Problem 15.

(Fair Value of Forward Contract) – With Present Value

On May 1, 20x2 Sahara Company purchased equipment from Saudi, with payment due on July 30, 20x2 with
payment due on July 30, 20x2.

On May 1, 20X1, Sahara Company entered into a forward contract with a foreign exchange dealer to purchase FC
1,000,000 for delivery on July 30, 20X2.

The relevant directly-quoted exchange rates at various dates follow:

Spot Rates Forward Rates to July 30, 20X2
May 1, 20X2 P1.185 P1.200
May 31, 20X2 1.190 1.210
June 30, 20X2 1.200 1.205
July 30, 20X2 1.215 1.215

Required: Compute the month end fair value of the forward contract (assuming the discount rate is 5%).

May 1 May 31 June 30 July 30

Variable-receivable 1.200 1.210 1.205 1.215
Fixed - pay 1.200 1.200 1.200 1.200
- 0.010 0.005 0.015
FC 1,000,000 1,000,000 1,000,000
Nominal Value 10,000 5,000 15,000
Discount (5%) 2/12 (83)
Discount (5%) 1/12 (21)
Fair Value 9,917 4,979 15,000

Hedge item Hedging instrument

May 1 Dr. Equipment 1,185,000 Dr. FW contract receivable 1,200,000
C r. Accounts payable 1,185,000 C r. FW contract payable 1,200,000
(1,000,000 x 1.185) (1,000,000 x 1.200)

May 31 Dr. Forex loss 5,000 Dr. FW contract receivable 9,917

C r. Accounts payable 5,000 C r. Forex gain 9,917
1,000,000 1.1850 1,185,000
1,000,000 1.1900 1,190,000
5,000

June 30 Dr. Forex loss 10,000 Dr. Forex loss 4,937

C r. Accounts payable 10,000 C r. FW contract receivable 4,937
1,000,000 1.1900 1,190,000 (9,917 - 4,979)
1,000,000 1.2000 1,200,000
10,000

July 30 Dr. Forex loss 15,000 Dr. FW contract receivable 10,021

C r. Accounts payable 15,000 C r. Forex Gain 10,021
1,000,000 1.2000 1,200,000 (4,079 - 15,000)
1,000,000 1.2150 1,215,000
15,000

Dr. Accounts payable 1,215,000 Dr. C ash 1,215,000

C r. C ash 1,215,000 C r. FW contract receivable 1,215,000

Dr. Forward contract payable 1,200,000

C r. C ash 1,200,000
VI - Appendix: Options - Hedging an Exposed Liability

On December 1, 20x4, Janella Company paid cash to purchase 90-day "at-the-money" call option for 60,000
Thailand Baht. The option's purpose is to protect an exposed liability of 60,000 Thailand Baht relating to an
inventory purchase receive on December 1, 20x4 and to be paid on March 1, 20x5.

12/1/20x4 12/31/20x4 3/1/20x5

Spot rate (market price) P1.20 P1.28 P1.27
Strike price (exercise price) 1.20 1.20 1.20
Fair value of call option P360 P5,040 P4,200

Required: Prepare entries to record the above hedging item and hedging instrument (forward contracts)
transactions.

Problem VI
Based on the data given, the following situations can be derived:

Strike price Foreign

(exercise price Currency
Market or or option Option Element Time Intrinsic
Spot Rate price) Situation Existing Value** Value*
12/ 1/20x4 P1.20 P1.20 At-the-money TV P360 P 0
12/31/20x4 P1.28 P1.20 In-the-money TV & IV P240 P4,800
3/ 1/20x5 P1.27 P1.20 In-the-money IV*** P 0 P4,200
TV – time value; IV – intrinsic value.
* (Market price less – option price) x foreign currencies
** Fair value of option – intrinsic value
***time already expired, so need to determine time value unless It is a residual amount.

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

Hedged Item – Importing Transaction

(Exposed Liability) Hedging Instrument – Option Contracts
December 1, 20x4
Transaction Date Date of Inception/Hedging of 90 days Forwards

Inventory (60,000 FC x P1.2)……….. 72,000 Investment in FC Call Option…….. 360

Accounts payable………………. 72,000 Cash……………………………….. 360
To record purchase of goods on To record purchase of call
account using the spot rate on option.
12/1/1/x4.

December 31, 20x4

(Balance Sheet Date an intervening financial reporting date)

FC Transaction Loss………………….. 4,800 Investment in FC Call Option…… 4,680

Account payable………………… 4,800 FC Transaction Gain…. 4,680
[P1.28 – P1.20) x 60,000 FC (P5,040 – P360 = P4,680)
To record a loss on the exposed To record a gain on call option.
liability denominated in foreign
currency.

