Chapter 09 Solutions

CHAPTER 9
FOREIGN CURRENCY TRANSACTIONS AND

HEDGING FOREIGN EXCHANGE RISK
Answers to Problems
1. C (Foreign exchange gain/loss on foreign currency transaction)
An import purchase causes a foreign currency payable to be carried on
the books. If the foreign currency depreciates, the dollar value of the
foreign currency payable decreases, yielding a foreign exchange gain.
2. D (Method of accounting for foreign currency transactions)
Current accounting standards require a two-transaction perspective,
accrual approach.
3. B (Foreign exchange gain/loss on foreign currency transaction)
Foreign exchange gains related to foreign currency import purchases are
treated as a component of income before income taxes. If there is no
foreign exchange gain in operating income, then the purchase must have
been denominated in U.S. dollars or there was no change in the value of
the foreign currency from October 1 to December 1, 2013.
4. C
(Calculate foreign exchange gain/loss on foreign currency transaction)

The dollar value of the LCU receivable has decreased from $110,000 at
December 31, 2013 to $95,000 at February 15, 2014. This decrease of
$15,000 should be reported as a foreign exchange loss in 2014.
5. D
(Calculate foreign exchange gain/loss on foreign currency borrowing)

The increase in the dollar value of the euro note payable represents a
foreign exchange loss. In this case a $25,000 loss would have been
accrued in 2013 and a $10,000 loss will be reported in 2014.
6. D
(Foreign exchange gain/loss on foreign currency transaction)

A foreign currency receivable will generate a foreign exchange gain when
the foreign currency increases in dollar value. A foreign currency payable
will generate a foreign exchange gain when the foreign currency
decreases in dollar value. Hence, the correct combination is franc
(increase) and peso (decrease).
McGraw-Hill/Irwin
Hoyle, Schaefer, Doupnik, Advanced Accounting, 11/e
The McGraw-Hill Companies, Inc., 2013

9-1
7. D
(Calculate foreign exchange gain/loss)

The merchandise purchase results in a foreign exchange loss of $8,000,
the difference between the U.S. dollar equivalent at the date of purchase
and at the date of settlement.
The increase in the dollar equivalent of the notes principal results in a
foreign exchange loss of $20,000.
The total foreign exchange loss is $28,000 ($8,000 + $20,000).
8. D
(Forward contract cash flow hedge of foreign currency denominated

asset/liability)
The Thai baht is selling at a premium (forward rate exceeds spot rate).
The exporter will receive more dollars as a result of selling the baht
forward than if the baht had been received and converted into dollars on
April 1. Thus, the premium results in additional revenue for the exporter.
9. D
(Forward contract fair value hedge of foreign currency firm commitment)

The parts inventory will be recognized at the spot rate at the date of
purchase (FC100,000 x $.23 = $23,000).
10. D (Determine the fair value of a forward contract)

The forward contract must be reported on the December 31, 2013 balance
sheet as a liability. Barnum has locked-in to purchase ringgits at $0.042
per ringgit but could have locked-in to purchase ringgits at $0.037 per
ringgit if it had waited until December 31 to enter into the forward
contract. The forward contract must be reported at its fair value
discounted for two months at 12% [($.042 $.037) x 1,000,000 = $5,000 x .
9803 = $4,901.50].
11. C
(Calculate foreign exchange gain/loss on foreign currency transaction)

The 10 million won receivable has changed in dollar value from $35,000 at
12/1/13 to $33,000 at 12/31/13. The won receivable will be written down by
$2,000 and a foreign exchange loss will be reported in 2013 income.
12. B (Forward contract fair value hedge of foreign currency denominated

asset/liability)
The nominal value of the forward contract on December 31, 2013 is a
positive $2,000, the difference between the amount to be received from the
forward contract actually entered into, $34,000 ($.0034 x 10 million), and
the amount that could be received by entering into a forward contract on
December 31, 2013 that matures on March 31, 2014, $32,000 ($.0032 x 10
million). The fair value of the forward contract is the present value of
McGraw-Hill/Irwin
9-2

Solutions Manual
$2,000 discounted for three months ($2,000 x .9706 = $1,941.20). On

December 31, 2013, MNC Corp. will recognize a $1,941.20 gain on the
forward contract and a foreign exchange loss of $2,000 on the won
receivable. The net impact on 2013 income is $58.80.
13. A (Forward contract cash flow hedge of forecasted foreign currency
transaction)
The krona is selling at a premium in the forward market, causing Pimlico
to pay more dollars to acquire kroner than if the kroner were purchased at
the spot rate on March 1. Therefore, the premium results in an expense of
$10,000 [($.12 $.10) x 500,000].
The Adjustment to Net Income is the amount accumulated in Accumulated
Other Comprehensive Income (AOCI) as a result of recognizing the
Premium Expense and the fair value of the forward contract. The journal
entries would be as follows:
3/1
no journal entries
6/1
Premium Expense
AOCI
AOCI
Forward Contract
Foreign Currency
Forward Contract
Cash
AOCI
Adjustment to Net Income
$10,000
$10,000
$2,500
$2,500
$57,500
2,500
$60,000
$7,500
$7,500
14. C (Option cash flow hedge of forecasted foreign currency transaction)

This is a cash flow hedge of a forecasted transaction. The original cost of
the option is recognized as an Option Expense over the life of the option.
McGraw-Hill/Irwin

9-3
15-17. (Option fair value hedge of a foreign currency firm commitment)

15. B
16. D
The easiest way to solve problems 15 and 16 is to prepare journal entries
for the option fair value hedge and the firm commitment. The journal
entries are as follows:
9/1/13
Foreign Currency Option
Cash
$2,000
$2,000
12/31/13
Gain on Foreign Currency Option
$300
$300
Loss on Firm Commitment

Firm Commitment
[($.79 $.80) x 100,000 = $1,000 x .9803 = $980.30]
Net impact on 2013 net income:
3/1/14
$980.30
$980.30
$300.00
(980.30)
$(680.30)
$700
$700

