To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk Multiple Choice A discount or premium on a forward contract is deferred and included in the measurement of the related foreign currency transaction if the contract is classified as a: a hedge of a net investment in a foreign entity b hedge of an exposed asset or liability position c hedge of an identifiable foreign currency commitment d contract acquired to speculate in the movement of exchange rates The discount or premium on a forward contract entered into as a hedge of an exposed asset or liability position should be: a included as a separate component of stockholders‟ equity b amortized over the life of the forward contract c deferred and included in the measurement of related foreign currency transaction d none of these An indirect exchange rate quotation is one in which the exchange rate is quoted: a in terms of how many units of the domestic currency can be converted into one unit of foreign currency b for the immediate delivery of currencies exchanged c in terms of how many units of the foreign currency can be converted into one unit of domestic currency d for the future delivery of currencies exchanged A transaction gain is recorded when there is an: a importing transaction and the exchange rate increases b exporting transaction and the exchange rate increases c exporting transaction and the exchange rate decreases d none of these During 2011, a U.S company purchased inventory from a foreign supplier The transaction was denominated in the local currency of the seller The direct exchange rate increased from the date of the transaction to the balance sheet date The exchange rate decreased from the balance sheet date to the settlement date in 2012 For the years 2011 and 2012, transaction gains or losses should be recognized as: 2011 2012 a gain gain b gain loss c loss loss d loss gain http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-2 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition A transaction gain or loss is reported currently in the determination of income if the purpose of the forward contract is to: a hedge a net investment in a foreign entity b hedge an identifiable foreign currency commitment c speculate in foreign currency d none of these On November 1, 2011, American Company sold inventory to a foreign customer The account will be settled on March with the receipt of $500,000 foreign currency units (FCU) On November 1, American also entered into a forward contract to hedge the exposed asset The forward rate is $0.70 per unit of foreign currency American has a December 31 fiscal year-end Spot rates on relevant dates were: Per Unit of Foreign Currency $0.73 0.71 0.74 Date November December 31 March The entry to record the forward contract is a FCU Receivable 350,000 Premium on Forward Contract 15,000 Dollars Payable 365,000 b Dollars Receivable 365,000 Discount on Forward Contract FCU Payable 15,000 350,000 c FCU Receivable 365,000 Discount on Forward Contract Dollars Payable 15,000 350,000 d Dollars Receivable Discount on Forward Contract FCU Payable 365,000 350,000 15,000 http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 12-3 On November 1, 2011, American Company sold inventory to a foreign customer The account will be settled on March with the receipt of $450,000 foreign currency units (FCU) On November 1, American also entered into a forward contract to hedge the exposed asset The forward rate is $0.70 per unit of foreign currency American has a December 31 fiscal year-end Spot rates on relevant dates were: Date November December 31 March Per Unit of Foreign Currency $0.73 0.71 0.74 What will be the adjusted balance in the Accounts Receivable account on December 31, and how much gain or loss was recorded as a result of the adjustment? Receivable Balance a $319,500 b $319,500 c $333,000 d $333,000 Gain/Loss Recorded $9,000 gain $9,000 loss $4,500 gain $18,000 gain A transaction gain or loss at the settlement date is: a a change in the exchange rate quoted by a foreign exchange trader b synonymous with the translation of foreign currency financial statements into dollars c the difference between the recorded dollar amount of an account receivable denominated in a foreign currency and the amount of dollars received d the difference between the buying and selling rate quoted by a foreign exchange trader at the settlement date 10 From the viewpoint of a U.S company, a foreign currency transaction is a transaction: a measured in a foreign currency b denominated in a foreign currency c measured in U.S currency d denominated in U.S currency 11 The exchange rate quoted for future delivery of foreign currency is the definition of a(n): a direct exchange