BADVAC3X – GOVERNMENT AND NON-FOR-PROFIT ACCOUNTING

MODULE 7: DERIVATIVES AND HEDGE ACCOUNTING

PART I. DERIVATIVE CONCEPTS

Definition of Derivative

A derivative is a financial contract whose value depends on the performance of underlying financial asset, index or
other investment.

These can include foreign exchange rate, a commodity price, an interest rate, the price of another financial instrument or
other financial and non-financial variables.

Definition under IFRS 9

A financial instrument or other contract within the scope of this Standard with all three of the following characteristics.

a. its value changes in response to the change in a specified interest rate, financial instrument price, commodity
price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in
the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called
the ‘underlying’).
b. it requires no initial net investment or an initial net investment that is smaller than would be required for
other types of contracts that would be expected to have a similar response to changes in market factors.
c. it is settled at a future date.

Terminologies

The underlying of a derivative is an asset, basket of assets, index, or even another derivative. Examples includes the
following:

Price of a security
Index (Philippine Stock Exchange Index)
Interest rate
Foreign exchange rate (ex. PHP to USD)
Commodity price (ex. Price of oil per barrel)
Measure of creditworthiness (ex. Moody’s)
Occurrence or non-occurrence of a specific event

Notional amount and Notional

Notional/Notional amount is the underlying quantity that will/might be purchased or sold. Notional amount is denoted in
local currency while notional is denoted in the underlying units. Both are used to calculate the payments made on a
particular instrument.

It is the total value of a position’s assets. The term is commonly used in options, futures and currency markets because a
very small amount on invested money can control a large position (e.g. if an investor hold a future contract to buy 250
units of a stock and if a single stock is trading at P2,000 then the futures contract is similar to investing P500,000. Thus,
P500,000 is the notional amount of the contract.

Examples of notional are: 5M US Dollar, 5 shares of stock, 1,000 barrels. Examples of notional amounts are P250,
P235,000. P1,290,480.

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Types of Derivatives by Name

1. Forwards
2. Futures
3. Options
4. Swaps
5. Exotics

Types of Derivatives by Complexity

1. Linear instruments
2. Non-linear instruments
3. Structures instruments

Types of Derivatives by Market

1. Exchange-traded = organized exchange

2. Over-the-counter (OTC) instruments

Types of Derivatives by Risk Exposure

1. Forward-based derivatives (examples are forwards, futures and swaps). Under these contracts, it has a “two-
sided exposure” wherein each party has a favorable or unfavorable outcome but not both simultaneously (ex.
Both will not simultaneously have favorable outcomes). Consequently, the downside risk and the upside potential
on the hedged item are counterbalanced
2. Option-based derivatives (examples are option contracts, interest rate caps and interest rate floors). Under these
contracts, it has a “one-sided exposure” in which only one specified party can potentially have a favorable
outcome and it agrees to pay a premium at inception for this potentiality. The other party is paid the premium,
and it can potentially have only one unfavorable outcome. Consequently, only the downside risk on the hedged
item is counter balanced.

Purpose of Investing in Derivatives

1. Speculation/Trading. The assumption of risk in anticipation of gain

2. Risk Management (Hedging). Elimination of foreign currency risk, commodity price risk, interest rate risk and
credit risk through hedging.
3. Reduction of funding cost. Derivatives provide low-cost and off-balance sheet method of isolating exposure to
financial prices and talking and offsetting position to hedge that exposure.
4. Regulatory arbitrage. Derivatives are used sometimes to circumvent regulatory restrictions, taxes and accounting
rules.

Forward Contract

A forward contract is an agreement entered into today (02/11/21), either to sell or to buy a specific quantity
(buy $1,000/buy 1,000 barrels) of an underlying asset at specified future date (03/12/21) for a specified price
(P48.00 = $ 1.00/$80 per barrel)

A forward contract is an over the counter agreement between two parties that negotiate the terms of the deal. It is fully
customizable and typically not subject to a clearinghouse

Long and Short Positions

Long position.

