Solution manual advanced accounting 9e by hoyle ch09

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CHAPTER 9
FOREIGN CURRENCY TRANSACTIONS AND
HEDGING FOREIGN EXCHANGE RISK
Chapter Outline
I.

In today’s global economy, a great many companies deal in currencies other than their
reporting currencies.
A. Merchandise may be imported or exported with prices stated in a foreign currency.
B. For reporting purposes, foreign currency balances must be stated in terms of the
company’s reporting currency by multiplying it by an exchange rate.
C. Accountants face two questions in restating foreign currency balances.
1. What is the appropriate exchange rate for restating foreign currency balances?
2. How are changes in the exchange rate accounted for?
D. Companies often engage in foreign currency hedging activities to avoid the adverse impact
of exchange rate changes.
E. Accountants must determine how to properly account for these hedging activities.

II.

Foreign exchange rates are determined in the foreign exchange market under a variety of
different currency arrangements.
A. Exchange rates can be expressed in terms of the number of U.S. dollars to purchase one
foreign currency unit (direct quotes) or the number of foreign currency units that can be
obtained with one U.S. dollar (indirect quotes).
B. Foreign currency trades can be executed on a spot or forward basis.
1. The spot rate is the price at which a foreign currency can be purchased or sold today.
2. The forward rate is the price today at which foreign currency can be purchased or sold
sometime in the future.

3. Forward exchange contracts provide companies with the ability to “lock in” a price
today for purchasing or selling currency at a specific future date.
C. Foreign currency options provide the right but not the obligation to buy or sell foreign
currency in the future, and therefore are more flexible than forward contracts.

III. Statement 52 of the Financial Accounting Standards Board, issued in December 1981,
prescribes accounting rules for foreign currency transactions.
A. Export sales denominated in foreign currency are reported in U.S. dollars at the spot
exchange rate at the date of the transaction. Subsequent changes in the exchange rate
are reflected through a restatement of the foreign currency account receivable with an
offsetting foreign exchange gain or loss reported in income. This is known as a twotransaction perspective, accrual approach.
B. The two-transaction perspective, accrual approach is also used in accounting for foreign
currency payables. Receivables and payables denominated in foreign currency create an
exposure to foreign exchange risk.
IV. FASB Statement 133 (as amended by FASB Statement 138) governs the accounting for
derivative financial instruments and hedging activities including the use of foreign currency
forward contracts and foreign currency options.
A. The fundamental requirement of SFAS 133 is that all derivatives must be carried on the
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balance sheet at their fair value. Derivatives are reported on the balance sheet as assets
when they have a positive fair value and as liabilities when they have a negative fair value.
B. SFAS 133 (as amended by SFAS 138) provides guidance for hedges of the following

sources of foreign exchange risk:
1. foreign currency denominated assets and liabilities.
2. foreign currency firm commitments.
3. forecasted foreign currency transactions.
4. net investments in foreign operations (covered in Chapter 10).
C. Companies prefer to account for hedges in such a way that the gain or loss from the hedge
is recognized in net income in the same period as the loss or gain on the risk being
hedged. This approach is known as hedge accounting. Hedge accounting for foreign
currency derivatives may be applied only if three conditions are satisfied:
1. the derivative is used to hedge either a fair value exposure or cash flow exposure to
foreign exchange risk,
2. the derivative is highly effective in offsetting changes in the fair value or cash flows
related to the hedged item, and
3. the derivative is properly documented as a hedge.
D. SFAS 133 allows hedge accounting for hedges of two different types of exposure: cash
flow exposure and fair value exposure. Hedges of (1) foreign currency denominated
assets and liabilities, (2) foreign currency firm commitments, and (3) forecasted foreign
currency transactions can be designated as cash flow hedges. Hedges of (1) and (2) also
can be designated as fair value hedges. Accounting procedures differ for the two types of
hedges.
E. For cash flow hedges of foreign currency assets and liabilities, at each balance sheet date:
1. The hedged asset or liability is adjusted to fair value based on changes in the spot
exchange rate, and a foreign exchange gain or loss is recognized in net income.
2. The derivative hedging instrument is adjusted to fair value (resulting in an asset or
liability reported on the balance sheet), with the counterpart recognized as a change in
Accumulated Other Comprehensive Income (AOCI).
3. An amount equal to the foreign exchange gain or loss on the hedged asset or liability is
then transferred from AOCI to net income; the net effect is to offset any gain or loss on
the hedged asset or liability.
4. An additional amount is removed from AOCI and recognized in net income to reflect (a)