$2,019.70
Firm Commitment
[($.77 $.80) x 100,000 = $3,000 $980.30 = $2,019.70]
Foreign Currency (C$)
Sales
$77,000
Cash
Foreign Currency (C$)
$80,000
Firm Commitment
$3,000
McGraw-Hill/Irwin
9-4
$2,019.70
$77,000
$77,000
3,000
$3,000

Solutions Manual
15-17. (continued)
Sales
17. B Net cash inflow with option ($80,000 $2,000)
Cash inflow without option (at spot rate of $.77)
Net increase in cash inflow
700.00
(2,019.70)
77,000.00
3,000.00
$78,680.30
$78,000
77,000
$ 1,000
18-20. (Forward contract fair value hedge of a foreign currency firm commitment)
for the forward contract fair value hedge of a firm commitment. The journal
3/1
no journal entries
3/31
Forward Contract
Gain on Forward Contract
($1,250 $0)
$1,250

Firm Commitment
$1,250
$1,250
$1,250
Net impact on first quarter net income is $0.
McGraw-Hill/Irwin

9-5
18-20. (continued)
4/30
Loss on Forward Contract

Forward Contract
[Fair value of Forward Contract is
($.120 $.118) x 500,000 = $1,000;
$1,000 $1,250 = $250]
$250
Firm Commitment
Gain on Firm Commitment
$250
$250
$250
Foreign Currency (pesos)

Sales [500,000 pesos x $.118]
$59,000
Cash [500,000 x $.120]

Foreign Currency (pesos)
Forward Contract
$60,000
Firm Commitment
$1,000
$59,000
$59,000
1,000
$1,000
Net impact on second quarter net income is: Sales $59,000 Loss on
Forward Contract $250 + Gain on Firm Commitment $250 + Adjustment to
Net Income $1,000 = $60,000.
18. A
19. C
20. B Cash inflow with forward contract [500,000 pesos x $.12]
$60,000
Cash inflow without forward contract [500,000 pesos x $.118] 59,000
Net increase in cash flow from forward contract
$ 1,000
McGraw-Hill/Irwin
9-6

Solutions Manual
21-22. (Option cash flow hedge of a forecasted foreign currency transaction)

for the option cash flow hedge of a forecasted transaction. The journal
11/1/13
Cash
$1,500
$1,500
12/31/13
Option Expense
$400
$400
(The option has no intrinsic value at 12/31/13 so the entire change in fair
value is due to a change in time value; $1,500 $1,100 = $400 decrease
in time value. The decrease in time value of the option is recognized as
an expense in net income.)
Option Expense decreases net income by $400.
2/1/14
Option Expense
$1,100
900
Accumulated Other Comprehensive Income (AOCI)
(Record expense for the decrease in time value of the
option; $1,100 $0 = $1,100; and write-up option to fair
value ($.40 $.41) x 200,000 = $2,000 $1,100 = $900.)
Foreign Currency (BRL) [200,000 x $.41]
Cash [200,000 x $.40]
$82,000
Parts Inventory (Cost-of-goods-sold)

Foreign Currency (BRL)
$82,000
$80,000
2,000
$82,000
Accumulated Other Comprehensive Income (AOCI)

McGraw-Hill/Irwin
$2,000
$2,000
$2,000

9-7
21-22. (continued)
Option Expense
$ (1,100)
Cost-of-Goods-Sold
(82,000)
2,000
Decrease in Net Income $ (81,100)
21. B
22. C
23. (10 minutes) (Foreign currency payable -- import purchase)
a. The decrease in the dollar value of the LCU payable from November 1
(60,000 x .345 = $20,700) to December 31 (60,000 x .333 = $19,980) is
recorded as a $720 foreign exchange gain in 2013.
b. The increase in the dollar value of the LCU payable from December 31
($19,980) to January 15 (60,000 x .359 = $21,540) is recorded as a $1,560
foreign exchange loss in 2014.
24. (10 minutes) (Foreign currency receivable export sale)
a. The ostra receivable decreases in dollar value from (50,000 x $1.05)
$52,500 at December 20 to $51,000 (50,000 x $1.02) at December 31,
resulting in a foreign exchange loss of $1,500 in 2013.
b. The further decrease in dollar value of the ostra receivable from $51,000 at
December 31 to $49,000 (50,000 x $.98) at January 10 results in an
additional $2,000 foreign exchange loss in 2014.
25. (10 minutes) (Foreign currency receivable export sale)
9/15
9/30
10/15
Accounts Receivable (FCU) [100,000 x $.40]

Sales
$40,000
$40,000
Accounts Receivable (FCU)

Foreign Exchange Gain
[100,000 x ($.42 $.40)]
$2,000
Foreign Exchange Loss

[100,000 x ($.37 $.42)]
$5,000
Cash
$37,000
$2,000
$5,000
$37,000
26. (10 minutes) (Foreign currency payable -- import purchase)

McGraw-Hill/Irwin
9-8

Solutions Manual
12/1/13
Inventory
Accounts Payable (LCU) [60,000 x $.88]
$52,800
$52,800
12/31/13 Accounts Payable (LCU) [60,000 x ($.82 $.88)] $3,600

1/28/14
$3,600

$4,800
Accounts Payable (LCU) [60,000 x ($.90 $.82)]
Accounts Payable (LCU)
Cash
$4,800
$54,000
$54,000
27. (15 minutes) (Determine U.S. dollar balance for foreign currency transactions)
Problem assigned as graded homework, will provide solution after students
submit their answers
28. (25 minutes) (Prepare journal entries for foreign currency transactions)
2/1/13
4/1/13
6/1/13
8/1/13
Equipment
Accounts Payable (L) [40,000 x $.44]
$17,600
Accounts Payable (L)

Cash [40,000 x $.45]
$17,600
400
Inventory
$14,100
Accounts Receivable (L) [40,000 x $.48]

Sales
$19,200
$18,000
Cost-of-Goods Sold
Inventory [$14,100 x 70%]
10/1/13
$17,600
$14,100
$19,200
$9,870
$9,870
Cash [30,000 x $.49]

