Chapter 23

Accounting for Derivatives and Hedging

Transactions (Part 2)

PROBLEM 23-1: THEORY

1. D 6. C
2. A 7. B
3. A 8. C
4. D 9. C
5. A 10. B

PROBLEM 23-2: THEORY

1. A 6. B
2. E 7. D
3. D 8. A
4. A 9. B
5. A 10. D

PROBLEM 23-3: THEORY

1. B 6. D
2. B 7. A
3. B 8. B
4. B 9. C
5. C 10. C

PROBLEM 23-4: THEORY & COMPUTATIONAL

1. C

2. D

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3. A

4. D

5. Solution:
Hedged item – None Forward contract (Derivative)
Dec. 15, 20x1
No entry

Dec. 31, 20x1

Forward contract (asset)……30K
Gain on forward contract…..
30K
[ (48 - 45) x 10,000]

to record the value of the derivative

There is gain because if Puppy Co. purchases $10,000 using the

forward contract, the purchase price is ₱450,000; while if Puppy Co.
purchases $10,000 in the market, the purchase price is ₱480,000.

Variation 1: Gross settlement – Compound entry

Hedged item – None Forward contract (Derivative)
Jan. 15, 20x2
Cash – foreign currency...460K
($10,000 x ₱46 spot rate)
Loss on forward contract….20K
Forward contract (asset). 30K
Cash – local currency…
450K

to record the purchase of $10,000 from

the bank in exchange at the pre-agreed
purchase price of ₱450,000

Variation 2: Net settlement

Hedged item – None Forward contract (Derivative)

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 Jan. 15, 20x2
Cash – local currency…… 10K
[(46 – 45) x 10,000]
Loss on forward contract…20K
Forward contract (asset)….30K

to record the net cash settlement of the

forward contract

6. Solution:
Hedged item – Hedging instrument –
Accounts payable Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
Machine………………..4.1M No entry
(100K FCU x ₱41 spot rate)
Accounts payable………..
4.1M

Dec. 31, 20x1 Dec. 31, 20x1

FOREX loss………....300K Forward contract (asset)...300K
Accounts payable……300K [(₱43 - ₱40) x 100K]
[(₱44 - ₱41) x 100K FCU] Gain on forward contract….
300K
to adjust accounts payable for the
increase in spot rate to record the value of the derivative

Variation 1: Gross settlement – Compound entry

Hedged item – Hedging instrument –
Accounts payable Forward contract (Derivative)
Jan. 15, 20x2 Jan. 15, 20x2
Accounts payable……….4.4M Cash – foreign currency 4.2M
Cash – foreign currency (100K x ₱42spot rate)
4.2M Loss on forward contract .. 100K
(100,000 x 42) Cash – local currency…
FOREX gain…………… 4M
200K (100K x ₱40 agreed rate)
Forward contract (asset)
to record the payment of 100,000 FCU to 300K
the supplier
to record the purchase of 100,000 FCU
at the pre-agreed price of ₱4,000,000
(100,000 x ₱40)

Variation 2: Net settlement

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 Hedged item – Forward contract (Derivative)
Accounts payable
Jan. 15, 20x2 Jan. 15, 20x2
Accounts payable……….4.4M Cash – local currency… 200K
Cash – foreign currency [(42 – 40) x 100,000]
4.2M Loss on forward contract 100K
(100,000 x 42) Forward contract (asset)…
FOREX gain…………… 300K
200K
to record the net cash settlement of the
to record the payment of 100,000 FCU to forward contract
the supplier

7. Solution:
Hedged item – Hedging instrument –
Firm sale commitment Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry

Dec. 31, 20x1 Dec. 31, 20x1

Loss on firm commitment 20K Forward contract (asset).. 20K
Firm commitment (liability) Gain on forward contract..
20K 20K
[(₱4 – ₱3.8) x 100K FCUs] [(₱4 – ₱3.8) x 100K FCUs]

to recognize the change in the fair value to recognize the change in the fair value
of the firm commitment of the forward contract

Variation 1: Gross settlement – Compound entry

Jan. 15, 20x2 Jan. 15, 20x2
Cash (foreign currency)… 360K Cash (local currency)….....400K
(100K FCUs x ₱3.6 spot rate) Cash (foreign currency)….
Firm commitment (liability)..20K 360K
Loss on firm commitment... 20K Forward contract (asset)…
Sales…………………….. 20K
400K Gain on forward contract….
(100K FCUs x ₱4.00 forward 20K
rate)

to record the actual sale transaction, to

recognize the change in the fair value of to record the remittance of 100,000
the firm commitment, and to derecognize FCUs to the bank in exchange for the
the firm commitment pre-agreed sale price of ₱400,000

Variation 2: Net settlement

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 Jan. 15, 20x2 Jan. 15, 20x2
Cash (foreign currency)… 360K Cash (local currency)….....40K
(100K FCUs x ₱3.6 spot rate) (4 – 3.6) x 100,000
Firm commitment (liability)..20K Forward contract (asset)…
Loss on firm commitment... 20K 20K
Sales…………………….. Gain on forward contract….
400K 20K
(100K FCUs x ₱4.00 forward
rate)
to record the net settlement of the
to record the actual sale transaction, to
forward contract
recognize the change in the fair value of
the firm commitment, and to derecognize
the firm commitment

