_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. Hedge of a Forecasted Transaction - Cash Flow Hedge. On December 1, 20x4, Jaja
Company expects to purchase a machine for $1,200 in United States on March 1, 20x5.
The transaction is probable but there is no binding agreement for this purchase and is to
be denominated in dollars. Thus, transaction and settlement for the purchase of the
machine is March 1, 20x5.
Also, on December 1, 20x4, Jaja Company entered into the third forward contract to
purchase $1,200 on March 1, 20x5 for P40.15. Jaja Company designates the forward
contract as a hedging instrument in a cash flow hedge of the exposure to increases in the
dollar rate.
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 – other comprehensive income on December
31, 20x4
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 – other comprehensive income on March 1,
20x5

c. Fair value of forward contract 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 settlemen

I. Cash Flow Hedge - Hedge of a Forecasted Transaction.

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 – Hedging Instrument – Forward Contracts
Forecasted Transaction ( Broad Approach or Gross Position Accounting)
December 1, 20x4
Date of Forecast Date of Inception/Hedging of 90 days Forwards

No journal entry is required to record the forecasted FC Receivable from XD…………… 48,180
transaction. The forward contract is designated as a Pesos Payable to XD 48,180
hedge against the exposure to increases in the dollar (P40.15 x $1,200)
rate on March 1, 20x5. To record forward contract to
buy $1,200 using forward rate.
 December 31, 20x4
(Balance Sheet Date, an intervening financial reporting date)

No entry required, since it is only a forecasted FC Receivable from XD 300

transaction not guaranteed such as firm commitment. OCI – Exchange Gain (B/S) 300
[(P40.40 – P40.15) x $1,200]
To record a gain on foreign
currency to be received from
FC dealer.
FC – foreign currency; OCI - Other Comprehensive Income; B/S – Balance Sheet

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, 2011 (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

OCI – Exchange Loss (B/S)……… 240

FC Receivable from XD……… 240
[(P40.40 – P40.20) x $1,200]
To record a loss on foreign
currency to be received from
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.

Machinery (P40.20 x $1,200)………... 48,240 Cash……………………………………. 48,240

Cash ………………………………… 48,240 Investment in FC…………………. 48,240
To record the purchase of To record conversion of US dollars
equipment for $1,200 at the spot into cash for purchase of
rate of P40.20 machinery.

OCI – Exchange Gain……………….. 60 Other Comprehensive Income

Machinery………………………….. 60 3/1/x5 Loss 240 300… ….12/31/x4 Gain
To remove the gain recognized in 60 60 3/1/x5
OCI and adjust the carrying
amount if the machine that results
from the hedged transaction by
this amount. Also, to record the
basis adjustment of the carrying
value of the equipment. This entry
is recorded if PAS 39 par. 98b is
adopted.
760 C H A P T E R 20
The above entries reflect the transaction involving hedging item and hedging instrument of a
FORECASTED TRANSACTION.
b.
a.1. Gain or loss on hedged item, 12/31/20x4: None, no entry required
a.2. P300 gain, other comprehensive income - [(P40.40 – P40.15) x $1,200]
a.3. None, since no hedging effect transpires.
a.4. Gain or loss on hedged item, 3/1/20x4: None, no entry required for gain or loss. the
only entry is to record the purchase of machinery.
a.5. P240 loss, other comprehensive income - [(P40.40 – P40.20) x $1,200] to be recorded
on March 1, 20x5. The balance of the OCI – gain amounted to P60 computed as
follows:
Other Comprehensive Income
3/1/x5 Loss 240 300… ….12/31/x4 Gain
60 3/1/x5

c. Same with Exposed Liability

c.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

c.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

c.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

2. Not a Hedge Accounting – Speculation. Jaja Company entered into the third forward
contract for speculative purposes in anticipation for a gain, enters into a contract on
December 1, 20x4 to acquire US $1,200 (a currency in which the company has no
 receivables, payables, commitments or forecasted transactions) on March 1, 20x5 at a
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 hedging instrument on December 1, 20x4 income statement.
b.2. Net gain or loss on December 31, 20x4 income statement.
b.3. Gain or loss on hedging instrument 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. Fair value of forward contract 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

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***

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

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

FC Receivable from XD…………… 48,180

Pesos Payable to XD 48,180
(P40.15 x $1,200)
To record forward contract to
buy $1,000 using forward rate.