rate b indirect exchange rate c spot rate d forward exchange rate 12 A transaction loss would result from: a an increase in the exchange rate applicable to an asset denominated in a foreign currency b a decrease in the exchange rate applicable to a liability denominated in a foreign currency c the import of merchandise when the transaction is denominated in a foreign currency d a decrease in the exchange rate applicable to an asset denominated in a foreign currency http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-4 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition 13 The forward exchange rate quoted for the remaining term of a forward contract is used to account for the contract when the forward contract: a extends beyond one year or the current operating cycle b is a hedge of an identifiable foreign currency commitment c is a hedge of an exposed net liability position d was acquired to speculate in foreign currency 14 A transaction gain or loss on a forward contract entered into as a hedge of an identifiable foreign currency commitment may be: a included as a separate item in the stockholders‟ equity section of the balance sheet b recognized currently in the determination of net income c deferred and included in the measurement of the related foreign currency transaction d none of these 15 Craiger, Inc a U.S corporation, bought machine parts from Reinsch Company of Germany on March 1, 2011, for 70,000 marks, when the spot rate for marks was $0.5395 Craiger‟s year-end was March 31, 2011, when the spot rate for marks was $0.5445 Craiger bought 70,000 marks and paid the invoice on April 20, 2011, when the spot rate was $0.5495 How much should be shown in Craiger‟s income statements as foreign exchange (transaction) gain or loss for the years ended March 31, 2011 and 2012? a b c d 2011 $0 $0 $350 loss $350 loss 2012 $0 $350 loss $0 $350 loss 16 A forward exchange contract is transacted at a discount if the current forward rate is: a less than the expected spot rate b more than the expected spot rate c less than the current spot rate d more than the current spot rate 17 Stuart Corporation a U.S company, contracted to purchase foreign goods Payment in foreign currency was due one month after delivery Between the delivery date and the time of payment, the exchange rate changed in Stuart‟s favor The resulting gain should be reported in the financial statements as a(n): a component of other comprehensive income b component of income from continuing operations c extraordinary income d deferred income http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 18 12-5 Jackson Paving Company purchased equipment for 350,000 British pounds from a supplier in London on July 7, 2011 Payment in British pounds is due on Sept 7, 2011 The exchange rates to purchase one pound is as follows: July August 31, (year end) September Spot-rate 2.08 2.05 2.04 30-day rate 2.07 2.03 -60-day rate 2.06 1.99 -On its August 31, 2011 income statement, what amount should Jackson Paving report as a foreign exchange transaction gain: a $14,000 b $7,000 c $10,500 d $0 19 On September 1, 2011, Swash Plating Company entered into two forward exchange contracts to purchase 250,000 euros each in 90 days The relevant exchange rates are as follows: September 1, 2011 September 30, 2011 (year-end) Spot rate 1.46 1.50 Forward Rate For Dec 1, 2011 1.47 1.48 The first forward contract was to hedge a purchase of inventory on September 1, payable on December On September 30, what amount of foreign currency transaction loss should Swash Plating report in income? a $0 b $2,500 c $5,000 d $10,000 20 On September 1, 2011, Swash Plating Company entered into two forward exchange contracts to purchase 250,000 euros each in 90 days The relevant exchange rates are as follows: September 1, 2011 September 30, 2011 (year-end) Spot rate 1.46 1.50 Forward Rate For Dec 1, 2011 1.47 1.48 The second forward contract was strictly for speculation On September 30, 2011, what amount of foreign currency transaction gain should Swash Plating report in income? a $0 b $2,500 c $5,000 d $10,000 http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-6 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition 21 On November 1, 2011, Prism Company sold inventory to a foreign customer The account will be settled on March with the receipt of 250,000 foreign currency units (FCU) On November 1, Prism also entered into a forward contract to hedge the exposed asset The forward rate is $0.90 per unit of foreign currency Prism has a December 31 fiscal year-end Spot rates on relevant dates were: Date November December 31 March Per Unit of Foreign Currency $0.93 0.91 0.94 The entry to record the forward contract is a