Solution manual advanced accounting 2nd by hamlen CH08

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CHAPTER 8
SOLUTIONS TO MULTIPLE CHOICE QUESTIONS, EXERCISES AND PROBLEMS
MULTIPLE CHOICE
1.

d
Fiscal 2013: ($1.25 - $1.28) x €100,000 = $3,000 gain on payable
Fiscal 2014: ($1.32 – $1.25) x €100,000 = $7,000 loss on payable

2.

d
Fiscal 2013: ($1.31 - $1.30) x €100,000 = $1,000 gain on receivable
Fiscal 2014: ($1.28 - $1.31) x €100,000 = $3,000 loss on receivable

3.

b
Entries are:
November 15, 2013
Inventory

905,000
Accounts payable

December 31, 2013
Exchange loss

905,000

60,000

Accounts payable
$60,000 = ($0.965 - $0.905) x 1,000,000.
Investment in forward

60,000

55,000

Exchange gain
$55,000 = ($0.950 - $0.895) x 1,000,000.
April 15, 2014
Accounts payable

55,000

25,000

Exchange gain
$25,000 = ($0.940 - $0.965) x 1,000,000.
Exchange loss

25,000

10,000

Investment in forward
$10,000 = ($0.940 - $0.950) x 1,000,000

Accounts payable

940,000
Cash
Investment in forward

Solutions Manual, Chapter 8

10,000

895,000
45,000

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4.

a
See entries in 3. above. $15,000 gain = $25,000 gain - $10,000 loss.

5.

d
Entries are:
December 31, 2013
Investment in forward

55,000

Exchange gain
$55,000 = ($0.950 - $0.895) x 1,000,000.
Exchange loss

55,000

55,000
Firm commitment

March 1, 2014
Exchange loss

55,000

35,000

Investment in forward
$35,000 = ($0.915 - $0.950) x 1,000,000.
Firm commitment

35,000

35,000
Exchange gain

Inventory
Firm commitment

35,000
900,000
20,000

Accounts payable
April 15, 2014
Exchange loss

920,000

20,000

Accounts payable
$20,000 = ($0.940 - $0.920) x 1,000,000.
Investment in forward

20,000

25,000

Exchange gain
$25,000 = ($0.940 - $0.915) x 1,000,000.
Accounts payable

940,000
Cash
Investment in forward

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25,000

895,000
45,000

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6.

b
See entries in 5. above.

7.

c
Entries are:
December 31, 2013
Investment in forward

55,000

OCI
$55,000 = ($0.950 - $0.895) x 1,000,000.
April 15, 2014
OCI

55,000

10,000

Investment in forward
$10,000 = ($0.940 - $0.950) x 1,000,000.
Foreign currency

10,000

940,000
Investment in forward
Cash

Inventory

45,000
895,000
940,000

Foreign currency
8.

940,000

a
Entry to record cost of goods sold is:
Cost of goods sold
OCI

895,000
45,000
Inventory

9.

940,000

c
($0.940 - $0.915) x 1,000,000 = $25,000 loss

10.

a
Using the basis adjustment approach, IFRS nets the cash flow hedge gain against the
equipment, reducing the equipment account.
Depreciation expense is unaffected whether the cash flow hedge gain is reclassified as an
adjustment of the equipment or as an adjustment of depreciation expense.

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EXERCISES
E8.1

Recording Import Transactions

Purchases
Inventories
Accounts payable
Payments
Foreign currency
Cash
Accounts payable
Exchange loss
Exchange gain
Foreign currency

E8.2

Australia
Dr.
Cr.
204,000
204,000

Thailand
Dr.
Cr.
28,000
28,000

210,000

26,400
210,000

204,000
6,000

Indonesia
Dr.
Cr.
750
750
700

26,400
28,000
--

-210,000

Jordan
Dr.
710,000

710,000
710,000

700
750
--

1,600
26,400

Cr.