December 31, 20x4

(Balance Sheet Date an intervening financial reporting date)

FC Receivable from XD 300

FC Transaction Gain 300
[(P40.40 – P40.15) x $1,200]
To record a gain on foreign
currency to be received from
FC dealer.

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

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

FC Transaction Loss………………… 240

762 C H A P T E R 20
FC Receivable from XD…………. 240
[(P40.40 – P40.20) x $1,200]
To record a loss on foreign
currency to be received from
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.

Cash……………………………………. 48,240
Investment in FC…………………. 48,240
To record conversion of US dollars
into cash.

b.
b.1. No gain or loss, since it is the date of hedging.
b.2. P300 gain - [(P40.40 – P40.15) x $1,200], only hedging instrument.
b.3. P240 loss

c.
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.
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
d.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

d.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
 \
II - Cash Flow Hedge - Hedge of a Forecasted Transaction
On December 1, 20x4, Jimmy Company estimates that at least 6,000 units of inventory will be
purchased from a company in United States during March 1, 20x5 for US P1,200. The transaction is
probable, and it is to be denominated in dollars. Sales of the inventory are expected to occur in
the six months following the purchase.
On the date, the company enters into a 90- day forward contract to purchase US P1,200 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: Prepare entries to record the above hedging item and hedging instrument (forward
contracts) transactions.

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.

The journal entries to record the hedged item and hedging instrument are as follows:

Hedged Item – Hedging Instrument – Forward Contracts

Forecasted Transaction ( Broad Approach or Gross Position Accounting)
December 1, 20x4
Date of Forecast Date of Inception/Hedging of 90 days Forwards

No journal entry is required to record the forecasted FC Receivable from XD…………… 48,180
transaction. The forward contract is designated as a Pesos Payable to XD 48,180
hedge against the exposure to increases in the dollar (P40.15 x $1,200)
rate on March 1, 20x5. To record forward contract to
buy $1,200 using forward rate.

December 31, 20x4

(Balance Sheet Date, an intervening financial reporting date)

No entry required, since it is only a forecasted FC Receivable from XD 300

transaction not guaranteed such as firm commitment. OCI – Exchange Gain (B/S) 300
[(P40.40 – P40.15) x $1,200]
To record a gain on foreign
764 C H A P T E R 20
currency to be received from
FC dealer.
FC – foreign currency; OCI - Other Comprehensive Income; B/S – Balance Sheet

Notice that unlike the fair value hedge, there is no offsetting firm commitment entry since this is a
forecasted transaction. The exchange gain or loss is reported in comprehensive income and will
affect the income statement when the inventory is eventually sold. On the balance sheet, the
forward contract is reported as an asset at its fair value of P300, and the offsetting amount is
reported in other comprehensive income (as a gain).

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
Fair value of Forward Contract, 12/1/20x4.. P 300

On March 1, 2011 (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

OCI – Exchange Loss (B/S)……… 240

FC Receivable from XD……… 240
[(P40.40 – P40.20) x $1,200]
To record a loss on foreign
currency to be received from
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.

Inventory (P40.20 x $1,200)………... 48,240 Cash……………………………………. 48,240

Cash ………………………………… 48,240 Investment in FC…………………. 48,240
To record the purchase of To record conversion of US dollars
merchandise for $1,200 at the into cash for purchase of
spot rate of P40.20 machinery.
Suppose that in April 1, 20x5, the inventory is sold for P54,000 cash.
The entries to record the sale and to reclassify the amounts from Other Comprehensive Income
(a P50 gain, including P250 gain on December 31, 20x4, plus the P200 loss on March 1, 20x5) into
earnings are as follows:
April 1, 20x5
Date of Transaction (Sale) Settlement Date/Date of Expiration of Contract

Cash………... 54,000
Sales………………………………… 54,000
To record the sale of merchandise.

Cost of goods sold…………………… 48,240

Inventory, at cost………………… 48,240
To record cost of sales.
OCI – Exchange Loss……………….. 60 Other Comprehensive Income
Cost of goods sold....................... 60 3/1/x5 Loss 240 300… ….12/31/x4 Gain
To remove the gain recognized in 60 60 3/1/x5
OCI and release the OCI to profit
or loss. This entry is recorded in
accordance with PAS 39 par. 98a
is adopted.