the current period’s amortization of the original discount or premium on the forward
contract (if a forward contract is the hedging instrument) or (b) the change in the time
value of the option (if an option is the hedging instrument).
F. For fair value hedges of foreign currency assets and liabilities, at each balance sheet date:
1. The hedged asset or liability is adjusted to fair value based on changes in the spot
exchange rate, and a foreign exchange gain or loss is recognized in net income.
2. The derivative hedging instrument is adjusted to fair value (resulting in an asset or
liability reported on the balance sheet), with the counterpart recognized as a gain or
loss in net income.
G. Under fair value hedge accounting for hedges of foreign currency firm commitments:
1. the gain or loss on the hedging instrument is recognized currently in net income, and
2. the change in fair value of the firm commitment is also recognized currently in net
income.
This accounting treatment requires (1) measuring the fair value of the firm commitment, (2)
recognizing the change in fair value in net income, and (3) reporting the firm commitment
on the balance sheet as an asset or liability. A decision must be made whether to
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measure the fair value of the firm commitment through reference to (a) changes in the spot
exchange rate or (b) changes in the forward rate.
H. SFAS 133 allows cash flow hedge accounting for hedges of forecasted foreign currency
transactions. For hedge accounting to apply, the forecasted transaction must be probable
(likely to occur). The accounting for a hedge of a forecasted transaction differs from the

accounting for a hedge of a foreign currency firm commitment in two ways:
1. Unlike the accounting for a firm commitment, there is no recognition of the forecasted
transaction or gains and losses on the forecasted transaction.
2. The hedging instrument (forward contract or option) is reported at fair value, but
because there is no gain or loss on the forecasted transaction to offset against,
changes in the fair value of the hedging instrument are not reported as gains and
losses in net income. Instead they are reported in other comprehensive income. On
the projected date of the forecasted transaction, the cumulative change in the fair
value of the hedging instrument is transferred from other comprehensive income
(balance sheet) to net income (income statement).

Learning Objectives
Having completed Chapter 9, “Foreign Currency Transactions and Hedging Foreign Exchange
Risk,” students should be able to fulfill each of the following learning objectives:
1. Read and understand published foreign exchange quotes.
2. Understand the one-transaction and two-transaction perspectives to accounting for foreign
currency transactions.
3. Account for foreign currency transactions using the two-transaction perspective.
4. Explain the concept of exposure to foreign exchange risk that arises from foreign currency
transactions.
5. Explain how forward contracts and options can be used to hedge foreign exchange risk.
6. Account for forward contracts and options used as hedges of
a. foreign currency denominated assets and liabilities,
b. foreign currency firm commitments, and
c. forecasted foreign currency transactions.
7. Account for foreign currency borrowings.

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Answer to Discussion Question
Do we have a gain or what?
This case demonstrates the differing kinds of information provided through application of current
accounting rules for foreign currency transactions and derivative financial instruments.
The Ahnuld Corporation could have received $200,000 from its export sale to Tcheckia if it had
required immediate payment. Instead, Ahnuld allows its customer six months to pay. Given the
future exchange rate of $1.70, Ahnuld would have received only $170,000 if it had not entered into
the forward contract. This would have resulted in a decrease in cash inflow of $30,000. In
accordance with SFAS 52, the decrease in the value of the tcheck receivable is recognized as a
foreign exchange loss of $30,000. This loss represents the cost of extending credit to the foreign
customer if the tcheck receivable is left unhedged.
However, rather than leaving the tcheck receivable unhedged, Ahnuld sells tchecks forward at a
price of $180,000. Because the future spot rate turns out to be only $1.70, the forward contract
provides a benefit, increasing the amount of cash received from the export sale by $10,000. In
accordance with SFAS 133, the change in the fair value of the forward contract (from zero initially to
$10,000 at maturity) is recognized as a gain on the forward contract of $10,000. This gain reflects
the cash flow benefit from having entered into the forward contract, and is the appropriate basis for
evaluating the performance of the foreign exchange risk manager. (Students should be reminded
that the forward contract will not always improve cash inflow. For example, if the future spot rate
were $1.85, the forward contract would result in $5,000 less cash inflow than if the transaction were
left unhedged.)
The net impact on income resulting from the fluctuation in the value of the tcheck is a loss of
$20,000. Clearly, Ahnuld forgoes $20,000 in cash inflow by allowing the customer time to pay for
the purchase, and the net loss reported in income correctly measures this. The $20,000 loss is

useful to management in assessing whether the sale to Tcheckia generated an adequate profit
margin, but it is not useful in assessing the performance of the foreign exchange risk manager. The
net loss must be decomposed into its component parts to fairly evaluate the risk manager’s
performance.
Gains and losses on forward contracts designated as fair value hedges of foreign currency assets
and liabilities are relevant measures for evaluating the performance of foreign exchange risk
managers. (The same is not true for cash flow hedges. For this type of hedge, performance should
be evaluated by considering the net gain or loss on the forward contract plus or minus the forward
contract premium or discount.)

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Answers to Questions
1.

Under the two-transaction perspective, an export sale (import purchase) and the subsequent
collection (payment) of cash are treated as two separate transactions to be accounted for
separately. The idea is that management has made two decisions: (1) to make the export sale
(import purchase), and (2) to extend credit in foreign currency to the foreign customer (obtain
credit from the foreign supplier). The income effect from each of these decisions should be
reported separately.

2.

Foreign currency receivables resulting from export sales are revalued at the end of accounting
periods using the current spot rate. An increase in the value of a receivable will be offset by
reporting a foreign exchange gain in net income, and a decrease will be offset by a foreign
exchange loss. Foreign exchange gains and losses are accrued even though they have not
yet been realized.

3.

