ACC-430-Chapter 6
What has occurred when one company purchases the right to buy a foreign currency sometime in the future at an exchange rate quoted today?
The company has acquired a call option.
What has occurred when one company arranges to buy a foreign currency sometime in the future, at an exchange rate quoted today?
The company has entered a forward contract.
What is the intrinsic value of a foreign currency option?
The gain that could be realized if the option was exercised immediately
What are the two methods of accounting for changes in the value of a foreign currency transaction?
The one-transaction perspective and the two-transaction perspective
What is "asset exposure" to foreign exchange risk?
The possibility that an asset denominated in a foreign currency will change in value because of a change in the foreign exchange rate
What is a "foreign exchange rate?"
The price to buy a foreign currency
Under U.S. GAAP, what method is required to account for foreign currency transactions?
The two-transaction perspective must be used.
On December 1st, Year 1, assume that Eximco designates a forward contract as a cash flow hedge of a foreign-currency-denominated asset. On December 1st, Year 1 how would Eximco prepare a entry to record the forward contract if there is no cash changes hand and the forward contract has a fair value of zero?
There is no formal entry for the forward contract.
What is the requirement for reporting derivatives under international accounting standards and U.S. GAAP?
They must be shown on the balance sheet at fair value.
Under U.S. GAAP, what is the proper treatment of unrealized foreign exchange gains?
They should be recognized in income on the date the exchange rate changes.
Under U.S. GAAP, what is the proper treatment of unrealized foreign exchange losses?
They should be recorded on the Income Statement in the period the exchange rate changes.
True or false: If Eximco elects to treat a forward contract as a fair value hedge, then the gain or loss on the forward contract is taken directly to net income and there is no separate amortization of the original discount on the forward contract.
True
True or false: With a cash flow hedge, an expense equal to the original forward contract discount is recognized in net income over the life of the contract.
True
The exchange rate between Japanese yen and the U.S. dollar on May 2, Year 1 is: USD/JPY 0.0088. This is the indirect quote for ______.
USD
Northland Corporation recorded £1,000,000 in Accounts Receivable for sales to customers in the United Kingdom and recorded Accounts Payable of 2,000,000 Yuan for product purchased from China. If Northland recorded a foreign currency exchange loss on its receivables and a foreign currency gain on its payables, what must have happened to each currency?
Yuan depreciated, Pound depreciated
True or false: A variety of factors determine the exchange rate between two currencies. The exchange rate fluctuates.
true
True or false: The straight-line allocation of forward contract discounts and premiums is allowed by the FASB.
true
Whether gains and losses from changes in the fair value of derivatives are recognized on the income statement as part of net income or on the balance sheet as a component of other comprehensive income depends on ______.
whether the derivative is used for hedging purpose or for speculation
Eximco enters into a foreign currency put option to hedge a foreign exchange rate exposure of an account receivable denominated in a foreign currency. On the maturity date, if the spot rate is greater than the strike price, then the fair value of the foreign currency put option ______.
would be $0
To hedge its exposure to a decline in the U.S. dollar value of the foreign currency commitment, Eximco purchases a put option to sell 1,000,000 euros on March 1, Year 2, at a strike price of $1.50 (the spot rate). Eximco elects to measure the fair value of a firm commitment through reference to changes in the U.S. dollar - euro spot rate. The spot rate between the U.S. dollar and the euro on December 31, Year 1 is $1.52 = 1 Euro. Assume the present value factor for two months at an annual interest rate of 12% is 0.9803. How much would be the fair value of the firm commitment on December 31, Year 1?
$19,606
To hedge its exposure to a decline in the U.S. dollar value of the foreign currency commitment, Eximco purchases a put option to sell 1,000,000 euros on March 1, Year 2, at a strike price of $1.48. Eximco elects to measure the fair value of a firm commitment through reference to changes in the U.S. dollar - euro spot rate. The spot rate between the U.S. dollar and the euro on December 31, Year 1 is $1.51 = 1 euro. Assume the present value factor for two months at an annual interest rate of 12% is 0.9803. How much would be the fair value of the firm commitment on December 31, Year 1?
$29,409
Eximco has a long-term relationship with its Spanish customer and can reliably forecast that the customer will require delivery of goods costing 1,000,000 euro in March 1 of Year 2, when the spot rate is $1.00. Confident that it will receive 1,000,000 euro on March 1, Year 2. Eximco hedges its forecasted foreign currency transaction by purchasing 1,000,000 euro put option on December 1, Year 1. The option has a strike price of $1.50 and a premium of $0.085 per euro. How much is the fair value of the option on December 1, Year 1?
