_PROBLEMS_

I – Acquisition Costs
I - (Buyer’s Point of View) Using Foreign Currency Forward Contracts as a Hedging Instrument
On December 1, 20x4, Jaja Company entered into four forward exchange contracts to purchase
US $1,200 in 90 days for delivery on March 1, 20x5 for P40.15. The exchange rates available on
various dates are as follows (fiscal year-end is December 31):
12/1/20x4 12/31/20x4 3/1/20x5
Spot rate . . . . . . . . . . . . . . . . . . . . P40.00 P40.30 P40.20
30-day forward rate . . . . . . . . . . P40.05 P40.45 P40.40
60-day forward rate . . . . . . . . . . P40.10 P40.40 P40.50
90-day forward rate . . . . . . . . . . P40.15 P40.45 P40.60
Required: Using the gross or net approach in recording forward contracts, assume the following
situations:
1. Not a Hedge Accounting - Importing Transaction (Exposed Liability). On December 1,
20x4, Jaja Company purchased inventory for US $1,200 payable on March 1, 20x5 (i.e., the
transaction is payable in dollars.
Also on December 1, 20x4, Jaja Company entered into the first forward contract to buy
$1,200 on March 1, 20x5 for P40.15.
a. Prepare entries to record the above hedging item and hedging instrument (forward
contracts) transactions.
b. Determine the following:
b.1. Gain or loss on hedged item on December 31, 20x4 income statement.
b.2. Gain or loss on hedging instrument on December 31, 20x4 income statement.
b.3. Net gain or loss on December 31, 20x4 income statement.
b.4. Gain or loss on hedged item on March 1, 20x5 income statement.
b.5. Gain or loss on hedging instrument on March 1, 20x5 income statement.
b.6. Net gain or loss on March 1, 20x5 income statement.
c. The balance of accounts payable on:
c.1. December 31, 20x4
c.2. March 1, 20x5
d. The balance of pesos payable to foreign currency exchange dealer on:
d.1. December 1, 20x4 using gross method
d.2. December 1, 20x4 using net method
d.3. December 31, 20x4 using gross method
d.4. December 31, 20x4 using net method
e. Fair value of forward contract on:
e.1. December 1, 20x4 – indicate whether asset or liability
e.2. December 31, 20x4 – indicate whether asset or liability
e.3. March 1, 20x5 immediately before settlement – indicate whether asset or liability
f. The amount of inventory purchased on March 1, 20x5.
In relation to the above data, the following relevant exchange rates are needed for further
analysis in relation to hedged item and hedging instrument:

Forward Rate for

3/1/20x5 Settlement
Spot Rate (or Expiration)
December 1, 20x4…………………………. P40.00 P40.15 (*90 days)
December 31, 20x4…………………………. P40.30 P40.40 (**60 days)
March 1, 20x5………………………………….. P40.20***
*original 90-day forward rate on 12/1/20x4
**remaining or current forward rate on 12/31/20x4
***the forward rate at expiration or maturity is equal to spot rate as the remaining period of the forward contract is zero.

1. Not a Hedge Accounting - Importing Transaction (Exposed Liability).

a. The journal entries to record the hedged item and hedging instrument are as follows:
Gross Method
Hedged Item – Importing Transaction Hedging Instrument – Forward Contracts
(Exposed Liability) ( Broad Approach or Gross Position Accounting)
December 1, 20x4
Transaction Date Date of Inception/Hedging of 90 days Forwards

Inventory ($1,200 x P40)…………... 48,000 FC Receivable from XD…………… 48,180

Accounts payable………………. 48,000 Pesos Payable to XD 48,180
To record purchase of goods on (P40.15 x $1,200)
account using the spot rate on To record forward contract to
2/1/1/x4. buy $1,200 using forward rate.
*XD – exchange dealer

If the financial statements are prepared on December 1, 20x4, the value of the forward
contract is as follows:

Balance Sheet Presentation on 12/1/20x4

FC Receivable from XD……………………… P48,180
Less: Pesos payable to XD…………………… 48,180
Forward Contract (fair value)………………. P 0

December 31, 20x4

(Balance Sheet Date an intervening financial reporting date)

FC Transaction Loss 360 FC Receivable from XD…………… 300

Account payable……………. 360 FC Transaction Gain 300
[P40.30 – P40.00) x $1,200 [(P40.40 – P40.15) x $1,200]
To record a loss on the exposed To record a gain on foreign
liability denominated in foreign currency to be received from
currency. FC dealer.
*FC – foreign currency

If the financial statements are prepared on December 31, 20x4, the value of the forward
contract is as follows
Balance Sheet Presentation on 12/31/20x4
FC Receivable from XD (P40.40 x $1,200)… P48,480
Less: Pesos payable to XD (fixed at P40.15) 48,180
Forward Contract (fair value – asset)……… P 300
On March 1, 20x5 (the transaction date and the settlement date), the journal entries are:

March 1, 20x5
Settlement Date Settlement Date/Date of Expiration of Contract
 Accounts payable 120 FC Transaction Loss 240
FC Transaction gain……. 120 FC Receivable from XD 240
[(P40.20 – P40.30) x $1,200}…….. [(P40.40 – P40.20) x $1,200]
To record a gain from 12/31/x4 to To record a loss on foreign
3/1/x5 on liability denominated in currency to be received from
FC. FC dealer.