Foreign exchange gains and losses are created by two factors: having foreign currency
exposures (foreign currency receivables and payables) and changes in exchange rates.
Appreciation of the foreign currency will generate foreign exchange gains on receivables and
foreign exchange losses on payables. Depreciation of the foreign currency will generate
foreign exchange losses on receivables and foreign exchange gains on payables.

4.

Hedging is the process of eliminating exposure to foreign exchange risk so as to avoid
potential losses from fluctuations in exchange rates. In addition to avoiding possible losses,
companies hedge foreign currency transactions and commitments to introduce an element of
certainty into the future cash flows resulting from foreign currency activities. Hedging involves
establishing a price today at which foreign currency can be sold or purchased at a future date.

5.

A party to a foreign currency forward contract is obligated to deliver one currency in exchange
for another at a specified future date, whereas the owner of a foreign currency option can
choose whether to exercise the option and exchange one currency for another or not.

6.

Hedges of foreign currency denominated assets and liabilities are not entered into until a
foreign currency transaction (import purchase or export sale) has taken place. Hedges of firm
commitments are made when a purchase order is placed or a sales order is received, before a
transaction has taken place. Hedges of forecasted transactions are made at the time a future
foreign currency purchase or sale can be anticipated, even before an order has been placed or
received.

7.

Foreign currency options have an advantage over forward contracts in that the holder of the
option can choose not to exercise if the future spot rate turns out to be more advantageous.
Forward contracts, on the other hand, can lock a company into an unnecessary loss (or a
reduced gain). The disadvantage associated with foreign currency options is that a premium
must be paid up front even though the option might never be exercised.

8.

SFAS 133 requires an enterprise to recognize all derivative financial instruments as assets or
liabilities on the balance sheet and measure them at fair value.

9.

The fair value of a foreign currency forward contract is determined by reference to changes in
the forward rate over the life of the contract, discounted to the present value. Three pieces of

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information are needed to determine the fair value of a forward contract at any point in time
during its life: (a) the contracted forward rate when the forward contract is entered into, (b) the
current forward rate for a contract that matures on the same date as the forward contract
entered into, and (c) a discount rate; typically, the company’s incremental borrowing rate.
The manner in which the fair value of a foreign currency option is determined depends on
whether the option is traded on an exchange or has been acquired in the over the counter
market. The fair value of an exchange-traded foreign currency option is its current market price
quoted on the exchange. For over the counter options, fair value can be determined by
obtaining a price quote from an option dealer (such as a bank). If dealer price quotes are
unavailable, the company can estimate the value of an option using the modified BlackScholes option pricing model. Regardless of who does the calculation, principles similar to
those in the Black-Scholes pricing model will be used in determining the value of the option.
10. Hedge accounting is defined as recognition of gains and losses on the hedging instrument in
the same period as the recognition of gains and losses on the underlying hedged asset or
liability (or firm commitment).
11. For hedge accounting to apply, the forecasted transaction must be probable (likely to occur),
the hedge must be highly effective in offsetting fluctuations in the cash flow associated with the
foreign currency risk, and the hedging relationship must be properly documented.
12. In both cases, (1) sales revenue (or the cost of the item purchased) is determined using the
spot rate at the date of sale (or purchase), and (2) the hedged asset or liability is adjusted to
fair value based on changes in the spot exchange rate with a foreign exchange gain or loss
recognized in net income.
For a cash flow hedge, the derivative hedging instrument is adjusted to fair value (resulting in
an asset or liability reported on the balance sheet), with the counterpart recognized as a
change in Accumulated Other Comprehensive Income (AOCI). An amount equal to the
foreign exchange gain or loss on the hedged asset or liability is then transferred from AOCI to

net income; the net effect is to offset any gain or loss on the hedged asset or liability. An
additional amount is removed from AOCI and recognized in net income to reflect (a) the
current period’s amortization of the original discount or premium on the forward contract (if a
forward contract is the hedging instrument) or (b) the change in the time value of the option (if
an option is the hedging instrument).
For a fair value hedge, the derivative hedging instrument is adjusted to fair value (resulting in
an asset or liability reported on the balance sheet), with the counterpart recognized as a gain
or loss in net income. The discount or premium on a forward contract is not allocated to net
income. The change in the time value of an option is not recognized in net income.
13. For a fair value hedge of a foreign currency asset or liability (1) sales revenue (cost of
purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the hedged
asset or liability is adjusted to fair value based on changes in the spot exchange rate with a
foreign exchange gain or loss recognized in net income. The forward contract is adjusted to
fair value based on changes in the forward rate (resulting in an asset or liability reported on the
balance sheet), with the counterpart recognized as a gain or loss in net income. The foreign
exchange gain (loss) and the forward contract loss (gain) are likely to be of different amounts
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resulting in a net gain or loss reported in net income.
For a fair value hedge of a firm commitment, there is no hedged asset or liability to account for.
The forward contract is adjusted to fair value based on changes in the forward rate (resulting in
an asset or liability reported on the balance sheet), with a gain or loss recognized in net
income. The firm commitment is also adjusted to fair value based on changes in the forward