$8,500
Eximco has a long-term relationship with its Spanish customer and can reliably forecast that the customer will require delivery of goods costing 1,000,000 euro in March 1 of Year 2, when the spot rate is $1.00. Confident that it will receive 1,000,000 euro on March 1, Year 2. Eximco hedges its forecasted foreign currency transaction by purchasing 1,000,000 euro put option on December 1, Year 1. The option has a strike price of $1.50 and a premium of $0.009 per euro. How much is the fair value of the option on December 1, Year 1?
$9,000
Which information is needed to determine the fair value of a forward contract: 1. The forward rate at the date the forward contract was entered into 2. The current forward rate for a contract that matures on the same date as the forward contract entered into 3. A discount rate—typically, the company's incremental borrowing rate
, 2, and 3
What information is needed to determine the fair value of a foreign currency forward contract?
-The forward rate at the date the contract was entered -The current forward rate for a contract that matures on the same dates as the forward contract that was entered into -A discount rate to determine the present value of the contract **All of the above information is needed
The accounting for a hedge of a forecasted transaction differs from the accounting for a hedge of a foreign currency firm commitment. The difference(s) include(s): 1. Unlike the accounting for a firm commitment, there is no recognition of the forecasted transaction or gains and losses on the forecasted transaction. 2. The hedging instrument is reported at fair value but because there is no gain or loss on the forecasted transaction to offset against, changes in the fair value of the hedging instrument are not reported as gains and losses in net income. Instead they are reported in other comprehensive income. On the projected date of the forecasted transaction, the cumulative change in the fair value of the hedging instrument is transferred from other comprehensive income to net income.
1 and 2
The specific entries required to account for a foreign currency hedging relationship are determined by a combination of the following factor(s): 1. The type of item being hedged 2. The nature of the item being hedged 3. The type of hedging instrument being used 4. The nature of the hedged risk
1, 2, 3, and 4
The type(s) of hedging instrument include(s): 1. Forward contract 2. Option contract 3. Swap 4. Futures 5. Cash flow hedge
1, 2, 3, and 4
A cash flow exposure exists for: 1. Recognized foreign currency assets and liabilities. 2. Foreign currency firm commitments. 3. Forecasted foreign currency transactions.
1, 2, and 3
A hedging contract qualifies for hedge account if it meets the following requirements for hedge effectiveness: 1. There is an economic relationship between the eligible hedged item and the hedging instrument. 2. The effect of credit risk does not dominate the value changes that result from the economic relation between the eligible hedged item and the hedging instrument. 3. The hedge ratio of the hedging relationship is the same as that resulting from the quantity of the hedged item that the entity actually hedges and the quantity of the hedging instrument that the entity actually uses to hedge that quantity of hedged item.
1, 2, and 3
Hedge accounting for foreign currency derivatives may be used only if which of the following conditions are satisfied? 1. The derivative is used to hedge either a fair value exposure or cash flow exposure to foreign exchange risk (nature of the hedge risk). 2. The derivative is highly effective in offsetting changes in the fair value or cash flows related to the hedged item (hedge effectiveness). 3. The derivative is properly documented as a hedge (hedge document).
1, 2, and 3
The accounting treatment for the fair value hedge of an unrecognized foreign currency firm commitment requires: 1. Measuring the fair value of the firm commitment. 2. Recognizing the change in fair value in net income. 3. Reporting the firm commitment on the balance sheet as an asset or liability.
1, 2, and 3
The three conditions to use hedge accounting for foreign currency derivatives include: 1. Nature of the hedge risk 2. Hedge effectiveness 3. Hedge documentation 4. Types of hedging contracts 5. The length of the hedging contracts
1, 2, and 3
A hedging contract qualifies for hedge account if it meets all of the following requirements for hedge effectiveness, EXCEPT: 1. There is an economic relationship between the eligible hedged item and the hedging instrument. 2. The effect of credit risk does not dominate the value changes that result from the economic relation between the eligible hedged item and the hedging instrument. 3. The hedge ratio of the hedging relationship is the same as that resulting from the quantity of the hedged item that the entity actually hedges and the quantity of the hedging instrument that the entity actually uses to hedge that quantity of hedged item.
4. The hedge contract must be formally documented on the date a foreign currency forward contract is entered into or a foreign currency option is acquired.