On March 1, 20x5 (the transaction date and the settlement date), the journal entries are:

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

Accounts payable……………. 600 FC Transaction Loss…………………. 840

FC Transaction gain……. 600 Investment in FC Call Option… 840
[(P1.28 – P1.27) x 60,000 FC…….. (P5,040 – P4,200)
 To record a gain from 12/31/x4 to To record a loss on call option
3/1/x5 on liability denominated in
FC.

Accounts payable…………………… 76,200 Cash……………………………………. 4,200

Cash [(P1.20 x 60,000 FC) + Investment in FC Call Option… 4,200
P4,200, proceeds from call To record the derecognition of
option]………………………….. 76,200 call option on realization.
To record payment of accounts
payable at spot rate.

VII - Appendix: Options - Hedging a Foreign Currency Firm Commitment

Ube Company ordered equipment from foreign supplier on November 20, 20x4 at a price of 60,000 foreign
currencies (FC) when the spot rate was P0.20 per FC. Delivery and payment were scheduled for December 20,
20x4. On November 20, 20x4, Ube acquired a 30-day call option on 60,000 FCs at a strike price of P0.20, paying a
premium of P120. It designates the option as a fair value hedge of a foreign currency firm commitment. The fair
value of the firm commitment is measured by referring to changes in the spot rate. The parts arrive and Ube
makes payment according to schedule. Ube does not close its books until December 31. The relevant exchange
rates and option premiums are as follows:

11/20/20x4 12/20/20x4
Spot rate (market price) P0.20 P0.21
Strike price (exercise price) 0.20 0.20
Fair value of call option P120 P600

Required: Prepare entries to record the above hedging item and hedging instrument (forward contracts)
transactions.

Problem VII
The following table summarizes the succeeding journal entries in relation to hedged item and
hedging instrument:

Firm Commitment Call Option Contract

Total Call Option (CO Premium x FCs)
Spot Fair Change in (CO)Premium Fair Value of Call Change in
Date Rate value Fair Value per FC Option Fair Value
11/20/x4 P0.20 P.002 P120
12/20/x4 P0.21 (P 600)* (P 600)** P.010*** P600 P480
* $12,000 – $12,600 = $(600).
**(P0.21 – P0.20, spot) x 60,000 FC.
***The premium on 12/20 for an option that expires on that date is equal to the option’s intrinsic value. Given the spot
rate on 12/20 of P.21, a call option with a strike price of P.20 has an intrinsic value of P.01 per mark.
Based on the above data, the following situations can be derived:

Strike price Foreign

(exercise price Currency
Market or or option Option Element Time Intrinsic
Spot Rate price) Situation Existing Value** Value*
11/20/20x4 P0.20 P0.20 At-the-money TV P120 P 0
12/20/20x4 P0.21 P0.20 In-the-money IV P 0 P 600
TV – time value; IV – intrinsic value.
* (Market price less – option price) x foreign currencies
** Fair value of option – intrinsic value

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

Hedged Item – Importing Transaction

(Firm Commitment) Hedging Instrument – Option Contracts
November 20, 20x4
Date of Commitment Date of Inception/Hedging of 90 days Forwards

There is no entry to record the sales agreement Investment in FC Call Option…… 120
because it is an executory contract. Cash………………………………. 120
To record purchase of call
option.

December 20, 20x4

Date of Transaction and Settlement Settlement Date/Date of Expiration of Contract

FC Loss on Firm Commitment……… 600 Investment in FC Call Option…… 120

Firm Commitment………………… 600 FC Transaction Gain…. 120
[(P.21 – P0.20) x 60,000 FC] (P600 – P480 = P100)
To record loss on firm commitment To record a gain on call option.
based on spot rate.

Equipment…………………………….. 12,600 Cash……………………………….. 600

Cash [(P0.20 x 60,000 FC) + 12,600 Investment in FC Call Option 600
P600, proceeds from call To record the derecognition of
option]………………………….. call option on realization.
To record purchase of equipment
at spot rate (P.21 x 60,000 FC)

Firm Commitment …………………… 600

Equipment…………………………. 600
To derecognized firm
commitment and adjust the
carrying amount of equipment.

VIII - Appendix: Options - Hedging a Foreign Currency Firm Commitment

The same data in Problem VII, except that the spot rate on December 20, 20x4 is P0.18 instead of P0.21.

The relevant exchange rates and option premiums are as follows:

11/20/20x4 12/20/20x4
Spot rate (market price) P0.20 P0.18
Strike price (exercise price) 0.20 0.20
Fair value of call option P120 N/A

N/A - not applicable

Required: Prepare entries to record the above hedging item and hedging instrument (forward contracts)
transactions.