Accounts Receivable (L) [$19,200 x 3/4]
$14,700
$14,400

11/1/13
300
Accounts Payable (L) [$14,100 x 2/3]

Foreign Exchange Loss [20,000 x ($.50 $.47)]
Cash [20,000 x $.50]
12/31/13 Foreign Exchange Loss

Accounts Payable (L) [10,000 x ($.52 $.47)]
McGraw-Hill/Irwin
$9,400
600
$10,000
$500
$500

9-9
Accounts Receivable (L) [10,000 x ($.52 $.48)]

2/1/14
3/1/14
$400
$400
Cash [10,000 x $.54]

Accounts Receivable (L) [10,000 x $.52]
$5,400

Cash [10,000 x $.55]
$5,200
300
McGraw-Hill/Irwin
9-10
$5,200
200
$5,500

Solutions Manual
29. (20 minutes) (Determine income effect of foreign currency payable import
purchase)
a.
Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (December 1, 2013), the liability had a dollar value of
$70,400 (AL 160,000 x $.44). On December 31, 2013, the dollar value has
risen to $76,800 (AL 160,000 x $.48). The increase in the dollar value of
the liability creates a foreign exchange loss of $6,400 ($76,800 $70,400)
in 2013.
By March 1, 2014, when the liability is paid, the dollar value has dropped
to $72,000 (AL 160,000 x $.45) creating a foreign exchange gain of $4,800
($72,000 $76,800) to be reported in 2014.
b. Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (September 1, 2013), the liability had a dollar value of
$73,600 (AL 160,000 x $.46). On December 1, 2013, when the liability is
paid, the dollar value has decreased to $70,400 (AL 160,000 x $.44). The
drop in the dollar value of the liability creates a foreign exchange gain of
$3,200 ($70,400 $73,600) in 2013.
c.
Benjamin, Inc. has a liability of AL 160,000. On the date that this liability
was created (September 1, 2013), the liability had a dollar value of
$73,600 (AL 160,000 x $.46). On December 31, 2013, the dollar value has
risen to $76,800 (AL 160,000 x $.48). The increase in the dollar value of
the liability creates a foreign exchange loss of $3,200 ($76,800 $73,600)
in 2013.
By March 1, 2014, when the liability is paid, the dollar value has dropped
to $72,000 (AL 160,000 x $.45) creating a foreign exchange gain of $4,800
($72,000 $76,800) to be reported in 2014.
McGraw-Hill/Irwin

9-11
30. (30 minutes) (Foreign currency borrowing)

a.
9/30/13
Cash
$100,000
Note payable (dudek) [1,000,000 x $.10]
(To record the note and conversion of 1 million
dudeks into $ at the spot rate.)
12/31/13 Interest Expense

$525
Interest Payable (dudek)
[1,000,000 x 2% x 3/12 = 5,000 dudeks x
$.105 spot rate]
(To accrue interest for the period 9/30 12/31/13.)
Note Payable (dudek) [1 m x ($.105 $.10)]
(To revalue the note payable at the spot rate of
$.105 and record a foreign exchange loss.)
$5,000
9/30/14
$1,800
525
Interest Expense [15,000 dudeks x $.12]

Foreign Exchange Loss [5,000 dudeks x
($.12 $.105)]
Cash [20,000 dudeks x $.12]
(To record the first annual interest payment,
record interest expense for the period 1/1 9/30/14,
and record a foreign exchange loss on the
interest payable accrued at 12/31/13.)
$525
$5,000
75
12/31/14 Interest Expense

$625
Interest Payable (dudek) [5,000 dudeks x $.125]
(To accrue interest for the period 9/30 12/31/14.)
$20,000
Note Payable (dudek) [1 m x ($.125 $.105)]
(To revalue the note payable at the spot rate of
$.125 and record a foreign exchange loss.)
McGraw-Hill/Irwin
9-12
$100,000
$2,400
$625
$20,000

Solutions Manual
30. (continued)
9/30/15
Interest Expense [15,000 dudeks x $.15]

Foreign Exchange Loss [5,000 dudeks x
($.15 $.125)]
Cash [20,000 dudeks x $.15]
(To record the second annual interest payment,
record interest expense for the period 1/1 9/30/15,
and record a foreign exchange loss on the interest
payable accrued at 12/31/14.)
Note Payable (dudek)
Cash [1 m dudeks x $.15]
(To record payment of the 1 million dudek note.)
$2,250
625
125
$3,000
$125,000
25,000
$150,000
b. The effective cost of borrowing can be determined by considering the total

interest expense and foreign exchange losses related to the loan and
comparing this with the amount borrowed:
2013
Interest expense
Foreign exchange loss
Total
2014
Interest expense
Foreign exchange losses
Total
2015
Interest expense
Foreign exchange losses
Total
$525
5,000
$5,525 / $100,000 = 5.525% for 3 months =
= 22.1% for 12 months
$2,425
20,075
$22,500 / $100,000 = 22.5% for 12 months
$2,250
25,125
$27,375 / $100,000 = 27.38% for 9 months

Because of appreciation in the value of the dudek, the effective annual
borrowing costs range from 22.1% 36.5%.
McGraw-Hill/Irwin

9-13
30.
(continued)
The net cash flow from this borrowing is:
Cash outflows:
Interest ($2,400 + $3,000)
Principal
Cash inflow:
Borrowing
Net cash outflow
$5,400
150,000
$155,400
(100,000)
$ 55,400
Ignoring compounding, this results in an effective borrowing cost of

approximately 27.7% per year [$55,400 / $100,000 = 55.4% over two years / 2
years = 27.7% per year].
31. (40 minutes) (Forward contract hedge of foreign currency receivable)
a. Cash Flow Hedge
12/1/13
Accounts Receivable (K) [20,000 x $2.00]

Sales
$40,000
$40,000
No entry for the forward contract.