Eximco enters into a peso put option contract on December 1st, 2017, to hedge against an exposure to foreign exchange risk of an account receivable denominated in pesos due on Mar 1, 2018. Eximco decides to designate a foreign currency option as a cash flow hedge. Assume that the fair value of the option has gone down from December 1st to December 31st, 2017 and that the option strike price is less than the spot rate so its intrinsic value is $0. What would be the entry to adjust the fair value of the option on December 31, 2017?
A debit entry to AOCI and a credit entry to Foreign Currency Option
On December 1, Year 1, Eximco enters into a forward contract used as fair value hedge of a firm commitment to sell 1,000,000 euro on March 1, Year 2 at $1,485,000. On December 31, Year 1, the forward rate for a contract to deliver euro on March 1, Year 2 is $1.496 = 1 euro. Assume that 0.9803 is the present value factor for 2 months at an annual interest rate of 12% per year. How much is the gain or loss on the firm commitment on December 31, Year 1?
A gain of $10,783
On December 1, Year 1, Eximco enters into a forward contract used as fair value hedge of a firm commitment to sell 1,000,000 euro on March 1, Year 2 at $1,475,000. On December 31, Year 1, the forward rate for a contract to deliver euro on March 1, Year 2 is $1.496 = 1 euro. Assume that 0.9803 is the present value factor for 2 months at an annual interest rate of 12% per year. How much is the gain or loss on the firm commitment on December 31, Year 1?
A gain of $20,586
Select the best answer to complete the following statement: "To avoid the uncertainty related to foreign exchange rates, companies often use foreign currency ______ to ______ against the effect of unfavorable changes in the value of foreign currencies."
derivatives, hedge
Under the one-transaction perspective, any change in the domestic currency value regarding to the foreign currency will be accounted for as an adjustment to ______.
Accounts Receivable and Sales
How should discounts or premiums on forward contracts be treated if the derivative is hedging a foreign-currency-denominated asset?
Amortized over the life of the forward contract
How should cash flows arising from hedging instruments be classified in statements of cash flows?
As operating, investing or financing activities, based on the classification of the cash flows from the hedged item
Under U.S. GAAP, where are changes in the fair value of derivatives reported?
As part of "Accumulated Other Comprehensive Income" on the Balance Sheet
Which standard(s) require(s) companies to use a two-transaction perspective in accounting for foreign currency transactions?
Both IFRS and U.S. GAAP
What kind of exposure exists for foreign currency firm commitments?
Both fair value exposure and cash flow exposure
How is the fair value of a foreign currency forward contract determined?
By reference to changes in the forward rate over the life of the contract, discounted to the present value
Select the best answer to complete the following statement: "A foreign currency option gives the holder of the option ______ to trade foreign currency in the future."
the right but not the obligation
What kind of exposure exists for recognized foreign currency assets and liabilities?
Cash flow exposure
To hedge an exposure to foreign exchange risk arising from a foreign currency account receivable of 1,000,00 euro, Eximco purchased a foreign currency put option. This put option will give Eximco ______.
the right to sell 1,000,000 euro
The exchange rate between the euro and the U.S. dollar on January 15, Year 1 is EUR/USD 0.867. This is the direct quote for ______.
EUR
Where are gains and losses arising from changes in the fair value of derivatives recognized initially?
Either on the income statement as a part of net income or on the balance sheet as a component of other comprehensive income
Eximco is a U.S. exporter, sells goods to a Japanese customer with payment to be made in Japanese yen. Which type of exposure to foreign exchange risk does Eximco have?
Export sale transaction exposure
Which country pegs their currency to U.S. dollar?
Hong Kong
Which IAS provides guidance to account for the effects of changes in foreign exchange rates?
IAS 21
Which IFRS replaced IAS 39 requirements for classification, measurement, impairment, hedge accounting, and derecognition?
IFRS 9, Financial Instruments
The number of Japanese yen (¥) required today to buy one U.S. dollar ($) today is called:
the spot rate.
The value of the currency is allowed to fluctuate freely according to market forces, with little or no intervention from the central bank. Which exchange rate mechanism is it?
Independent float
King's Bank, a British company, purchases market research services from Harris Interactive, a U.S. company. As per the terms of the contract, payment is to be made three months later in U.S. dollars when the report is delivered. How would King's Bank like to see the exchange rate move, assuming it isn't hedging the transaction?
It hopes that the British pound appreciates in value against the U.S. dollar.