rate (resulting in a liability or asset reported on the balance sheet), and a gain or loss on firm
commitment is recognized in net income. The firm commitment gain (loss) offsets the forward
contract loss (gain) resulting in zero impact on net income. Sales revenue (cost of purchases)
is recognized at the spot rate at the date of sale (purchase). The firm commitment account is
closed as an adjustment to net income in the period in which the hedged item affects net
income.
14. For a cash flow hedge of a foreign currency asset or liability (1) sales revenue (cost of
purchases) is recognized at the spot rate at the date of sale (purchase) and (2) the hedged
asset or liability is adjusted to fair value based on changes in the spot exchange rate with a
foreign exchange gain or loss recognized in net income. The forward contract is adjusted to
fair value (resulting in an asset or liability reported on the balance sheet), with the counterpart
recognized as a change in Accumulated Other Comprehensive Income (AOCI). An amount
equal to the foreign exchange gain or loss on the hedged asset or liability is then transferred
from AOCI to net income; the net effect is to offset any gain or loss on the hedged asset or
liability. An additional amount is removed from AOCI and recognized in net income to reflect
the current period’s allocation of the discount or premium on the forward contract.
For a hedge of a forecasted transaction, the forward contract is adjusted to fair value (resulting
in an asset or liability reported on the balance sheet), with the counterpart recognized as a
change in Accumulated Other Comprehensive Income (AOCI). Because there is no foreign
currency asset or liability, there is no transfer from AOCI to net income to offset any gain or
loss on the asset or liability. The current period’s allocation of the forward contract discount or
premium is recognized in net income with the counterpart reflected in AOCI. Sales revenue
(cost of purchases) is recognized at the spot rate at the date of sale (purchase). The amount
accumulated in AOCI related to the hedge is closed as an adjustment to net income in the
period in which the forecasted transaction was anticipated to occur.
15. In accounting for a fair value hedge, the change in the fair value of the foreign currency option
is reported as a gain or loss in net income. In accounting for a cash flow hedge, the change in
the entire fair value of the option is first reported in other comprehensive income, and then the
change in the time value of the option is reported as an expense in net income.
16. The accounting for a foreign currency borrowing involves keeping track of two foreign currency

payables—the note payable and interest payable. As both the face value of the borrowing and
accrued interest represent foreign currency liabilities, both are exposed to foreign exchange
risk and can give rise to foreign currency gains and losses.

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Answers to Problems
1. C An import purchase causes a foreign currency payable to be carried on the
books. If the foreign currency depreciates, the dollar value of the foreign
currency payable decreases, yielding a foreign exchange gain.
2. D SFAS 52 requires a two-transaction perspective, accrual approach.
3. B Foreign exchange gains related to foreign currency import purchases are
treated as a component of income before income taxes. If there is no foreign
exchange gain in operating income, then the purchase must have been
denominated in U.S. dollars or there was no change in the value of the
foreign currency from October 1 to December 1, 2009.
4. C

The dollar value of the LCU receivable has decreased from $110,000 at
December 31, 2009 to $95,000 at February 15, 2010. This decrease of $15,000
should be reported as a foreign exchange loss in 2010.

5. D

The increase in the dollar value of the euro note payable represents a foreign
exchange loss. In this case a $25,000 loss would have been accrued in 2009
and a $10,000 loss will be reported in 2010.

6. D

A foreign currency receivable will generate a foreign exchange gain when the
foreign currency increases in dollar value. A foreign currency payable will
generate a foreign exchange gain when the foreign currency decreases in
dollar value. Hence, the correct combination is franc (increase) and peso
(decrease).

7. D

The merchandise purchase results in a foreign exchange loss of $8,000, the
difference between the U.S. dollar equivalent at the date of purchase and at
the date of settlement.
The increase in the dollar equivalent of the note’s principal results in a
foreign exchange loss of $20,000.
The total foreign exchange loss is $28,000 ($8,000 + $20,000).

8. D

The Thai baht is selling at a premium (forward rate exceeds spot rate). The
exporter will receive more dollars as a result of selling the baht forward than
if the baht had been received and converted into dollars on April 1. Thus, the
premium results in additional revenue for the exporter.

9. D

The parts inventory will be recognized at the spot rate at the date of purchase
(FC100,000 x $.23 = $23,000).

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10. D The forward contract must be reported on the December 31, 2009 balance
sheet as a liability. Barnum has locked-in to purchase ringgits at $0.042 per
ringgit but could have locked-in to purchase ringgits at $0.037 per ringgit if it
had waited until December 31 to enter into the forward contract. The forward
contract must be reported at its fair value discounted for two months at 12%
[($.042 – $.037) x 1,000,000 = $5,000 x .9803 = $4,901.50].
11. C The 10 million won receivable has changed in dollar value from $35,000 at
12/1/09 to $33,000 at 12/31/09. The won receivable will be written down by
$2,000 and a foreign exchange loss will be reported in 2009 income.
12. B The nominal value of the forward contract on December 31, 2009 is a positive
$2,000, the difference between the amount to be received from the forward
contract actually entered into, $34,000 ($.0034 x 10 million), and the amount
that could be received by entering into a forward contract on December 31,
2009 that matures on March 31, 2010, $32,000 ($.0032 x 10 million). The fair
value of the forward contract is the present value of $2,000 discounted for
two months ($2,000 x .9706 = $1,941.20). On December 31, 2009, MNC Corp.
will recognize a $1,941.20 gain on the forward contract and a foreign