12/31/13 Accounts Receivable (K)
[20,000 x ($2.10-$2.00)]
$2,000
$2,000
AOCI
$2,450.75
Forward Contract
$2,450.75
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
AOCI
$2,000
$2,000
AOCI
$500
Premium revenue
[20,000 x ($2.075 $2.00) = $1,500 x 1/3 = $500]
McGraw-Hill/Irwin
9-14
$500

Solutions Manual
31. (continued)
Impact on 2013 income:
Sales
Premium Revenue
Total
3/1/14
$40,000
2,000
(2,000)
500
$40,500
Accounts Receivable (K)

[20,000 x ($2.25 $2.10)]
$3,000
$3,000
AOCI
$1,049.25
Forward Contract
$1,049.25
[20,000 x ($2.25 $2.075) = $3,500 2,450.75] = $1,049.25
AOCI
$3,000
AOCI
Premium revenue
[$1,500 x 2/3 = $1,000]
$1,000
$3,000
$1,000
Foreign Currency (K) [20,000 x $2.25]

$45,000
Cash [20,000 x $2.075]

Forward Contract
Foreign Currency (K)
$41,500
3,500

Premium revenue
Total
$45,000
$45,000
$3,000
(3,000)
1,000
$1,000
Impact on net income over both periods: $40,500 + $1,000 = $(41,500); equal
to cash inflow.
McGraw-Hill/Irwin

9-15
31. (continued)
b. Fair Value Hedge
12/1/13 Accounts Receivable (K) [20,000 x $2.00]
Sales
$40,000
$40,000

12/31/13 Accounts Receivable (K)
[20,000 x ($2.10 $2.00)]
$2,000
$2,000

$2,450.75
Forward Contract
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
Sales
Total
3/1/14
$2,450.75
$40,000.00
2,000.00
(2,450.75)
$39,549.25

[20,000 x ($2.25 $2.10)]
$3,000
$3,000

$1,049.25
Forward Contract
$1,049.25
[20,000 x (2.25 $2.075) = $3,500 2,450.75 = $1,049.25]
$45,000
Cash [20,000 x $2.075]

Forward Contract
$41,500
3,500

Total
$45,000
$45,000
$3,000.00
(1,049.25)
$1,950.75
Impact on net income over both periods: $39,549.25 + $1,950.75 = $41,500;

equal to cash inflow.
32. (40 minutes) (Forward contract hedge of foreign currency payable)
McGraw-Hill/Irwin
9-16

Solutions Manual
a. Cash Flow Hedge

12/1/13Parts Inventory (COGS)
Accounts Payable (K)
[20,000 x $2.00]
$40,000
$40,000

[20,000 x ($2.10 $2.00)]
$2,000
$2,000
Forward Contract
$2,450.75
AOCI
$2,450.75
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
AOCI
$2,000
$2,000
Premium Expense
$500
AOCI
[20,000 x ($2.075 $2.00) = $1,500 x 1/3 = $500]
Parts inventory (COGS)
Premium Expense
Total
$500
$(40,000)
(2,000)
2,000
(500)
$(40,500)
McGraw-Hill/Irwin

9-17
32. (continued)
3/1/14

[20,000 x ($2.25 $2.10)]
$3,000
$3,000
Forward Contract
$1,049.25
AOCI
$1,049.25
[20,000 x ($2.25 $2.075) = $3,500 2,450.75 = $1,049.25]
AOCI
$3,000
Premium Expense
AOCI
[$1,500 x 2/3 = $1,000]
$1,000
$3,000
$1,000

Cash
Forward Contract
$45,000

$45,000

Premium Expense
Total
$41,500
3,500
$45,000
$(3,000)
3,000
(1,000)
$(1,000)
Impact on net income over both periods: $(40,500) + $(1,000) = $(41,500);

equal to cash outflow.
McGraw-Hill/Irwin
9-18

Solutions Manual
32. (continued)
b. Fair Value Hedge
12/1/13Parts inventory (COGS)
[20,000 x $2.00]
$40,000
$40,000

12/31/13

[20,000 x ($2.10 $2.00)]
$2,000
$2,000
Forward Contract
$2,450.75
$2,450.75
[20,000 x ($2.075 $2.20) = $2,500 x .9803 = $2,450.75]
Parts inventory (COGS)
Total
3/1/14
$(40,000.00)
(2,000.00)
2,450.75
$(39,549.25)

[20,000 x ($2.25 $2.10)]
$3,000
$3,000
Forward Contract
$1,049.25
$1,049.25
[20,000 x ($2.25 $2.075) = $3,500 2,450.75 = $1,049.25]
Cash
Forward Contract
$45,000

$45,000
McGraw-Hill/Irwin
$41,500
3,500
$45,000

9-19
32. (continued)
Total
$(3,000.00)
1,049.25
$(1,950.75)
Impact on net income over both periods: $(39,549.25) + $(1,950.75) =

$(41,500.00); equal to cash outflow.
33. (30 minutes) (Option hedge of foreign currency receivable)
a. Cash Flow Hedge
6/1
Accounts Receivable (P)

Sales [$.045 x 1,000,000 pesos]
$45,000
$45,000

$2,000
Cash
$2,000
6/30

[($.048 $.045) x 1,000,000]
$3,000
$3,000
AOCI
[($.0018 $.0020) x 1,000,000]
$200
$200
Loss on Foreign Currency Option

AOCI
$3,000
$3,000
Option Expense
AOCI
Date
6/1
6/30
9/1
Fair Value
$2,000
$1,800
$1,000
McGraw-Hill/Irwin
9-20
Intrinsic Value
$0
$0
$1,000
$200
$200
Time Value
$2,000
$1,800
$0
Change in Time Value
$ 200
$1,800

Solutions Manual
33. (continued)
9/1

[($.044 $.048) x 1,000,000]
$4,000
$4,000
AOCI
[$1,800 $1,000]
$800
$800
AOCI
$4,000
$4,000
Option Expense
$1,800
AOCI
(Change in time value of option is recognized as expense)
Foreign Currency (P)
$44,000
Cash
$45,000
$1,800
$44,000
$44,000
$1,000
Impact on Net Income over the Two Accounting Periods:

Sales
$45,000
Foreign currency option expense
(2,000)
Impact on net income
$43,000 = Net cash inflow
b. Fair Value Hedge
6/1
6/30

Sales [$.045 x 1,000,000]
$45,000
$45,000

Cash
$2,000

[($.048 $.045) x 1,000,000]
$3,000

McGraw-Hill/Irwin
$2,000
$3,000
$200
$200

9-21
33. (continued)
9/1

[($.044 $.048) x 1,000,000]
$4,000
$4,000
$800
$800

$44,000
Cash
$45,000
$44,000
$44,000
$1,000
Impact on Net Income over the Two Accounting Periods:

Sales
$45,000
3,000
(4,000)
(1,000)
$43,000
= Net cash inflow
McGraw-Hill/Irwin
9-22

Solutions Manual
34. (30 minutes) (Option hedge of foreign currency payable)

a. Cash Flow Hedge
6/1
6/30
Date
6/1
6/30
9/1
Inventory [$.085 x 1,000,000]

Accounts Payable (M)
$85,000
$85,000

Cash
$2,000

[($.088 .085) x 1,000,000]
$3,000

AOCI
[$4,000 $2,000]
$2,000
AOCI
$3,000
Option Expense
AOCI
$1,000*
Fair Value
$2,000
$4,000
$5,000
Intrinsic Value
$0
$3,000
$5,000
$2,000
$3,000
$2,000
$3,000
$1,000
Time Value
$2,000
$1,000
$0
McGraw-Hill/Irwin
Change in Time Value

-$1,000*
-$1,000**

9-23
34. (continued)
9/1

[($.09 $.088) x 1,000,000]
$2,000

AOCI
[$5,000 $4,000]
$1,000
AOCI
$2,000
Option Expense
AOCI
$1,000**
$2,000
$1,000
$2,000
$1,000
Foreign Currency (M)

Cash
$90,000

$90,000
Impact on net income:

Option Expense
McGraw-Hill/Irwin
9-24
$85,000
$5,000
$90,000
($2,000)

Solutions Manual
34.
(continued)
b. Fair Value Hedge

6/1
6/30
9/1
Inventory
[$.085 x 1,000,000]
$85,000

Cash
$2,000

[($.088 $.085) x 1,000,000]
$3,000

[$4,000 $2,000]
$2,000

[($.09 $.088) x 1,000,000]
$2,000

[$5,000 $4,000]
$1,000
$85,000
$2,000
$3,000
$2,000
$2,000
$1,000

Cash
$90,000

$90,000
Impact on net income:

McGraw-Hill/Irwin
$85,000
5,000
$90,000
($5,000)
3,000
($2,000)

9-25
35. (30 minutes) (Forward contract cash flow hedge of foreign currency
denominated asset)
Date
11/01/13
12/31/13
4/30/14
Account Receivable (FCU) Forward

SpotU.S. DollarChange in U.S.Rate to
RateValue Dollar Value
4/30/14
Fair Value
$.53
$53,000
$.52
$.50
$50,000
-$3,000
$.48
$.49
$49,000
-$1,000
$.49
Forward Contract
Change in
Fair Value
$0
$3,8441
+$3,844
$3,0002
- $ 844
$52,000 $48,000 = $4,000 x .961 = $3,844; where .961 is the present value factor for
four months at an annual interest rate of 12% (1% per month) calculated as 1/1.01 4.
2
$52,000 $49,000 = $3,000.
1
2013 Journal Entries

11/01/13 Accounts Receivable (FCU)
Sales
$53,000
$53,000
There is no entry for the forward contract.

$3,000
$3,000
AOCI
$3,000
Forward Contract
AOCI
$3,844
$3,000
$3,844
Discount expense
AOCI
[100,000 x ($.53 $.52) = $1,000 x 2/6 = $333.33]
$333.33
$333.33
The impact on net income for the year 2013 is:

Sales
Net Gain (Loss)
Discount Expense
McGraw-Hill/Irwin
9-26
$53,000.00
(3,000.00)
3,000.00
0.00
(333.33)
$52,666.67

Solutions Manual
35. (continued)
4/30/14

$1,000
AOCI
$1,000
$1,000
$1,000
AOCI
Forward Contract
$844
$844
Discount expense
AOCI
$666.67
Foreign Currency (FCU)

$49,000
Cash
Foreign Currency (FCU)
Forward Contract
$52,000
$666.67
$49,000
$49,000
3,000

Net Gain (Loss)
Discount Expense
$(1,000.00)
1,000.00
McGraw-Hill/Irwin
0.00
(666.67)
$(666.67)

9-27
36. (30 minutes) (Forward contract fair value hedge of net foreign currency
denominated asset)
Account Receivable (Payable) (mongs) Forward
Change in U.S.
Rate to
Date
U.S. Dollar Value
Dollar Value
1/31/14
11/30/13 $265,000 ($159,000)
$.52
12/31/13 $250,000 ($150,000) -$15,000 (-$9,000)
$.48
1/31/14 $245,000 ($147,000) -$ 5,000 (-$3,000)
$.49
Forward Contract
Change in
Fair Value
Fair Value
$0
$7,9211
+$7,921
$6,0002
- $1,921
$104,000 $96,000 = $8,000 x .9901 = $7,921; where .9901 is the present value factor
for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.01.
2
$104,000 $98,000 = $6,000.
1

11/30
Accounts Receivable (mongs)

Sales
[$.53 x 500,000 mongs]
$265,000
Inventory
Accounts Payable
[$.53 x 300,000 mongs]
$159,000
$265,000
$159,000
There is no formal entry for the forward contract.

