Chapter 24 Accounting for Derivatives and Hedging

Transactions (Part 3)
Multiple Choice Computational
Answers at a glance:
1. C
11. B
2. C
12. C
3. A
13. D
4. A
14. A
5. C
15. D
6. A
16. B
7. C
17. A
8. D
18. A
9. D
19. B
10. A
20. D

21.
22.
23.
24.
25.
26.
27.
28.
29.
30.

C
B
A
C
A
C
B
A
D
D

31.
32.
33.
34.
35.
36.
37.
38.
39.
40.

Solutions:
1. C
Solution:
Hedged item None

B
C
B
A
A
B
A
C
B
A

41.
42.
43.
44.
45.
46.
47.
48.
49.
50.

C
D
C
B
C
D
A
A
D
B

51.
52.
53.
54.
55.
56.
57.
58.
59.
60.
61.
62.
63.
64.
65.

C
B
E
A
A
B
E
B
B
A
C
B
E
E
B

Futures contract (Derivative)

Dec. 1, 20x1
Deposit with broker ..80K
Cash..80K
to record the initial margin deposit with
the broker

2. C
Solution:
Hedged item None

Futures contract (Derivative)

Dec. 31, 20x1
Loss on futures contract..40K
Futures contract (liability)...40K
[(200 - 190) x 4,000]
to record the value of the derivative
computed as the change in the underlying

183

multiplied by the notional amount.

3. A
Solution:
Hedged item None

Futures contract (Derivative)

Feb. 1, 20x2
Loss on futures contract 20K
[(190 - 185) x 4,000]

Futures contract (liability)..40K

Cash local currency 20K
Deposit with broker.....80K
to recognize loss on the change in the fair
value of the futures contract and to record
the net cash settlement of the futures
contract.

40,000 loss in 20x1 + 20,000 loss in 20x2 = 60,000 total loss

4. A (See entry above)
5. C
Solution:
Hedged item Inventory

Hedging instrument
Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker .384K
Cash...384K

Dec. 1, 20x1
No entry

to record the initial margin deposit with

the broker

6. A
Solution:
Hedged item Inventory

Hedging instrument
Futures contract (Derivative)

Dec. 31, 20x1

Inventory.100K
Gain on fair value change...100K

Dec. 31, 20x1

Loss on futures contract.80K
Futures contract (liability)...80K

[(12,250 12,000) x 400]

[(12,300 -12,100) x 400]

to recognize the change in the fair value

less costs to sell of the gold inventory.

to recognize the change in the fair value

of the futures contract.

7. C (See entries above)

8. D
Solution:
Hedged item Inventory
Feb. 1, 20x2

Futures contract (Derivative)

Feb. 1, 20x2

184

Loss on fair value change180K

[(12,250 11,800) x 400]

Inventory180K

Futures contract (asset).. 200K

Gain on futures contract200K
[(12,300 11,800) x 400]

to recognize the change in the fair value

less costs to sell of the gold inventory.

to recognize the change in the fair value

of the futures contract.

Feb. 1, 20x2
Cash..4.72M
Sale (11.8 spot price x 400).. 4.72M

Feb. 1, 20x2
Cash.504K
[(12.1K 11.8K) x 400] + 384K

Futures contract (asset)......120K

(200K asset 80K liability)

Cost of goods sold. 4.72M

Inventory (4.8M +100K 180K) 4.72M
to recognize
inventory.

the

sale

of

the

gold

Deposit with broker..384K

to record the net cash settlement of the
futures contract.

9. D (See entries above)

10. A
Solution:
Outflow on deposit with broker - Dec. 1, 20x1
Cash receipt from sale
Net cash receipt on settlement of futures contract
Net cash receipt (equal to the pre-agreed sale price)

(384,000)
4,720,000
504,000
4,840,000

11. B
Solutions:
Hedged item
Inventory

Hedging instrument
Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker ..80K
Cash..80K

Dec. 1, 20x1
No entry

to record the initial margin deposit with

the broker

Dec. 31, 20x1

Inventory.68K
Gain on fair value change.....68K

Dec. 31, 20x1

Loss on futures contract....56K
Futures contract (liability).. 56K

[(371 354) x 1,000]

to recognize the change in the fair value
of the inventory due to changes in the
hedged risk.

[(374 -360) x 4,000]

to recognize the change in the fair value
of the futures contract.

12. C (See entries above)

13. D (See entries above)
14. A
185

Solution:
Hedged item Inventory

Futures contract (Derivative)

Feb. 1, 20x2
Loss on fair value change132K
[(371 338) x 4,000]

Inventory132K

Feb. 1, 20x2
Futures contract (asset).. 144K
Gain on futures contract 144K
[(374 338) x 4,000]

to recognize the change in the fair value

of the inventory due to changes in the
hedged risk.

to recognize the change in the fair value

of the futures contract.

Feb. 1, 20x2
Cash (338 spot price x 4K)..1.352M
Sales...1.352M

Feb. 1, 20x2
Cash.168K

Cost of goods sold.896K

Inventory (960K + 68K 132K) 896K

(144K asset 56K liability)

to recognize the sale of the soybean

inventory.

[(360 338) x 4K] + 80K deposit

Futures contract (asset)........88K

Deposit with broker80K
to record the net cash settlement of the
futures contract.

15. D (1,352,000 sales less 896,000 cost of sales) = 456,000 (See

entries above)
16. B
Solution:
Hedged item
Firm sale commitment

Hedging instrument
Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker .120K
Cash.120K

Dec. 1, 20x1
No entry

to record the initial margin deposit with

the broker

Dec. 31, 20x1

Loss on firm commitment.. 120K

Dec. 31, 20x1

Future contract (asset) 140K

[(240 210) x 4,000]

[(235 200) x 4,000]

Firm commitment (liability) 120K

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

Gain on futures contract..140K

to recognize the change in the fair value
of the futures contract

17. A (See entries above)

18. A
Solution:
Hedged item
Firm sale commitment
Feb. 1, 20x2
Firm commitment (liability)..120K
Loss on firm commitment.... 40K

Hedging instrument
Futures contract (Derivative)
Feb 1, 20x2
Cash .320K
[(250 200) x 4,000] + 120K deposit

Deposit with broker 120K

[(250 240) x 4,000]

186

Cash.. 840K

Futures contract (asset).140K

Gain on futures contract.. 60K

(210 contract price x 4,000)

Sale (250 spot price x 4,000)... 1M
to record the actual sale transaction

[(250 235) x 4,000]

to record the net settlement of the futures
contract.