What is a foreign currency transaction?
It is a business deal denominated in a currency other than a company's domestic currency.
Why must the two-transaction perspective be used for recording foreign currency transactions under U.S. GAAP?
Management made two decisions: one to sell and another to extend credit in a foreign currency.
What is "hedge accounting?"
Matching gains or losses from hedging with losses or gains from the risk being hedged.
Which standard(s) require(s) companies to use the deferral approach to account for unrealized foreign exchange gains and losses?
Neither IFRS or U.S. GAAP
Salisbury Trade Inc. is a U.S. corporation, buys goods from a Chinese company with payment to be made in U.S. dollars. Which type of exposure to foreign exchange risk does Salisbury Trade Inc. have?
No exposure to foreign exchange risk
Which type of option refers to the sale of foreign currency by the holder of the option?
Put
On December 1st, Year 1, assume that Eximco designates a forward contract as a cash flow hedge of a 1,000,000 euro account receivable. The spot rate is $1.50 = 1 euro. The forward rate is $1.40 = 1 euro. On December 31st, Year 1, the new spot rate is $1.51 = 1 euro. The journal entry to adjust the value of the euro receivable to the new spot rate and a foreign exchange gain resulting fro the appreciation of the euro since December 1st, Year 1 would include ______.
a credit entry to Foreign Exchange Gain of $10,000
The journal entry to record the purchase of the foreign currency option at its fair value would include ______.
a debit entry to Foreign Currency Option
Eximco enters a forward contract to hedge an account receivable denominated in Japanese yen, a foreign currency to Eximco. If the spot rate is 1USD = 108 Japanese yen, and the forward rate is 1USD = 120 Japanese yen, then the Japanese yen is selling at ______.
a discount
The spot rate for Australian dollar today is US$0.892, and the one-month forward rate is $0.882. In the one-month forward market, the Australian dollar is sold at ______.
a discount
Select the best answer to complete the following statement: "IAS 21 and FASB ASC 830 require companies to use the ______ to account for unrealized foreign exchange gains and losses. Under this approach, a firm report unrealized foreign exchange gains and losses in ______ in the period in which the exchange rate changes."
accrual approach, net income
Eximco enters into a put option to hedge a foreign exchange rate exposure of an account receivable denominated in a foreign currency. On the maturity date of the put option, the spot rate is greater than the strike price, Eximco should ______.
allow the option to expire unexercised and sell its foreign currency at the spot rate
Select the best answer to complete the following statement: "Regarding the accounting for fair value hedge, at each balance sheet date, the derivative hedging instrument is adjusted to fair value, resulting in ______ reported on the balance sheet, with the counterpart recognized as a gain or loss in ______."
an asset or liability, net income
Select the best answer to complete the following statement: "The fundamental requirement is that all derivatives must be carried on the balance sheet date at their fair value. Derivatives are reported on the balance sheet as ______ when they have a positive fair value and as ______ when they have a negative fair value."
assets, liabilities
To meet the requirement of hedge documentation, the hedge contract must ______.
be formally documented at the inception of the hedge
Select the best answer to complete the following statement: "To hedge an exposure to foreign exchange risk arising from a foreign currency account receivable of 1,000,00 euro, Eximco purchased a foreign currency put option. This put option will give Eximco the right ______ the obligation to ______ 1,000,000 euro on a certain date, at a predetermined strike price."
but not, sell
Select the best answer to complete the following statement: "A ______ exists if changes in exchange rates can affect the amount of cash flow to be realized from a transaction, with changes in ______ reflected in ______."
cash flow exposure, cash flow, net income
To qualify as a cash flow hedge, the hedging instrument must ______.
completely offset the variability in the cash flows associated with the foreign currency receivable or payable
Select the best answer to complete the following statement: "The major issue in accounting for foreign currency transactions is how to deal with the change in the domestic-currency value of the account receivable resulting from the ______ and the account payable resulting from an ______ when foreign currency ______ in value."
export import changes
Select the best answer to complete the following statement: "Regarding the accounting for fair value hedge, at each balance sheet date, the hedged asset or liability is adjusted to ______ according to changes in the ______, and a foreign exchange gain or loss is recognized in net income."
fair value spot exchange rate
Select the best answer to complete the following statement: "Regarding the accounting for cash flow hedges, at each balance sheet date, the derivative hedging instrument is adjusted to ______, resulting in an asset or liability reported on the balance sheet, with the counterpart recognized as a change in ______."
fair value, Accumulated Other Comprehensive Income
Select the best answer to complete the following statement: "According to IFRS 9, Financial Instruments, all derivatives should be reported on the balance sheet at ______. Off-balance-sheet treatment is ______."
fair value, not acceptable
A noncancelable sales order that specifies foreign currency price and date of delivery is known as a:
foreign currency firm commitment.