12/31

$15,000
$15,000
Accounts Payable (mongs)

$9,000
Forward Contract
$7,921
$9,000
$7,921

Sales
Net Foreign Exchange Loss $ (6,000)
7,921
Net Gain (Loss)
McGraw-Hill/Irwin
9-28
$265,000
1,921
$266,921

Solutions Manual
36. (continued)
1/31

$5,000

$3,000

Forward Contract
$1,921
$5,000
$3,000
$1,921
Foreign Currency (mongs)

$245,000

$147,000
Cash
Forward Contract
$104,000
$245,000
$147,000
$98,000
$6,000

Net Foreign Exchange Loss
$(2,000)
(1,921)
$(3,921)
The net effect on the balance sheet is an increase in cash of $104,000 and an
increase in inventory of $159,000 with a corresponding increase in retained
earnings of $263,000 ($266,921 $3,921).
McGraw-Hill/Irwin

9-29
37. (40 minutes) (Forward contract fair value hedge foreign currency receivable
and firm commitment (sale))
a. Foreign Currency Receivable
10/01
Accounts Receivable (LCU)

Sales (100,000 LCUs x $.69)
$69,000
$69,000

12/31

[($.71 $.69) x 100,000]
$2,000
$2,000

$8,910.90
Forward Contract
[($.74 $.65) x 100,000 = $ 9,000 x .9901 = $ 8,910.90]
1/31

[($.72 $.71) x 100,000]
$8,910.90
$1,000
$1,000
Forward Contract
$ 1,910.90
$ 1,910.90
[($.72 $.65) x 100,000 = $ 7,000 loss 8,910.90 = $ 1,910.90 gain]
Foreign Currency (LCU)
$72,000
Cash
Forward Contract
$65,000
$7,000
$72,000
$72,000
The impact on net income:

Sale
McGraw-Hill/Irwin
9-30
$69,000.00
3,000.00
(8,910.90)
1,910.90
$65,000.00 = Cash Inflow

Solutions Manual
37. (continued)
b. Foreign Currency Firm Commitment (Sale)
10/01
There is no entry to record either the sales agreement or the

forward contract as both are executory contracts.
12/31

Forward Contract
$8,910.90
Firm Commitment
$8,910.90
Forward Contract
$1,910.90

Firm Commitment
$1,910.90
1/31
$8,910.90
$8,910.90
$1,910.90
$1,910.90

Sales
$72,000
Cash
Forward Contract
$65,000
$7,000

Firm Commitment
$7,000
$72,000
$72,000
$7,000
Impact on Net Income:

Sales
Net Loss on Forward Contract
Net Gain on Firm Commitment
McGraw-Hill/Irwin
$72,000
(7,000)
7,000
(7,000)
$65,000 = Cash Inflow

9-31
38. (30 minutes) (Forward contract fair value hedge of a foreign currency firm
commitment (purchase))
Forward
Date 10/31
8/1
9/30
10/31
Rate to
Fair Value
$.30
$.325
$.320 (spot)
Forward Contract
Fair Value
$0
$4,950.50 1
$4,0002
Firm Commitment
Change in
Fair Value
+ $4,950.50
$ 950.50
Change in
Fair Value
$0
$(4,950.50)1
$(4,000)2
$0
$4,950.50
+ $ 950.50
($65,000 $60,000) = $5,000 x .9901 = $4,950.5; where .9901 is the present value factor
for one month at an annual interest rate of 12% (1% per month) calculated as 1/1.01.
2
($64,000 $60,000) = $4,000.
a. Journal entries
8/1
There is no entry to record either the purchase agreement or the

forward contract as both are executory contracts.
9/30
Forward Contract
$4,950.50

Firm Commitment
$4,950.50

Forward Contract
$950.50
Firm Commitment
$950.50
Foreign Currency (rupees)

Cash
Forward Contract
$64,000
Inventories (Cost-of-Goods-Sold)
Foreign Currency (rupees)
$64,000
10/31
Firm Commitment
$4,950.50
$4,950.50
$950.50
$950.50
$60,000
4,000
$64,000
$4,000
$4,000
b. Assuming the inventory is sold in the fourth quarter, the net impact on net
income is negative $60,000:
Cost-of-Goods-Sold
Net impact on net income
$(64,000)
4,000
$(60,000)
c. The net cash outflow is $60,000.
McGraw-Hill/Irwin
9-32

Solutions Manual
39. (30 minutes) (Option fair value hedge of a foreign currency firm commitment
(sale))
Firm Commitment
Spot
Date Rate Fair Value
6/1
6/30
9/1
$1.00
$0.99
$0.97
Change in
Fair Value
for 9/1
$(4,901.50)1
$(15,000)2
$ 4,901.50
$10,098.50
Option
Option
Premium
Fair Value
Fair Value
Change in
$0.010
$0.016
$0.030
$5,000
$8,000
$15,000
+ $3,000
+ $7,000
$495,000 $500,000 = $(5,000) x .9803 = $(4,901.5), where .9803 is the present value
factor for two months at an annual interest rate of 12% (1% per month) calculated as
1/1.012.
2
$485,000 $500,000 = $(15,000).
a. Journal Entries
6/1

Cash
$5,000
$5,000
There is no entry to record the sales agreement

because it is an executory contract.
6/30

Firm Commitment
9/1

Firm Commitment
$4,901.50
$4,901.50
$3,000
$3,000
$10,098.50
$10,098.50
$7,000
$7,000
Foreign Currency (lek)

Sales
$485,000
Cash
Foreign Currency (lek)
$500,000
Firm Commitment
$15,000
McGraw-Hill/Irwin
$485,000
$485,000
15,000
$15,000

9-33
39. (continued)
b. Impact on Net Income
The impact on net income for the second quarter is:
$(4,901.50)
3,000.00
$(1,901.50)
The impact on net income for the third quarter is:

Sales
Gain on Foreign Currency option
$485,000.00
(10,098.50)
7,000.00
15,000.00
$496,901.50
The impact on net income over the second and third quarters is:
$495,000 ($496,901.50 $1,901.50)
c. Net Cash Inflow
The net cash inflow resulting from the sale is: $500,000 $5,000 = $495,000
McGraw-Hill/Irwin
9-34

Solutions Manual
40. (20 minutes) (Option fair value hedge of a foreign currency firm commitment
(purchase))
Firm Commitment
Spot
11/20
$.20
a) 12/20 $.21
b) 12/20 $.18
$(500)1
$1,0002
Option
Change in
Premium
Fair Value
for 12/20 Fair Value
$500
+ $1,000
$.008
$.0103
$.0004
Option
Change in
Fair Value
$400
$500
$0
+ $100
$400
$10,000 $10,500 = $(500).