exchange loss of $2,000 on the won receivable. The net impact on 2009
income is –$58.80.
13. A The krona is selling at a premium in the forward market, causing Pimlico to
pay more dollars to acquire kroner than if the kroner were purchased at the
spot rate on March 1. Therefore, the premium results in an expense of
$10,000 [($.12 – $.10) x 500,000].
The Adjustment to Net Income is the amount accumulated in Accumulated
Other Comprehensive Income (AOCI) as a result of recognizing the premium
expense and the fair value of the forward contract. The journal entries would
be as follows:
3/1

no journal entries

6/1

Premium Expense
AOCI
AOCI
Forward Contract
Foreign Currency
Forward Contract
Cash
AOCI
Adjustment to Net Income

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$10,000

$10,000
$2,500
$2,500
$57,500
2,500
$60,000
$7,500
$7,500
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14. C This is a cash flow hedge of a forecasted transaction. The original cost of the
option is recognized as an Option Expense over the life of the option.
15. B
16. D
The easiest way to solve problems 15 and 16 is to prepare journal entries for
the option fair value hedge and the firm commitment. The journal entries are
as follows:
9/1/09
Foreign Currency Option
Cash

$2,000
$2,000

12/31/09
Foreign Currency Option

Gain on Foreign Currency Option

$300
$300

Loss on Firm Commitment
Firm Commitment
[($.79 – $.80) x 100,000 = $1,000 x .9803 = $980.30]
Net impact on 2009 net income:
Gain on Foreign Currency Option
Loss on Firm Commitment

3/1/10
Foreign Currency Option
Gain on Foreign Currency Option

$980.30
$980.30

$300.00
(980.30)
$(680.30)

$700
$700

Loss on Firm Commitment
$2,019.70
Firm Commitment
[($.77 – $.80) x 100,000 = $3,000 – $980.30 = $2,019.70]

Foreign Currency (C$)
Sales

$77,000

Cash
Foreign Currency (C$)
Foreign Currency Option

$80,000

Firm Commitment
Adjustment to Net Income

$3,000

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$2,019.70

$77,000

$77,000
3,000

$3,000
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16. (continued)
Net impact on 2010 net income:
Gain on Foreign Currency Option
Loss on Firm Commitment
Sales
Adjustment to Net Income

$

700.00
(2,019.70)
77,000.00
3,000.00
$78,680.30

17. B Net cash inflow with option ($80,000 – $2,000)
Cash inflow without option (at spot rate of $.77)
Net increase in cash inflow

$78,000
77,000
$ 1,000

18 and 19.
The easiest way to solve problems 18 and 19 is to prepare journal entries for
the forward contract fair value hedge of a firm commitment. The journal
entries are as follows:

3/1

no journal entries

3/31

Forward Contract
Gain on Forward Contract
($1,250 – $0)

$1,250

Loss on Firm Commitment
Firm Commitment

$1,250

$1,250

$1,250

Net impact on first quarter net income is $0.

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18 and 19. (continued)
4/30

Loss on Forward Contract
Forward Contract
[Fair value of forward contract is
($.120 – $.118) x 500,000 = $1,000;
$1,000 – $1,250 = $250]

$250

Firm Commitment
Gain on Firm Commitment

$250

$250

$250

Foreign Currency (pesos)
Sales [500,000 pesos x $.118]

$59,000

Cash [500,000 x $.120]
Foreign Currency (pesos)
Forward Contract

$60,000

Firm Commitment
Adjustment to Net Income

$1,000

$59,000
$59,000
1,000
$1,000

Net impact on second quarter net income is: Sales $59,000 – Loss on Forward
Contract $250 + Gain on Firm Commitment $250 + Adjustment to Net Income
$1,000 = $60,000.
18. A
19. C
20. B Cash inflow with forward contract [500,000 pesos x $.12]
$60,000
Cash inflow without forward contract [500,000 pesos x $.118] 59,000
Net increase in cash flow from forward contract
$ 1,000

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21 and 22.
The easiest way to solve problems 21 and 22 is to prepare journal entries for
the option cash flow hedge of a forecasted transaction. The journal entries
are as follows:
11/1/09
Foreign Currency Option
Cash

$1,500
$1,500

12/31/09
Option Expense
$400
Foreign Currency Option
$400
(The option has no intrinsic value at 12/31/09 so the entire change in fair
value is due to a change in time value; $1,500 – $1,100 = $400 decrease in
time value. The decrease in time value of the option is recognized as an
expense in net income.)
Option Expense decreases net income by $400.
2/1/10
Option Expense
$1,100
Foreign Currency Option
900
Accumulated Other Comprehensive Income (AOCI)

(Record expense for the decrease in time value of the
option; $1,100 – $0 = $1,100; and write-up option to fair
value ($.40 – $.41) x 200,000 = $2,000 – $1,100 = $900.)
Foreign Currency (BRL) [200,000 x $.41]
Cash [200,000 x $.40]
Foreign Currency Option