710,000
710,000
--

50
700

-710,000

Recording Export Transactions

Sales
Accounts receivable
Sales
Collection
Foreign currency
Exchange loss
Exchange gain
Accounts receivable
Cash
Foreign currency

Argentina
Dr.
Cr.

59,750
59,750

Canada
Dr.
Cr.
404,000
404,000

India
Dr.
Cr.
7,200
7,200

South Africa
Dr.
Cr.
14,100
14,100

62,750
--

410,000
--

6,600
600

13,700
400

3,000
59,750
62,750

6,000
404,000
410,000

62,750

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-7,200
6,600

410,000

-14,100
13,700

6,600

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E8.3

Recording Import and Export Transactions

Import Transactions
Transaction 1
Transaction date:
Inventory

3,300
Accounts payable

Payment date:
Accounts payable
Exchange loss

3,300

3,300
500
Cash

3,800

Transaction 2
Transaction date:
Inventory

180,000
Accounts payable

Payment date:
Accounts payable

180,000

180,000
Exchange gain
Cash

9,000
171,000

Export Transactions
Transaction 3
Transaction date:
Accounts receivable

118,400
Sales

Payment date:
Cash
Exchange loss

105,200
13,200

Accounts receivable

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118,400

118,400

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Transaction 4
Transaction date:
Accounts receivable

712,500
Sales

Payment date:
Cash

712,500

746,700
Exchange gain
Accounts receivable

E8.4

Item
1
2
3
4

34,200
712,500

Adjusting Entry at Balance Sheet Date
Book Balance ($)
Dr. (Cr.)
$ 75,000
240,000
(550,000)
(50,000)

Dollar Equivalent, 12/31
Dr. (Cr.)
$ 80,000 = $.08 x 1,000,000
229,500 = $1.02 x 225,000
(540,000) = $1.35 x 400,000
(52,000) = $.26 x 200,000

Adjusting Entry
Accounts payable
($10,000 - $2,000)

Adjustment Needed
Dr. (Cr.)
$ 5,000 gain
10,500 loss
10,000 gain
2,000 loss

8,000

Accounts receivable
($10,500 - $5,000)
5,500
Exchange gain
2,500
To record the net transaction loss on the receivables and payables at December 31; $2,500
gain = ($5,000 + $10,000) gain – ($10,500 + $2,000) loss.

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E8.5

Hedging Foreign-Currency-Denominated Liability

a.

March 15, 2014
Inventory

18,100

Accounts payable
To record goods purchased; $18,100 = $.000905 x 20,000,000.

18,100

April 14, 2014
Exchange loss

60
Accounts payable
To restate payable at current spot rate; $60 = ($.000908 - $.000905) x 20,000,000.
Investment in forward contract

60

160

Exchange gain
To restate forward contract to current fair value; $160 = ($.000908 - $.000900) x
20,000,000.
Foreign currency

160

18,160

Investment in forward
contract
160
Cash
18,000
To record payment to the dealer, receipt of 20,000,000 won, valued at the current spot rate
of $.000908/W, and fulfillment of the forward purchase contract.
Accounts payable

18,160
Foreign currency

18,160

b.
Dollars paid (to broker) with the hedge:
Dollars that would have been paid at the current spot rate to purchase
foreign currency for the supplier; (.000908 x 20,000,000):
Cash gain (amount saved) from hedging:

Solutions Manual, Chapter 8

$18,000
-18,160
$ 160

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E8.6
a.

Hedging Foreign-Currency-Denominated Asset
September 1, 2013
Accounts receivable

26,000,000

Sales
To record sales made; $26,000,000 = $.65 x 40,000,000.

