[Anonymous]

I’m having trouble understanding a Wiley textbook question (not a big surprise), halp? To retain copyrights or whatnot I’m just using the “essence” of the question, but all of the actual information is changed. If you have the 2012 FAR Wiley book, it’s question 38 on page 723.

A company enters into a forward exchange contract on December 15th to hedge a purchase of inventory that took place in October, Year 1, and payable in February, Year 2. The forward exchange contract is to purchase 100,000 pesos in 90 days. At December 31, Year 1, what amount of foreign currency transaction GAIN from this forward contract should the company include in net income?

The forward rates that apply here are the rate on December 15th of $0.85 and December 31st of $0.88.

The answer is of course a gain of $3,000. I understand the computation… but why is this a GAIN? From 12/15 to 12/31 the value of the dollar decreased as compared to the foreign currency, right? So how is that a gain?

Thanks for halp!

[HumanPiranha]

i always tried to look at it this way: How many beers could i buy per dollar?

If 100,000 beers were .88 cents per beer, you could buy 88,000 beers

if 100,000 beers were .85 cents per beer, you could buy only 85,000 beers

you can now drink three thousand extra beers thanks to the change in the price of the beer. dont drink them all at once though, you might get sick.

you can always try it with a journal entry, too. journal entries help with these sorts of things..

[Anonymous]

Hey thanks for your help!

Turns out this one is covered in the video lectures; since it is a hedge, it is treated opposite to what the hedge is… hedging? So since they bought inventory on credit (liability) the hedge is treated like an asset. Therefore, the increase in the value of the foreign currency can be viewed as an increase in a receivable, and thus a gain.

Terribly confusing, good thing this appears to be a small section of the review!

[Anonymous]

I wouldn't spend a lot of time on that question.

[Minimorty]

@piranha – your math could use some work, but your concept is good. 🙂

[Author]

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