of each year based on the prevailing
market rate at January 1 of each year. The interest rate at January 1, 2008 was 10
percent. Aggie Company also has a two-year P 500, 000 loan, but Aggie’s loan
carries a fixed interest rate of 10 percent. Cougar Company does not want to bear
the risk that interest rates may increase in year two of the loan. Aggie Company
believes that rates may decrease and they would prefer to have variable debt. So
the two companies enter into an interest rate swap agreement whereby Aggie
agrees to make Cougar’s interest payment in 2009 and Cougar likewise agrees to
make Aggie’s interest payments in 2009. The two companies agree to make
settlement payments, for the difference only, on December 31, 2009. If the interest
rate on December 31, 2008 is 12 percent, what amount will Cougar report as the
fair value of the interest rate swap at December 31, 2008 (answers rounded to the
nearest peso)?

a. P 0 c. P 10, 000
b. P 8, 929 d. P 500, 000

FINANCIAL STATEMENTS TRANSLATION

I - TRANSLATION TO THE PRESENTATION CURRENCY – Functional

Currency is not the currency of a hyperinflationary economy (Current Rate
Method/ Net Investment Method/Closing Rate Method)

Pardi Corporation, a Philippine owned corporation had 100% ownership interest of

Sari Company based in the Toronto, Canada. Sari’s trial balance at December 31,
2008 in Canadian Dollars is as follows:

Debits Credits
Cash $ 30, 000
Accounts Receivable 18, 000
Land and Buildings - net 100, 000
Accounts payable $ 18, 000
Bonds payable - 10% 45, 000
Capital stock 50, 000
Retained Earnings, January 1 30,000
Dividends 5, 000
Sales 75, 000
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 Cost of Sales and Expenses 65, 000 0
TOTALS $ 218, 000 $ 218, 000

In addition, the following information was available:

1. Transactions involving land and buildings, bonds payable, and capital stock
all occurred in 2004.

2. Dividends were declared on March 15, 2008 and paid on October 15, 2008.

3. The relevant exchange rates for every 1 Canadian dollar were as follows:

2004- historical P 35.00

1-Jan-08 P 41.00
31-Jan-08 P 42.00
15-Mar-08 P 46.00
15-Oct-08 P 48.00
Average for 2004
- 2008 P 48.50
Average for 2008 P 47.00
31-Dec-08 P 49.00

Required: Translate the financial statement of the Canadian Subsidiary into

Presentation Currency if the functional currency is not the currency of a
hyperinflationary economy (Current Rate Method/Net Investment Method/Closing
rate Method), assuming that:

a. Sales, purchases and all operating expenses are assumed to have occurred
evenly throughout the year.
b. The peso balance of Retained Earnings on December 31, 2007, was P 1, 230,
000.

II - TRANSLATION TO THE PRESENTATION CURRENCY – Functional

Currency is the currency of a hyperinflationary economy

Certain balance sheet accounts of a foreign subsidiary of Maan Company at

December 31, 2008, have been translated into Philippine pesos as follows:

Translated at
Current Rates Historical rates
Notes Receivable,
long-term P 240, 000 P 200, 000
Prepaid Rent 85, 000 80, 000
Patent 150, 000 170, 000
Goodwill 200, 000 210, 000
Inventories 90, 000 95, 000
Buildings (net) 400, 000 420,000
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 TOTALS P 1, 165, 000 P 1, 175, 000

The Subsidiary’s functional currency is not the currency of hyperinflationary

economy (Current Rate Method/ Net Investment/Closing Rate Method). What total
amount of assets should be included in Maan’s December 31, 2008 consolidated
balance sheet for the above accounts?

a. P 1, 280, 000 c. P 1, 175, 000

b. P 1, 215, 000 d. P 1, 165, 000

III

A wholly-owned subsidiary of Mary, Inc. has certain expense accounts for the year
ended December 31, 2008, stated in local currency units (LCU) as follows:

LCU
Depreciation of equipment (related assets were
purchased 1/1/2005) 120, 000
Provision for doubtful accounts 80, 000
Rent 200, 000
Amortization of copyrights (acquired on 1/1/2006) 50, 000

The exchange rates at various dates are as follows:

Peso Equivalent
of 1 LCU
31-Dec-08 P .40
Average for the year ended
12/31/2008 P .44
1-Jan-06 P .50
1-Jan-07 P .52

The subsidiary’s functional currency is not the currency of hyperinflationary

economy (Current Rate Method/ Net Investment Method/Closing Rate Method)

The charges of the expense accounts occurred evenly approximately evenly during
the year. What total peso amount should be included in Mary’s 2008 consolidated
income statement to reflect these expenses?

a. P 225, 000 c. P 198, 000

b. P 209, 200 d. P 180, 000

IV – Hyperinflationary Economy

Using the same information in Problem III above, except that the subsidiary’s
functional currency is the currency of a hyperinflationary economy. What total
21
peso amount should be included in Mary’s 2008 consolidated income statement to
reflect these expenses ignoring price index?

a. P 225, 000 c. P 198, 000

b. P 209, 200 d. P 180, 000

V – Hyperinflationary Economy

Pinoy Company operates in a hyperinflationary economy. Its balance sheet at

December 31, 2008, follows:

Baht
('000)
Property, plant and
equipment 900
Inventory 2, 700
Cash 350
Share Capital (issued
2004) 400
Retained Earnings 2, 350
Non-current Liabilities 500
Current Liabilities 700

The general price index had moved in this way:

31-Dec
2004 100
2005 130
2006 150
2007 240
2008 300

The property, plant and equipment were purchased on December 31, 2006, and
there is a six months’ inventory held. The non-current liabilities were a loan raised
on March 31, 2008.

Determine the following:

1. The total assets after adjusting for hyperinflation should be:

a. 1, 550 c. 5, 850
b. 5, 150 d. 11, 850

2. The Retained Earnings on December 31, 2008: (‘000)

22
 a. 2, 350 c. 2, 937
b. 2, 750 d. 7, 050

3. The Retained Earnings on December 31, 2008 (in ‘000’s) assuming the
following exchange rates:

31-Dec
2004 P 1.20
2005 P 1.24
2006 P 1.27
2007 P 1.50
2008 P 1.75

a. P 4, 812.50 c. P 3, 525.00
b. P 4, 125.00 d. P 2, 750.00

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