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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
Gain on Forward Contract $5,940.60
Foreign Currency (euro) $220,000
Cash $212,000
Forward Contract 8,000
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.
Change Change
Spot Option Fair in Fair Intrinsic Time in Time
Date Rate Premium Value Value Value Value Value
09/15 $1.00 $.035 $7,000 - $0 $7,0001-
1 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.
2 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.
3 The time value of the option at maturity is zero.
9/15 Inventory $200,000
Accounts Payable (euro) $200,000
AOCI $7,000
AOCI $10,000
Gain on Foreign Currency Option $10,000
Accounts Payable (euro) $10,000
Foreign Currency Option $6,000
AOCI $6,000
AOCI $10,000
Gain on Foreign Currency Option $10,000
Option Expense $4,000
AOCI $4,000
42. (continued)
Part e. Option Fair Value Hedge of a Foreign Currency Firm Commitment
(Purchase)
Firm Commitment Option Foreign Currency Option
Spot Change in Premium Change in
Date Rate Fair Value Fair Value for 10/31 Fair Value Fair Value
9/15 $1.00 $0 - $.035 $ 7,000 -
1 ($200,000 – $210,000) 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 Foreign Currency Option $7,000
Cash $7,000
9/30 Foreign Currency Option $7,000
Gain on Foreign Currency Option $7,000
Firm Commitment $10,099
Foreign Currency (euro) $220,000
Cash $200,000
Foreign Currency Option 20,000
Inventory $220,000
Chapter 9 Develop Your Skills
Research Case—International Flavors and Fragrances
The responses to this assignment might change over time as the company
changes its use of foreign currency derivatives or changes the manner in
which it discloses its foreign currency hedging activities in the annual report.
The following responses are based on IFF’s 2012 annual report.
1. In 2012, IFF provided information in the annual report related to its
management of foreign exchange risk in the following locations:
2. Note 14 indicates that IFF uses foreign currency forward contracts to
reduce exposure to cash flow volatility arising from foreign currency
fluctuations associated with intercompany loans, foreign currency
3. Toward the end of Note 14, the company indicates that “the ineffective
Accounting Standards Case—Forecasted Transactions
Questions asked in the case are:
Is management’s intent sufficient to assess that a forecasted transaction is
likely to occur?
If not, what additional evidence must be considered?
Source of guidance: FASB ASC 815-20-55-24 Derivatives and Hedging; Hedging-
ASC 815-20-55-24 states: “An assessment of the likelihood that a forecasted
transaction will take place should not be based solely on management's intent
a. The frequency of similar past transactions
d. The extent of loss or disruption of operations that could result if the
transaction does not occur
e. The likelihood that transactions with substantially different characteristics
The answers to the specific questions asked in the case are:
Management’s intent is not sufficient to assess whether a forecasted
transaction is likely to occur.
Excel Case—Determine Foreign Exchange Gains and Losses
Note to Instructors: At the time this case is assigned to students, please verify
1., 2. and 3. Spreadsheet for the calculation of the foreign exchange gains
(losses) related to Import/Export Company’s foreign currency
transactions for the year 2012.
Foreign
Currency
Type of
Transaction
Amount in
Foreign
Currency
Trans-
action
Date
Exchange
Rate at
Transaction
Date
$ Value on
Transaction
Date
Settle-
ment Date
Exchange
Rate at
Settlement
Date
$ Value on
Settlement
Date
Foreign
Exchange
Gain
(Loss)
Brazilian
real (BRL)
Import
purchase (100,000) 1/10/2012 0.553189 (55,318.90) 5/10/2012 0.511316 (51,131.60) $4,187.30
Swiss
franc
(CHF) Export sale 50,000 1/10/2012 1.05384 52,692.00 4/10/2012 1.087158 54,357.90 1,665.90
Chinese
yuan
(CNY)
Import
purchase (340,000) 1/10/2012 0.158353 (53,840.02) 10/10/2012 0.158893 (54,023.62) (183.60)
Total Net
Foreign
Exchange
Gain
(Loss) $4,524.15
Import/Export Company reported a net foreign exchange gain of $4,524.15 in
2012 income.