FCU Receivable Premium on Forward Contract Dollars Payable 232,500 b Dollars Receivable Discount on Forward Contract FCU Payable 232,500 c 232,500 FCU Receivable Discount on Forward Contract Dollars Payable d Dollars Receivable Discount on Forward Contract FCU Payable 22 225,000 7,500 7,500 225,000 7,500 225,000 225,000 7,500 232,500 On November 1, 2011, National Company sold inventory to a foreign customer The account will be settled on March with the receipt of 200,000 foreign currency units (FCU) On November 1, National also entered into a forward contract to hedge the exposed asset The forward rate is $0.80 per unit of foreign currency National has a December 31 fiscal year-end Spot rates on relevant dates were: Date November December 31 March Per Unit of Foreign Currency $0.83 0.81 0.84 What will be the adjusted balance in the Accounts Receivable account on December 31, and how much gain or loss was recorded as a result of the adjustment? a b c d Receivable Balance $170,000 $162,000 $168,000 $164,000 Gain/Loss Recorded $4,000 gain $4,000 loss $2,000 gain $2,000 loss http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 23 12-7 Caldron Company purchased equipment for 375,000 British pounds from a supplier in London on July 3, 2011 Payment in British pounds is due on Sept 3, 2011 The exchange rates to purchase one pound is as follows: July August 31, (year end) September Spot-rate 1.58 1.55 1.54 30-day rate 1.57 1.53 -60-day rate 1.56 1.49 -On its August 31, 2011, income statement, what amount should Caldron report as a foreign exchange transaction gain: a $18,750 b $3,750 c $11,250 d $0 24 On April 1, 2011, Trent Company entered into two forward exchange contracts to purchase 300,000 euros each in 90 days The relevant exchange rates are as follows: April 1, 2011 April 30, 2011 (year-end) Spot rate 1.16 1.20 Forward Rate For Aug 1, 2011 1.17 1.18 The first forward contract was to hedge a purchase of inventory on April 1, payable on December On April 30, what amount of foreign currency transaction loss should Trent report in income? a $0 b $3,000 c $9,000 d $12,000 25 On April 1, 2011, Trent Company entered into two forward exchange contracts to purchase 300,000 euros each in 90 days The relevant exchange rates are as follows: April 1, 2011 April 30, 2011 (year-end) Spot rate 1.16 1.20 Forward Rate For Aug 1, 2011 1.17 1.18 The second forward contract was strictly for speculation On April 30, 2011, what amount of foreign currency transaction gain should Trent report in income a $0 b $3,000 c $9,000 d $12,000 http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-8 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition Problems 12-1 On November 1, 2010, Dorsey Company sold inventory to a company in England The sale was for 600,000 British pounds and payment will be received on February 1, 2011 On November 1, Dorsey entered into a forward contract to sell 600,000 British pounds on February at the forward rate of $1.65 Spot rates for the British pound are as follows: November $1.61 December 31 1.67 February 1.62 Dorsey has a December 31 fiscal year-end Required: Compute each of the following: The dollars to be received on February 1, 2011, from selling the 600,000 pounds to the exchange dealer The dollars that would have been received from the account receivable if Dorsey had not hedged the sale contract with the forward contract The discount or premium on the forward contract The transaction gain or loss on the exposed asset related to the sale in 2010 and 2011 The transaction gain or loss on the forward contract in 2010 and 2011 The amount of the discount or premium on the forward contract amortized in 2010 and 2011 12-2 On December 1, 2010, Derrick Corporation agreed to purchase a machine to be manufactured by a company in Brazil The purchase price is 1,150,000 Brazilian reals To hedge against fluctuations in the exchange rate, Derrick entered into a forward contract on December to buy 1,150,000 reals on April 1, the agreed date of machine delivery, for $0.375 per real The following exchange rates were quoted: Forward Rate Date Spot Rate (Delivery on 4/1) December 0.390 0.375 December 31 0.370 0.373 April 0.385 Required: Prepare journal entries necessary for Derrick during 2010 and 2011 to account for the transactions described above http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 12-3 12-9 Colony Corp., a U.S corporation, entered into a contract on November 1, 2010, to sell two machines to Crown Company, for 95,000 foreign currency units (FCU) The machines were to be delivered and the amount collected on March 1, 2011 In order to hedge its commitment, Colony entered into a forward contract for 95,000 FCU delivery on March 1, 2011 The forward contract met all conditions for hedging an identifiable foreign currency commitment Selected exchange rates for FCU at various dates were as follows: November 1, 2010 – Spot rate Forward rate for delivery on March 1, 2011 December 31, 2010 – Spot rate Forward rate for delivery on March 1, 2011 March 1, 2011 – Spot rate $1.3076 1.2980 1.3060 1.3150 1.2972 Required: Prepare all journal entries relative to the above on the books of Colony Corp on the following dates: November 1, 2010 Year-end adjustments on December 31, 2010 March 1, 2011 (Include all adjustments related to the forward contract.) 