19. B (See entries above)

20. D (See entries above)
21. C
Solution:
The changes in the expected cash flows on the forecasted
transaction and the changes in the fair values of futures contract are
computed as follows:
Hedging
Hedged item:
instrument:
Forecasted
Futures
transaction
contracts
(Broccoli)
(Cauliflower)
Mar. 31, 20x1
Current prices Mar. 31
95.18
94.52
Previous prices Jan. 1
93.76
92.98
1.42
1.54
Increase (Decrease)
Multiplied by: Kilograms of commodity
4,000
4,000 a
(5,680)
6,160
Changes during the period 3/31/x1
Fair value - 1/1/x1
Cumulative changes 3/31/x1
(5,680)
6,160
June 30, 20x1
Current prices June 30
Previous prices Mar. 31
Increase (Decrease)
Multiplied by: Kilograms of commodity
Changes during the period 6/30/x1

Fair value - 3/31/x1

Cumulative changes 6/30/x1
a

96.20
95.18
1.02
4,000
(4,080)
(5,680)
(9,760)

95.36
94.52
0.84
4,000
3,360
6,160
9,520

No. of futures contracts x Kilograms covered by each contract = (10 x 400) = 4,000.

Cumulative changes in:

Fair values of futures contract

March 31
6,160
5,680
Expected cash flows of forecasted transaction
Ratio
108%
22. B (See solutions above)
187

June 30
9,520
9,760
98%

23. A
Solution:
To determine the ineffectiveness of the hedge, the following
procedures are performed:
Step 1:
Step 2:
Step 3:
Step 4:

Determine the cumulative changes in the expected cash

flows on the forecasted transaction.
Determine the cumulative changes in the fair values of the
hedging instrument.
Determine the lower of the amounts computed in Step 1
and Step 2, in absolute values.
The amount determined in Step 3 is the effective portion
which is recognized in other comprehensive income. The
difference between the change in the fair value of the
hedging instrument and the effective portion represents the
ineffective portion which is recognized in profit or loss.

The steps above are applied as follows:

Forecasted
Futures
transaction contract
Broccoli Cauliflower
Dates

Cumulative Cumulative
change in change in
cash flows fair values
(Step 1)
(Step 2)
a

1/1/x1
3/31/x1
6/30/x1

(5,680)
(9,760)

Effective portion - OCI

(Step 3)
Lower of a
OCI
and b
during
Cumulative
the
OCI
period
d=c-

6,160
9,520

5,680
9,520

prev. bal.

5,680
3,840

Ineffective portion P/L (Step 4)

Cumulative
P/L
e=b-c

480
-

P/L
during
the
period
f=eprev. bal.

480
(480)

24. C (See table above)

25. A - On March 31, 20x1, the effect of the hedge is overhedge
(the increase in the cash inflows from the hedging instrument is
greater than the increase in the expected cash outflows on the
hedged item).
26. C
Solution:
Hedged item Highly probable
forecast transaction

Hedging instrument
Futures contract (Derivative)

Jan. 1, 20x1
No entry

Jan. 1, 20x1
No entry

Mar. 31, 20x1

No entry

Futures contract..6,160

Mar. 31, 20x1

188

Accumulated OCI 5,680

Gain on futures contract. 480
to recognize the change in the fair value
of the effective portion of the futures
contract in OCI and the ineffective
portion in profit or loss.

June 30, 20x1

June 30, 20x1

Inventory384,800
(4,000 x 96.20)

Cash.384,800
to record the purchase of broccoli at the
current price.

Futures contract. 3,360

Loss on futures contract.. 480
Accumulated OCI. 3,840
to recognize the change in the fair value
of the effective portion of the futures
contract in OCI and the ineffective
portion in profit or loss.

June 30, 20x1

Cash9,520
Futures contract.. 9,520
(6,160 + 3,360)
to record the net settlement of the futures
contract.

27. B (See table above)

28. A (See table above)
29. D (See entry above)
30. D This amount is reclassified to profit or loss when the related
inventory is sold.
31. B (384,800 cost of inventory 9,520 reclassification adjustment
of OCI) = 375,280
32. C
Solution:
Hedged item
Account receivable
Dec. 15, 20x1
Accounts receivable 1.92M
(4M yens x 0.48 spot rate)

Hedging instrument
Put option (Derivative)
Dec. 15, 20x1
Put option .... 30K
Cash.. 30K

Sales...1.92M
Dec. 31, 20x1
Dec. 31, 20x1
Accounts receivable40K
Loss on put option....10K
[4M x (0.49 - 0.48)]
Put option..10K
FOREX gain....40K
(30K 20K)

189

to adjust the accounts receivable for the

increase in spot exchange rate

to recognize loss on the decrease in the

fair value of the option.

Jan. 15, 20x2

Cash foreign currency.. 1.84M

Jan. 15, 20x2

Cash local currency1.88M

(4M x 0.46 current spot rate)

(4M x 0.47 option price)

Put option (30K 10K).. 20K

Cash foreign currency. 1.84M
Gain on put option. 20K

FOREX loss.. 120K

Accounts receivable.1.96M
(1.92M + 40K)
to record the receipt of 4M yens from
customer

to record the exercise of the put option

which is in the money.

33. B (See entries above)

34. A 20,000 - carrying amount of the option
35. A
Solution:
Hedged item None

Call option (Derivative)

April 1, 20x1

April 1, 20x1
Call option .... 2,400
Cash.. 2,400

June 30, 20x1

June 30, 20x1

Call option .... 24,000
[(106 100) x 4,000]

Gain on call option. 24,000

to record the increase in the fair value of
the call option due to the increase in
intrinsic value (excess of market value of
shares over exercise price).

June 30, 20x1

Loss on call option.800
(2,400 1,600)

Call option..800
to record the decrease in the fair value of
the call option due to the decrease in
1
time value.

July 1, 20x1

July 1, 20x1
Cash

24,000

[(106 100) x 4,000]

Loss on call option.1,600

Call option ...... 25,600
(2,400 + 24,000 800)
to record the net settlement of the call
option contract.

190

36. B (See entries above)

37. A (See entries above)
38. C
Solution:
Hedged item Highly probable
forecast transaction

Hedging instrument
Put option (Derivative)
Oct. 1, 20x1
Put option ....25.6K
Cash.. 25.6K

Oct. 1, 20x1
No entry

to record the purchase of option contract

39. B Cash flow hedge because the hedged item is a highly

probable forecasted transaction.
40. A
Solution:
The gain or loss on December 31, 20x1 is computed as follows:

10.1.x1 (see table above)

12.31.x1
(1.12M 1.45) 783,216

Gain (Loss)

Change in:
Intrinsic value Time value
(OCI)
(P/L)
25,600
10,802
10,802

13,196
(12,404)

Change in
fair value of
option
25,600
24,000
(1,600)

41. C (See table above)

42. D
Solution:

12.31.x1(see table above)

4.1.x2
(1.12M 1.50) 783,216

Gain (Loss)

Change in:
Intrinsic value Time value
(OCI)
(P/L)
10,802
13,196
36,549
25,747

43. C 746,667 + 36,550 = 783,217

Solution:
Hedged item Highly probable
forecast transaction
191

(13,196)

Change in
fair value of
option
24,000
36,549
12,549

April 1, 20x2
Accounts receivable.746,667
Sales746,667
(1,120,000 1.50 spot rate)
to record the actual sale transaction

April 1, 20x2
Accumulated OCI..36,550
(10,802 + 25,748)