The party that purchases the forward contract.

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The party that agrees to purchase an asset in the future

The party that anticipates that the price of an asset will increase

Short position.

The party that sells the forward contract.

The party that agrees to sell an asset in the future

The party that anticipates that the price of the asset will decrease

Option Contracts

An option is an agreement that gives the buyer the right, but not the obligation, to buy or sell an asset at a
predetermined price from the seller.

Characteristics:

• Contingent on an event taking place

• Payment of an option premium or price at inception
• Either over the counter and customized or exchange-listed and standardized

Types of Underlying

Equity, Bonds, Currency, Commodity, Interest rate

Example of Terms of an Option Contract

“A call option to buy 5 thousand barrels3 of crude oil1 at US$80 per barrel2 at the end of 6 months4. The option price is
US$1,0005.”
1
Underlying. The financial variable from which derivative derives its value.
2
Exercise/Strike Price. The stated price for which an underlying may be purchased or sold.
3
Notional. The quantity of the underlying to which the contract applies (Notional Amount: $400,000 = 5,000 x $80)
4
Expiration Date. The maturity date which gives rise to the notion of an option’s time to expiration
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Option premium. Also known as option price, which is the money paid when the option contract is initiated.

Call Option and Put Option

A call option is an option to buy an asset at a fixed price on some future date.
Right to buy
Buyer / Seller /
Holder Writer
Obligation to sell

A put option is an option to sell an asset at a fixed price on some future date
Right to sell
Buyer / Seller /
Holder Writer
Obligation to buy

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Moneyness of the option

In the future, the option buyer will find it beneficial to:

• Exercise the option when the payoff is positive, i.e. the option is in-the-money
• Not exercise the option when its payoff is nil, i.e. the option is at-the-money or out-of-the-money

Possible Outcomes
Market Price > Exercise Market Price = Exercise Market Price < Exercise
Price Price Price
Call Option In-the-money At-the-money Out-of-the-money
Put Option Out-of-the-money At-the-money In-the-money

Examples:

Strike (Exercise) Price Spot(Market) Price Calls (option to buy) Puts (option to sell)
100 50 Deeply out of the money Deeply in the money
100 90 Out of the money In the money
100 100 At the money At the money
100 110 In the money Out of the money
100 150 Deeply in the money Deeply out of the money

Long Versus Short Position in Options

Call Option Put Option

Long Position Bought an option to buy an asset Bought an option to sell an asset
Short Position Sold an option to buy an asset Sold an option to sell an asset

Intrinsic and Time Value Component of the Option

The option premium consists of two amounts: (1) intrinsic value and (2) time value. Intrinsic value is the difference
between the market price and the preset strike price at any point in time. It represents the amount realized by the option
holder, if exercising the option immediately. Time value refers to the option’s value over and above its intrinsic value. It is
the portion of the option premium that can be attributable to the time remaining until the expiration of the option
contract.

Presentation of Options is Balance Sheet

Presentation of an unexpired option Presentation of an unexpired option

contract in the option holder’s contract in the option writer’s balance
Option is: balance sheet sheet
Out-of-the-money Asset (time value only) Liability
At-the-money Asset (time value only) Liability
In-the-money Asset (intrinsic + time value) Liability

PART II. HEDGING ACTIVITIES

Cornerstone of IFRS 9

IFRS 9 is based on the following cornerstone decisions made by the IASB:

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 1. Derivatives are contracts that create rights and obligations that meet the definition of assets and liabilities (thus
these right and obligations are reported in the balance sheet – not in a ‘off-balance sheet’ manner).
2. Fair value is the only relevant measure for reporting of derivatives, thus derivatives are reported in the balance
sheet at their fair value – whether or not they hedge an item
3. Only items that are assets and liabilities are reportable in the balance sheet (thus losses in derivatives cannot be
deferred and reported as assets and gains on derivatives cannot be deferred and reported as liabilities).
4. Gain and losses on derivatives must be reported in earnings currently – except in certain specific situations in
which the gains and losses must be reported in equity section. Furthermore, in certain specified situations in
which the gain or loss on the hedging transactions must be reported in earnings currently, the normal accounting
for hedged item must be altered so that the offsetting loss or gain on the hedged item is also reported currently
in earnings. The accounting treatment for both types of these certain specified situations comprises what is
collectively referred to as “hedge accounting”