26,000,000

September 30, 2013
Exchange loss

400,000

Accounts receivable
400,000
To restate receivable at current spot rate; $400,000 = ($.65 - $.64) x 40,000,000.
Investment in forward contract

480,000
Exchange gain
480,000

To restate the forward contract to its current fair value; $480,000 = ($.652 - $.64) x
40,000,000.
Foreign currency

25,600,000
Accounts receivable
25,600,000
To record receipt of currency from Brazilian customer; $25,600,000 = $.64 x
40,000,000.
Cash

26,080,000

Foreign currency
25,600,000
Investment in forward
contract
480,000
To record delivery of currency to the dealer, receipt of $26,080,000 as specified in
the contract, and settlement of the forward contract.
b.
Dollars received (from broker) with the hedge:
Dollars that would have been received from the customer's
foreign currency at the current spot rate (.64 x 40,000,000):
Cash gain (increased proceeds) from hedging:

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$26,080,000

- 25,600,000
$ 480,000

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E8.7

Hedged Purchase Commitment and Foreign-Currency-Denominated
Liability

September 15, 2014

No entry

November 15, 2014
Investment in forward contract

15,000
Exchange gain
15,000
To record change in fair value of the forward contract; $15,000 = ($.105 - $.104) x
15,000,000.
Exchange loss

15,000

Firm commitment

To record the loss on the firm purchase commitment.
Inventories

15,000

1,545,000

Accounts payable
To record delivery of the goods at the current spot rate of $.103.
Firm commitment

1,545,000

15,000

Inventories
15,000
To adjust the carrying value of the goods for the accumulated loss on the firm commitment
during the commitment period.
December 31, 2014
Exchange loss

30,000
Accounts payable
30,000
To record loss due to increase in dollar value of accounts payable; $30,000 = ($.105 $.103) x 15,000,000.
Investment in forward contract

30,000
Exchange gain

30,000
To record increase in value of forward purchase contract; $30,000 = ($.107 - $.105) x
15,000,000.
January 15, 2015
Exchange loss

45,000

Accounts payable
To record loss on accounts payable; $45,000 = ($.108 - $.105) x 15,000,000.

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45,000

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Investment in forward contract

15,000

Exchange gain
15,000
To record increase in fair value of forward purchase contract; $15,000 = ($.108 - $.107) x
15,000,000.
Foreign currency

1,620,000

Investment in forward
contract
Cash
To record fulfillment of the forward contract.
Accounts payable

60,000
1,560,000

1,620,000

Foreign currency
To record payment to the Mexican supplier.

E8.8

1,620,000

Hedged Sale Commitment and Foreign-Currency-Denominated Asset

April 15, 2013

No entry

April 30, 2013
Exchange loss

8,000

Investment in forward
contract
To record decline in fair value of the forward contract; $8,000 = ($.148 - $.140) x
1,000,000.
Firm commitment

8,000

8,000

Exchange gain
To record gain on U.S. dollar value of the firm sale commitment.

8,000

Accounts receivable

146,000
Sales revenue
146,000
To record delivery of goods to the South African customer; $146,000 = $.146 x 1,000,000.
Sales revenue

8,000

Firm commitment
To adjust the sales revenue for the change in value of the firm sales commitment.

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8,000

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May 15, 2013
Accounts receivable

3,000

Exchange gain
To record gain on accounts receivable; $3,000 = ($.149 - $.146) x 1,000,000.
Exchange loss

1,000

Investment in forward
contract
To record decline in fair value of the forward contract; $1,000 = ($.149 - $.148) x
1,000,000.
Foreign currency

3,000

1,000

149,000

Accounts receivable
149,000
To record receipt of rands from the South African customer, valued at the current spot rate
of $.149.
Cash
Investment in forward contract

140,000
9,000

Foreign currency
149,000
To record delivery of the rands to the dealer, and settlement of the forward contract.

E8.9

Hedged Forecasted Purchase

June 30, 2013
Investment in forward contract

840

Other comprehensive
income
To record increase in fair value of forward purchase contract;
$840 = ($1.44 - $1.38) x 14,000.

Foreign currency

840

20,160

Investment in forward
contract
Cash
To record settlement of forward contract.
Inventory

840
19,320

20,160

Foreign currency
20,160
To record delivery of merchandise and payment to supplier; $20,160 = $1.44 x 14,000.