Sales 36,550
to reclassify accumulated OCI to profit or
loss

44. B
45. C
Solution:
20x1
320,000
320,000
-

Receive variable a
Pay 8% fixed
Net cash settlement - receipt

20x2
400,000
320,000
80,000

The interest rates used are the current rates as at the beginning of
the year (i.e., 4M x 8% = 320,000) & (4M x 10% = 400,000).
There is no cash settlement in 20x1 because the variable and fixed
rates are the same (i.e., 8% and 8%, respectively).
The net cash settlement in 20x2 is discounted to determine the fair
value of the derivative on Dec. 31, 20x1:
Net cash settlement receipt (due on Dec. 31, 20x2)
PV of 1 @ 10%, n=1
Fair value of derivative - 12/31/x1 (asset)

80,000
0.90909
72,727

46. D the gain is recognized in OCI not in P/L

Solution:
Hedged item
Hedging instrument
Variable interest payments
Interest rate swap (Derivative)
Dec. 31, 20x1
Interest expense 320,000
Cash (4M x 8%).... 320,000

Dec. 31, 20x1

Interest rate swap..72,727
Accumulated OCI.72,727

to recognize interest expense on the

variable-rate loan

to recognize the change in the fair value

of the interest rate swap

47. A (See computation in #45)

192

48. A (400,000 80,000) = 320,000 (See entries below)

Solution:
Hedged item
Hedging instrument
Variable interest payments
Interest rate swap (Derivative)
Dec. 31, 20x2
Interest expense.400,000
Cash (4M x 10%) ...400,000

Dec. 31, 20x2

Cash80,000
Interest rate swap....72,727
Accum. OCI (squeeze)7,273

to recognize interest expense on the

variable-rate loan

to record the net cash settlement of the

interest rate swap

Dec. 31, 20x2

Loan payable.4M
Cash4M

Dec. 31, 20x2

Accumulated OCI..80,000
Interest expense.80,000

to record the settlement of the loan

to reclassify accumulated OCI to profit or

loss

49. D
Solution:
Receive variable a (4M x 9%) & (4M x 8%)
Pay 9% fixed
Net cash settlement payment
a

20x1
360,000
360,000
-

20x2
320,000
360,000
(40,000)

Based on the current rates as at the beginning of the year.

The net cash settlement is discounted to determine the fair value of

the derivative on Dec. 31, 20x1.
Net cash payment (due annually starting on Dec. 31, 20x2)
PV of ordinary annuity of 1 @8%, n=2
Fair value of derivative - 12/31/x1 (liability)

(40,000)
1.783265
(71,331)

50. B (See computation above)

51. C (See computation above)
52. B The fair value of the derivative on this date.
Solution:
20x3
480,000
360,000
120,000

Receive variable (4M x 12%)

Pay 9% fixed
Net cash settlement receipt

The net cash settlement is discounted to determine the fair value of

the derivative on Dec. 31, 20x2.
193

Net cash receipt (due on Dec. 31, 20x3 maturity date)

Multiply by: PV of 1 @12%, n=1
Fair value of derivative - 12/31/x2 (asset)

120,000
0.892857
107,143

53. E
CORRECTION: Dear Sir/Maam: The correct answer was
omitted from the answer choices. I am sorry for the error.
The CORRECT ANSWER is 360,000 (320,000 + 40,000) (See
entries below)
Solution:
Hedged item
Variable interest payments

Hedging instrument
Interest rate swap (Derivative)

Dec. 31, 20x2

Interest expense320,000
Cash (4M x 8%)...320,000

Dec. 31, 20x2

Interest rate swap..40,000
Cash.40,000

to recognize interest expense on the

variable-rate loan

to record the periodic net cash settlement

on the interest rate swap - (see previous

computation)

Dec. 31, 20x2

Interest expense...40,000
Accumulated OCI40,000
to record a piecemeal reclassification of
accumulated OCI to profit or loss

54. A (See computations in #52)

55. A
Solution:
The change in the fair value of the interest rate swap is determined as
follows:
Fair value of interest rate swap Dec. 31, 20x2 - (asset)
107,143
Less: Carrying amount of interest rate swap Dec. 31, 20x2
(31,331)
(71,331 liability 40,000 net cash settlement) - (liability)
Change in fair value gain
138,474
56. B
Solution:
20x3
480,000
360,000
120,000

Receive variable (1M x 12%)

Pay 9% fixed
Net cash settlement receipt
57. E
194

CORRECTION: Dear Sir/Maam: The correct answer was

omitted from the answer choices. I am sorry for the error.
The CORRECT ANSWER is 360,000 (See solution below)
Interest expense (4M x 12%)
Reclassification of accum. OCI

480,000
(120,000)

Net interest expense - 20x3

360,000

58. B
Solutions:
Hedging instrument:
The net cash settlement on the swap is determined as follows:
20x1
20x2
Receive 10% fixed
400,000
400,000
Pay variablea (4M x 10%) & (4M x 12%)
400,000
480,000
(80,000)
Net cash settlement payment
a

Based on the current rates as at the beginning of the year.

The net cash settlement is discounted to determine the fair value of

the derivative on Dec. 31, 20x1.
Net cash payment (due annually starting on Dec. 31, 20x2)
PV of ordinary annuity of 1 @12%, n=2
Fair value of derivative - 12/31/x1 (liability)

(80,000)
1.69005
(135,204)

PV of ordinary annuity is used because swap payments are made at each yearend (i.e., Dec. 31, 20x2 and Dec. 31, 20x3; n=2). A liability is recognized
because the net cash settlement is a payment.

59. B
Solution:
Fair value of derivative - 12/31/x1 (liability)
Fair value of derivative - 12/1/x1
Unrealized loss on the derivative instrument

(135,204)
(135,204)

60. A
Solution:
Hedged item:
The fair value of the loan payable on Dec. 31, 20x1 is determined as
follows:
PVF @12%
current rate,
Future cash flows:
Present
n=2
value
Principal
4,000,000 0.797193878
3,188,776
Interest at 10% fixed rate
400,000 1.69005102
676,020
195

3,864,796
Fair value of loan payable - Dec. 31, 20x1
Carrying amount of loan payable - Dec. 31, 20x1
Gain on decrease in liability

3,864,796
4,000,000
135,204

61. C
Solution:
Date
12/31/x1
12/31/x2

Interest
payments

Interest
expense @ 12%

Amortization

400,000

463,776

63,776

Present
value
3,864,796
3,928,572

62. B
Solution:
Hedging instrument:
The net cash settlement in 20x3 is determined as a basis for
adjusting the fair value of the interest rate swap on Dec. 31, 20x2.
20x3
Receive 10% fixed
400,000
Pay variable (4M x 14%)
560,000
Net cash settlement payment
(160,000)
The net cash settlement is discounted to determine the fair value of
the derivative on Dec. 31, 20x2.
Net cash payment (due on Dec. 31, 20x3 maturity date)
Multiply by: PV of 1 @14%, n=1
Fair value of derivative - 12/31/x2 (liability)