Distinguishing Hedging and Hedge Accounting

The word “hedging” is a broad and general term, it is a means of minimizing risk. The simplest hedge is when an
enterprise takes out a foreign currency loan to finance and foreign currency investment. If the foreign currency
strengthens, then the value of the asset and the burden of liability will increase by the same amount. Any gains or losses
will the cancelled out.

Hedge accounting recognizes systematically the offsetting effects on net profit or loss of changes in the fair value of
the hedging instrument and the related item being hedged. The hedging instrument will normally be a derivative.

PFRS 9 identifies three types of hedge:

1. Fair value hedge. This hedge against the risk of changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment (or portion of such asset, liability, or firm commitment) attributable to a particular
risk. Such as the fair value of a fixed rate debt will change as a result of changes in interest rates.
2. Cash flow hedge. This hedge against the risk of changes in expected cash flows. It is a hedge of exposure to
variability in cash flows that is attributable to a particular risk associated with:
a. A recognized asset or liability such as future interest payments or variable-interest debt, or
b. A highly probable forecasted transaction such as forecasted sale or purchase that will affect future reported
profit or loss.
3. Hedge of a net investment in foreign operations.

Forward Contract

A forward contract is an agreement between a buyer and a seller that requires the delivery of some commodity at a
specified future date at a price agreed to today (the exercise price). A typical example of forward contract is foreign
currency forward contracts.

A foreign currency forward contract is an agreement to buy or sell a foreign currency at:

1. A specified future date (usually within 12 months), and

2. A specified exchange rate. The rate is called the forward rate.

At the inception of the contract, the forward rate normally varies from the spot rate. The difference between the two
rates is referred to as a discount (premium) if the forward rate is less than (greater than) the spot rate.

The use of the forward contract includes the following:

1. Hedges
a. Forward contracts used as a hedge of a foreign currency transactions. These includes importing and
exporting transactions denominated in foreign currency. These hedges do not qualify for hedge

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 accounting under PAS 39 because the foreign exchange gains and losses are already reported at market
value on the balance sheet.
b. Forward contracts used as a hedge of an unrecognized firm commitment (This type of hedge are now treated
as fair value hedge rather than cash flow hedge. However, PAS 39 par 87 clarifies that a hedge of a foreign
currency risk of a firm commitment can be treated either as a cash flow hedge or a fair value hedge). Hedge
accounting rules apply. Both the change in the value of the hedging instrument and the value of the hedged
item are reported in the books.
An example of an unrecognize firm commitment would be when the firm enters into a contract to purchase
an asset in two months for a fixed amount of foreign currency.
c. Forward contracts used as a hedge of a net investment in foreign operations. A foreign currency transaction
is considered a hedge of an net investment in a foreign entity if the forward contract is design as, and
effective as, a hedge of the net investment. The gain or loss on the hedging instrument is reported in the
equity the same manner as the translation adjustments.
2. Speculation. Forward contracts can be used to speculate changes in foreign currency. Forward rate should be
used because a firm speculating in foreign currency changes is exposed to the risk of movements in the forward
rate. Foreign exchange gains and losses are reported currently in the income statement.