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July 12, 2013

Cash

19,000
Sales

19,000

To record merchandise sale.
Other comprehensive income
Cost of goods sold

840
19,320

Inventory
20,160
To record cost of sale, including release of gain on forward contract to cost of goods sold.

E8.10

Hedged Forecasted Sale

November 30, 2014
Other comprehensive income

10,000
Investment in forward
contract
10,000
To record decrease in value of forward contract; $10,000 = ($1.03 - $1.02) x 1,000,000.

Foreign currency

1,030,000

Sales revenue
To record merchandise sale; $1,030,000 = $1.03 x 1,000,000.
Sales revenue

1,030,000

10,000

Other comprehensive
income
To transfer the loss on the hedge to current earnings.
Cash
Investment in forward contract
Foreign currency
To record settlement of forward contract.

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10,000

1,020,000
10,000
1,030,000

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E8.11
a.

Recording International Investment
October 1, 2012
Short-term Investments

124,500

Cash
124,500
To record the purchase of a 6-month certificate of deposit, face value 1,000,000
krona, from a Swedish bank; implied spot rate = $.1245 = $124,500/1,000,000.
December 31, 2012
Short-term investments

20,000

Exchange gain
To accrue the transaction gain on the certificate of deposit;
$20,000 = ($.1445 - $.1245) x 1,000,000.

20,000

Interest receivable

5,418.75
Interest income
5,418.75
To accrue interest income to December 31, 2012 based on the December 31
exchange rate; $5,418.75 = $.1445(3/12)(.15) x 1,000,000.
March 31, 2013
Exchange loss

21,700

Short-term investments
To accrue the transaction loss on the certificate of deposit since December 31,
2012; $21,700 = ($.1445 - $.1228) x 1,000,000.

21,700

Exchange loss

813.75
Interest receivable
813.75
To accrue the transaction loss on the interest receivable; $813.75 = ($.1445-$.1228)
x 37,500; 37,500 = .15(3/12)1,000,000, the interest (in krona) accrued on December
31, 2012.
Interest receivable

4,605

Interest income
4,605

To record interest income for the period January 1, 2013 to March 31, 2013 based
on the March 31exchange rate; $4,605 = $.1228 x 37,500 [(= (3/12).15 x
1,000,000)].

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Foreign currency

132,010

Short-term investments
122,800
Interest receivable
9,210
To record the receipt of foreign currency for principal and interest at maturity of the
certificate of deposit; $132,010 = $.1228 x 1,075,000.
Cash

132,010

Foreign currency
To record conversion of 1,075,000 krona into dollars.
b.

E8.12
a.

132,010

This investment returned $7,510, the difference between the $124,500 paid to
acquire the certificate and the $132,010 received at maturity, in six months. The
effective annual interest rate on this investment is ($7,510/$124,500) x 2 = 12.06%.
The company should compare this return with that obtainable on alternative
investments.

Speculative Foreign Contracts
Forward purchase contract: (.$.13 - $.128) x 10,000,000 = $20,000 current liability
Forward sale contract: ($.84 - $.834) x 10,000,000 = $60,000 current asset

b.

December 31, 2013
Exchange loss

30,000
Investment in forward
contract
To record loss accrued since December 16 on speculative forward purchase
contract; $30,000 = ($.125 - $.128) x 10,000,000.
Exchange loss

80,000

Investment in forward

contract
To record loss accrued since December 16 on speculative forward sale contract;
$80,000 = ($.842 - $.834) x 10,000,000.

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30,000

80,000

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January 15, 2014
Investment in forward contract

60,000

Exchange gain
To record gain accrued since December 31 on speculative forward purchase
contract; $60,000 = ($.131 - $.125) x 10,000,000.
Foreign currency

1,310,000

Investment in forward
contract

Cash
To record settlement of the forward purchase contract; $10,000 = -$20,000 $30,000 + $60,000.
Cash

60,000

10,000
1,300,000

1,310,000

Foreign currency
To record conversion of $H10,000,000 into dollars.