(160,000)
0.877192982
(140,351)

63. E
CORRECTION: Dear Sir/Maam: The correct answer was
omitted from the answer choices. I am sorry for the error.
The CORRECT ANSWER is (85,147) (See solution below)
Fair value of interest rate swap Dec. 31, 20x2 - (liability)
Carrying amount of interest rate swap Dec. 31, 20x2
(135,204 liability 80,000 net cash settlement) - (liability)
Change in fair value loss (increase in liability)

140,351
(55,204)
85,147

64. E
CORRECTION: Dear Sir/Maam: The correct answer was
omitted from the answer choices. I am sorry for the error.
The CORRECT ANSWER is (68,923) (See solution below)
Solution:
196

Hedged item:
The fair value of the loan payable on Dec. 31, 20x2 is determined as
follows:
PVF @14%
current rate,
Future cash flows:
Present
n=1
value
Principal
4,000,000 0.877192982
3,508,772
Interest at 10% fixed rate
400,000 0.877192982
350,877
3,859,649
The gain or loss on the change in the fair value of the loan payable is
determined as follows:
Fair value of loan payable - Dec. 31, 20x2
3,859,649
Carrying amt. - Dec. 31, 20x2 (see amortization table above)
3,928,572
Gain on decrease in liability Dec. 31, 20x2
68,923

65. B
Solution:
Date
12/31/x2
12/31/x3

Interest
payments

Interest
expense @ 14%

Amortization

400,000

540,351

140,351

Present
value
3,859,649
4,000,000

Exercises
1. Solution:
The entry on December 1, 20x1 is as follows:
Hedged item None
Futures contract (Derivative)
Dec. 1, 20x1
Deposit with broker ..80K
Cash..80K
to record the initial margin deposit with
the broker

Dec. 31, 20x1

Loss on futures contract..20K
Futures contract (liability)...20K
[(200 - 190) x 2,000]
to record the value of the derivative
computed as the change in the underlying
multiplied by the notional amount.

Feb. 1, 20x2
Loss on futures contract 10K
[(190 - 185) x 2,000]

Futures contract (liability).. 20K

Cash local currency 10K
Deposit with broker.....40K

197

to recognize loss on the change in the

market value of the futures contract and
to record the net cash settlement of the
futures contract.

2. Solution:
The entries are as follows:
Hedged item Inventory

Hedging instrument - Futures

contract (Derivative)
Dec. 1, 20x1
Deposit with broker ..192K
Cash..192K

Dec. 1, 20x1
No entry

to record the initial margin deposit with

the broker

Dec. 31, 20x1

Inventory.50K
Gain on fair value change.....50K

Dec. 31, 20x1

Loss on futures contract.40K
Futures contract (liability)...40K

[(12.250K 12K) x 200]

[(12.3K -12.1K) x 200]

to recognize the change in the fair value

less costs to sell of the gold inventory.

to recognize the change in the fair value

of the futures contract.

Feb. 1, 20x2
Loss on fair value change90K

Feb. 1, 20x2
Futures contract (asset).. 100K
Gain on futures contract 100K

[(12.250K 11.8K) x 200]

Inventory..90K

[(12.3K 11.8K) x 200]

to recognize the change in the fair value

less costs to sell of the gold inventory.

to recognize the change in the fair value

of the futures contract.

Feb. 1, 20x2
Cash..2.36M
Sale (11.8 spot price x 200).. 2.36M

Feb. 1, 20x2
Cash.252K

Cost of goods sold. 2.36M

Inventory (2.4M + 50K 90K) 2.36M

(100K asset 40K liability)

to recognize the sale of the gold

inventory.

[(12.1K 11.8K) x 200] + 192K

Futures contract (asset)........60K

Deposit with broker 192K
to record the net cash settlement of the
futures contract.

3. Solution:
The entries on December 1, 20x1 are as follows:
Hedged item Inventory
Hedging instrument - Futures
contract (Derivative)
Dec. 1, 20x1
No entry

Dec. 1, 20x1
Deposit with broker ..40K
Cash..40K

198

to record the initial margin deposit with

the broker

Dec. 31, 20x1

Inventory.34K
Gain on fair value change.....34K

Dec. 31, 20x1

Loss on futures contract....28K
Futures contract (liability)..28K

[(371 354) x 2,000]

[(374 -360) x 2,000]

to recognize the change in the fair value

of the inventory due to changes in the
hedged risk.

to recognize the change in the fair value

of the futures contract.

Feb. 1, 20x2
Loss on fair value change66K

Feb. 1, 20x2
Futures contract (asset).. 72K
Gain on futures contract 72K

[(371 338) x 2,000]

Inventory..66K

[(374 338) x 2,000]

to recognize the change in the fair value

of the inventory due to changes in the
hedged risk.

to recognize the change in the fair value

of the futures contract.

Feb. 1, 20x2
Cash (338 spot price x 2K). 676K
Sales..676K

Feb. 1, 20x2
Cash.84K

Cost of goods sold448K

Inventory (480K + 34K 66K). 448K

(72K asset 28K liability)

[(360 338) x 2K] + 40K deposit

Futures contract (asset)........44K

Deposit with broker40K
to record the net cash settlement of the
futures contract.

to recognize the sale of the soybean

inventory.

4. Solution:
Hedged item Firm sale
commitment

Hedging instrument - Futures

contract (Derivative)
Dec. 1, 20x1
Deposit with broker ..60K
Cash..60K

Dec. 1, 20x1
No entry

to record the initial margin deposit with

the broker

Dec. 31, 20x1

Loss on firm commitment..60K

Dec. 31, 20x1

Future contract (asset)70K

[(240 210) x 2,000]

[(235 200) x 2,000]

Firm commitment (liability)60K

Gain on futures contract.. 70K

to recognize the change in the fair value

of the firm commitment

to recognize the change in the fair value

of the futures contract

Feb. 1, 20x2
Firm commitment (liability)..60K
Loss on firm commitment....20K

Feb 1, 20x2
Cash .160K
[(250 200) x 2,000] + 60K deposit

[(250 240) x 2,000]

Cash..420K
(210 contract price x 2,000)
Sale (250 spot price x 2,000)...500K

199

Deposit with broker ..60K

Futures contract (asset). 70K
Gain on futures contract...30K
[(250 235) x 2,000]

to record the actual sale transaction, to

recognize the change in the fair value of
the firm commitment, and to derecognize
the firm commitment.

to recognize the change in the fair value

of the futures contract and to record the
net settlement of the futures contract.