Summary of Hedge Accounting

Fair value Hedge Cash Flow Hedge

Hedging Instrument (Forward
Contract)
Gain or loss on hedging instrument
Gain or loss on the hedged item due
to hedged risk
Gain or loss in the other
comprehensive income transferred to
profit or loss
On balance sheet carried at fair value
Recognized immediately in profit or
loss
Recognized immediately in profit or
loss
Not applicable
On balance sheet carried at fair value
To the extent, the hedge is effective,
recognized as other comprehensive
income
The ineffective portion of the gain or
loss will be reported immediately in
profit or loss
Not applicable – forecasted
transactions are not recognized
If the hedged item is a forecasted
purchase of inventory, the gains and
losses on the hedging instrument will
be reclassified into earnings, when
the inventory is sold, or when a
forecasted purchase of equipment,
the gains or losses on the hedging
instrument will be reclassified into
earnings as the equipment is
depreciated.

Futures Contract

A futures contract is the same thing with forward contracts except that instead of being negotiated between two parties,
the contract is a standard one that is sponsored by an organized exchange. With a futures contract, the exchange
handles the cash settlements, between the two parties to the contract. Accordingly, with a futures contract, the two
parties to the agreement almost never directly contact one another. This is not true with forward contracts because they
are directly negotiated between two parties.

Assessing Hedge Effectiveness (Cash Flow Hedge)

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In order to qualify for hedge accounting, the hedge relationship must meet the following effectiveness criteria at the
beginning of the each hedged period:

1. There is an economic relationship between the hedged item and the hedging instrument – meaning that the
hedging instrument and the hedged item must be expected to have offsetting changes in fair value
2. The effect of credit risk does not dominate the value changes that result from that economic relationship; and
3. The hedge ratio of the hedging relationship is the same as that actually used in economic hedge. i.e. hedge ratio
is designated based on actual quantities of hedged item and the hedging instrument

Derivative is Compare cumulative changes in FV of hedging

accounted as cash instrument (A) and cumulative changes in present
flow hedge value of expected cash flows (B)

(A) > (B) (A) ≤ (B)

Ineffective portion: Effective portion: No ineffective portion.

(A) – (B) (P/L) (B) (OCI/Equity) Effective portion = cumulative
changes in FV of hedging
instrument (OCI/Equity)
Discounting of Fair Value of Forward Contract

PFRS 9 requires the recognition of an interest factor if interest is significant. This requires discounting of fair value of the
forward contract. The discounting is not necessary to the hedged item because spot is in effect. The only exception is
when option contract is used to determine the gain or loss on the hedged item.

Spilt Accounting in Assessing/Measuring Hedge Effectiveness

PFRS 9 requires all derivatives to be valued at their fair values. Thus, both the time value element and the intrinsic value
element are measured at fair value. Accordingly, the need to determine the breakdown of the total fair value occurs only
if split accounting is used.

Intrinsic value may be viewed was conceptually different from the time value. It theoretically can be accounted for
separately from the time value. Carving out the time value element and reporting its gain or loss separately from the
manner of reporting intrinsic value element’s gain or loss is referred to as split accounting.

Intrinsic value is the incremental premium paid (difference between the spot price and the exercise price – to be placed
in this favorable position). The entire premium is called the time value (time value is analogous to a prepaid insurance
that could be amortized over the life of the option period).

PFRS 9 permits (but does not require) an entity to exclude all of part of a derivative’s time value element in assessing
hedge effectiveness. Thus, split accounting (accounting for the time value element in a separate manner from the
intrinsic value element) is permitted.

For forward contract purposes, time value element applies to premium and discounts on forward rates.

If hedge effectiveness were assessed by excluding time value element, the presumed changes in fair value of the foreign
currency commitment would be based on the changes in the spot rate – not the changes in the forward rate. Thus, one
compares:

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 1. Only the foreign currency forward’s intrinsic value change (attributable to the change in the spot rate) with,
2. The change in the foreign currency commitment’s fair value using the change in the spot rate.