1,310,000

Note to instructor: The speculation in $H produced a net cash gain of $10,000 (=
$1,310,000 - $1,300,000).
Investment in forward contract

60,000

Exchange gain
To record gain accrued since December 31 on speculative forward sale contract;
$60,000 = ($.836- $.842) x 10,000,000.
Foreign currency

60,000

8,360,000

Cash
8,360,000
To record acquisition of $S on the spot market to settle the forward sale contract.
Cash

8,400,000

Investment in forward
contract
40,000
Foreign currency
8,360,000
To record settlement of the forward sale contract; $40,000 = $60,000 - $80,000 +
$60,000.
Note to instructor: The speculation in $S produced a net cash gain of $40,000
(= 8,400,000 - 8,360,000).

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PROBLEMS
P8.1
a.

Computation of Exchange Gain or Loss
Computation of Exchange Adjustment on Receivables
Foreign Currency
Exchange Rate
Country
Amount
(12/31/12)
Belgium
300,000
$ 1.438
India
1,200,000
.0235
Saudi Arabia
90,000
.2666
Dollar amount of foreign currency receivables at 12/31/12
Less amount per books ($428,200 + $23,950 + $24,000)
Exchange gain on receivables

Amount ($)
$ 431,400
28,200
23,994
$ 483,594
(476,150)
$
7,444

Computation of Exchange Adjustment on Payables

Foreign Currency
Exchange Rate
Country
Amount
(12/31/12)
Japan
(1,000,000)
$ .01303
Mexico
(500,000)
.08140
Dollar amount of foreign currency payables at 12/31/12
Less amount per books ($12,000 + $39,550)
Exchange loss on payables

Amount ($)
$ (13,030)
(40,700)
$(53,730)
(51,550)
$ (2,180)

Computation of Exchange Adjustment on Other Assets (Liabilities)
(1)
Foreign Currency
Forward Rate
Item
Dr. (Cr.)
(12/31/12)

Forward purchase
contract (pesos)
500,000
Forward sale
contract (euros)
(300,000)
Dollar amount of other assets (liabilities)
denominated in foreign currencies at 12/31/12
Less amount per books [$(1,125) + $(10,000)]
Exchange loss on other assets (liabilities)
Net exchange gain (loss) in 2012;
$7,444 + ($2,180) + ($2,050).

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$ .08165
1.44400

Amount ($)
(Contract rate
minus current
forward rate) x
(1)
$

25
( 13,200)

$ (13,175)

(11,125)
$ (2,050)
$

3,214

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Adjusting Entry - Books of Wheelstick Corporation
Accounts receivable
7,444
Investment in forward purchase
contract
1,150
Accounts payable
2,180
Investment in forward sale
contract
3,200
Exchange gain
3,214
To record the exchange adjustments on accounts receivable, accounts payable, and
the forward purchase and sale contracts at December 31, 2012; $1,150 = $25 –
($1,125); ($3,200) = ($13,200) – ($10,000).
b.

The forward purchase contract is a hedge of the accounts payable to Mexican

suppliers. Following is an analysis of the exchange gains and losses on the
exposure and the hedge investment:

Accounts payable
Investment in forward purchase contract
Net exchange gain (loss)

Book
Value
$39,550
(1,125)

12/31/12
Value
$40,700
25

Exchange
Gain (Loss)
$ (1,150)
1,150
$
0

The forward sale contract is a hedge of the accounts receivable from Belgian customers.
Following is an analysis of the exchange gains and losses on the exposure and the hedge
investment:

Accounts receivable
Investment in forward purchase contract

Net exchange gain (loss)

Book
Value
$428,200
(10,000)

12/31/12
Value
$431,400
(13,200)

Exchange
Gain (Loss)
$ 3,200
(3,200)
$
0

Both forward contracts are 100 percent effective in hedging Wheelstick’s exposure to
foreign exchange risk on the receivables from Belgian customers and the payables to
Mexican suppliers.