8. Solution:
Hedged item – Hedging instrument –
Firm purchase commitment Forward contract (Derivative)
Oct. 1, 20x1 Oct. 1, 20x1
No entry No entry

Dec. 31, 20x1 Dec. 31, 20x1

Loss on firm commitment .. 3,882 Forward contract (asset)... 3,882
Firm commitment (liability) Gain on forward contract
3,882 3,882

to recognize the change in the fair value to recognize the change in the fair value
of the firm commitment of the forward contract

(₱100 – ₱96) x 1,000 meters of yarn x PV of 1 @1%*, n=3 = 4,000 x

0.970590 = 3,882

* (12% ÷ 12 months) = 1% per month

Hedged item – Hedging instrument –

Firm purchase commitment Forward contract (Derivative)

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 Mar. 31, 20x2 Mar. 31, 20x2
Inventory (92 x 1,000). 92,000 Cash [(100 - 92) x 1,000]...8,000
Loss on firm commitment Gain on forward
(8,000 – 3,882)………….. 4,118 contract (8,000 – 3,882)….
Firm commitment 4,118
(liability)………………….3,882 Forward contract (asset)…
Cash ……………………… 3,882
100,000
(100 fixed contract price x 1,000)

to record the actual purchase transaction

and to derecognize the firm commitment to net cash settlement of the forward
contract.

9. Solution:
Scenario (a):
Hedged item – Highly Hedging instrument –
probable forecast transaction Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry

Dec. 31, 20x1 Dec. 31, 20x1

No entry Accumulated OCI… ……. 4K
Forward contract (liability)… 4K
[(100 –96) x 1,000

to recognize the change in the fair value

of the forward contract

Jan. 15, 20x2 Jan. 15, 20x2

Inventory…………………..92K Accumulated OCI… ……. 4K
(1,000 x 92 current spot rate) Forward contract (liability)… 4K
Cash …………………...…… [(96 - 92) x 1,000
92K
to recognize the change in the fair value
to record the actual purchase transaction of the forward contract

Jan. 15, 20x2

Forward contract (liability)… 8K
Cash ……………………….…
8K

to record the net settlement of the

forward contract.

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 Feb. 14, 20x2 Feb. 14, 20x2
Cash…………………….360K Cost of goods sold…………..8K
Cost of goods sold………92K Accumulated OCI… ………..
Inventory…………………….. 8K
92K
Sales………………………..
360K
to reclassify accumulated losses on
forward contract to profit or loss as an
to record the sale of inventory
increase in cost of goods sold.

Scenario (b):
Hedged item – Highly Hedging instrument –
probable forecast transaction Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry

Dec. 31, 20x1 Dec. 31, 20x1

No entry Accumulated OCI… ……. 4K
Forward contract (liability)… 4K
[(100 –96) x 1,000

to recognize the change in the fair value

of the forward contract

Jan. 15, 20x2 Jan. 15, 20x2

Inventory…………………..92K Accumulated OCI… ……. 4K
(1,000 x 92 current spot rate) Forward contract (liability)… 4K
Cash …………………...…… [(96 - 92) x 1,000
92K
to recognize the change in the fair value
to record the actual purchase transaction of the forward contract

Jan. 15, 20x2 Jan. 15, 20x2

Inventory…………………...8K Forward contract (liability)… 8K
Accumulated OCI……………. Cash ……………………….…
8K 8K

to remove the accumulated OCI and to record the net settlement of the
adjust it to the initial cost of the forward contract.
inventory

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 Feb. 14, 20x2 Feb. 14, 20x2
Cash…………………….360K No entry
Cost of goods sold…… 100K
Inventory……………………
100K
Sales………………………..
360K

to record the sale of inventory

PROBLEM 23-5: MULTIPLE CHOICE: COMPUTATIONAL

1. A Pinoy Corp. recognizes no net gain or net loss. By opening the letter
of credit, Pinoy Corp. fixes its net exposure to exchange rate risk at
₱27.50.

2. A
Solution:
Contract rate 0.70
30-day futures rate on 12/31/01 0.65
Decrease 0.05
Multiply by: No. of Swiss francs 50,000
Loss 2,500

3. B
Current price (¥47,850,000 ÷ ¥115) $416,087
Fixed amount of dollars to be received from the ¥47,850,000 $435,000
Deficiency - Receipt 18,913

4. C
Solution:
Current price (¥47,850,000 ÷ ¥105) $455,714
Fixed amount of dollars to be received from the
¥47,850,000 $435,000
Excess – Payment $(20,714)

5. B
Solution:
Current price (¥47,850,000 ÷ ¥115) $416,087

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Fixed amount of dollars to be received from the ¥47,850,000 $435,000
Difference - Fair value $18,913