PART III. PROBLEMS

STRAIGHT PROBLEM

PROBLEM 1 (Forward Exchange Contract): On December 1, 20x4 Jaja Company entered into four forward exchange
contracts to purchase US $1,200 in 90 days for delivery on March 1, 20x5 for P40.15. The exchange rates available on
various dates are as follows (Fiscal year end is December 31)

Dec 1, 20x4 Dec 31, 20x4 March 1, 20x5

Spot rate P40.00 P40.30 P40.20
30-day forward rate P40.05 P40.45 P40.40
60-day forward rate P40.10 P40.40 P40.50
90-day forward rate P40.15 P40.45 P40.60

Required: Journal entries, assuming the following situations

1. (Not a Hedge Accounting – Importing transaction) On December 1, 20x4, Jaja Company purchased inventory for
US$1,200 payable on March 1, 20x5 (The transaction is payable in USD)
2. (Hedging on Unrecognized Foreign Currency Firm Commitment – Fair Value Hedge) On December 1, 20x4 Jaja
Company contracts to purchase special order goods from Boston Company. The contract meets the requirement
of a firm commitment – fair value hedge. Their manufacture and delivery will take place in 90 days (on March 1,
20x5). The contract price is US$ 1,200 to be paid by March 1, 20x5.
Also on December 1, 20x4 Jaja Company enters into second forward contract in hedging foreign currency
payable commitment with a contract to receive $1,200 in 90 days at the forward rate of P40.15
3. (Hedge of a Forecasted Transaction – Cash Flow Hedge). On December 1, 20x4, Jaja Company expects to
purchase a machine for $1,200 in US on March 1, 20x5. The transaction is probable but there is no binding
agreement for this purchase and is to be denominated in US dollars. Thus, transaction and settlement for the
purchase of the machine is March 1, 20x5.
Also on December 1, 20x4 Jaja Company entered into the third forward contract to purchase $1,200 on March 1,
20x5 for P40.15. Jaja Company designates the forward contract as a hedging instrument in a cash flow hedge of
the exposure to increases in the dollar rate.
4. (Not a Hedge Accounting – Speculation) Jaja Company entered into the third forward contract for speculative
purposes in anticipation of gain, enter into a contract on December 1, 20x4 to acquire $1,200 (a currency in
which the company has no receivables, payables, commitments or forecasted transactions) on March 1, 20x5 at a
forward rate of P40.15.
5. (Not a Hedge Accounting – Importing transaction). Same as No 1, except that there is a relevant discount rate of
12%.

PROBLEM 2 (Option Contract – Hedging an Exposed Liability): On December 1, 20x4, Janella Company paid cash to
purchase 90-day “at-the-money” call option for 60,000 Thailand Baht. The option purpose is to protect an exposed
liability of 60,000 Thailand Baht relating to an inventory purchase received on December 1, 20x4 and to be paid on March
1, 20x5.

12/1/x4 12/31/x4 3/1/x5

Spot rate (market price) P1.20 P1.28 P1.27
Strike price (exercise price) P1.20 P1.20 P1.20
Fair value of call option P360 P5,040 P4,200

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Required: Prepare entries to record the above hedging item and hedging instrument (option contract) transactions.

MULTIPLE CHOICE QUESTIONS:

Problem 2: Valley Enterprises purchases inventory of 1,000,000 foreign currency units (FCU’s) from a foreign supplier on
August 13 with payment due on November 1. Management of Valley Enterprises immediately enter into a forward
contract to hedge this transaction. Valley prepares quarterly financial statement with a December 31 year-end. The
relevant exchange rates and forward contract fair values are as follows:
Date Spot rate Nov 1 forward rate Forward contract fair value
Aug. 13 P1.116 P1.120 P0
Sept. 30 P1.129 P1.126 P6,000
Nov. 1 P1.138 P1.138 P18,000
1. What is the balance in the accounts payable account on August 13?
a. P1,116,000 b. P1,138,000 c. P1,129,000 d. P1,130,000
2. What is the balance in the accounts payable account on September 30?
a. P1,116,000 b. P1,138,000 c. P1,129,000 d. P1,130,000
3. What is the amount of the exchange loss recognized with respect to the accounts payable account on September
30?
a. P13,000 b. P22,000 c. P9,000 d. P4,000
4. What is the balance in the accounts payable account on November 1, immediately before the collection?
a. P1,138,000 b. P1,116,000 c. P13,000 d. P1,129,000
5. What is the amount of the exchange loss recognized with respect to the accounts payable account on November
1?
a. P13,000 b. P22,000 c. P9,000 d. P4,000
6. What is the balance in the forward contract account on August 13?
a. P6,000 b. P12,000 c. P18,000 d. P 0
7. What is the balance in the forward contract account on September 30?
a. P6,000 asset b. P6,000 liability c. P18,000 asset d. P 0
8. What is the amount of the exchange loss or gain to be recognized with respect to the forward contract on
September 30?
a. P6,000 loss b. P6,000 gain c. P12,000 loss d. P12,000 gain
9. What is the balance in the forward contract account on November 1?
a. P6,000 asset b. P12,000 liability c. P18,000 asset d. P 0
10. What is the amount of the exchange loss or gain to be recognized with respect to the forward contract on
November 1?
a. P18,000 loss b. P18,000 gain c. P12,000 loss d. P12,000 gain
11. What is the net increase or decrease in cash flow from having entered into this forward contract hedge?
a. Zero b. P18,000 increase c. P18,000 decrease d. P4,000 decrease
12. What is the amount of premium or discount on forward contract?
a. Zero c. P4,000 premium revenue
b. P4,000 premium expense d. P4,000 discount expense

II. FOREIGN EXCHANGE TRANSACTIONS WITH HEDGING INSTRUMENTS

Problem 6: Taste Bits Inc. purchased chocolates from Thailand for 200,000 bahts on December 1, 2015. Payment is due
on January 30, 2016. On December 1, 2015, the company also entered into a 60-day forward contract to purchase
200,000 bahts. The forward contract is not designated as a hedge. The rates were as follows:
Dates Spot rate Forward rate

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December 1, 2015 P0.89 P0.90 (60 days)
December 31, 2015 P0.91 P0.93 (30 days)
January 30, 2016 P0.92
13. The entries on December 31, 2015 include a
a. credit to Foreign Currency Payable to Exchange Broker, P4,000
b. debit to Foreign Currency Receivable from Exchange Broker, P6,000
c. debit to Foreign Currency Receivable from Exchange Broker, P186,000
d. debit to Foreign Currency Transaction Gain, P4,000
14. The entries on January 30, 2016 include a:
a. debit to Pesos Payable to Exchange Broker, P180,000
b. credit to Cash, P184,000
c. credit to Premium on Forward Contract, P4,000
d. debit to Foreign Currency Receivable from Exchange Broker, P180,000
15. The entries on January 30, 2016 include a:
a. credit to Foreign Currency Units (Bahts), P184,000
b. credit to Cash, P180,000
c. debit to Foreign Currency Transaction Loss, P4,000
d. debit to Pesos Payable to Exchange Broker, P184,000
16. The entries on January 30, 2016 include a:
a. debit to Pesos Payable to Exchange Broker, P184,000
b. credit to Foreign Currency Transaction Gain, P4,000
c. credit to Foreign Currency Receivable from Exchange Broker, P180,000
d. debit to Foreign Currency Units (Bahts), P184,000

Problem 7: 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 = P0.683. Stark received the goods on May 1 when the spot rate was 1 FC = P0.687.
Also on May 1, Stark entered into 90-day forward contract to purchase 500,000 FC at a forward rate of 1 FC = P0.693.
Payment was made to the foreign vendor on August 1 when the spot rate was 1 FC = P0.696. Stark has a June 30 year-
end. On that date, the spot rate was 1 FC = P0.691, and the forward rate on the contract was 1 FC = P0.695. Changes in
the current value of the forward contract are measured as the present value of the changes in the forward rates over
time. The relevant discount rate is 6%
17. The foreign exchange gain on hedging instrument (forward contract) on June 30 amounted to:
a. P2,000 b. P1,000 c. P995 d. Zero
18. The nominal value of the forward contract on June 30 amounted to:
a. P2,000 b. P1,000 c. P995 d. Zero
19. The fair value of the forward contract on June 30 amounted to:
a. P1,000 asset b. P995 liability c. P995 asset d. Zero
20. The net decrease on Stark net income on June 30 income statement amounted to:
a. P2,000 b. P1,000 c. P1,005 d. P995
21. The foreign exchange gain due to hedging instrument (forward contract) on August 1 amounted to:
a. P2,500 b. P2,000 c. P1,500 d. P505

