[yhe1223]

Question 1:

On December 12, year 1, Imp Co. entered into three forward exchange contracts, each to purchase 100,000

euros in 90 days. The relevant exchange rates are as follows:

Spot rate Forward rate

(for 3/12, year 2)

December 12, year 1 $1.86 $1.80

December 31, year 1 $1.96 $1.83

Imp entered into the first forward contract to hedge a purchase of inventory in November of year 1, payable in

March of year 2. At December 31, year 1, what amount of foreign currency transaction gain should Imp include

in income from this forward contract?

$0

$ 3,000

$ 5,000

$10,000

The answer for this one is D$10000,forward contract is a foreign currency transaction. The accounting for a gain or loss on a foreign currency

transaction that is intended to hedge an identifiable foreign currency commitment is considered a foreign currency

hedge and works like a fair value hedge. Gains and losses on this qualifying fair value hedge shall be recognized

currently in earnings. The gain or loss realized on this forward exchange contract is computed by multiplying the

foreign currency amount of the contract by the difference between the spot rate at the balance sheet date and the

2/6/13spot rate at the inception of the contract (or the spot rate last used to measure a gain or loss on that contract for

an earlier period). (1.96-1.86)x100000

Question 2:

The following information pertains to Flint Co.’s sale of 10,000 foreign currency units under a forward contract

dated November 1, of the current year for delivery on January 31 of the following year:

11/1 12/31

Spot-rate $0.80 $0.83

30-day future rates 0.79 0.82

90-day future rates 0.78 0.81

Flint entered into the forward contract in order to speculate in the foreign currency. In Flint’s income statement

for the current year ended December 31, what amount of loss should be reported from this forward contract?

$400

$300

$200

$0

For this one, the answer is A $400,A forward exchange contract (forward contract) is an agreement to exchange different currencies at a specified

future date and at a specified rate (the forward rate). A forward contract is a foreign currency transaction.

Therefore, a gain or loss on a forward contract is included in determining net income in accordance with the

requirements for other foreign currency transactions. A gain or loss on a speculative forward contract (that is, a

contract that does not hedge an exposure) is computed by multiplying the foreign currency amount of the

contract by the difference between the forward rate available for the remaining maturity of the contract and the

contracted forward rate (or the forward rate last used to measure a gain or loss on that contract for an earlier

period).

Foreign currency units 10,000

Times: excess of forward rate available for the remaining maturity of the contract and the contracted

forward rate ($0.82 – $0.78) × $0.04

Loss on forward contract $ 400

Can anyone here help me why these two similar question have different answer?

Got so confused…

Thank you

Step by step
BEC 75 2013/11
FAR 76 2014/10
AUD 87 2015/1
REG 83 2015/3

[yhe1223]

Can anyone help?

Step by step
BEC 75 2013/11
FAR 76 2014/10
AUD 87 2015/1
REG 83 2015/3

[M.O.D.]

For question 2 the company is speculating, and thus the speculative contracts are measured at market value. It sold a contract (Nov 1 to Jan 31 = 90 day) at 0.78 which was valued at 30 days (Dec 31 to Jan 31) at $0.82. Because it a short transaction, it lost money when the value of the contract rose (0.04)

In question 1 it is a fair value hedge against changes in asset values, in this case a commitment to purchase inventory. The company has to recognize gains/losses on that commitment, and it uses the change in the foreign currency hedge to offset those asset gains/losses. As such, it measures the underlying dollar value of the currency itself, not of the contract used to establish that hedge.

BA Mathematics, UC Berkeley
Certificates in CPA and EA preparation, College of San Mateo
CMA I 420, II 470
FAR 91, AUD Feb 2015 (Gleim self-study)

[Anonymous]

yhe1223,

what course are you using?

I have Roger and they have this question too (question 1), with the different answer and explanation. Here:

On December 12, year 11, Imp Co. entered into three forward exchange contracts, each to purchase 100,000 LCU’s in 90 days. The relevant exchange rates are as follows:

Spot rate

Forward rate

(for March 12, year 12)

December 12, year 11 $0.88 $0.90

December 31, year 11 $0.98 $0.93

Imp entered into the first forward contract to hedge a purchase of inventory in November year 1, payable in March year 2. At December 31, year 11, what amount of foreign currency transaction gain should Imp include in income from this forward contract?

a

$0

b

$3,000

c

$5,000

d

$10,000

Right answer is B

You answered correctly

Correct! Since the forward contract was entered into to hedge a liability that is payable in March, it would be accounted for as a cash flow hedge. At December 31, Imp has a contract to purchase 100,000 LCUs on March 12 for $.90 per LCU when the expected exchange rate is $.93 per LCU. As a result, Imp will gain $.03 per LCU and the derivative would be worth (100,000 x $.03) $3,000. The derivative would be adjusted to fair value but any again or loss would be recognized in comprehensive income until such time as the effect on the hedged item. In this case, the hedged item is a payable related to the purchase of inventory, which would have been originally recorded at the spot rate in November, which is not given. At December 31, year 11, the spot rate has increased to $.98, requiring that the liability be increased to $98,000 resulting in a loss. As a result, the gain on the cash flow derivative would be recognized in income in the same period.

I think the answer 3000 is right, but this is fair value hedge

As to your second question, gain/losses from fair value hedges and speculations (derivatives) are recognized in I/S. Gain/loss on cash flow hedge is recognized in OCI

[Author]

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