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P8.2

Import and Export Transactions and Hedged Commitment

August 14, 2013
Exchange loss

80,000

Investment in forward
contract
80,000
To record decline in fair value of forward contract; $80,000 = ($1.45 - $1.43) x 4,000,000.
Firm commitment

80,000

Exchange gain
To record reduction in cost of firm commitment.
Foreign currency
Investment in forward contract

80,000

5,720,000
80,000

Cash
To record settlement of forward purchase contract.

Inventory

5,800,000

5,720,000

Foreign currency
To record delivery of merchandise and payment to supplier;
$5,720,000 = $1.43 x 4,000,000.
Inventory

5,720,000

80,000

Firm commitment
To adjust inventory balance for value of firm commitment.
September 1, 2013
Accounts receivable

80,000

1,140,000

Sales revenue
To record sales to concern in Poland; $840,000 = $.38 x 3,000,000.
November 3, 2013
Exchange loss

1,140,000

60,000

Accounts receivable
To record decline in value of receivable; $60,000 = ($.48 - $.46) x 3,000,000.
Foreign currency

1,080,000

Accounts receivable
To record receipt of payment from customer.
Cash
Foreign currency
To record exchange of zloty into dollars.

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60,000

1,080,000

1,080,000
1,080,000

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P8.3
a.

Accounting for Forward Contracts—Hedging and Speculation
December 31, 2012
Exchange loss

120,000

Investment in forward
contract
To record decline in value of forward sale contract #1;
$120,000 = ($.165 - $.105) x 2,000,000.

120,000

Firm commitment

120,000
Exchange gain
To record increase in sales value of firm commitment related to contract #1.
Investment in forward contract

120,000

180,000

Other comprehensive income
To record increase in value of forward purchase contract #2;
$60,000 = ($.165 - $.105) x 3,000,000.

Exchange loss

180,000

60,000

Investment in forward
contract
60,000
To record loss on speculative contract #3; $60,000 = ($.165 - $.105) x 1,000,000.
January 29, 2013
Exchange loss

54,000

Investment in forward
contract
54,000
To record decline in value of forward sale contract #1 since December 31; $54,000
= ($.192 - $.165) x 2,000,000.
Firm commitment

54,000
Exchange gain
To record increase in sales value of firm commitment related to contract #1.
Foreign currency

54,000

384,000

Sales revenue
To record sale to Danish customer; $384,000 = $.192 x 2,000,000.
174,000
Firm commitment
To adjust sales revenue for the accumulated balance in the firm commitment
account.

384,000

Sales revenue

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Cash
Investment in forward contract

210,000
174,000

Foreign currency
To record the settlement of forward sale contract #1.

Investment in forward contract

384,000

81,000

Other comprehensive
income
To record increase in value of forward purchase contract #2;
$81,000 = ($.192 - $.165) x 3,000,000.
Foreign currency

81,000

576,000

Investment in forward
contract
Cash
To record settlement of forward purchase contract #2.
Inventory

261,000
315,000

576,000

Foreign currency
To record purchase #2 at the current spot rate of $.192.
Exchange loss

576,000

27,000

Investment in forward
contract
27,000
To record loss on forward sale contract #3; $27,000 = ($.192 - $.165) x 1,000,000.
Foreign currency

192,000
Cash
192,000
To record purchase of krone in the spot market, in anticipation of settlement of
forward sale contract #3.
Cash
Investment in forward contract
Foreign currency
To record settlement of forward sale contract #3.

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105,000
87,000
192,000

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b.

December 31, 2012 Balance Sheet:
Investment in forward contracts has a net balance of zero.
Firm commitment has a net debit balance of $120,000 (current asset).
Other comprehensive income is increased by $180,000 (stockholders= equity).
2012 Income Statement:
Net exchange loss on speculative activity is $60,000.

c.

