Test bank with answers for advanced accounting 3e by jeter chapter 12

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Chapter 12
Accounting for Foreign Currency Transactions
And Hedging Foreign Exchange Risk
Multiple Choice
1.

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.

2.

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.

3.

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.

4.

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.

5.

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




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12-2 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
6.

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.

7.

On November 1, 2011, American Company sold inventory to a foreign customer. The account will
be settled on March 1 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 1
December 31
March 1

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




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Chapter 12 Accounting for Foreign Currency Transactions
And Hedging Foreign Exchange Risk
8.

12-3

On November 1, 2011, American Company sold inventory to a foreign customer. The account will
be settled on March 1 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 1
December 31
March 1

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
9.

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.

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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.




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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 7
August 31, (year end)
September 7
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 1. 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.




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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 1 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 1
December 31
March 1

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 1 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 1
December 31
March 1

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




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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 3
August 31, (year end)
September 3
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 1.
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.




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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 1 at the forward rate of
$1.65. Spot rates for the British pound are as follows:
November 1
$1.61
December 31
1.67
February 1
1.62
Dorsey has a December 31 fiscal year-end.

Required:
Compute each of the following:
1.

The dollars to be received on February 1, 2011, from selling the 600,000 pounds to the exchange
dealer.

2.

The dollars that would have been received from the account receivable if Dorsey had not hedged the
sale contract with the forward contract.

3.

The discount or premium on the forward contract.

4.

The transaction gain or loss on the exposed asset related to the sale in 2010 and 2011.

5.

The transaction gain or loss on the forward contract in 2010 and 2011.

6.

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 1 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 1
0.390
0.375

December 31
0.370
0.373
April 1
0.385
--

Required:
Prepare journal entries necessary for Derrick during 2010 and 2011 to account for the transactions described
above.




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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:
1.
November 1, 2010.
2.
Year-end adjustments on December 31, 2010.
3.
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 1. 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.




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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

1 euro = 1.45
1 euro = 1.43
1 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:
1.

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.

2.

On November 1, 2011, the company enters into a forward contract to sell 500,000 pesos for

$0.0948 on February 1, 2012.

3.

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
4.

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 1 to account for the forward
contract, the firm commitment, and the transaction to sell the equipment.

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Chapter 12 Accounting for Foreign Currency Transactions 12-11
And Hedging Foreign Exchange Risk
Short Answer
1.
2.

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
1.

Define currency exchange rates and distinguish between “direct” and “indirect” quotations.

2.

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.

3.

Name the three stages of concern to the accountant in accounting for import–export transactions.
Briefly explain the accounting for each stage.

4.

How should a transaction gain or loss be reported that is related to an unsettled receivable recorded
when the firm‟s inventory was exported?

5.

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?

6.

Explain what is meant by the “two-transaction method” in recording exporting or importing transactions. What support is given for this method?

7.

Describe a forward exchange contract.

8.

Explain the effects on income from hedging a foreign currency exposed net asset position or net
liability position.

9.

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,




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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.
1.

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?

2.

Suppose the executive was not involved in back-dating the ESOs. Does the executive face any
ethical issues?




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Chapter 12 Accounting for Foreign Currency Transactions 12-13
And Hedging Foreign Exchange Risk

ANSWER KEY
Multiple Choice
1.
2.
3.
4.
5.
6.
7.

c
b
c
b
d
c
d

8.
9.
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

1.

Dollars received = 600,000 × $1.65 = $990,000

2.

Dollars received = 600,000 × $1.62 = $972,000

3.

Premium on forward contract = ($1.65 - $1.61) × 600,000 = $24,000

4.

2010 transaction gain = ($1.67 - $1.61) × 600,000 = $36,000
2011 transaction loss = ($1.67 - $1.62) × 600,000 = $(30,000)

5.

2010 transaction loss = ($1.67 - $1.61) × 600,000 = ($36,000)
2011 transaction gain = ($1.67 - $1.62) × 600,000 = $30,000

6.

12-2

Premium amortized in 2010 = $24,000 × 2/3 = $16,000
Premium amortized in 2011 = $24,000 × 1/3 = $8,000

2010
Dec. 1

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



23,000


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12-14 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
12-2

(Continued)
2011
Apr. 1 FC Receivable from Exchange Dealer
Deferred Transaction Adjustment
($0.385 - $0.370) × 1,150,000)

1.

2.

3.

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



76


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Chapter 12 Accounting for Foreign Currency Transactions 12-15
And Hedging Foreign Exchange Risk
12-4

A.

October 1
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 1
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



45,000


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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



14,000


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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. 1

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. 1

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




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12-18 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition
Short Answer
1.

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.




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Chapter 12 Accounting for Foreign Currency Transactions 12-19

And Hedging Foreign Exchange Risk
2.

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 3 situations)

Short Answer Textbook Question Solutions

1.

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.

2.

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.

3.

(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.

4.

A transaction gain (loss) related to an unsettled receivable should be included in the
determination of net income for the current period.

5.

Receivable recorded at the transaction date
Receivable recorded at the balance sheet date
Transaction loss
Receivable is reported at $600 in the balance sheet.

6.

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



$.009 $900
$.006 600
$300


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12-20 Test Bank to accompany Jeter and Chaney Advanced Accounting 3rd Edition

7.

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.

8.

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.

9.

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




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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.
1. 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.
2. 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.