5. Solutions:
The changes in the expected cash flows/ fair value of futures contract
are computed as follows:

Mar. 31, 20x1

Price - 3/31
Price - 1/1
Increase (Decrease)
Multiplied by:
Multiplied by:
Change in cash flow/ fair value gain (loss) 3/31/x1
Fair value - 1/1/x1
Cumulative change in cash flow/
fair value - gain (loss) 3/31/x1
June 30, 20x1
Price - 6/30
Price - 3/31
Increase (Decrease)
Multiplied by:
Multiplied by:
Change in cash flow/ fair value gain (loss) 6/30/x1
Fair value - 3/31/x1
Cumulative change in cash flow/
fair value - gain (loss) 6/30/x1
a
b

Forecasted
transaction Broccoli

Futures
contracts Cauliflower

95.18
93.76
1.42
2,000
N/A

94.52
92.98
1.54
10 a
200 b

(2,840)
-

3,080
-

(2,840)

3,080

96.20
95.18
1.02
2,000
N/A

95.36
94.52
0.84
10 a
200 b

(2,040)
(2,840)

1,680
3,080

(4,880)

4,760

Number of futures contracts.

Number of kilograms of cauliflower covered by each futures contract.

There are losses on the forecasted transaction because the

purchase prices of broccoli increased. There are gains on the
200

futures contract because purchase prices of cauliflower increased

but ABC Co. is still able to purchase at a lower price.
Requirement (a):
Assessment of highly effectiveness and ineffectiveness
The highly effectiveness of the hedge as of March 31, 20x1 and
June 30, 20x1 are assessed as follows:
March
June 30,
31, 20x1
20x1
Cumulative change in fair value of futures
contract
3,080
4,760
Cumulative change in expected cash
flows of forecasted transaction
2,840
4,880
Ratio
108%
98%
Requirement (b):
Forecasted
transaction
Broccoli
Change
in cash
flows
3/31/x1
6/30/x1

Cumulative
change

Futures contract
- Cauliflower
Change
in fair
values

Cumu
-lative
chang
e

(2,840)
(2,040)

(2,840)
(4,880)

3,080
1,680

3,080
4,760

Lower of
b and d
in
absolute
amounts

Accumulated
in OCI

2,840
4,760

2,840
1,920

Requirement (c):
The pertinent entries are as follows:
Hedged item Highly probable
Hedging instrument Futures
forecast transaction
contract (Derivative)
Jan. 1, 20x1
No entry
Mar. 31, 20x1
No entry

Jan. 1, 20x1
No entry
Mar. 31, 20x1

Futures contract.. 3,080

Accumulated OCI 2,840
Gain on futures contract. 240
to recognize the change in the fair value
of the effective portion of the futures
contracts in other comprehensive
income and the ineffective portion in
profit or loss.

June 30, 20x1

Inventory192,400
(2,000 x 96.20)

June 30, 20x1

Futures contract. 1,680

201

Loss on futures contract.. 240

Accumulated OCI. 1,920

Cash..192,400
to record the purchase of broccoli at the
current price.

to recognize in other comprehensive

income the change in the fair value of the
effective portion of the futures contracts
and to reclassify into other
comprehensive income the gain on the
futures contracts that was previously
recognized in earnings.

June 30, 20x1

Cash4,760
Futures contract..4,760
(3,080 + 1,680)
to record the net settlement of the futures
contract.

July 15, 20x1

Cash260,000
Cost of goods sold.192,400
Inventory 192,400
Sales.260,000

July 15, 20x1

Accumulated OCI.4,760

to record the sale of inventory

to reclassify accumulated gains on

forward contract to profit or loss as a
reduction to cost of goods sold.

(2,840 + 1,920)

Cost of goods sold4,760

6. Solution:
The entries are as follows:
Hedged item Sale

Hedging instrument Put

option (Derivative)

Dec. 15, 20x1

Accounts receivable960K
(2M yens x 0.48 spot rate)

Sales...960K
Dec. 31, 20x1
Accounts receivable20K
[2M x (0.49 - 0.48)]

FOREX gain....20K

Dec. 15, 20x1

Put option ....15K
Cash..15K
Dec. 31, 20x1
Loss on put option....5K
Put option..5K
(15K 10K)

to adjust accounts receivable for the

increase in spot exchange rate

to recognize loss on the decrease in fair

value of the option.

Jan. 15, 20x2

Cash foreign currency920K

Jan. 15, 20x2

Cash local currency940K

(2M x 0.46 current spot rate)

(2M x 0.47 option price)

FOREX loss...50K
Accounts receivable.980K
(960K + 20K)

202

Put option10K
Cash foreign currency920K
Gain on put option.10K

to record the receipt of 1M yens from

customer

to record the exercise of the put option

which is in the money.

7. Solution:
The entry on April 1, 20x1 is as follows:
Hedged item None
Hedging instrument Call
option (Derivative)
April 1, 20x1

April 1, 20x1
Call option .... 1,200
Cash.. 1,200

June 30, 20x1

June 30, 20x1

Call option .... 12,000
[(106 100) x 2,000]

Gain on call option. 12,000

to record the increase in the fair value of
the call option due to the increase in
intrinsic value.

June 30, 20x1

Loss on call option.400
(1,200 800)

Call option..400
to record the decrease in the fair value of
the call option due to the decrease in
time value.

July 1, 20x1

July 1, 20x1
Cash12,000
[(106 100) x 2,000]

Loss on call option.... 800

Call option .....12,800
(1,200 + 12,000 400)
to record the net settlement of the call
option contract.

8. Solution:
The entries are as follows:
Hedged item Forecast
transaction
Oct. 1, 20x1
No entry

Hedging instrument Put

option (Derivative)
Oct. 1, 20x1
Put option ....12.8K
Cash..12.8K
to recognize the cost incurred to purchase
the option contract

203

The gain or loss on the hedging instrument recognized in other

comprehensive income is computed as follows:
"Spot" intrinsic
Date
value of option
Oct. 1, 20x1
Dec. 31, 20x1 (INR 560K 1.43) - (INR 560K 1.45)
5,402
Apr. 1, 20x2
(INR 560K 1.43) - (INR 560K 1.50)
18,276
The total net loss/gain on December 31, 20x1 is computed as follows:
Change in "spot" intrinsic value - effective portion (OCI)
(5,402)
(0 - 5,402)
Change in fair value of option - ineffective portion
(800)
(12K - 12.8K)
Total loss during the period excluded component
(6,202)
The entries on December 31, 20x1 are as follows:
Hedged item Forecast
Hedging instrument Put
transaction
option (Derivative)
Dec. 31, 20x1
Loss on put option (excluded
component)....6,202
Put option.. 800
Accumulated OCI.. 5,402

Dec. 31, 20x1

No entry

to recognize loss on the effective and

ineffective portions of the decrease in fair
value of the option.