Pesos Payable from XD……………. 48,180

Cash………………………………. 48,180
To record payment to
exchange dealer.

Investment in FC……………………. 48,240

FC Receivable from XD 48,240
To record receipt of foreign
Currency.

Accounts payable…………………… 48,240 Cash……………………………………. 48,240

Cash (refer to note below)……… 48,240 Investment in FC…………………. 48,240
To record payment of accounts To record conversion of US dollars
payable at spot rate. into cash for payment of
accounts payable.
Note: This entry may be ignored and instead the
Investment in FC will be outright credited in payment
of accounts payable. For succeeding illustrations the
conversion of FC to peso cash to settle items acquired
will be used.

These transactions can be summarized in the following table.

Hedged Item (Exposed Liability) Hedging Instrument (Forward Contract)

Transaction Transaction
Accounts Payable Balance gain (loss) FC Receivable Balance gain (loss)
12/1/20x4 P48,000 12/1/20x4 P48,180
12/31/20x4 48,360 (P 360) 12/31/20x4 48,480 P 300
3/1/20x5 48,240 120 3/1/20x5 48,240 (240)
Total gain (loss) (P 240) P 60

Thus, the net effect is a P150 loss when the forward contract is used.

“Net” Position Accounting

The following illustrates the effects of “net” position accounting using the same illustration
above:
Hedged Item – Importing Transaction Hedging Instrument – Forward Contracts
(Exposed Liability) ( Net Position Accounting)
December 1, 20x4
Transaction Date Date of Inception/Hedging of 90 days Forwards

Inventory ($1,200 x P40)…………... 48,000 Memorandum entry only,

Accounts payable………………. 48,000 No formal journal entry as the fair value of forward
To record purchase of goods on contract is zero.
account using the spot rate on
2/1/1/x4.
It should be noted that the accounts payable for the inventory purchase is recorded using
the spot rate on the transaction date (on December 1, 20x3).

December 31, 20x4

(Balance Sheet Date, an intervening financial reporting date)
 FC Transaction Loss 360 Forward Contract 300
Accounts payable 360 FC Transaction Gain 300
[P40.30 – P40.00) x $1,200 [(P40.40 – P40.15) x $1,200]
To record a loss on the exposed To record a gain on foreign
liability denominated in foreign currency to be received from
currency. FC dealer.
*FC – foreign currency

If the financial statements are prepared on December 31, 20x4, the value of the forward
contract is as follows:

Forward contract (debit balance – asset)………………………. P 300

The income statement would report an exchange loss of P360 and an exchange gain of P250.

On March 1, 20x5 (the transaction date and the settlement date), the journal entries are:

March 1, 20x5
Settlement Date Settlement Date/Date of Expiration of Contract

Accounts payable 120 FC Transaction Loss 240

FC Transaction gain……. 120 Forward Contract 240
[(40.20 – P40.30) x $1,200}…….. [(P40.40 – P40.20) x $1,200]
To record a gain from 12/31/x4 to To record a loss on foreign
3/1/x5 on liability denominated in currency to be received from
FC. FC dealer.

Accounts payable (P40.20 x $1,200) 48,240 Cash………………………………….. 60

Cash (P40.20 x $1,200) or * 48,240 Forward Contract 60
To record payment to exchange Net settlement received from the
dealer (XD) dealer on expiration or maturity
date of forward contract.
*(P40.15, forward rate on the date of inception x $1,200) + cash received from the exchange dealer of P50.

