Chapter 23

Chapter 23
Accounting for Derivatives and Hedging

Transactions (Part 2)
PROBLEM 23-1: THEORY

1. D 6. C
2. A 7. B
3. A 8. C
4. D 9. C
5. A 10. B

1. A 6. B
2. E 7. D
3. D 8. A
4. A 9. B
5. A 10. D

1. B 6. D
2. B 7. A
3. B 8. B
4. B 9. C
5. C 10. C
PROBLEM 23-4: THEORY & COMPUTATIONAL

1. C
2. D
3. A
4. D
1
5. Solution:
Hedged item – None Forward contract (Derivative)
Dec. 15, 20x1
No entry
Dec. 31, 20x1

Forward contract (asset)……30K
Gain on forward contract…..30K
[ (48 - 45) x 10,000]
to record the value of the derivative
There is gain because if Puppy Co. purchases $10,000 using the

forward contract, the purchase price is ₱450,000; while if Puppy Co.
purchases $10,000 in the market, the purchase price is ₱480,000.
Variation 1: Gross settlement – Compound entry

Jan. 15, 20x2
Cash – foreign currency...460K
($10,000 x ₱46 spot rate)
Loss on forward contract….20K
Forward contract (asset). 30K
Cash – local currency… 450K
to record the purchase of $10,000 from

the bank in exchange at the pre-agreed
purchase price of ₱450,000
Variation 2: Net settlement

Jan. 15, 20x2
Cash – local currency…… 10K
[(46 – 45) x 10,000]
Loss on forward contract…20K
Forward contract (asset)….30K
to record the net cash settlement of the

forward contract
6. Solution:
Hedged item – Hedging instrument –
Accounts payable Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
Machine………………..4.1M No entry
(100K FCU x ₱41 spot rate)
Accounts payable………..4.1M
2
Dec. 31, 20x1 Dec. 31, 20x1
FOREX loss………....300K Forward contract (asset)...300K
Accounts payable……300K [(₱43 - ₱40) x 100K]
[(₱44 - ₱41) x 100K FCU] Gain on forward contract….300K
to adjust accounts payable for the to record the value of the derivative
increase in spot rate

Jan. 15, 20x2 Jan. 15, 20x2
Accounts payable……….4.4M Cash – foreign currency 4.2M
Cash – foreign currency 4.2M (100K x ₱42spot rate)
(100,000 x 42) Loss on forward contract .. 100K
FOREX gain…………… 200K Cash – local currency… 4M
(100K x ₱40 agreed rate)
to record the payment of 100,000 FCU to Forward contract (asset) 300K
the supplier
to record the purchase of 100,000 FCU at
the pre-agreed price of ₱4,000,000
(100,000 x ₱40)

Hedged item – Forward contract (Derivative)
Accounts payable
Jan. 15, 20x2 Jan. 15, 20x2
Accounts payable……….4.4M Cash – local currency… 200K
Cash – foreign currency 4.2M [(42 – 40) x 100,000]
(100,000 x 42) Loss on forward contract 100K
FOREX gain…………… 200K Forward contract (asset)…300K
to record the payment of 100,000 FCU to to record the net cash settlement of the
the supplier forward contract
7. Solution:
Firm sale commitment Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry
Dec. 31, 20x1 Dec. 31, 20x1

Loss on firm commitment 20K Forward contract (asset).. 20K
Firm commitment (liability) 20K Gain on forward contract.. 20K
[(₱4 – ₱3.8) x 100K FCUs] [(₱4 – ₱3.8) x 100K FCUs]
to recognize the change in the fair value to recognize the change in the fair value
of the firm commitment of the forward contract
3
Jan. 15, 20x2 Jan. 15, 20x2
Cash (foreign currency)… 360K Cash (local currency)….....400K
(100K FCUs x ₱3.6 spot rate) Cash (foreign currency)….360K
Firm commitment (liability)..20K Forward contract (asset)… 20K
Loss on firm commitment... 20K Gain on forward contract….20K
Sales……………………..400K
(100K FCUs x ₱4.00 forward rate)
to record the actual sale transaction, to to record the remittance of 100,000 FCUs
recognize the change in the fair value of to the bank in exchange for the pre-
the firm commitment, and to derecognize agreed sale price of ₱400,000
the firm commitment