12-4 On October 1, 2010, Nance Company purchased inventory from a foreign customer for 750,000 units of foreign currency (FCU) due on January 31, 2011 Simultaneously, Nance entered into a forward contract for 750,000 units of FC for delivery on January 31, 2011, at the forward rate of $0.75 Payment was made to the foreign customer on January 31, 2011 Spot rates on October 1, December 31, and January 31, were $0.72, $0.73, and $0.76, respectively Nance amortizes all premiums and discounts on forward contracts and closes its books on December 31 Required: A B C 12-5 Prepare all journal entries relative to the above to be made by Nance on October 1, 2010 Prepare all journal entries relative to the above to be made by Nance on December 31, 2010 Compute the transaction gain or loss on the forward contract that would be recorded in 2011 Indicate clearly whether the amount is a gain or loss On October 1, 2010, Kline Company shipped equipment to a foreign customer for a foreign currency (FC) price of FC 3,000,000 due on January 31, 2011 All revenue realization criteria were satisfied and accordingly the sale was recorded by Kline Company on October Simultaneously, Kline entered into a forward contract to sell 3,000,000 FCU on January 31, 2011 for $1,200,000 Payment was received from the foreign customer on January 31, 2011 Spot rates on October 1, December 31, and January 31 were $0.42, $0.425, and $0.435, respectively Kline amortizes all premiums and discounts on forward contracts and closes its books on December 31 Required: Prepare all journal entries relative to the above to be made by Kline during 2010 and 2011 http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-10 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition 12-6 On July 15, Worth, Inc purchased 88,500,000 yen worth of parts from a Tokyo company paying 20% down, and the balance is due in 90 days Interest is payable at a rate of 8% on the unpaid balance The exchange rate on July 15, was $1.00 = 118 Japanese yen On October 13, the exchange rate was $1.00 = 114 Japanese yen Required: Prepare journal entries to record the purchase and payment of this foreign currency transaction in U.S dollars 12-7 On November 1, 2010, Bisk Corporation, a calendar-year U.S Corporation, invested in a speculative contract to purchase 700,000 euros on January 31, 2011, from a German brokerage firm Bisk agreed to buy 700,000 euros at a fixed price of $1.46 per euro The brokerage firm agreed to send 700,000 euros to Bisk on January 31, 2011 The spot rates for euros are: November 1, 2010 December 31, 2010 January 31, 2011 euro = 1.45 euro = 1.43 euro = 1.44 Required: Prepare the journal entries that Bisk would record on November 1, December 31, and January 31 12-8 Consider the following information: On November 1, 2011, a U.S firm contracts to sell equipment (with an asking price of 500,000 pesos) in Mexico The firm will take delivery and will pay for the equipment on February 1, 2012 On November 1, 2011, the company enters into a forward contract to sell 500,000 pesos for $0.0948 on February 1, 2012 Spot rates and the forward rates for February 1, 2012, settlement were as follows (dollars per peso): November 1, 2011 Balance sheet date (12/31/11) February 1, 2012 Spot Rate $0.0954 0.0949 0.0947 Forward Rate for 2/1/12 $0.0948 0.0944 On February 1, the equipment was sold for 500,000 pesos The cost of the equipment was $20,000 Required: Prepare all journal entries needed on November 1, December 31, and February to account for the forward contract, the firm commitment, and the transaction to sell the equipment http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions 12-11 And Hedging Foreign Exchange Risk Short Answer Accounting for a foreign currency transaction involves the terms measured and denominated Describe a foreign currency transaction and distinguish between the terms measured and denominated There are a number of business situations in which a firm may acquire a forward exchange contract Identify three common situations in which a forward exchange contract can be used as a hedge Short