P8.4
a.

Observe that the forward contracts entered into by Futura represented a perfect
hedge. That is, forward sale contracts #1 and #3 were hedged by forward purchase
contract #2. One could argue that these forward exchange contracts were
unnecessary, and whatever transaction costs were incurred by Futura in connection
with the contracts represent an unnecessary loss to the firm.

Hedging, Leverage, Return on Assets
Note that the December 31, 2012 spot rate is $.80 (= $400 million/C$500 million)
and the forward rate in the contract is $.88 (= $440 million/C$500 million). If the
exchange rate is $.83/C$ at the end of the first quarter, Cheesecake Factory incurs a
net loss on the forward contract of $25 million, since the C$ could be bought for
$.83 instead of the $.88 forward rate; ($25 million) = ($.83 - $.88) x 500 million.
The contract requires purchase of C$ for $440 million when the expected prevailing

market price is $415 million. Concurrently there is a $15 million [= ($.83- $.80) x
500 million] exchange loss on the payable that increases liabilities.
Without the hedge, Cheesecake Factory's payable to the international supplier
increases by $15 million and the $15 million exchange loss decreases equity. There
is no change in total assets. Using the data in the problem, measured leverage rises
to .715 [= ($700 + $15)/$1,000].
With the hedge, the payable still increases by $15 million. The forward contract is
shown as a current liability of $25 million. Using the data in the problem,
measured leverage becomes .74 [= ($700 + $15 + $25)/$1,000].

b.

If Cheesecake Factory did not use the forward contract, it could borrow $400
million now and buy the needed foreign currency. This would cost $412 million,
including 12% interest for 3 months. The forward contract costs $440 million. In
addition, if the company borrows, it could invest the C$ in short-term international
investments until required by the international supplier. This alternative seems to
dominate the forward contract.

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c.

As above, there is a $15 million exchange loss on the payable which decreases

operating income. The forward rate implied by the contract is $.81 (= $405
million/$500 million). Thus there is a $10 million gain on the forward purchase
contract that increases assets, since the exchange rate increases from $.81 to $.83 at
the end of the quarter.
Without the hedge, and assuming an annual ROA of .16 (.04 quarterly), at current
exchange rates projected operating income for the first quarter is $44 million [= .04
($1,000 + $1,200)/2]. Without the hedge, the $15 million exchange loss due to the
increasing exchange rate reduces operating income to $29 million and the quarterly
ROA to .026 [ = $29/($1,000 + $1,200/2)].
With the hedge, operating income is again reduced by the $15 million loss on the
payable, but increases by the $10 million gain on the forward purchase contract.
Operating income is $39 million = ($44 million - $5 million) and the quarterly
ROA is .035 [= $39/($1,000 + $1,200 + $10)/2].

P8.5
a.

Transaction Exposure and Credit Analysis
Using the information given, we can compute Poole's cash flow from operations as
follows (in millions):
Net income
$ 150
+ Depreciation expense
50
- Increase in noncash working capital
(40)
- Unrealized transaction gains on long-term debt
(22)
Cash flow from operations
$ 138

Because earnings overstate cash from operations by $12 million, "nearness to cash"
could be improved.

b.

Sales generate cash flows. When sales are denominated in a foreign currency,
however, the amount of cash ultimately collected is affected by changes in the
exchange rate, as well as by the general risk of default. Although we do not know
Poole's 2014 projected sales to these international customers, we do know that onethird of the ending inventory is designated to be sold to them. Wide variations in
the exchange rate will likely have material effects on dollar cash flows from these
sales.
The suggested analysis involves calculating the dollars lost on sale of the
designated inventory if customers pay Poole when the dollar strengthens and the
exchange rate falls to $.20/peso. In this case, the 500 million pesos will produce
$75 million (= $175 - $.20 x 500) less, more than half of Poole's 2013 operating
cash flow.