$10,000 $9,000 = $1,000.
3
The premium on 12/20 for an option that expires on that date is equal to the options
intrinsic value. Given the spot rate on 12/20 of $.21, a call option with a strike price of
$.20 has an intrinsic value of $.01 per mark.
4
The premium on 12/20 for an option that expires on that date is equal to the options
intrinsic value. Given the spot rate on 12/20 of $.18, a call option with a strike price of
$.20 has no intrinsic value the premium on 12/20 is $.000.
2
a.
The option strike price ($.20) is less than the spot rate ($.21) on December 20,
the date the parts are to be paid for. Therefore, Big Arber will exercise its
option. The journal entries are as follows:
11/20

Cash
$400
$400
There is no entry to record the purchase agreement

12/20

Firm Commitment
$500

$100
$500
$100
Foreign Currency (pijio)

Cash
$10,500
Parts inventory
$10,500
$10,000
500
$10,500
The following entry is made in the period when the inventory affects net
income through cost-of-goods-sold:
Firm Commitment
$500
$500
40. (continued)
McGraw-Hill/Irwin

9-35
b. The option strike price ($.20) is greater than the spot rate ($.18) on December
20, the date the parts are to be paid for. Therefore, Big Arber will allow the
option to expire unexercised. Foreign currency will be acquired at the spot
rate on December 20. The journal entries are as follows:
11/20

Cash
$400
$400
There is no entry to record the purchase agreement

12/20
Firm Commitment
$1,000
$1,000
$400
$400

Cash
$9,000
Parts Inventory
$9,000
$9,000
$9,000
The following entry is made in the period when the inventory affects net
income through cost-of-goods-sold:
Firm Commitment
McGraw-Hill/Irwin
9-36
$1,000
$1,000

Solutions Manual
41. (20 minutes) (Option cash flow hedge of a forecasted transaction)

a.
12/15/13 Foreign Currency Option
Cash [1 million marks x $.005]
$5,000
$5,000
No journal entry related to the forecasted

transaction.
12/31/13 Foreign Currency Option
AOCI
To recognize the increase in the value of
the foreign currency option with the counterpart
recorded in AOCI.
$3,000
$3,000
Option Expense
$1,000
AOCI
To recognize the decrease in the time value
of the option as expense.
[($.584 $.58) x 1,000,000 = $4,000 $3,000 = $1,000]
3/15/14

AOCI
To recognize the increase in the value of the
Foreign Currency Option with the counterpart
recorded in AOCI.
Option Expense
AOCI
To recognize the decrease in the time value of
the option as expense.
Foreign Currency (marks)
Cash
To record exercise of the foreign currency
option at the strike price of $.58 and close
out the foreign currency option account.
$2,000
$2,000
$4,000
$4,000
$590,000
$580,000
10,000
Parts Inventory
$590,000
Foreign Currency (marks)
To record the purchase of parts and payment
of 1 million marks to the supplier.
McGraw-Hill/Irwin
$1,000
$590,000

9-37
41. (continued)
AOCI
To transfer the amount accumulated in AOCI
as an adjustment to net income in the period
in which the forecasted transaction occurs.
$10,000
$10,000
b. Impact on net income: 2013 Option Expense
$(1,000)
2014 Cost-of-goods-sold
Option Expense
$(590,000)
(4,000)
10,000
$(584,000)
The impact on net income over the two periods is $(585,000).

c. Net cash outflow for parts: $585,000 = ($5,000 + $580,000)
42. (60 minutes) (Unhedged foreign currency transaction; forward contract and
option hedge of foreign currency liability; forward contract and option hedge
of foreign currency firm commitment (purchase))
Part a. Foreign Currency Liability (Unhedged)
9/15
9/30
10/31
Inventory
Accounts Payable (euro)
$200,000

$10,000

$10,000
$200,000
$10,000
$10,000
Foreign Currency (euro)

Cash
$220,000

$220,000
McGraw-Hill/Irwin
9-38
$220,000
$220,000

Solutions Manual
42. (continued)
Part b. Forward Contract Fair Value Hedge of a Foreign Currency Liability
Spot
Date Rate Value
9/15
$1.00
9/30
$1.05
10/31
$1.10
Accounts Payable (C)

Forward
U.S. Dollar
Change in U.S.
Rate to
Dollar Value 10/31 Fair Value
$200,000
$1.06
$210,000
+$10,000
$1.09
$220,000
+$10,000
$1.10
Forward Contract
Change in
Fair Value
$0
$5,940.60 1
+$5,940.60
$8,000.00 2
+$2,059.40
$218,000 $212,000 = $6,000 x .9901 = $5,940.60; where .9901 is the present value
factor for one month at an annual interest rate of 12% (1% per month) calculated as
1/1.01.
2
$220,000 $212,000 = $8,000.
9/15
Inventory
$200,000
$200,000

9/30

Forward Contract
10/31

$10,000
$10,000
$5,940.60
$5,940.60
$10,000
$10,000
Forward Contract
$2,059.40

Cash
Forward Contract
$220,000

$220,000
McGraw-Hill/Irwin

9-39
$2,059.40
$212,000
8,000
$220,000
42. (continued)
Part c. Forward Contract Fair Value Hedge of a Foreign Currency Firm
Commitment (Purchase)
9/15
There is no formal entry for the forward contract or the purchase order.
9/30
Forward Contract
$5,940.60

Firm Commitment
$5,940.60
Forward Contract
$2,059.40

Firm Commitment
$2,059.40

Cash
Forward Contract
$220,000
Inventory
$220,000
10/31
$5,940.60
$5,940.60
$2,059.40
$2,059.40
$212,000
8,000
$220,000
The following entry is made in the period when the inventory affects net income
through cost-of-goods-sold:
Firm Commitment
McGraw-Hill/Irwin
9-40
$8,000
$8,000