Answer Questions from the Textbook Define currency exchange rates and distinguish between “direct” and “indirect” quotations Explain why a firm is exposed to an added risk when it enters into a transaction that is to be settled in a foreign currency Name the three stages of concern to the accountant in accounting for import–export transactions Briefly explain the accounting for each stage How should a transaction gain or loss be reported that is related to an unsettled receivable recorded when the firm‟s inventory was exported? A U.S firm carried a receivable for 100,000 yen Assuming that the direct exchange rate declined from $.009 at the date of the transaction to $.006at the balance sheet date, compute the transaction gain or loss What balance would be reported for the receivable in the firm‟s balance sheet? Explain what is meant by the “two-transaction method” in recording exporting or importing transactions What support is given for this method? Describe a forward exchange contract Explain the effects on income from hedging a foreign currency exposed net asset position or net liability position What criteria must be satisfied for a foreign currency transaction to be considered a hedge of an identifiable foreign currency commitment? 10 The FASB classifies forward contracts as those acquired for the purpose of hedging and those acquired for the purpose of speculation What main differences are there in accounting for these two classifications? 11 How are foreign currency exchange gains and losses from hedging a forecasted transaction handled? 12 What is a put option, and how might it be used to hedge a forecasted transaction? 13 Define a derivative instrument, and describe the keystones identified by the FASB for the accounting for such instruments 14 Differentiate between forward-based derivatives and option-based derivatives 15 List some of the criteria laid out by the FASB that are required for a gain or loss on forecasted transactions (a cash flow hedge) to be excluded from the income statement If these criteria are satisfied, http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-12 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition where are the gains or losses reported, and when (if ever) are they shown in the income statement? What is the rationale for this treatment? Business Ethics Question from Textbook Executive stock options (ESOs) are used to provide incentives for executives to improve company performance ESOs are usually granted “at-the-money,” meaning that the exercise price of the options is set to equal the market price of the underlying stock on the grant date Clearly, executives would prefer to be granted options when the stock price (and thus the exercise price) is at its lowest Backdating options is the practice of choosing a past date when the market price was particularly low Backdating has not, in the past, been illegal if no documents are forged, if communicated to the shareholders, and if properly reflected in earnings and in taxes Since backdating gives the executive an “instant” profit, why wouldn‟t the firm simply grant an option with the exercise price lower than the cur-rent market price? Suppose the executive was not involved in back-dating the ESOs Does the executive face any ethical issues? http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions 12-13 And Hedging Foreign Exchange Risk ANSWER KEY Multiple Choice c b c b d c d 10 11 12 13 14 b c b d d d c 15 16 17 18 19 20 21 d a b c d b d 22 23 24 25 b c d b Problems 12-1 Dollars received = 600,000 × $1.65 = $990,000 Dollars received = 600,000 × $1.62 = $972,000 Premium on forward contract = ($1.65 - $1.61) × 600,000 = $24,000 2010 transaction gain = ($1.67 - $1.61) × 600,000 = $36,000 2011 transaction loss = ($1.67 - $1.62) × 600,000 = $(30,000) 2010 transaction loss = ($1.67 - $1.61) × 600,000 = ($36,000) 2011 transaction gain = ($1.67 - $1.62) × 600,000 = $30,000 12-2 Premium amortized in 2010 = $24,000 × 2/3 = $16,000 Premium amortized in 2011 = $24,000 × 1/3 = $8,000 2010 Dec FC Receivable from Exchange Dealer Deferred Transaction Adjustment Dollars Payable to Exchange Dealer Dec 31 Deferred Transaction Adjustment FC Receivable from Exchange Dealer ($0.39 - $0.37) × 1,150,000) 448,500 17,250 431,250 23,000 http://downloadslide.blogspot.com 23,000 To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition 12-2 (Continued) 2011 Apr FC Receivable from Exchange Dealer Deferred Transaction Adjustment ($0.385 - $0.370) × 1,150,000) 17,250 Investment in Foreign Currency FC Receivable from Exchange Dealer 442,750 Dollars Payable to Exchange Dealer Cash 431,250 Machine Investment in Foreign Currency 442,750 Deferred Transaction Adjustment Machine 