Jan. 15, 20x2 Jan. 15, 20x2
(100K FCUs x ₱3.6 spot rate) (4 – 3.6) x 100,000
Firm commitment (liability)..20K Forward contract (asset)… 20K
Loss on firm commitment... 20K Gain on forward contract….20K
Sales……………………..400K
(100K FCUs x ₱4.00 forward rate)
to record the actual sale transaction, to to record the net settlement of the forward
recognize the change in the fair value of contract
the firm commitment, and to derecognize
the firm commitment
8. Solution:
Firm purchase commitment Forward contract (Derivative)
Oct. 1, 20x1 Oct. 1, 20x1
No entry No entry
Dec. 31, 20x1 Dec. 31, 20x1

Loss on firm commitment .. 3,882 Forward contract (asset)... 3,882
Firm commitment (liability) 3,882 Gain on forward contract 3,882
to recognize the change in the fair value to recognize the change in the fair value
of the firm commitment of the forward contract
(₱100 – ₱96) x 1,000 meters of yarn x PV of 1 @1%*, n=3 = 4,000 x

0.970590 = 3,882
* (12% ÷ 12 months) = 1% per month

4
Mar. 31, 20x2 Mar. 31, 20x2
Inventory (92 x 1,000). 92,000 Cash [(100 - 92) x 1,000]...8,000
Loss on firm commitment Gain on forward
(8,000 – 3,882)………….. 4,118 contract (8,000 – 3,882)…. 4,118
Firm commitment Forward contract (asset)…3,882
(liability)………………….3,882
Cash ………………………100,000
(100 fixed contract price x 1,000)
to record the actual purchase transaction to net cash settlement of the forward
and to derecognize the firm commitment contract.
9. Solution:
Scenario (a):
Hedged item – Highly probable Hedging instrument –
forecast transaction Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry
Dec. 31, 20x1 Dec. 31, 20x1

No entry Accumulated OCI… ……. 4K
Forward contract (liability)… 4K
[(100 –96) x 1,000
to recognize the change in the fair value

of the forward contract
Jan. 15, 20x2 Jan. 15, 20x2
Inventory…………………..92K Accumulated OCI… ……. 4K
(1,000 x 92 current spot rate) Forward contract (liability)… 4K
Cash …………………...……92K [(96 - 92) x 1,000
to record the actual purchase transaction to recognize the change in the fair value
Jan. 15, 20x2
Cash ……………………….… 8K
to record the net settlement of the

forward contract.
Feb. 14, 20x2 Feb. 14, 20x2

Cash…………………….360K Cost of goods sold…………..8K
Cost of goods sold………92K Accumulated OCI… ……….. 8K
Inventory……………………..92K
Sales………………………..360K
to record the sale of inventory to reclassify accumulated losses on

forward contract to profit or loss as an
increase in cost of goods sold.
5
Scenario (b):
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry
Dec. 31, 20x1 Dec. 31, 20x1

No entry Accumulated OCI… ……. 4K
[(100 –96) x 1,000
to recognize the change in the fair value

Jan. 15, 20x2 Jan. 15, 20x2
Inventory…………………..92K Accumulated OCI… ……. 4K
(1,000 x 92 current spot rate) Forward contract (liability)… 4K
Cash …………………...……92K [(96 - 92) x 1,000
Jan. 15, 20x2 Jan. 15, 20x2
Inventory…………………...8K Forward contract (liability)… 8K
Accumulated OCI…………….8K Cash ……………………….… 8K
to remove the accumulated OCI and to record the net settlement of the
adjust it to the initial cost of the forward contract.
inventory
Feb. 14, 20x2 Feb. 14, 20x2
Cash…………………….360K No entry
Cost of goods sold…… 100K
Inventory……………………100K
Sales………………………..360K
to record the sale of inventory
PROBLEM 23-5: MULTIPLE CHOICE: COMPUTATIONAL