$82,000

Parts Inventory (Cost-of-Goods-Sold)
Foreign Currency (BRL)

$82,000

$80,000
2,000

$82,000

Accumulated Other Comprehensive Income (AOCI)
Adjustment to Net Income

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$2,000

$2,000
$2,000

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21 and 22. (continued)
Net impact on 2010 net income:
Option Expense
$ (1,100)
Cost-of-Goods-Sold
(82,000)
Adjustment to Net Income
2,000
Decrease in Net Income $ (81,100)
21. B
22. C

23. (10 minutes) (Foreign Currency Purchase/Payable)
The decrease in the dollar value of the LCU payable from November 1 (60,000 x
.345 = $20,700) to December 31 (60,000 x .333 = $19,980) is recorded as a $720
foreign exchange gain in 2009. The increase in the dollar value of the LCU
payable from December 31 ($19,980) to January 15 (60,000 x .359 = $21,540) is
recorded as a $1,560 foreign exchange loss in 2010.
24. (10 minutes) (Foreign Currency Sale/Receivable)
The ostra receivable decreases in dollar value from (50,000 x $1.05) $52,500 at
December 20 to $51,000 (50,000 x $1.02) at December 31, resulting in a foreign
exchange loss of $1,500 in 2009. The further decrease in dollar value of the
ostra receivable from $51,000 at December 31 to $49,000 (50,000 x $.98) at
January 10 results in an additional $2,000 foreign exchange loss in 2010.

25. (10 minutes) (Foreign Currency Sale/Receivable)
9/15

9/30

10/15

McGraw-Hill/Irwin
9-14

Accounts Receivable (FCU) [100,000 x $.40]
Sales

$40,000
$40,000

Accounts Receivable (FCU)
Foreign exchange Gain
[100,000 x ($.42 – $.40)]

$2,000

Foreign Exchange Loss
Accounts Receivable (FCU)
[100,000 x ($.37 – $.42)]

$5,000

Cash
Accounts Receivable (FCU)

$37,000

$2,000

$5,000

$37,000
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26. (10 minutes) (Foreign Currency Purchase/Payable)
12/1/09

Inventory
Accounts Payable (LCU) [60,000 x $.88]

$52,800

$52,800

12/31/09 Accounts Payable (LCU) [60,000 x ($.82 – $.88)] $3,600
Foreign Exchange Gain
1/28/10

Foreign Exchange Loss
$4,800
Accounts Payable (LCU) [60,000 x ($.90 – $.82)]
Accounts payable (LCU)
Cash

$3,600

$4,800

$54,000
$54,000

27. (15 minutes) (Determine U.S. Dollar Balance for Foreign Currency Transactions)
Inventory and Cost of Goods Sold are reported at the spot rate at the date the
inventory was purchased. Sales are reported at the spot rate at the date of sale.
Accounts Receivable and Accounts Payable are reported at the spot rate at the
balance sheet date. Cash is reported at the spot rate when collected and the
spot rate when paid.
Inventory [50,000 pesos x 40% x $.17] ......................................................... $3,400
COGS [50,000 pesos x 60% x $.17] .............................................................. $5,100
Sales [45,000 pesos x $.18]........................................................................... $8,100
Accounts Receivable [45,000 – 40,000 = 5,000 pesos x $.21] ..................... $1,050
Accounts Payable [50,000 – 30,000 = 20,000 pesos x $.21] ........................ $4,200

Cash [(40,000 x $.19) – (30,000 x $.20)] ........................................................ $1,600

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28. (25 minutes) (Prepare Journal Entries for Foreign Currency Transactions)
2/1/09

4/1/09

6/1/09

8/1/09

Equipment
Accounts Payable (L) [40,000 x $.44]

$17,600

Accounts Payable (L)
Foreign Exchange Loss
Cash [40,000 x $.45]

$17,600

400

Inventory
Accounts Payable (L) [30,000 x $.47]

$14,100

Accounts Receivable (L) [40,000 x $.48]
Sales

$19,200

$18,000

Cost of Goods Sold
Inventory [$14,100 x 70%]
10/1/09

11/1/09

$19,200

$9,870

Cash [30,000 x $.49]
Accounts Receivable (L) [$19,200 x 3/4]
Foreign Exchange Gain
Accounts Payable (L) [$14,100 x 2/3]
Foreign Exchange Loss [20,000 x ($.50 – $.47)]
Cash [20,000 x $.50]

Accounts receivable (L) [10,000 x ($.52 – $.48)]
Foreign Exchange Gain

3/1/10

$14,100

$9,870

12/31/09 Foreign Exchange Loss
Accounts Payable (L) [10,000 x ($.52 – $.47)]

2/1/10

$17,600

$14,700
$14,400
300
$9,400
600
$10,000
$500
$500
$400
$400

Cash [10,000 x $.54]
Accounts Receivable (L) [10,000 x $.52]

Foreign Exchange Gain

$5,400

Accounts Payable (L) [10,000 x $.52]
Foreign Exchange Loss
Cash [10,000 x $.55]

$5,200
300

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Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

$5,200
200

$5,500

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29. (20 minutes) (Determine Income Effect of Foreign Currency Purchase/Payable)
a.

Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (December 1, 2009), the liability had a dollar value of $70,400

(AL 160,000 x $.44). On December 31, 2009, the dollar value has risen to
$76,800 (AL 160,000 x $.48). The increase in the dollar value of the liability
creates a foreign exchange loss of $6,400 ($76,800 – $70,400) in 2009.
By March 1, 2010, when the liability is paid, the dollar value has dropped to
$72,000 (AL 160,000 x $.45) creating a foreign exchange gain of $4,800
($72,000 – $76,800) to be reported in 2010.

b. Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (September 1, 2009), the liability had a dollar value of $73,600
(AL 160,000 x $.46). On December 1, 2009, when the liability is paid, the
dollar value has decreased to $70,400 (AL 160,000 x $.44). The drop in the
dollar value of the liability creates a foreign exchange gain of $3,200
($70,400 – $73,600) in 2009.
c.

Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (September 1, 2009), the liability had a dollar value of $73,600
(AL 160,000 x $.46). On December 31, 2009, the dollar value has risen to
$76,800 (AL 160,000 x $.48). The increase in the dollar value of the liability
creates a foreign exchange loss of $3,200 ($76,800 – $73,600) in 2009.
By March 1, 2010, when the liability is paid, the dollar value has dropped to
$72,000 (AL 160,000 x $.45) creating a foreign exchange gain of $4,800
($72,000 – $76,800) to be reported in 2010.

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30. (30 minutes) (Foreign Currency Borrowing)
a.

9/30/09

Cash
$100,000
Note Payable (dudek) [1,000,000 x $.10]
(To record the note and conversion of 1 million
dudeks into $ at the spot rate.)

12/31/09 Interest Expense
$525
Interest Payable (dudek)
[1,000,000 x 2% x 3/12 = 5,000 dudeks x
$.105 spot rate]
(To accrue interest for the period 9/30 – 12/31/09.)
Foreign Exchange Loss
Note payable (dudek) [1 m x ($.105 – $.10)]
(To revalue the note payable at the spot rate of
$.105 and record a foreign exchange loss.)
9/30/10

$100,000

$525

$5,000
$5,000

Interest Expense [15,000 dudeks x $.12]
$1,800
Interest Payable (dudek)
525
Foreign Exchange Loss [5,000 dudeks x
($.12 – $.105)]
75
Cash [20,000 dudeks x $.12]
(To record the first annual interest payment,
record interest expense for the period 1/1 – 9/30/10,
and record a foreign exchange loss on the
interest payable accrued at 12/31/09.)

$2,400

12/31/10 Interest Expense
$625
Interest Payable (dudek) [5,000 dudeks x $.125]
(To accrue interest for the period 9/30 – 12/31/10.)

$625

Foreign Exchange Loss
$20,000
Note Payable (dudek) [1 m x ($.125 – $.105)]
(To revalue the note payable at the spot rate of
$.125 and record a foreign exchange loss.)

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30. (continued)
9/30/11

Interest Expense [15,000 dudeks x $.15]
$2,250
Interest Payable (dudek)
625
Foreign Exchange Loss [5,000 dudeks x
($.15 – $.125)]
125
Cash [20,000 dudeks x $.15]
(To record the second annual interest payment,
record interest expense for the period 1/1 – 9/30/11,
and record a foreign exchange loss on the interest
payable accrued at 12/31/10.)
Note Payable (dudek)
$125,000
Foreign Exchange Loss

25,000
Cash [1 m dudeks x $.15]
(To record payment of the 1 million dudek note.)

$3,000

$150,000

b. The effective cost of borrowing can be determined by considering the total
interest expense and foreign exchange losses related to the loan and comparing
this with the amount borrowed:
2009
Interest expense
Foreign exchange loss
Total
2010
Interest expense
Foreign exchange losses
Total
2011
Interest expense
Foreign exchange losses
Total

$525
5,000
$5,525 / $100,000 = 5.525% for 3 months =
= 22.1% for 12 months
$2,425
20,075

$22,500 / $100,000 = 22.5% for 12 months

$2,250
25,125
$27,375 / $100,000 = 27.38% for 9 months
= 36.5% for 12 months

Because of appreciation in the value of the dudek, the effective annual
borrowing costs range from 22.1% – 36.5%.

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30.

(continued)
The net cash flow from this borrowing is:
Cash outflows:
Interest ($2,400 + $3,000)
Principal

Cash inflow:
Borrowing
Net cash outflow

$5,400
150,000
$155,400

(100,000)
$ 55,400

Ignoring compounding, this results in an effective borrowing cost of
approximately 27.7% per year [$55,400 / $100,000 = 55.4% over two years / 2
years = 27.7% per year].
31. (40 minutes) (Forward Contract Hedge of Foreign Currency Receivable)
a. Cash Flow Hedge
12/1/09

Accounts Receivable (K) [20,000 x $2.00]
Sales

$40,000
$40,000

No entry for the forward contract.
12/31/09 Accounts Receivable (K)
Foreign Exchange Gain
[20,000 x ($2.10-$2.00)]