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c.

P8.6
a.

Poole seems to have considerable exposure to exchange rate risk, with foreign
currency denominated claims in receivables, payables and long-term debt, and
susceptible revenue-driven cash flow streams. First, you would like more
information on the extent of this exposure and whether any of it represents natural
hedges. Second, you want to know management's plans to minimize this risk and
the relative cost of different strategies, such as forward contracts, international
loans and investments, and accelerated payment and collection policies.

Hedging a Foreign Currency Commitment—Effects on Income
November 30, 2013
Exchange loss

21,000

Investment in forward contract
21,000
To record decline in value of forward sale contract; $21,000 = ($1.310 - $1.268) x
500,000.
Firm commitment

21,000

Exchange gain
To record increase in sales value of the agreement with the Swiss customer.
625,000
Sales revenue
To record delivery of the motors to the Swiss customer; $625,000 = $1.25 x
500,000.

21,000

Accounts receivable

21,000
Firm commitment
To adjust sales revenue for the accumulated balance in the firm commitment
account.

625,000

Sales revenue

December 31, 2013
Exchange loss

5,000

Accounts receivable
To adjust accounts receivable balance to the new spot rate;
$5,000 = ($1.25 - $1.24) x 500,000.
Investment in forward
contract

21,000

5,000

10,000

Exchange gain

10,000
To record increase in value of forward sale contract; $10,000 = ($1.31 - $1.29) x
500,000.

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January 31, 2014
Accounts receivable

20,000

Exchange gain
To adjust accounts receivable balance to the new spot rate;
$20,000 = ($1.28 - $1.24) x 500,000.

20,000

Investment in forward
contract

5,000
Exchange gain
To record increase in value of forward sale contract; $5,000 = ($1.29 - $1.28) x
500,000.

5,000

Foreign currency

640,000
Accounts receivable
640,000
To record payment by Swiss customer to Ellis Corporation; $640,000 = $1.28 x
500,000.
Cash
Investment in forward
contract

634,000
6,000

Foreign currency
To record settlement of the forward sale contract.

640,000

b.
Exchange loss
Exchange gain
Sales revenue
Net effect on income

2013
$ ( 5,000)

10,000
604,000
$ 609,000

2014
$
-25,000
-$ 25,000

Note that the income effects for the two years sum to $634,000, the U.S. dollar
amount received from the sale and forward contract.
c.

With the forward contract, Ellis received $634,000 from the sale. Without the
contract, CHF500,000 would have been exchanged for $640,000 = $1.28 x 500,000.
Therefore Ellis lost $6,000 due to hedging. However, Ellis did gain peace of mind
in knowing the $634,000 was locked in.

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P8.7

Hedging a Forecasted Transaction

December 31, 2013
Investment in forward contract

21,000

Other comprehensive income
To record increase in value of forward purchase contract;
$21,000 = (1.441 - $1.420) x 1,000,000.
January 29, 2014
Inventory

21,000

1,450,000

Accounts payable
To record delivery of merchandise at current spot rate of $1.45.

1,450,000

March 1, 2014
Exchange loss

10,000

Accounts payable
To adjust the account payable to the current spot rate;
$10,000 = ($1.46 - $1.45) x 1,000,000.

10,000

Investment in forward contract

19,000

Other comprehensive income
To record increase in value of forward purchase contract;
$19,000 = ($1.46 - $1.441) x 1,000,000.
Other comprehensive income

19,000

10,000

Exchange gain
To reclassify OCI to earnings to offset loss on accounts payable.
Foreign currency

10,000

1,460,000

Investment in forward contract
Cash
To record settlement of the forward contract.
Accounts payable

40,000
1,420,000

1,460,000
Foreign currency

1,460,000

To record payment to the supplier.
April 8, 2014
Cash

1,600,000
Sales revenue

1,600,000

To record sale to U.S. customer.

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