1. A Pinoy Corp. recognizes no net gain or net loss. By opening the letter of
credit, Pinoy Corp. fixes its net exposure to exchange rate risk at
₱27.50.
2. A
Solution:
Contract rate 0.70
30-day futures rate on 12/31/01 0.65
Decrease 0.05
Multiply by: No. of Swiss francs 50,000
6
Loss 2,500
3. B
Current price (¥47,850,000 ÷ ¥115) $416,087
Fixed amount of dollars to be received from the ¥47,850,000 $435,000
Deficiency - Receipt
18,913
4. C
Solution:
Current price (¥47,850,000 ÷ ¥105) $455,714
Fixed amount of dollars to be received from the
¥47,850,000 $435,000
Excess – Payment
$(20,714)
5. B
Solution:
Current price (¥47,850,000 ÷ ¥115) $416,087
Fixed amount of dollars to be received from the ¥47,850,000 $435,000
$18,91
Difference - Fair value
3
PROBLEM 23-6: EXERCISES: COMPUTATIONAL

1. Solution:
Dec. 15, 20x1
No entry
Dec. 31, 20x1

Loss on forward contract…..30K
[ (48 - 45) x 10,000]
to record the value of the derivative
Jan. 15, 20x2

Forward contract (liability) .30K
Gain on forward contract… 20K
Cash – local currency…… 10K
[(46 – 45) x 10,000]
to record the net cash settlement of the

forward contract
7
2. Solution:
Accounts receivable Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
Accounts receivable…. 4.1M No entry
Sales……………….. 4.1M
(100K FCU x ₱41 spot rate)
Dec. 31, 20x1 Dec. 31, 20x1

Accounts receivable…. 300K Loss on forward contract….300K
FOREX gain……….... 300K Forward contract (liability)... 300K
[(₱44 - ₱41) x 100K FCU] [(₱43 - ₱40) x 100K]
Scenario A: Gross settlement – Compound entry

Jan. 15, 20x2 Jan. 15, 20x2
Cash – foreign currency 4.2M Cash – local currency… 4M
(100,000 x 42) (100K x ₱40 agreed rate)
FOREX loss…………… 200K Forward contract (liability) 300K
Accounts receivable…… 4.4M Cash – foreign currency 4.2M
(100K x ₱42 spot rate)
Gain on forward contract . 100K
Scenario B: Net settlement

Hedged item – Forward contract (Derivative)
Accounts payable
Jan. 15, 20x2 Jan. 15, 20x2
Cash – foreign currency 4.2M Forward contract (liability) 300K
(100,000 x 42) Cash – local currency… 200K
FOREX loss…………… 200K [(42 – 40) x 100,000]
Accounts receivable…… 4.4M Gain on forward contract . 100K
3. Solution:
Firm sale commitment Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry
Dec. 31, 20x1 Dec. 31, 20x1
8
Firm commitment (asset) 20K Loss on forward contract.. 20K
[(₱4 – ₱3.8) x 100K FCUs] Forward contract (liability).. 20K
Gain on firm commitment 20K [(₱4 – ₱3.8) x 100K FCUs]
Scenario A: Gross settlement – Compound entry

Jan. 15, 20x2 Jan. 15, 20x2
Equipment……………… 400K Cash (foreign currency)….360K
(100,000 x 4 forward rate) Forward contract (liability)… 20K
Firm commitment (asset).. 20K Loss on forward contract…. 20K
(100K FCUs x ₱3.6 spot rate)
Gain on firm commitment... 20K
Scenario B: Net settlement

Jan. 15, 20x2 Jan. 15, 20x2
Equipment……………… 400K Forward contract (liability)… 20K
(100,000 x 4 forward rate) Loss on forward contract…. 20K
Firm commitment (asset).. 20K Cash (local currency)..... 40K
Cash (foreign currency)… 360K
(100K FCUs x ₱3.6 spot rate)
Gain on firm commitment... 20K
4. Solution:
Oct. 1, 20x1 Oct. 1, 20x1
No entry No entry
Dec. 31, 20x1 Dec. 31, 20x1