12-3 17,250 November 1, 2010 Dollars Receivable from Exchange Dealer Deferred Transaction Adjustment FC Payable to Exchange Dealer ($1.2980 × 95,000 = $123,310) [($1.3076 - $1.2980) × 95,000 = $912) ($1.3076 × 95,000 = $124,222) December 31, 2010 FC Payable to Exchange Dealer Deferred Transaction Adjustment [($1.3076 - $1.3060) × 95,000 = $152] March 1, 2011 FC Payable to Exchange Dealer Deferred Transaction Adjustment [($1.3060 - $1.2972) × 95,000 = $836] 442,750 431,250 442,750 11,500 11,500 123,310 912 124,222 152 152 836 836 Investment in Foreign Currency Sales ($1.2972 × 95,000 = $123,234) 123,234 FC Payable to Exchange Dealer Investment in Foreign Currency ($1.2972 × 95,000 = $123,234) 123,234 Cash 123,310 123,234 123,234 Dollars Receivable from Exchange Dealer ($1.2980 × 95,000 = $123,310) Deferred Transaction Adjustment Sales [($1.2980 - $1.2972) × 95,000 = $76] 123,310 76 http://downloadslide.blogspot.com 76 To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions 12-15 And Hedging Foreign Exchange Risk 12-4 A October Purchases Accounts Payable ($0.72 × 750,000 = $540,000) FC Receivable from Exchange Dealer Premium on Forward Contract Dollars Payable to Exchange Dealer ($0.72 × 750,000 = $540,000) ($0.75 - $0.72) × 750,000 = $22,500) ($0.75 × 750,000 = $562,500) B December 31 Transaction Loss Accounts Payable [($0.73 - $0.72) × 750,000 = $7,500] FC Receivable from Exchange Dealer Transaction Gain [($0.73 - $0.72) × 750,000 = $7,500] Amortization Expense Premium on Forward Contract [($0.75 - $0.72) × 750,000 × (3/4) = $16,875] C 12-5 Value of FC receivable – January 31 $0.76 × 750,000 Carrying value – December 31 Transaction gain October Accounts Receivable Sales 540,000 540,000 540,000 22,500 562,500 7,500 7,500 7,500 7,500 16,875 16,875 $570,000 547,500 $ 22,500 1,260,000 1,260,000 Dollars Receivable from Exchange Dealer Discount on Forward Contract FC Payable to Exchange Dealer December 31 Accounts Receivable Transaction Gain (3,000,000 × 0.425) = 1,275,000 – 1,260,000 1,200,000 60,000 1,260,000 15,000 15,000 Transaction FC Payable to Exchange Dealer 15,000 Amortization Expense (60,000 × 3/4) Discount on Forward Contract 45,000 15,000 http://downloadslide.blogspot.com 45,000 To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-16 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition 12-5 (Continued) January 31 Accounts Receivable Transaction Gain ($3,000,000 × 0.435) = $1,305,000 – $1,275,000 Transaction Loss FC Payable to Exchange Dealer Investment in FC Accounts Receivable Cash FC Payable to Exchange Dealer Dollars Receivable from Exchange Dealer Investment in FC Amortization Expense Discount on Forward Contract 30,000 30,000 30,000 30,000 1,305,000 1,305,000 1,200,000 1,305,000 1,200,000 1,305,000 15,000 15,000 12-6 July 15 Oct 13 Purchases Accounts Payable Cash (88,500,000 yen / 118) 750,000 Accounts Payable Transaction Loss Cash (70,800,000 yen / 114) 600,000 21,053 600,000 150,000 621,053 Interest Expense 12,421 Cash (70,800,000 yen × (90/360) × 8% = 1,416,000 yen / 114 = 12,421) 12-7 Nov 1, 2010 Dec 31, 2010 FC Receivable from Exchange Dealer Dollars Payable to Exchange Dealer (700,000 × $1.46) Transaction Loss FC Receivable from Exchange Dealer (700,000 × ($1.44 – $1.46)) 12,421 1,022,000 1,022,000 14,000 http://downloadslide.blogspot.com 14,000 To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions 12-17 And Hedging Foreign Exchange Risk 12-7 (Continued) Jan 31, 2011 Dollars Payable to Exchange Dealer Investment in FC Cash FC Receivable from Exchange Dealer 1,022,000 1,008,000 Cash 1,008,000 1,022,000 1,008,000 Investment in FC 1,008,000 12-8 Nov Dollars Receivable from Exchange Dealer (500,000 × $0.0948) FC Payable to Exchange Dealer 47,400 47,400 Dec 31 FC Payable from Exchange Dealer Foreign Exchange Gain [(500,000 × ($0.0948 - $0.0944)] 200 Foreign Exchange Loss Firm Commitment [(500,000 × ($0.0948 - $0.0944)] 200 Foreign Exchange Loss FC Payable from Exchange Dealer [(500,000 × ($0.0944 - $0.0947)] 150 Firm Commitment Foreign Exchange Gain [(500,000 × ($0.0944 - $0.0947)] 150 Feb 200 200 150 150 Investment in FC Firm Commitment Sales (500,000 × $0.0948) 47,350 50 Cash FC Payable to Exchange Dealer Investment in FC Dollars Receivable from Exchange Dealer 47,400 47,350 Cost of Goods Sold Inventory 20,000 47,400 47,350 47,400 20,000 http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition Short Answer A foreign currency transaction is a transaction that requires settlement in a foreign currency, not in U.S dollars Transactions are normally measured and recorded in terms of the currency in which the reporting entity prepares its financial statements Assets and liabilities are denominated in a currency