MNC Corp. (a Philippine-based company) sold parts to a foreign customer on December 1, 2015, with payment of 10
million foreign currencies to be received on March 31, 2016. The following exchange rates apply:
Dates Spot rate Forward rate (for 3/31/2016)
December 1, 2015 P0.0035 P0.0034 (4 month)
December 31, 2015 P0.0033 P0.0032 (3 month)
March 31, 2016 P0.0038 N/A

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MNC’s incremental borrowing rate is 12 %. The present value factor for three months at an anuual rate of interest of 12
% (1% per month) is 0.9706
22. Assuming that MNC entered into no forward contract, how much foreign exchange gain or loss should it report
on its 2015 income statement with regard to this transaction?
a. P5,000 gain b. P3,000 gain c. P2,000 loss d. P1,000 loss
23. Using the same information in #26 and assuming that MNC entered into forward contract to sell 10 million
foreign currencies on December 1, 2015, as a fair value hedge of a foreign currency receivable, what is the net
impact on its net income in 2015 resulting from a fluctuation in the value of the foreign currencies?
a. No impact on net income c. P2,000 decrease in net income
b. P58.80 decrease in net income d. P1,941.20 increase in net income

Problem 8: On October 2, 2015, AST Inc. ordered a custom built passenger van from a Japanese firm. The purchase
order is non-cancelable. The purchase price is 1,000,000 yen with delivery and payment to be on March 31, 2016. On
October 2, 2015, AST Inc. entered into a forward contract to buy 1,000,000 yen on March 31, 2016 for P0.53. On March
31, 2016, the custom built passenger van was delivered.
Rates 10/2/2015 12/31/2015 3/31/2016
Spot rate P0.50 P0.56 P0.57
Forward rate P0.53 P0.58 P0.57

Accounted for as Fair Value Hedge

24. The December 31, 2015 profit and loss statement, net foreign exchange gain or loss (forward contract and
commitment):
a. P10,000 net gain c. Zero
b. P10,000 net loss d. Not applicable since hedge accounting does not apply
25. The Firm Commitment account balance as shown in the December 31, 2015 balance sheet amounted to:
a. P50,000 asset c. P50,000 liability
b. P60,000 liability d. None, since it is a fair value hedge
26. What is the fair value of the forward contract on December 31, 2015?
a. P50,000 receivable c. P60,000 receivable
b. P50,000 payable d. P60,000 payable
27. What is the fair value of the forward contract on March 31, 2016?
a. P50,000 receivable c. P40,000 receivable
b. P50,000 payable d. P40,000 payable
28. The Firm Commitment account balance on March 31, 2016 amounted to:
a. P10,000 asset c. P40,000 asset
b. P50,000 liability d. P40,000 liability
29. The value of equipment on March 31, 2016 if the firm commitment account will be adjusted to asset acquired:
a. P500,000 b. P530,000 c. P560,000 d. P570,000
30. The value of equipment on March 31, 2016 if the firm commitment account will be a separate adjustment to net
income
a. P500,000 b. P530,000 c. P560,000 d. P570,000

Accounted for as Cash Flow Hedge – PAS 39, par 87

31. The December 31, 2015 profit and loss statement, foreign exchange gain or loss on hedged item/commitment
amounted to:
a. P50,000 loss c. P60,000 loss
b. P50,000 gain d. Not applicable, since it is a cash flow hedge