The two most common derivatives used to hedge foreign exchange risk are ______.
foreign currency forward and foreign currency option contracts
Excel Sources Inc. is a U.S. incorporated company. Due to change in exchange rate, it receives $150,000 as payment against a sale of $165,000. Under the two-transaction perspective:
foreign exchange loss will be recorded for $15,000.
The price at which the foreign currency can be acquired is known as ______.
foreign exchange rate
Select the best answer to complete the following statement: "There probably are as many different corporate strategies regarding hedging ______ as there are companies exposed to that risk. Some companies simply require hedges of all ______ currency transactions. Others require the use of a forward contract hedge when the forward rate results in a greater cash ______ or smaller cash ______ than with the spot rate."
foreign exchange risk, foreign, inflow, outflow
Select the best answer to complete the following statement: "The hedging relationship must be ______ at the ______ of the hedge, that is, on the date a foreign currency forward contract is entered into or a foreign currency option is acquired."
formally documented, inception
When a currency is allowed to increase or decrease freely according to market forces, the currency is said to:
have independent float.
Select the best answer to complete the following statement: "It is quite common for companies to use foreign currency derivatives to ______ the exposure to ______ arising from forecasted foreign currency transactions."
hedge, foreign exchange risk
The major issue in accounting for foreign currency transactions is ______.
how to deal with the change in the domestic-currency value when the foreign currency changes in value
If the hedging instrument does not qualify as a cash flow hedge, or if the company elects not to designate the hedging instrument as a cash flow hedge, then the hedge ______.
is designated as a fair value hedge
For an upcoming trip, Pat wants to buy Euros at the local bank when the current exchange rate quoted on OANDA.com was $1.563 per €1. What should Pat plan to pay for €1,000?
more than $1,563
Eximco designates a forward contract as a fair value hedge. The gain and loss on the forward contract is taken directly to ______.
net income
Select the best answer to complete the following statement: "Assume that Eximco designates a foreign currency option as a cash flow hedge of a foreign-currency-denominated asset. The change in the fair value of the option is recognized in ______."
net income
Select the best answer to complete the following statement: "Under fair value hedge accounting, the gain or loss on the hedging instrument is recognized currently in ______ and the gain or loss on the firm commitment attributable to the hedged risk is recognized currently in ______."
net income, net income
Select the best answer to complete the following statement: "The hedging instrument is reported at fair value but because there is no gain or loss on the forecasted transaction to offset against, changes in the fair value of the hedging instrument are not reported as gains and losses in ______. Instead they are reported in ______. On the projected date of the forecasted transaction, the cumulative change in the fair value of the hedging instrument is transferred from ______ to ______.
net income, other comprehensive income, other comprehensive income, net income
Select the best answer to complete the following statement: "Regarding the accounting for cash flows, at each balance sheet date, an amount equal to the foreign exchange gain or loss recognized in ______ is then transferred to ______, to offset any gain or loss on the hedged asset or liability."
net income, accumulated other comprehensive income
In Year 1, Eximco enters into a foreign currency option contract to hedge against an exposure to foreign exchange risk of an account receivable denominated in foreign currency that is due in Year 2. Select the best answer to complete the following statement: "The accounting method for a foreign currency option, fair value hedge or cash flow hedge, would have ______ on cash flows ______ on the net amount of income recognized over the two-year period."
no impact, or
Select the best answer to complete the following statement: "Cash flows arising from hedging instruments are classified as ______, on the basis of the classification of the cash flows arising from the hedged item."
operating, investing, or financing activities
If the forward rate of a foreign currency (1 Australian dollar = $0.8) exceeds the spot rate (1 Australian dollar = $0.7) on a given date, the foreign currency is sold at ______.
premium
The two issues related to derivatives accounting include ______.
the determination of fair value and the treatment of the unrealized gains and losses that arise from the fair value adjustments
One of the reasons for a company to use a forward contract to hedge a recognized foreign-currency-denominate asset such as account receivable in a foreign currency is ______.
the exact amount of the transaction loss is known in advance at the hedging date