if their amounts are fixed in terms of that currency http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions 12-19 And Hedging Foreign Exchange Risk Forward exchange contracts can be used as a hedge of a (an): a foreign currency transaction b unrecognized firm commitment (a fair value hedge) c foreign-currency-denominated “forecasted” transaction (a cash flow hedge) d net investment in foreign operations (Note: question only asked for situations) Short Answer Textbook Question Solutions An exchange rate is the ratio between a unit of one currency and the amount of another currency for which that unit can be exchanged at a particular time A direct quotation is one in which the exchange rate is quoted in terms of how many units of the domestic currency can be converted into one unit of foreign currency An indirect quotation is stated in terms of converting one unit of domestic currency into units of foreign currency When a transaction is to be settled in a foreign currency, a change in the exchange rate increases or decreases the expected cash flow to be received or paid when the account is settled (1) Transaction Date at this date, the transaction is recorded If the transaction is stated in foreign currency units, the exchange rate prevailing at this date is used to convert the foreign currency units to domestic units (2) Balance Sheet Date at this date, recorded dollar balances (or other domestic currency, if applicable) representing receivables or payables that are to be settled in foreign currency units are revalued at the exchange rate on this date The adjustment is recorded as a transaction gain or loss (3) Settlement Date the foreign currency received or paid is converted into domestic currency at the spot rate A difference between the conversion and the carrying value of the receivable or payable is a transaction gain or loss A transaction gain (loss) related to an unsettled receivable should be included in the determination of net income for the current period Receivable recorded at the transaction date Receivable recorded at the balance sheet date Transaction loss Receivable is reported at $600 in the balance sheet A purchase (sale) is viewed as a transaction separate from the method of settlement Once the purchase (sale) is made, a firm has the choice of settling at the transaction date, thus incurring no gain or loss from subsequent changes in the exchange rate; or purchasing a forward contract, and also avoiding a gain or loss from holding foreign currency commitments The choice of settlement rests with management, and their decision should have no effect on the valuation of a purchase or sales transaction 100,000 100,000 http://downloadslide.blogspot.com $.009 $900 $.006 600 $300 To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12-20 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition A forward exchange contract is an agreement to buy or sell foreign currency units at a particular time for an agreed upon exchange rate This rate will usually be the forward rate at the time the contract is entered into and any difference between the forward rate and the spot rate is amortized to income over the life of the contract A forward contract to buy (sell) foreign currency has an opposite effect on income compared to the gain or loss associated with translation of a payable (receivable) to be settled in the foreign currency units In other words, as the exchange rate fluctuates, the forward contract will gain or lose the same amount as the payable or receivable will lose or gain Therefore, no net transaction gain or loss will be incurred The transaction must be designated as, and is effective as, a hedge of a foreign currency commitment, and the foreign currency commitment is firm 10 Forward contracts are valued using changes in forward rates and generally any gains or losses are recognized in the same period as changes in value of hedged item (Fair Value hedges) Gains or losses in Cash Flow hedges are deferred until the hedged item is included in income A forward contract held for speculation is recorded at the transaction date using the forward rate There is no separate accounting for a discount or premium Subsequent valuations (at balance sheet dates) are based on the forward rate available for the remaining life of the forward contract 11 Foreign currency exchange gains (losses) from hedging a forecasted transaction are deferred and included in the determination of the foreign currency transaction at transaction date 12 A put option is a contract that gives the holder the right to sell an asset (such as a unit of foreign currency) at a specified price within a specified time period Firms use these options to protect against