PROBLEM 23-6: EXERCISES: COMPUTATIONAL

1. Solution:
Hedged item – None Forward contract (Derivative)
Dec. 15, 20x1
No entry

Dec. 31, 20x1

Loss on forward contract…..30K
[ (48 - 45) x 10,000]
Forward contract (liability)…
30K

to record the value of the derivative

Jan. 15, 20x2

Forward contract (liability) .30K
Gain on forward contract…
20K
Cash – local currency……
10K
[(46 – 45) x 10,000]

to record the net cash settlement of the

forward contract

2. Solution:
Hedged item – Hedging instrument –
Accounts receivable Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
Accounts receivable…. 4.1M No entry
Sales………………..
4.1M
(100K FCU x ₱41 spot rate)

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 Dec. 31, 20x1
Accounts receivable…. 300K
FOREX gain………....
300K [(₱44 - ₱41) x 100K FCU]
Dec. 31, 20x1
Loss on forward contract….300K
Forward contract (liability)...
300K
[(₱43 - ₱40) x 100K]

Scenario A: Gross settlement – Compound entry

Hedged item – Hedging instrument –
Accounts payable Forward contract (Derivative)
Jan. 15, 20x2 Jan. 15, 20x2
Cash – foreign currency 4.2M Cash – local currency… 4M
(100,000 x 42) (100K x ₱40 agreed rate)
FOREX loss…………… 200K Forward contract (liability) 300K
Accounts receivable…… 4.4M Cash – foreign currency
4.2M
(100K x ₱42 spot rate)
Gain on forward contract .
100K

Scenario B: Net settlement

Hedged item – Forward contract (Derivative)
Accounts payable
Jan. 15, 20x2 Jan. 15, 20x2
Cash – foreign currency 4.2M Forward contract (liability) 300K
(100,000 x 42) Cash – local currency…
FOREX loss…………… 200K 200K
Accounts receivable…… 4.4M [(42 – 40) x 100,000]
Gain on forward contract .
100K

3. Solution:
Hedged item – Hedging instrument –
Firm sale commitment Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry

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 Dec. 31, 20x1
Firm commitment (asset) 20K
[(₱4 – ₱3.8) x 100K FCUs]
Gain on firm commitment
Scenario A: Gross settlement – Compound entry
Jan. 15, 20x2
Equipment……………… 400K
(100,000 x 4 forward rate)
Firm commitment (asset)..
20K
Cash (foreign currency)…
360K
(100K FCUs x ₱3.6 spot rate)
Gain on firm commitment...
20K
Scenario B: Net settlement
Jan. 15, 20x2
Equipment……………… 400K
(100,000 x 4 forward rate)
Firm commitment (asset)..
20K
Cash (foreign currency)…
360K
(100K FCUs x ₱3.6 spot rate)
Gain on firm commitment...
20K
4. Solution:
Hedged item –
Firm purchase commitment
Oct. 1, 20x1
No entry
Dec. 31, 20x1
Loss on forward contract.. 20K
Forward contract (liability)..
20K 20K
[(₱4 – ₱3.8) x 100K FCUs]
Jan. 15, 20x2
Cash (foreign currency)….360K
Forward contract (liability)… 20K
Loss on forward contract…. 20K
Cash (local currency)….....
400K
Jan. 15, 20x2
Forward contract (liability)… 20K
Loss on forward contract…. 20K
Cash (local currency).....
40K
Hedging instrument –
Forward contract (Derivative)
Oct. 1, 20x1
No entry
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 Dec. 31, 20x1 Dec. 31, 20x1
Firm commitment (asset) 3,941 Loss on forward contract 3,941
Gain on firm commitment .. Forward contract (liability)...
3,941 3,941

(₱100 – ₱96) x 1,000 meters of yarn x PV of 1 @0.5%*, n=3 = 4,000 x

0.985149 = 3,941

* (6% ÷ 12 months) = 0.5% per month

Hedged item – Hedging instrument –

Firm purchase commitment Forward contract (Derivative)
Mar. 31, 20x2 Mar. 31, 20x2
Cash………………… 100,000 Forward contract (liability)... 3,941
(100 fixed contract price x 1,000) Loss on forward contract ….4,059
Sales (92 x 1,000). (8,000 – 3,941)….
92,000 Cash [(100 - 92) x 1,000]...
Firm commitment (asset) 8,000
3,941
Gain on firm commitment 4,059

5. Solution:
Hedged item – Highly Hedging instrument –
probable forecast transaction Forward contract (Derivative)
Dec. 15, 20x1 Dec. 15, 20x1
No entry No entry

Dec. 31, 20x1 Dec. 31, 20x1

No entry Forward contract (asset)… 4K
[(100 –96) x 1,000
Accumulated OCI… ……. 4K

Jan. 15, 20x2 Jan. 15, 20x2

Cash…………………..92K Forward contract (asset)… 4K
(1,000 x 92 current spot rate) [(96 - 92) x 1,000
Sales…………………...…… Accumulated OCI… ……. 4K
92K
to recognize the change in the fair value
to record the actual purchase transaction of the forward contract

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Jan. 15, 20x2 Jan. 15, 20x2
Accumulated OCI… ……….. 8K Cash ………………………. 8K
Sales…………………...…… 8K Forward contract (asset)… 8K

to reclassify accumulated losses on to record the net settlement of the

forward contract to profit or loss as an forward contract.
increase in sales

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