Question 1

Barnes Company entered into a forward contract during the current year to hedge the risk of a material supply cost increase.Based on the current market,at year-end the present value of the estimated amount they will have to pay in ten months is $750,000.What entry would be recorded at year-end closing,assuming that no amount was recorded for this contract until this time?

Accepted Answer

D

Question 2

Cirtus Corporation,a U.S.corporation,placed an order for inventory from a Mexican supplier on September 18 when the spot rate was $0.0840 = 1 peso.The invoice price will be denominated in pesos.At that time,they entered into a 30-day forward contract (designated as a fair value hedge of the firm commitment to purchase)to purchase 860,000 pesos at a forward rate of $0.0810.On October 18 when the inventory was received,the spot rate was $0.0890.At what amount should the inventory be carried on Cirtus' books?

Accepted Answer

A)Inventory = 860,000 × .081 = $69,660

Question 3

A highly-effective hedge of an existing asset or liability that is reported on the balance sheet would be recorded using

Accepted Answer

A highly-effective hedge of an existing asset or liability that is reported on the balance sheet would be recorded using Fair Value Hedge Accounting. This type of accounting is used to reduce the risk of changes in fair value of assets or liabilities due to fluctuations in market conditions. Under this method, changes in the fair value of the hedging instrument and the hedged item are recognized in earnings.

Question 4

A fair value hedge differs from a cash flow hedge because a fair value hedge

Accepted Answer

A fair value hedge records gains or losses in the value of the derivative directly to earnings of the company, whereas a cash flow hedge defers the gains or losses in the value of the derivative using Other Comprehensive Income. Option A is incorrect because a fair value hedge can be used for firm purchase or sales commitments. Option B is incorrect because a fair value hedge is recorded regardless of its effectiveness. Therefore, the correct answer is option C.

Question 5

If a financial instrument is classified as a cash flow hedge,then

Accepted Answer

For a cash flow hedge, the effective portion of its gains or losses is reported in other comprehensive income (a component of equity on the balance sheet) until the forecasted transaction occurs. If a fiscal year-end occurs before the settlement date of the hedged item, the gains or losses remain in equity and are not recognized in the income statement until the hedged transaction affects earnings.

Question 6

The purchase price of an option contract is typically recorded as

Accepted Answer

The purchase price of an option contract is recorded as an asset on the balance sheet because it represents a financial instrument that has value and can be sold or traded in the future.

Question 7

A forward contract used as a cash flow hedge will be recorded as an asset if

Accepted Answer

A forward contract used as a cash flow hedge will be recorded as an asset when the holder is expecting to receive a payment as a result of the contract. This is because the forward contract is being used to mitigate the risk of changes in future cash flows, and any expected receipt will increase the holder's cash flow in the future.

Question 8

Use the following information to answer the question(s)below.
On November 2,2011,Bellamy Corporation sells product to their Danish customer.At the same time,Bellamy signed a forward contract to sell 200,000 Danish krone in ninety days to hedge the account receivable at $0.1905,the 90-day forward rate.The receivable is expected to be collected in ninety days.Assume the forward contract will be settled net and this is a fair value hedge.The related exchange rates are shown below:
 
-Assuming a present value factor of 1 for simplicity,what is the fair value of this forward contract on December 31?

Accepted Answer

The answer of Use the following information to answer the...

Question 9

When a cash flow hedge is appropriate,the effective portion of the gain or loss on the derivative is

Accepted Answer

The effective portion of the gain or loss on the derivative in a cash flow hedge is deferred using other comprehensive income. This means that it is not recognized immediately and is instead recognized over time, typically amortized over the period of the agreement. This approach helps to match the gain or loss on the derivative with the changes in the cash flows of the underlying asset or liability being hedged.

Question 10

Which of the following hedging strategies would a business most likely use?

Accepted Answer

A business that imports goods or services would most likely want to hedge its foreign denominated accounts payable to protect itself against any adverse movements in exchange rates. By purchasing forward contracts, the business can lock in the exchange rate at which it will pay for the goods or services, thereby reducing its exposure to exchange rate risk.

Question 11

Which of the following is not an approach appropriate for hedge accounting?

Accepted Answer

There is no such approach called "Critical Term Hedge Accounting". The other three options are legitimate approaches for hedge accounting.

Question 12

When preparing their year-end financial statements,the Warner Company includes a footnote regarding their hedging activities during the year.Which of the following is not required to be disclosed?

Accepted Answer

While disclosing the types of risks being hedged and how they are being hedged and the net gain or loss reported for the period for fair value hedges and where in the financial statements it is reported are required to be disclosed, alternative hedging options declined is not a required disclosure. However, if the company deems it significant, they may choose to disclose it. The disclosure of how hedge effectiveness is determined and assessed is also a required disclosure.

Question 13

Use the following information to answer the question(s)below.
On November 2,2011,Bellamy Corporation sells product to their Danish customer.At the same time,Bellamy signed a forward contract to sell 200,000 Danish krone in ninety days to hedge the account receivable at $0.1905,the 90-day forward rate.The receivable is expected to be collected in ninety days.Assume the forward contract will be settled net and this is a fair value hedge.The related exchange rates are shown below:
 
-Assuming a present value factor of 1 for simplicity,what is the fair value of this forward contract on January 31?