Possible discussion points for instructors: Note that all transactions had a $
value on transaction date of approximately $53,000. The size of the foreign
exchange gains and losses reported in the last column differs substantially
Excel Case (continued)
On the other hand, the large appreciation in the value of the CLP over the
same time period resulted in a foreign exchange loss on a foreign currency
payable.
Analysis Case—Cash Flow Hedge
1. Given the $6,000 total Premium Expense, the forward rate on 2/1/15 must
have been $1.06 [($1.06 – $1.00 spot) x 100,000 euros = $6,000].
2. Given that the forward contract is reported as a liability of $1,980 ($2,000 x
3. Given that the cost of goods sold is $103,000, the spot rate on 5/1/15 must
have been $1.03. Linber must pay $1.06 per euro under the forward
4. The Premium Expense of $6,000 reflects the increase in cost for the parts
Internet Case—Historical Exchange Rates
Note to Instructors: At the time this case is assigned to students, please verify
1. Spreadsheets for the calculation of the foreign exchange gains (losses)
related to Pier Ten Company’s foreign currency account receivables.
Currency Code
Foreign
Currency
Account
Receivable
Exchange
Rate on
10/15/12
U.S. Dollar
Value on
10/15/12
Indian rupee INR
1,062,00
0 0.018851 $ 20,019.76
830,00
Malaysian ringgit MYR
61,20
0 0.32704 20,014.85
$ 80,064.34
Currency Code
Foreign
Currency
Account
Receivable
Exchange
Rate on
10/31/12
U.S. Dollar
Value on
10/31/12
Foreign
Exchange
Gain (Loss)
on 10/31/12
Indian rupee INR
1,062,00
0 0.018586 $ 19,738.33 $ (281.43)
Philippine peso PHP
830,00
0 0.024307 20,174.81 165.17
1,578,00
Internet Case (continued)
Currency Code
Foreign
Currency
Account
Receivable
Exchange
Rate on
11/15/12
U.S. Dollar
Value on
11/15/12
Foreign
Exchange
Gain (Loss)
on 11/15/12
Indian rupee INR
1,062,00
0 0.018265 $ 19,397.43 $ (340.90)
Philippine peso PHP
830,00
0 0.024279 20,151.57 (23.24)
Japanese yen JPY
1,578,00
0 0.012319 19,439.38 (304.55)
61,20
Currency Code
Foreign
Currency
Account
Receivable
U.S. Dollar
Value on
10/15/12
U.S. Dollar
Value on
11/15/12
Net Foreign
Exchange
Gain (Loss)
1,062,00
Japanese yen JPY
1,578,00
0 20,020.09 19,439.38 (580.70)
Malaysian ringgit MYR
61,20
0 20,014.85 19,983.70 (31.15)
2. Pier Ten would have reported a net foreign exchange loss of $320.44 in the
fiscal year ended October 31, 2012 and a net foreign exchange loss of
3. Assuming a strike price equal to the October 15, 2012 spot rate, the only
foreign currency transactions for which the purchase of a put option
Internet Case (continued)
put option in INR had been acquired, and the net cash flow from the JPY
receivable would have been $480.70 greater ($580.70 FX loss avoided less
$100.00 cost of the option) if a put option in JPY had been acquired.
$100.00 (the cost of the option).
Communication Case—Forward Contracts and Options
To: Mr. Dewey Nukem, CEO, Palmetto Bug Extermination Company (PBEC)
The primary advantage of using forward contracts to hedge foreign exchange
risk is that there is no cost to enter into them. The disadvantage is that the
company is obligated to exchange foreign currency for dollars at the
contracted forward rate. Depending upon the future spot rate, this may or
Exporters sometimes use forward contracts to hedge export sales (import
purchases) when the foreign currency is selling at a forward premium
(discount) as this locks in premium revenue (discount revenue). The risk
associated with this strategy is that the customer may or may not pay on
Since PBEC is making import purchases, it has more control over the timing
of when it will need foreign currency. In that case, it should be safe to enter
The bottom line is that there is no right or wrong answer to the question