April 1, 20x2
Accounts receivable.373,334
Sales373,334
(560,000 1.50 spot rate)
to record the actual sale transaction

April 1, 20x2
Loss on put option (excluded
component) 6,598
Put option 6,276
Accumulated OCI..12,874
to record the changes in fair values

April 1, 20x2
Accumulated OCI..18,276
(5,402 + 12,874)

Sales.18,276
to reclassify accumulated OCI to profit or
loss

April 1, 20x2
Cash... 18,276
Put option18,276
(12,800 - 800 + 6,276)
to record the exercise and settlement of
the put option

9. Solutions:
The entries on January 1, 20x1 are as follows:
Hedged item Variable interest Hedging instrument Interest
payments
rate swap (Derivative)
Jan. 1, 20x1
Cash.2M

Jan. 1, 20x1
No entry

204

Loan payable2M
to recognize loan payable

The change in fair value of the derivative is analyzed as follows:

Dec. 31, 20x1
Dec. 31, 20x2
Receive variable a
160,000
200,000
Pay 8% fixed
160,000
160,000
Net cash settlement - receipt
40,000
a

Interest rates used are the current rates as at the beginning of the
year (i.e., 160,000 = 2M x 8%; 200,000 = 2M x 10%).
The fair value of the derivative is the discounted value of the net
cash settlement.
Net cash settlement - receipt
40,000
PV of 1 @ 10%, n=1
0.90909
Fair value of derivative - 12/31/x1
36,364

The entries on December 31, 20x1 are as follows:

Hedged item Variable interest Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x1
Interest expense160,000
Cash.160,000

Dec. 31, 20x1

Interest rate swap..36,364
Accumulated OCI.36,364

to recognize interest expense

to recognize unrealized gain in OCI for

the increase in fair value of the interest
rate swap

The entries on December 31, 20x2 are as follows:

Hedged item Variable interest Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x2
Interest expense160,000
Cash.160,000

Dec. 31, 20x2

Cash40,000
Interest rate swap....36,364
Accumulated OCI 3,636

to recognize interest expense

to record the net cash settlement of the
interest rate swap

Dec. 31, 20x2

Loan payable.2M
Cash2M

Dec. 31, 20x2

Accumulated OCI..40,000
Interest expense.40,000

to record the settlement of the loan

to reclassify accumulated OCI to profit or

loss

10. Solutions:
205

The entries on January 1, 20x1 are as follows:

Hedged item Variable interest Hedging instrument Interest
payments
rate swap (Derivative)
Jan. 1, 20x1
Cash.2M
Loan payable2M

Jan. 1, 20x1
No entry

to recognize loan payable

The net cash settlement on the interest rate swap on December 31,
20x1 is computed as follows:

Receive variable - 9% current rate at Jan. 1, 20x1

Pay 9% fixed
Net cash settlement - Dec. 31, 20x1

Dec. 31, 20x1

180,000
180,000
-

There is no cash settlement because the current rate as of the

beginning of 20x1 and the fixed rate are equal. However, since the
rate on January 1, 20x2 is 8% (i.e., not equal to the fixed rate of 9%),
there is an expected cash settlement in future periods. This will be the
basis in determining the fair value of the interest rate swap as of
December 31, 20x1.
Jan. 1, 20x2
Receive variable - 8% current rate at Jan. 1, 20x2
160,000
Pay 9% fixed
180,000
(20,000)
Net cash settlement - payment, Dec. 31, 20x2
The discounted amount of the net cash settlement is the deemed fair
value of the interest rate swap on December 31, 20x1.
Net cash settlement - payment, Dec. 31, 20x2
(20,000)
a
1.783265
Multiply by: PV of ordinary annuity of 1 @8%, n=2
Fair value of interest rate swap Dec. 31, 20x1
(35,667)
a

The discount rate used is the current market rate as of January 1,

20x2. PV of ordinary annuity is used because swap payments are
made each year-end. An n of 2 is used because there are two future
payments to be made, i.e., December 31, 20x2 and December 31,
20x3.
The entries on December 31, 20x1 are as follows:
Hedged item Variable interest Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x1

Dec. 31, 20x1

206

Interest expense180,000
Cash.180,000

Accumulated OCI.35,667
Interest rate swap...35,667

to recognize interest expense

to recognize unrealized loss in OCI for the

decrease in fair value of the interest rate
swap

The entries on December 31, 20x2 are as follows:

Hedged item Variable interest Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x2
Interest expense180,000
Cash.180,000

Dec. 31, 20x2

Interest rate swap.20,000
Cash.20,000

to recognize interest expense

to record the periodic net cash settlement

on the interest rate swap (see previous

computations)
Dec. 31, 20x2
Interest expense...20,000
Accumulated OCI20,000
to record piecemeal reclassification of
accumulated OCI to profit or loss

The expected net cash settlement on December 31, 20x3 is

determined as a basis for adjusting the fair value of the interest rate
swap.
Jan. 1, 20x3
Receive variable - 12% current rate at Jan. 1, 20x3
240,000
Pay 9% fixed
180,000
60,000
Net cash settlement - receipt, Dec. 31, 20x3
Net cash settlement - receipt, Dec. 31, 20x3
Multiply by: PV of 1 @12%, n=1 b
Fair value of interest rate swap - Dec. 31, 20x2

60,000
0.892857
53,572

The discount rate used is the current market rate as of January 1,

20x3. An n of 1 is used because there is one future payment to be
made, i.e., December 31, 20x3.
The unrealized gain (loss) on the change in fair value of the interest
rate swap is determined as follows:
Fair value of interest rate swap - Dec. 31, 20x2
53,572
Carrying amount of interest rate swap - Dec. 31, 20x2,
net of net cash settlement (35,667 - 20,000)
(15,667)
Unrealized gain on increase in fair value of interest
69,235
207

rate swap - Dec. 31, 20x2

The entry to recognize the change in fair value of the interest rate
swap on December 31, 20x2 is as follows:
Hedged item Variable interest Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x2
Interest rate swap.69,235
Accumulated OCI.69,235
to recognize unrealized gain in OCI for
the increase in fair value of the interest
rate swap

The entries on December 31, 20x3 are as follows:

Hedged item Variable interest Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x3
Interest expense180,000
Cash.180,000

Dec. 31, 20x3

Cash60,000
Interest rate swap53,570
Accum. OCI (squeeze).. 6,430

to recognize interest expense

to record the final net cash settlement
on the interest rate swap and to close the
balance of the interest rate swap account.

Dec. 31, 20x3

Loan payable.2M
Cash.2M

Dec. 31, 20x2

Accumulated OCI60,000
Interest expense....60,000

to record the settlement of the loan

to record final reclassification of

accumulated OCI to profit or loss

11. Solution:
The entries on January 1, 20x1 are as follows:
Hedged item Fixed interest
Hedging instrument Interest
payments
rate swap (Derivative)
Jan. 1, 20x1
Cash.2M
Loan payable2M

Jan. 1, 20x1
No entry

to recognize loan payable

There is no cash settlement on December 31, 20x1 because the

current rate as of the beginning of 20x1 and the fixed rate are equal
(i.e., both at 10%). However, since the rate on January 1, 20x2 is
12%, there is an expected cash settlement in future periods. This will
be the basis in determining the fair value of the interest rate swap as
of December 31, 20x1.
Jan. 1, 20x2
208

Receive 10% fixed

Pay variable - 12% current rate at Jan. 1, 20x2
Net cash settlement - payment, Dec. 31, 20x2

200,000
240,000
(40,000)