Forward Contract (Asset/Liability)

12/31/x4 Gain… 300 240… …..3/1/x5 Loss
3/1/x5 Net…… 60 60
b.
b.1. P360 loss - [(P40.30 – P40.00) x $1,200]
b.2. P300 gain - [(P40.40 – P40.15) x $1,200]
b.3. P360 loss – P300 gain = P60 net loss (decrease in net income)
b.4. P120 gain - [(P40.20 – P40.30) x $1,200}
b.5. P240 loss - [(P40.40 – P40.20) x $1,200]
b.6. P240 loss – P120 gain = P120 net loss (decrease in net income)

c.
c.1. P48,360 - [P40.30, spot rate/current rate on the balance sheet date x $1,200]
c.2. P48,240 – [P40.20, spot rate on the date of settlement x $1,200]

d.
d.1. P48,180 - [P40.15, original (90-day) forward rate on the date of hedging x $1,200]
d.2. No entry required
d.3. Same amount with d.1
d.4. No entry required
e.
e.1.
Gross Method
 FC Receivable from XD……………………… P48,180
Less: Pesos payable to XD…………………… 48,180
Forward Contract (fair value)………………. P 0

Net Method: Zero. No entry required.

e.2. P300 asset

Gross method
FC Receivable from XD (P40.40 x $1,200)… P48,480
Less: Pesos payable to XD (fixed at P40.15) 48,180
Forward Contract (fair value – asset)……… P 300

Net Method: P300.

Forward contract (debit balance – asset)… P 300

e.3. P60 debit balance – asset

Gross method
FC Receivable from XD (P40.20 x $1,200)… P48,240
Less: Pesos payable to XD (fixed at P40.15) 48,180
Forward Contract (fair value – asset)……… P 60

Net Position
Forward Contract (Asset/Liability)
12/31/x4 Gain… 300 240… …..3/1/x5 Loss
3/1/x5 Net…… 60

f. P48,000 [P40, spot (current) rates on the date of transaction x $1,200]

2. Hedging an Unrecognized Foreign Currency Firm Commitment – Fair Value Hedge. On

December 1, 20x4, Jaja Company contracts to purchase special order goods from Boston
Company. The contract meets the requirements of a firm commitment - fair value hedge.
Their manufacture and delivery will take place in 90 days (on March 1, 20x5). The contract
price is $1,200 to be paid by March 1, 20x5. Thus, the transaction date and the settlement
date are both March 1, 20x5.

Also, on December 1, 20x4, Jaja Company entered into the second forward contract in
hedging foreign currency payable commitment with a contract to receive $1,200 in 90
days at the forward rate of P40.15.
a. Prepare entries to record the above hedging item and hedging instrument (forward
contracts) transactions.
b. Determine the following:
b.1. Gain or loss on hedged item (firm commitment) on December 31, 20x4 income
statement.
b.2. Gain or loss on hedging instrument on December 31, 20x4 income statement.
b.3. Net gain or loss on December 31, 20x4 income statement.
b.4. Gain or loss on hedged item (firm commitment) on March 1, 20x5 income
statement.
b.5. Gain or loss on hedging instrument on March 1, 20x5 income statement.
b.6. Net gain or loss on March 1, 20x5 income statement.
 c. The balance of pesos payable to foreign currency exchange dealer on:
c.1. December 1, 20x4 using gross method
c.2. December 1, 20x4 using net method
c.3. December 31, 20x4 using gross method
c.4. December 31, 20x4 using net method
d. The balance of the Firm Commitment account on:
d.1. December 1, 20x4 – indicate whether asset or liability
d.2. December 31, 20x4 – indicate whether asset or liability
d.3. March 1, 20x5 immediately before settlement – indicate whether asset or liability
e. Fair value of forward contract on:
e.1. December 1, 20x4 – indicate whether asset or liability
e.2. December 31, 20x4 – indicate whether asset or liability
e.3. March 1, 20x5 immediately before settlement – indicate whether asset or liability
f. The amount of inventory purchased on March 1, 20x5 (assuming the firm commitment
account will be closed to earnings account).
g. The amount of inventory purchased on March 1, 20x5 (assuming the firm commitment
account will be closed to inventory purchase account).

In relation to the above data, the following relevant exchange rates are needed for further
analysis in relation to hedged item and hedging instrument:

Forward Rate for

3/1/20x5 Settlement
Spot Rate (or Expiration)
December 1, 20x4…………………………. P40.00 P40.15 (*90 days)
December 31, 20x4…………………………. P40.30 P40.40 (**60 days)
March 1, 20x5………………………………….. P40.20***
*original 90-day forward rate on 12/1/20x4
**remaining or current forward rate on 12/31/20x4
***the forward rate at expiration or maturity is equal to spot rate as the remaining period of the forward contract is zero.

Gross Method (for Net Position – same with Exposed Liability)

a. The journal entries to record the hedged item and hedging instrument are as follows:
Hedged Item – (Unrecognized Hedging Instrument – Forward Contracts
Foreign Currency Firm Commitment) ( Broad Approach or Gross Position
Accounting)
December 1, 20x4
Date of Commitment (Date of Issuing the
Purchase Order) Date of Inception/Hedging of 90 days
Forwards

No journal entry is required to record the FC Receivable from 48,180

firm XD……………
commitment. The forward contract is Pesos Payable to XD 48,180
designated as a hedge of the firm (P40.15 x $1,200)
commitment to purchase inventory on To record forward
March 1, 20x5. The hedge is accounted contract to
for as a fair value hedge. buy $1,200 using forward
rate.