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 32. The December 31, 2015 foreign exchange gain or loss on the hedging instrument (forward contract) amounted
to:
a. P50,000 gain, other comprehensive income
b. P50,000 gain, current earnings
c. P60,000 loss, other comprehensive income
d. P60,000 gain, current earnings
33. The Firm Commitment account balance amounted on March 31, 2016 amounted to:
a. P10,000 asset c. P40,000 liability
b. P50,000 liability d. None, since it is a cash flow hedge
34. The value of the equipment on March 31, 2016 assuming that AST Inc. has elected to apply PAS 39 par 98 (b),
and adjust the cost of non-financial items acquired:
a. P500,000 b. P530,000 c. P560,000 d. P570,000

35. Happ, Inc. agreed to purchase merchandise from a foreign vendor on November 30, 20x3. The goods will arrive
on January 31, 20x4 and payment of P100,000 foreign currency units (FCU) due February 28, 20x4. On
November 30, 20x3, Happ signed an agreement with a foreign exchange broker to buy 100,000 FCU’s on
February 28, 20x4. Exchange rates to purchase 1 FCU are as follows:
Rates 11/30/x3 12/31/x3 1/31/x4 2/28/x4
Spot P1.65 P1.62 P1.59 P1.57
30 day P1.64 P1.59 P1.60 P1.59
60 day P1.63 P1.56 P1.58 P1.58
90 day P1.65 P1.63 P1.64 P1.62
Because of this commitment hedge, Happ will record the merchandise at what value when it arrives in January?
a. P165,000 b. P164,000 c. P160,000 d. P159,000

Problem 9: Ward Enterprises sells aircraft seat cushions to most major airplane manufacturers. The company has made
sales to a foreign customer for several years and management believes that sales to this customer will continue. On
November 30, management initiates a forward contract for 300,000 foreign currency units (FCU’s) to hedge the
forecasted sales to foreign customer. Historically the sale has occurred around February 1 and payment is received by
March 15. The spot and March 15 forward exchange rates on November 30 are P1.139 and P1.138 respectively. Ward
prepares quarterly financial statements with a December 31 year-end. The relevant exchange rates and forward contract
fair values are as follows:
Date Spot rate Mar 15 forward rate Forward contract fair value
Dec. 31 P1.141 P1.140 (P600)
Feb. 1 P1.136 P1.137 P300
Mar. 15 P1.133 P1.133 P1,500
36. What is the value recognized in the financial accounting records on November 30 for the forward contract?
a. (P600) b. P300 c. P 0 d. P1,500
37. What is the value of the forward contract at December 31?
a. (P600) liability b. P600 asset c. (P900) liability d. P1,500 asset
38. What is the gain (loss) on the forward contract included in other comprehensive income at December 31?
a. P300 gain b. P300 loss c. P600 gain d. P600 loss
39. What is the value of the forward contract at February 1?
a. (P300) liability b. P300 asset c. P 0 d. P1,500 asset
40. What is the gain (loss) on the forward contract included in other comprehensive income at February 1?
a. P300 gain b. P300 loss c. P900 gain d. P900 loss

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Problem 10: On November 1, 2015, Creamline Dairy Corp. concluded that the Thailand baht would weaken during the
next six months because of the coup that transpires recently. In hopes of reporting a gain, Creamline entered into a
foreign exchange forward contract for speculation on November 1, 2015 to sell 1,000,000 baht on April 30, 2016 at the
forward rate.
Rate 11/1/2015 12/31/15 4/30/16
Spot rate (baht) P1.190 P1.180 P1.210
Forward rate (baht) P1.199 P1.187 P1.210
41. The December 31, 2015 profit and loss statement, foreign exchange gain or loss on forward contract amounted
to:
a. P10,000 gain b. P10,000 loss c. P12,000 gain d. P12,000 loss
42. On April 30, 2016, foreign exchange gains or loss on forward contract amounted to (ignoring any discount
reversal):
a. P23,000 gain b. P23,000 loss c. P30,000 gain d. P30,000 loss

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