The discounted amount of the net cash settlement is the deemed fair
value of the interest rate swap on December 31, 20x1.
Net cash settlement - payment, Dec. 31, 20x2
(40,000)
Multiply by: PV of ordinary annuity of 1 @12%, n=2 a
1.69005
Fair value of interest rate swap Dec. 31, 20x1
(67,602)
a

The discount rate used is the current market rate as of January 1,

20x2. PV of ordinary annuity is used because swap payments are
made each year-end. An n of 2 is used because there are two future
payments to be made, i.e., December 31, 20x2 and December 31,
20x3.
The fair value of the loan payable as of December 31, 20x1 is
determined as follows:
PVF @12%
current rate,
Future cash flows:
Present
n=2
value
Principal
2,000,000 0.797193878
1,594,388
Interest at 10% fixed rate 200,000
1.69005102
338,010
1,932,398
The gain or loss on the change in the fair value of the hedged item is
determined as follows:
Fair value of loan payable - Dec. 31, 20x1
1,932,398
Carrying amount of loan payable - Dec. 31, 20x1
2,000,000
Gain on decrease in liability
67,602
The entries on December 31, 20x1 are as follows:
Hedged item Fixed interest
Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x1
Interest expense200,000
Cash.200,000

Dec. 31, 20x1

Unrealized loss.67,602
Interest rate swap.67,602

to recognize interest expense

to recognize unrealized loss in P/L for the

decrease in fair value of the interest rate
swap

Dec. 31, 20x1

Loan payable.67,602
Unrealized gain..67,602

209

to recognize unrealized gain in P/L for the

decrease in fair value of loan payable

The interest expense in December 31, 20x2 is determined through

the effective interest method. This is because there is a discount
represented by the decrease in liability on December 31, 20x1. A
partial amortization table is provided below:
Present
Interest
Interest
Amortization
Date
payments expense @ 12%
value
12/31/x1
1,932,398
12/31/x2
31,888
200,000
1,964,286
231,888
The entries on December 31, 20x2 are as follows:
Hedged item Fixed interest
Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x2
Interest expense231,888
Cash...200,000
Loan payable..31,888
to recognize interest expense

Dec. 31, 20x2

Interest rate swap.40,000
Cash.40,000
to record the periodic net cash settlement
on the interest rate swap (see previous

computations)

The expected net cash settlement on December 31, 20x3 is

determined as a basis for adjusting the fair value of the interest rate
swap.
Jan. 1, 20x3
Receive 10% fixed
200,000
Pay variable - 14% current rate at Jan. 1, 20x3
280,000
Net cash settlement - payment, Dec. 31, 20x3
(80,000)
Net cash settlement - payment, Dec. 31, 20x3
Multiply by: PV of 1 @14%, n=1 b
Fair value of interest rate swap - Dec. 31, 20x2

(80,000)
0.87719
(70,176)

The discount rate used is the current market rate as of January 1,

20x3. An n of 1 is used because there is one future payment to be
made, i.e., December 31, 20x3.

The unrealized gain (loss) on the change in fair value of the interest
rate swap is determined as follows:
Fair value of interest rate swap - Dec. 31, 20x2
(70,176)
Carrying of interest rate swap - Dec. 31, 20x2, net of
(27,602)
net cash settlement (33,801 20,000)
Unrealized loss on decrease in fair value of interest
(42,574)
210

rate swap - Dec. 31, 20x2

The fair value of the loan payable as of December 31, 20x2 is
determined as follows:
PVF @14%
current rate,
n=1

Future cash flows:

Principal
Interest at 10% fixed rate

2,000,000
200,000

0.877192982
0.877192982

Present
value
1,754,386
175,438
1,929,824

The gain or loss on the change in the fair value of the hedged item is
determined as follows:
Fair value of loan payable - Dec. 31, 20x2
1,929,824
Carrying amount of loan payable - Dec. 31, 20x2
1,964,286
(see amortization table above)
Gain on decrease in liability
34,462
The entries to recognize the changes in fair values of the loan
payable and interest rate swap on December 31, 20x2 are as follows:
Hedged item Fixed interest
Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x2
Loan payable.34,462
Unrealized gain..34,462

Dec. 31, 20x2

Unrealized loss.42,574
Interest rate swap.42,574

to recognize unrealized gain in P/L for the

decrease in fair value of loan payable

to recognize unrealized loss in P/L for the

decrease in fair value of the interest rate
swap

The interest expense in 20x3 is again computed using the effective

interest method.
Interest
Present
Interest
Date
payments expense @ 14% Amortization
value
12/31/x2
1,929,824
12/31/x3
70,176
200,000
2,000,000
270,176
The entries on December 31, 20x3 are as follows:
Hedged item Fixed interest
Hedging instrument Interest
payments
rate swap (Derivative)
Dec. 31, 20x3
Interest expense270,176
Cash...200,000
Loan payable..70,176

Dec. 31, 20x3

Interest rate swap.70,176
Loss on interest rate
swap (squeeze)...9,824
Cash.80,000

to recognize interest expense

to record the final net cash settlement

211

(see previous computations) and to

derecognize the interest rate swap
Dec. 31, 20x3
Loan payable.2M
Cash.2M
to record the settlement of the loan

12. Solutions:
Case #1:
The inter-company accounts are adjusted to closing rates as
follows:
Receivable from XYZ, Inc. (in pesos)
Multiply by: Spot rate
Adjusted balance of Payable to ABC Co. (in AMD)

2,000,000
2
4,000,000

Payable to ABC Co. (in AMD) - unadjusted

Adjusted balance of Payable to ABC Co. (in AMD)
FOREX loss recognized in subsidiary's separate
income statement (in AMD)

3,500,000
4,000,000
(500,000)

The subsidiarys profit or loss after FOREX adjustment on intercompany accounts is computed as follows:
XYZ's separate profit before FOREX loss (in AMD)
3,500,000
FOREX loss recognized in subsidiary's separate income
statement (in AMD)
(500,000)
XYZ's separate profit after FOREX loss (in AMD)
3,000,000
The translation adjustment to be recognized in OCI in the
consolidated financial statements can now be computed as follows:
Translation of XYZ's net assets
Net assets of sub., July 1, 20x1
at opening rate
Net assets of sub., July 1, 20x1
at closing rate
Decrease in net assets FOREX translation loss
Parent's share in FOREX
translation loss

(6M 1.50)

P4,000,000

(6M 2.00)

3,000,000
(1,000,000)
100%

Translation of XYZ's profit

Profit of subsidiary at average
rate
Profit of sub at closing rate
Decrease in profit - FOREX
translation loss

(3M 1.75)

1,714,286

(3M 2)

1,500,000
(214,286)

212

P(1,000,000)

Parent's share in FOREX gain

100%

Total FOREX translation

loss OCI (in pesos)

(214,286)
P (1,214,286)