December 31, 20x4

(Balance Sheet Date, an intervening financial reporting date)
 FC Transaction Loss 300 FC Receivable from 300
XD……………
Firm Commitment 300 FC Transaction Gain 300
[P40.40 – P40.15) x [(P40.40 – P40.15) x
$1,200 $1,200]
To record a loss on firm To record a gain on
commitment using the foreign
change in the forward currency to be received
rate. from
FC dealer.
*FC – foreign currency

Balance Sheet Presentation on 12/31/20x4

Assets Liability
FC Receivable from XD (P40.40 x Firm
$1,200)....…...P48,480 Commitment…………………………………...P
Less: Pesos Payable to XD(fixed at 300
P40.15)….… 48,180
Forward Contract (fair
value)……………………P 300

On March 1, 20x5 (the transaction date and the settlement date), the journal entries are:

March 1, 20x5
Date of Transaction and Settlement Settlement Date/Date of Expiration of
Contract

Firm Commitment………… 240 FC Transaction Loss 240

……………
FC Transaction gain……. 240 FC Receivable from 240
To record a gain on fair XD………
value of [(P40.40 – P40.20) x
firm commitment. $1,200]
To record a loss on
foreign
currency to be received
from
exchange dealer.

Pesos Payable from 48,180

XD…………….
48,180
Cash……………………………….
To record payment to
exchange dealer.

Investment in 48,240
FC…………………….
FC Receivable from XD 48,240
To record receipt of
foreign
currency.
 Inventory (P40.20 x 48,24 Cash……………………………… 48,24
$1,200)…………. 0 ……. 0
Cash 48,24 Investment in 48,24
…………………………… 0 FC……………..…... 0
……
To record the To record conversion of US
purchase of dollars into cash for purchase
inventory for $1,200 at of inventory.
spot rate.

Firm 60
Commitment…………………….
60
Inventory…………………………….
To remove the carrying
amount of the firm
commitment from the balance
sheet6 and adjust the initial
carrying amount of the
machine that results from the
firm commitment. This
treatment is an accordance
with PAS 39 par. 89b.

Firm Commitment
3/1/x5 Gain……. 300… …..12/31/x4
240 Loss
60 3/1/x5
60 Net

b.
b.1. P300 loss - [(P40.40 – P40.15) x $1,200]
b.2. P300 gain - [(P40.40 – P40.15) x $1,200]
b.3. P300 loss – P300 gain = P0
b.4. P240 gain - [(P40.40 – P40.20) x $1,200}
b.5. P240 loss - [(P40.40 – P40.20) x $1,200]
b.6. P240 loss – P240 gain = P0
c. – same with Exposed Liability
c.1. P48,180 - [P40.15, original (90-day) forward rate on the date of hedging x $1,200]
c.2. No entry required
c.3. Same amount with c.1
c.4. No entry required
d.
d.1. Zero, no entry required
d.2. P300 liability, [(P40.40 – P40.15) x $1,200]
d.3. P60, liability
Firm Commitment
3/1/x5 Gain……. 300… …..12/31/x4
240 Loss
60 3/1/x5
Net

e. Same with Exposed Liability

 e.1. Net Method: Zero. No entry required.
Gross Method
FC Receivable from XD……………………… P48,180
Less: Pesos payable to XD…………………… 48,180
Forward Contract (fair value)………………. P 0

e.2. P300 asset

Net Method: P300.
Forward contract (debit balance – asset)… P 300

Gross method
FC Receivable from XD (P40.40 x $1,200)… P48,480
Less: Pesos payable to XD (fixed at P40.15) 48,180
Forward Contract (fair value – asset)……… P 300

e.3. P60 debit balance – asset

Gross method
FC Receivable from XD (P40.20 x $1,200)… P48,240
Less: Pesos payable to XD (fixed at P40.15) 48,180
Forward Contract (fair value – asset)……… P 60

Net Method
Forward Contract (Asset/Liability)
12/31/x4 Gain… 300 240… …..3/1/x5 Loss
3/1/x5 Net…… 60

f. P48,240, spot rate on the date of transaction.

Inventory at spot rate on the date of transaction (P40.20 x $1,200)…………….P48,240

g. P48,180, original (90-day) forward rate on the date of hedging

Inventory at spot rate on the date of transaction (P40.20 x $1,200)…………….P48,240
Less: Firm Commitment account – liability, 3/1/20x5………………………………. 60
Inventory at original (90-day) forward rate on the date of hedging, P40.15….P48,180