Accepted Answer

The answer of Use the following information to answer the...

Question 14

On May 1,2011,Listing Corporation receives inventory items from their Bulgarian supplier.At the same time,Listing signed a forward contract to purchase 75,000 Bulgarian lev in sixty days to hedge the inventory purchase at $0.738,the 60-day forward rate.Payment for the inventory will be due in sixty days in Bulgarian lev.Assume the forward contract will be settled net and this qualifies as a fair value hedge.The related exchange rates are shown below:  Assuming a present value factor of 1 for simplicity,what is the fair value of this forward contract on May 31?

Accepted Answer

A)
Current forward rate: 75,000 lev × $0.7400 $55,500
Contracted forward rate: 75,000 lev × $0.7380 55,350
Net change in value 150
With PV = 1,Net change = asset value

Question 15

International accounting standards differ from U.S.Generally Accepted Accounting Principles in that International standards

Accepted Answer

International accounting standards permit firm sale or purchase commitments to be accounted for as either fair value hedges or cash flow hedges, while U.S. Generally Accepted Accounting Principles require that such commitments are accounted for as cash flow hedges.

Question 16

Use the following information to answer the question(s)below.
On November 2,2011,Bellamy Corporation sells product to their Danish customer.At the same time,Bellamy signed a forward contract to sell 200,000 Danish krone in ninety days to hedge the account receivable at $0.1905,the 90-day forward rate.The receivable is expected to be collected in ninety days.Assume the forward contract will be settled net and this is a fair value hedge.The related exchange rates are shown below:
 
-Assuming a present value factor of 1 for simplicity,what is the fair value of this forward contract on November 2?

Accepted Answer

Since the forward rate and the spot rate are equal on November 2, there is no change in the exchange rate and therefore no gain or loss on the forward contract. Thus, the fair value of the forward contract is $0.

Question 17

Use the following information to answer the question(s)below.
On December 1,2011,Thomas Company,a U.S.corporation,purchases inventory from a vendor in Italy for 400,000 euros.Payment is due in 90 days.To hedge the transaction,Thomas signs a forward contract to buy 400,000 euros in 90 days at $1.3670.Thomas uses a discount rate of 6% (present value factor for 30 days = .9950;60 days = .9901;90 days = .9851).Assume the forward contract will be settled net and this is a cash flow hedge.Currency exchange rates are shown below:
 
-What is the fair value of the forward contract at February 29?

Accepted Answer

D)Current forward rate: 400,000 euros × $1.3712 $548,480
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Question 18

Use the following information to answer the question(s)below.
On December 1,2011,Thomas Company,a U.S.corporation,purchases inventory from a vendor in Italy for 400,000 euros.Payment is due in 90 days.To hedge the transaction,Thomas signs a forward contract to buy 400,000 euros in 90 days at $1.3670.Thomas uses a discount rate of 6% (present value factor for 30 days = .9950;60 days = .9901;90 days = .9851).Assume the forward contract will be settled net and this is a cash flow hedge.Currency exchange rates are shown below:
 
-What is the fair value of the forward contract at January 30?

Accepted Answer

B)
Current forward rate: 400,000 euros × $1.369 $547,600
Contracted forward rate: 400,000 euros × $1.367 546,800
Net change in value 800
PV for 30 days @ 6% .9950
Fair value of forward contract on 1/30/12 $ 796

Question 19

Use the following information to answer the question(s)below.
On December 1,2011,Thomas Company,a U.S.corporation,purchases inventory from a vendor in Italy for 400,000 euros.Payment is due in 90 days.To hedge the transaction,Thomas signs a forward contract to buy 400,000 euros in 90 days at $1.3670.Thomas uses a discount rate of 6% (present value factor for 30 days = .9950;60 days = .9901;90 days = .9851).Assume the forward contract will be settled net and this is a cash flow hedge.Currency exchange rates are shown below:
 
-What is the fair value of the forward contract at December 31,2011?

Accepted Answer

C)
Current forward rate: 400,000 euros × $1.3660 $546,400
Contracted forward rate: 400,000 euros × $1.3670 546,800
Net change in value (400)
PV for 60 days @ 6% .9901
Fair value of forward contract on 12/31/11 $ (396.04)

Question 20

Taydus Corporation,a U.S.corporation,sold goods on December 2 to a company overseas,and is now carrying a receivable denominated in euros.Taydus signed a 60-day forward contract on that same date to sell euros.The spot rate was $1.40 on the date they signed the contract and the 60-day forward rate was $1.36.At the end of that month when they closed the books at their fiscal year-end,the spot rate was $1.42 and the 30-day forward rate was $1.40.Assume this is a fair value hedge.The forward contract will not be settled net.What would be reported by Taydus for the year ending December 31?

Accepted Answer

B)The spot rate increased $.02,resulting in a gain on the receivable.
The forward rate increased $.04,resulting in a larger loss on the forward,thus they experienced a net exchange loss.

Quiz 13: Accounting for Derivatives and Hedging Activities