Case #2:
The fair value of the forward contract on July 1, 20x1 is zero.
The fair value of the forward contract on December 31, 20x1 is
computed as follows:
4,950,496
Six-month forward rate at 12/31/20x1 (10M 2.02)
6,493,506
Terms of the forward contract (10M 1.54)
Difference between forward contract and forward rates
1,543,012
Multiply by: PV factor (given)
0.971286
1,498,706
Fair value of forward contract - Dec. 31, 20x1
The gain (loss) on the forward contract is computed as follows:
Fair value of forward contract - July 1, 20x1
Fair value of forward contract - Dec. 31, 20x1
1,498,706
Increase in fair value - Unrealized gain in OCI (gross
1,498,706
of tax)
Less: Deferred tax liability (1,498,706 x 40%)
(599,482)
Unrealized gain in OCI (net of tax)
899,224
The total translation gain (loss) to be recognized in other
comprehensive income is computed as follows:
Total FOREX translation loss OCI (without hedging (1,214,286)
see Case #1)
Unrealized gain in OCI - net of tax
899,224
Total FOREX translation loss - OCI (with hedging)
(315,062)
13. Solution:
Case #1:
Fixed selling price
Selling price at current spot rate (2M 35)
Excess to be paid to broker

50,000
57,143
(7,143)

Case #2:
Fixed selling price
Selling price at current spot rate (2M 50)
Deficiency to be received from broker

50,000
40,000
10,000

213

Case #3:
Fixed selling price
Selling price at current spot rate (2M 45)
Fair value of forward contract receivable
14. Solution:
Requirement (a):
Fixed purchase price (P600 x 2,000)
Purchase price at current market price (P700 x 2,000)
Derivative asset - receivable from broker

50,000
44,444
5,556

1,200,000
1,400,000
200,000

The derivative need not be discounted since it is to be settled within

15 days.
Requirement (b):
Fixed purchase price (P600 x 2,000)
Purchase price at current market price (P550 x 2,000)
Derivative liability - payable to broker

1,200,000
1,100,000
(100,000)

15. Solutions:
Requirement (a):
P10,000,000 (200,000 kilos notional figure x P50 forward price)
Requirement (b):
Fixed purchase price (200,000 x P50)
Purchase price at current market price (200,000 x 65)
Receivable from broker
Multiply by: PV of 1 @10%, n=1
Fair value of derivative asset

10,000,000
13,000,000
3,000,000
0.90909
2,727,270

Requirement (c):
Fixed purchase price (200,000 x P50)
Purchase price at current market price (200,000 x 40)
Payable to broker
Multiply by: PV of 1 @10%, n=0
Fair value of derivative liability

10,000,000
8,000,000
(2,000,000)
1
(2,000,000)

214

16. Solution:
"Long" futures contract to purchase gold:
Fixed purchase price (P2,000 x 200)
Purchase price at current market price (P1,800 x 200)
Payable to broker

400,000
360,000
(40,000)

"Long" futures contract to purchase silver:

Fixed purchase price (P1,600 x 400)
Purchase price at current market price (P1,900 x 400)
Receivable from broker
"Short" futures contract to sell coffee beans:
Fixed selling price (P250 x 2,000)
Selling price at current market price (P220 x 2,000)
Receivable from broker
"Short" futures contract to sell potatoes:
Fixed selling price (P60 x 3,000)
Selling price at current market price (P75 x 3,000)
Payable to broker

640,000
760,000
120,000

500,000
440,000
60,000

180,000
225,000
(45,000)
95,000

Net derivative asset

17. Solutions:
Case #1:
Purchase price using the option
Purchase price without the option (2M 35)
Savings from exercising the option - gross
Less: Cost of purchased option
Net savings from call option
Case #2:
Purchase price using the option
Purchase price without the option (1M 50)
Savings from exercising the option - gross

50,000
57,142
7,142
(2,000)
5,142

50,000
40,000
-

ABC Co. would have been better off not to have purchased the call
option.

215

18. Solution:
Sale price using the option (P220 x 40,000)
Sale price without the option (P250 x 40,000)
Savings from exercising the option - gross

8,800,000
10,000,000
-

ABC Co. would have been better off not to have purchased the put
option. Since options give the holder the right, and not the obligation,
to exercise the option, ABC Co. will simply write-off the cost of the
option as loss. Accordingly, ABC Co. will recognize P20,000 loss on
the option in its 20x1 financial statements.
Answer: P20,000 loss on put option
19. Solutions:
Requirement (a): Derivative asset (liability) Dec. 31, 20x1
8,800,000
Fixed purchase price (P220 x 40,000)
9,600,000
Purchase price at current market price (P240 x 40,000)
Derivative asset - receivable from broker
800,000
Requirement (b): Unrealized gain (loss) on December 31, 20x1
Fair value of call option - July 1, 20x1 (cost)
20,000
Fair value of call option - Dec. 31, 20x1
(see computations above)
800,000
Unrealized gain - increase in fair value
780,000
Requirement (c): Net cash settlement on March 31, 20x2
8,800,000
Fixed purchase price (P220 x 40,000)
10,000,000
Purchase price at current market price (P250 x 40,000)
Net cash settlement - receipt
1,200,000
Requirement (d): Realized gain (loss) on March 31, 20x2.
March. Cash (see Requirement c)
1,200,000
31,
Call option (see Requirement a)
800,000
20x2
Gain on call option (squeeze)
400,000
to record the net settlement of the call
option

Alternative solution: (250 240) x 40,000 = 400,000

216

20. Solutions:
Case #1:
Requirement (a): Net cash settlement
Receive variable (at Jan. 1 current rates)
Pay 10% fixed
Net cash settlement - (payment) (due on Dec.
31, 20x3)

20x1
200,000
200,000

20x2
160,000
200,000

(40,000)

Requirement (b): Fair value of derivative

Net cash settlement - (payment) (due on Dec. 31, 20x3)
PV of 1 @8%, n=1
Fair value of interest rate swap - liability (payable)

(40,000)
0.9259
(37,036)

Case #2:
Requirement (a): Net cash settlement
Receive variable (at Jan. 1 current rates)
Pay 10% fixed
Net cash settlement receipt (due on Dec. 31,

20x1
200,000
200,000

20x2
240,000
200,000

40,000

20x3)

Requirement (b): Fair value of derivative

Net cash settlement - receipt (due on Dec. 31, 20x3)
PV of 1 @12%, n=1
Fair value of interest rate swap - asset (receivable)

40,000
0.8929
35,716

21. Solutions:
Requirement (a):
Answer: P2,000,000. The notional amount is the principal amount of
the loan covered by the hedging instrument.
Requirement (b):
Receive variable (2M x 9%)
Pay 8% fixed
Net cash settlement - receipt (due each year-end for the
next four years)
Multiply by: PV ordinary annuity @9%, n=4
Fair value of forward contract receivable
Requirement (c):
Receive variable (2M x 12%)

180,000
160,000
20,000
3.23972
64,794

240,000
217

Pay 8% fixed
Net cash settlement - receipt (due each year-end for the
next three years)
Multiply by: PV ordinary annuity @12%, n=3
Fair value of forward contract - receivable

218

160,000
80,000
2.40183
192,146