expected unfavorable changes in exchange rates If a company has a contract to sell inventory and is expected to receive a foreign currency, the company can use the option to sell the foreign currency received from the sale to deliver on the option, thus locking into a foreign exchange rate 13 A derivative instrument may be defined as a financial instrument that by its terms at inception or upon occurrence of a specified event, provides the holder (or writer) with the right (or obligation) to participate in some or all of the price changes of another underlying value of measure, but does not require the holder to own or deliver the underlying value of measure Thus its value is derived from the underlying value of measure In SFAS No 133, the FASB identified the following as keystones for the accounting for derivative instruments: * Derivative instruments represent rights or obligations that meet the definitions of assets or liabilities and should be reported in financial statements * Fair value is the most relevant measure for financial instruments and the only relevant measure for derivative instruments * Only items that are assets or liabilities should be reported as such in the balance sheet * Special accounting for items designated as being hedged should be provided only for http://downloadslide.blogspot.com To Todownload downloadmore moreslides, slides,ebook, ebook,solutions solutionsand andtest testbank, bank,visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions 12-21 And Hedging Foreign Exchange Risk qualifying items, as demonstrated by an assessment of the expectation of effective offsetting changes in fair values or cash flows during the term of the hedge for the risk being hedged 14 Derivative instruments can be divided into two broad categories: a) Forward-based derivatives, such as forwards, futures, and swaps, in which either party can potentially have a favorable or unfavorable outcome, but not both simultaneously (e.g., both will not simultaneously have favorable outcomes) b) Option-based derivatives, such as interest rate caps, option contracts, and interest rate floors, in which only one party can potentially have a favorable outcome and it agrees to a premium at inception for this potentiality; the other party is paid the premium, and can potentially have only an unfavorable outcome 15 The FASB allows deferral of the income statement recognition of the gains and losses on forecasted transactions if certain criteria are met Like other gains and losses that are excluded from the income statement, they must be included as components of “other comprehensive income” and reported in the stockholders‟ equity section of the balance sheet The criteria for this treatment include: The forecasted transaction is specifically identifiable at the time of the designation as a single transaction or a group of individual transactions The forecasted transaction is probable and it presents exposure to price changes that are expected to affect earnings and cause variability in cash flows The forecasted transaction involves an exchange with an outside (unrelated) party (intercompany foreign currency transactions are excluded) The forecasted transaction does not involve a business combination They are reclassified into earnings when the forecasted transaction occurs and the item is recorded in earning Business Ethics Business ethics solutions are merely suggestions of points to address The objective is to raise the students' awareness of the topics, and to invite discussion In most cases, there is clear room for disagreement or conflicting viewpoints Stock options, in theory, are used to create incentives for the firm‟s executives to increase operating performance The practice of backdating options defeats this purpose The point of backdating options is to avoid issuing „in the money‟ stock options which would have had both accounting and tax consequences not favorable to the firm Backdating avoids accounting recognition Executives always have the right not to exercise options if they feel that there is an ethical issue However, if the proper disclosures are followed (which is rarely the case), then back-dating options is not illegal under current laws http://downloadslide.blogspot.com ... andtest testbank, bank, visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 12- 3... andtest testbank, bank, visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com Chapter 12 Accounting for Foreign Currency Transactions And Hedging Foreign Exchange Risk 12- 3... solutionsand andtest testbank, bank, visit visithttp://downloadslide.blogspot.com http://downloadslide.blogspot.com 12- 10 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition 12- 6 On