Solutions Manual
42. (continued)
Part d. Option Cash Flow Hedge of a Foreign Currency Liability
The following schedule summarizes the changes in the components of the fair
value of the euro call option with a strike price of $1.00 for October 31.
Spot
Date
Rate
09/15 $1.00
09/30 $1.05
10/31 $1.10
1
Option
Fair
Premium
Value
$.035 $7,000
$.070 $14,000
$.100 $20,000
Change
in Fair
Value
+ $7,000
+ $6,000
Intrinsic
Value
$0
$10,0002
$20,000
Time
Value
$7,0001
$4,0002
$03
Change
in Time
Value
- $3,000
- $4,000
Because the strike price and spot rate are the same, the option has no intrinsic
value. Fair value is attributable solely to the time value of the option.
With a spot rate of $1.05 and a strike price of $1.00, the option has an intrinsic
value of $10,000. The remaining $4,000 of fair value is attributable to time value.
The time value of the option at maturity is zero.
9/15
Inventory
Cash
9/30

AOCI
AOCI
Option Expense
AOCI
McGraw-Hill/Irwin
$200,000
$200,000
$7,000
$7,000
$10,000
$10,000
$7,000
$7,000
$10,000
$10,000
$3,000
$3,000

9-41
42. (continued)
10/31

AOCI
AOCI
Option Expense
AOCI
$10,000
$10,000
$6,000
$6,000
$10,000
$10,000
$4,000
$4,000

Cash
$220,000

$220,000
McGraw-Hill/Irwin
9-42
$200,000
$20,000
$220,000

Solutions Manual
42. (continued)
Part e. Option Fair Value Hedge of a Foreign Currency Firm Commitment
(Purchase)
Firm Commitment
Option
Spot
Change in
Premium
Fair Value
for 10/31
9/15
$1.00
$0
$.035
9/30
$1.05
$ (9,901)
$ 9,901 1
$.070
10/31
$1.10
$(20,000)
$10,099
$.100

Fair Value
$ 7,000
$14,000
$20,000
Change in
Fair Value
+$7,000
+$6,000
$210,000 $200,000 = $(10,000) x .9901 = $(9,901), where .9901 is the present value
factor for one month at an annual interest rate of 12% (1% per month) calculated as
1/1.01.
9/15
9/30
10/31

Cash
$7,000

$7,000

Firm Commitment
$9,901

$6,000

Firm Commitment
$7,000
$7,000
$9,901
$6,000
$10,099
$10,099

Cash
$220,000
Inventory
$220,000
$200,000
20,000
$220,000
The following entry is made in the period when the inventory affects net income
through cost-of-goods-sold:
Firm Commitment
McGraw-Hill/Irwin
$20,000
$20,000

9-43

Chapter 09 Solutions

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CHAPTER 9

FOREIGN CURRENCY TRANSACTIONS AND

(Calculate foreign exchange gain/loss on foreign currency transaction)

(Calculate foreign exchange gain/loss on foreign currency borrowing)

(Foreign exchange gain/loss on foreign currency transaction)

The McGraw-Hill Companies, Inc., 2013

(Calculate foreign exchange gain/loss)

(Forward contract cash flow hedge of foreign currency denominated

(Forward contract fair value hedge of foreign currency firm commitment)

10. D (Determine the fair value of a forward contract)

(Calculate foreign exchange gain/loss on foreign currency transaction)

12. B (Forward contract fair value hedge of foreign currency denominated

The McGraw-Hill Companies, Inc., 2013

$2,000 discounted for three months ($2,000 x .9706 = $1,941.20). On

14. C (Option cash flow hedge of forecasted foreign currency transaction)

The McGraw-Hill Companies, Inc., 2013

15-17. (Option fair value hedge of a foreign currency firm commitment)

Loss on Firm Commitment

Loss on Firm Commitment

The McGraw-Hill Companies, Inc., 2013

Loss on Firm Commitment

Net impact on first quarter net income is $0.

The McGraw-Hill Companies, Inc., 2013

Loss on Forward Contract

Foreign Currency (pesos)

Cash [500,000 x $.120]

The McGraw-Hill Companies, Inc., 2013

21-22. (Option cash flow hedge of a forecasted foreign currency transaction)

Parts Inventory (Cost-of-goods-sold)

Accumulated Other Comprehensive Income (AOCI)

The McGraw-Hill Companies, Inc., 2013

Accounts Receivable (FCU) [100,000 x $.40]

Accounts Receivable (FCU)

Foreign Exchange Loss

26. (10 minutes) (Foreign currency payable -- import purchase)

The McGraw-Hill Companies, Inc., 2013

12/31/13 Accounts Payable (LCU) [60,000 x ($.82 $.88)] $3,600

Foreign Exchange Loss

Accounts Payable (L)

Accounts Receivable (L) [40,000 x $.48]

Cash [30,000 x $.49]

Foreign Exchange Gain

Accounts Payable (L) [$14,100 x 2/3]

12/31/13 Foreign Exchange Loss

The McGraw-Hill Companies, Inc., 2013

Accounts Receivable (L) [10,000 x ($.52 $.48)]

Cash [10,000 x $.54]

Accounts Payable (L) [10,000 x $.52]

The McGraw-Hill Companies, Inc., 2013

The McGraw-Hill Companies, Inc., 2013

30. (30 minutes) (Foreign currency borrowing)

12/31/13 Interest Expense

Interest Expense [15,000 dudeks x $.12]

12/31/14 Interest Expense

The McGraw-Hill Companies, Inc., 2013

Interest Expense [15,000 dudeks x $.15]

b. The effective cost of borrowing can be determined by considering the total

= 36.5% for 12 months

The McGraw-Hill Companies, Inc., 2013

Ignoring compounding, this results in an effective borrowing cost of

Accounts Receivable (K) [20,000 x $2.00]

No entry for the forward contract.

The McGraw-Hill Companies, Inc., 2013

Accounts Receivable (K)