Firm commitment (asset) 3,941 Loss on forward contract 3,941
Gain on firm commitment .. 3,941 Forward contract (liability)... 3,941
(₱100 – ₱96) x 1,000 meters of yarn x PV of 1 @0.5%*, n=3 = 4,000 x

0.985149 = 3,941
* (6% ÷ 12 months) = 0.5% per month

Mar. 31, 20x2 Mar. 31, 20x2
9
Cash………………… 100,000 Forward contract (liability)... 3,941
(100 fixed contract price x 1,000) Loss on forward contract ….4,059
Sales (92 x 1,000). 92,000 (8,000 – 3,941)….
Firm commitment (asset) 3,941 Cash [(100 - 92) x 1,000]... 8,000
Gain on firm commitment 4,059
5. Solution:
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry
Dec. 31, 20x1 Dec. 31, 20x1

No entry Forward contract (asset)… 4K
[(100 –96) x 1,000
Accumulated OCI… ……. 4K
Jan. 15, 20x2 Jan. 15, 20x2

Cash…………………..92K Forward contract (asset)… 4K
(1,000 x 92 current spot rate) [(96 - 92) x 1,000
Sales…………………...……92K Accumulated OCI… ……. 4K
Jan. 15, 20x2 Jan. 15, 20x2
Accumulated OCI… ……….. 8K Cash ………………………. 8K
Sales…………………...…… 8K Forward contract (asset)… 8K
to reclassify accumulated losses on to record the net settlement of the

forward contract to profit or loss as an forward contract.
increase in sales
10

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Chapter 23 - Teacher's Manual - Aa Part 2

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Accounting for Derivatives and Hedging

PROBLEM 23-1: THEORY

PROBLEM 23-2: THEORY

PROBLEM 23-3: THEORY

PROBLEM 23-4: THEORY & COMPUTATIONAL

Dec. 31, 20x1

to record the value of the derivative

There is gain because if Puppy Co. purchases $10,000 using the

Variation 1: Gross settlement – Compound entry

to record the purchase of $10,000 from

Variation 2: Net settlement

to record the net cash settlement of the

Variation 1: Gross settlement – Compound entry

Variation 2: Net settlement

Dec. 31, 20x1 Dec. 31, 20x1

Variation 2: Net settlement

Dec. 31, 20x1 Dec. 31, 20x1

(₱100 – ₱96) x 1,000 meters of yarn x PV of 1 @1%*, n=3 = 4,000 x

* (12% ÷ 12 months) = 1% per month

Hedged item – Hedging instrument –

Dec. 31, 20x1 Dec. 31, 20x1

to recognize the change in the fair value

to record the net settlement of the

Feb. 14, 20x2 Feb. 14, 20x2

to record the sale of inventory to reclassify accumulated losses on

Dec. 31, 20x1 Dec. 31, 20x1

to recognize the change in the fair value

to record the sale of inventory

PROBLEM 23-5: MULTIPLE CHOICE: COMPUTATIONAL

PROBLEM 23-6: EXERCISES: COMPUTATIONAL

Dec. 31, 20x1

to record the value of the derivative

Jan. 15, 20x2

to record the net cash settlement of the

Dec. 31, 20x1 Dec. 31, 20x1

Scenario A: Gross settlement – Compound entry

Scenario B: Net settlement

Dec. 31, 20x1 Dec. 31, 20x1

Scenario A: Gross settlement – Compound entry

Scenario B: Net settlement

Dec. 31, 20x1 Dec. 31, 20x1

(₱100 – ₱96) x 1,000 meters of yarn x PV of 1 @0.5%*, n=3 = 4,000 x

* (6% ÷ 12 months) = 0.5% per month

Hedged item – Hedging instrument –

Dec. 31, 20x1 Dec. 31, 20x1

Jan. 15, 20x2 Jan. 15, 20x2

to reclassify accumulated losses on to record the net settlement of the

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