$2,000
$2,000

AOCI

$2,450.75
Forward Contract
[20,000 x ($2.075 – $2.20) = $2,500 x .9803 = $2,450.75]
Loss on Forward Contract
AOCI

$2,000
$2,000

AOCI
$500
Premium Revenue
[20,000 x ($2.075 – $2.00) = $1,500 x 1/3 = $500]

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Hoyle, Schaefer, Doupnik, Advanced Accounting, 9/e

$2,450.75

$500

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31. (continued)
Impact on 2009 income:
Sales

Foreign Exchange Gain
Loss on Forward Contract
Premium Revenue
Total
3/1/10

$40,000
2,000
(2,000)
500
$40,500

Accounts Receivable (K)
Foreign Exchange Gain
[20,000 x ($2.25 – $2.10)]

$3,000
$3,000

AOCI
$1,049.25
Forward Contract
[20,000 x ($2.25 – $2.075) = $3,500 – 2,450.75] = $1,049.25
Loss on Forward Contract
AOCI

$3,000

AOCI
Premium Revenue

[$1,500 x 2/3 = $1,000]

$1,000

$3,000

$1,000

Foreign Currency (K) [20,000 x $2.25]
Accounts Receivable (K)

$45,000

Cash [20,000 x $2.075]
Forward Contract
Foreign Currency (K)

$41,500
3,500

Impact on 2010 income:
Foreign Exchange Gain
Loss on Forward Contract
Premium Revenue
Total

$1,049.25

$45,000

$45,000

$3,000
(3,000)
1,000
$1,000

Impact on net income over both periods: $40,500 + $1,000 = $(41,500); equal to
cash inflow.

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31. (continued)
b. Fair Value Hedge
12/1/09 Accounts Receivable (K) [20,000 x $2.00]
Sales

$40,000
$40,000

No entry for the forward contract.
12/31/09 Accounts Receivable (K)
Foreign Exchange Gain

[20,000 x ($2.10 – $2.00)]

$2,000
$2,000

Loss on Forward Contract
$2,450.75
Forward contract
[20,000 x ($2.075 – $2.20) = $2,500 x .9803 = $2,450.75]
Impact on 2009 income:
Sales
Foreign exchange gain
Loss on forward contract
Total
3/1/10

$2,450.75

$40,000.00
2,000.00
(2,450.75)
$39,549.25

Accounts Receivable (K)
Foreign Exchange Gain
[20,000 x ($2.25 – $2.10)]

$3,000
$3,000

Loss on Forward Contract
$1,049.25
Forward Contract
$1,049.25
[20,000 x (2.25 – $2.075) = $3,500 – 2,450.75 = $1.049.25]
Foreign Currency (K) [20,000 x $2.25]
Accounts Receivable (K)

$45,000

Cash [20,000 x $2.075]
Forward Contract
Foreign Currency (K)

$41,500
3,500

Impact on 2010 income:
Foreign Exchange Gain
Loss on Forward Contract
Total

$45,000

$45,000

$3,000.00
(1,049.25)
$1,950.75

Impact on net income over both periods: $39,549.25 + $1,950.75 = $41,500;
equal to cash inflow.
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32. (40 minutes) (Forward Contract Hedge of Foreign Currency Payable)
a. Cash Flow Hedge
12/1/09 Parts Inventory (COGS)
Accounts Payable (K)
[20,000 x $2.00]

$40,000
$40,000

No entry for the Forward Contract.
12/31/09 Foreign Exchange Loss
Accounts Payable (K)
[20,000 x ($2.10 – $2.00)]

$2,000
$2,000

Forward Contract
$2,450.75

AOCI
[20,000 x ($2.075 – $2.20) = $2,500 x .9803 = $2,450.75]
AOCI
Gain on Forward Contract

$2,000
$2,000

Premium Expense
$500
AOCI
[20,000 x ($2.075 – $2.00) = $1,500 x 1/3 = $500]
Impact on 2009 income:
Parts Inventory (COGS)
Foreign Exchange Loss
Gain on forward contract
Premium Expense
Total

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$2,450.75

$500

$(40,000)
(2,000)
2,000
(500)

$(40,500)

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32. (continued)
3/1/10

Foreign Exchange Loss
Accounts Payable (K)
[20,000 x ($2.25 – $2.10)]

$3,000
$3,000

Forward Contract
$1,049.25
AOCI
$1,049.25
[20,000 x ($2.25 – $2.075) = $3,500 – 2,450.75 = $1,049.25]
AOCI
Gain on Forward Contract

$3,000

Premium Expense
AOCI

[$1,500 x 2/3 = $1,000]

$1,000

$3,000

$1,000

Foreign Currency (K) [20,000 x $2.25]
Cash
Forward Contract

$45,000

Accounts Payable (K)
Foreign currency (K)

$45,000

Impact on 2010 income:
Foreign Exchange Loss
Loss on Forward Contract
Premium revenue
Total

$41,500
3,500

$45,000

$(3,000)
3,000
(1,000)
$(1,000)

Impact on net income over both periods: $(40,500) + $(1,000) = $(41,500); equal
to cash outflow.

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