Problem VIII
The relevant exchange rates and option premiums are as follows:

11/20/20x4 12/20/20x4
Spot rate (market price) P0.20 P0.18
Strike price (exercise price) 0.20 0.20
Fair value of call option P480 N/A
N/A – not applicable

The following table summarizes the succeeding journal entries in relation to hedged item and
hedging instrument:

Firm Commitment Call Option Contract

Total Call Option (CO Premium x FCs)
Spot Fair Change in (CO)Premium Fair Value of Call Change in
Date Rate value Fair Value per FC Option Fair Value
11/20/x4 P0.20 P.002 P120
12/31/x4 P0.18 P1,200* P1,200** P.000*** P 0 (P120)
* P12,000 – P10,800 = P1,200
**(P.20 – P.18) x 60,000 FC
***The premium on 12/20 for an option that expires on that date is equal to the option’s intrinsic value. Given the spot
rate on 12/20 of P.18, a call option with a strike price of P.20 has no intrinsic value – the premium on 12/20 is P.000.

Based on the above data, the following situations can be derived:

Strike price Foreign

(exercise price Currency
Market or or option Option Element Time Intrinsic
Spot Rate price) Situation Existing Value** Value*
11/20/20x4 P0.20 P0.20 In-the-money TV & IV P120 P 0
12/20/20x4 P0.18 P0.20 In-the-money IV P 0 P 0
TV – time value; IV – intrinsic value.
* (Market price less – option price) x foreign currencies
** None since the option price is greater than the market price.

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

Hedged Item – Importing Transaction

(Firm Commitment) Hedging Instrument – Option Contracts
November 20, 20x4
Date of Commitment Date of Inception/Hedging of 90 days Forwards

There is no entry to record the sales agreement Investment in FC Call Option…… 120
because it is an executory contract. Cash………………………………. 120
To record purchase of call
option.

December 20, 20x4

Date of Transaction and Settlement Settlement Date/Date of Expiration of Contract

Firm Commitment……… 1,200 FC Transaction Loss……….…… 120

FC Gain on Firm Commitment 1,200 Investment in FC Call Option 120
[(P0.20 – P0.18) x 60,000 FC] (P120 – P0 = P120)
To record loss on firm commitment To record a gain on call option.
 based on spot rate.

Equipment…………………………….. 12,000 No entry required since the

Cash [(P0.20 x 60,000 FC) + 12,000 Investment in call option has no value
P0, no proceeds from call
option]…………………………..
To record purchase of equipment
at spot rate (P.21 x 50,000 FC)

Equipment……….…………………… 1,200
Firm Commitment………………. 1,200
To derecognized firm
commitment and adjust the
carrying amount of equipment.

IX - Appendix: Options - Hedging a Foreign Currency Forecasted Transaction

On January 1, 20x4, Ging paid P20,400 cash to acquire a call foreign currency option for 1,200,000 Thailand Baht,
with an expiration date of December 31, 20x4. The option hedges 20x5 forecasted importing purchases of
1,200,000 Thailand Baht. At June 30, 20x4, import purchases totaled 900,000 Thailand Baht, of which 720,000
Thailand Baht had been resold to Philippine customers. The firm's fiscal year ends June 30.

1/1/20x4 6/30/20x4 12/31/20x4

Spot rate (market price) P1.15 P1.18 P1.17
Strike price (exercise price) P1.14 P1.14 P1.14
Fair value of call option at 6/30/20x4 P20,400 P52,800 N/A

N/A - not applicable

Required: Prepare entries to record the above hedging item and hedging instrument (forward contracts)
transactions.

Problem IX
Based on the data given in the problem, the following situations can be derived:

Strike price Foreign

(exercise price Currency
Market or or option Option Element Time Intrinsic
Spot Rate price) Situation Existing Value** Value*
1/ 1/20x4 P1.15 P1.14 In-the-money TV & IV P8,400 P12,000
6/30/20x4 P1.18 P1.14 In-the-money TV & IV P4,800 P48,000
12/31/20x4 P1.17 P1.14 In-the-money IV*** P 0 P36,000
TV – time value; IV – intrinsic value.
* (Market price less – option price) x foreign currencies
** Fair value of option – intrinsic value
***time already expired, so need to determine time value unless It is a residual amount.

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

Hedged Item – Importing Transaction

(Forecasted Transaction) Hedging Instrument – Option Contracts
December 1, 20x4
Transaction Date Date of Inception/Hedging of 90 days Forwards

No journal entry is required to record the forecasted Investment in FC Call Option…….. 20,400
transaction. The forward contract is designated as a Cash……………………………….. 20,400
hedge against the exposure to increases in the dollar To record purchase of call
rate on March 1, 20x5. option.

December 31, 20x4

 (Balance Sheet Date an intervening financial reporting date)

No entry required, since it is only a forecasted Investment in FC Call Option…….. 32,400

transaction not guaranteed such as firm commitment. OCI – FC Transaction Gain (B/S) 32,400
[P1.18 – P1.14) x 1,200,000 =
P52,800 – P20,400 = P32,400]
To record a gain on call option.

OCI – FC Transaction Gain (B/S) 25,920

FC Transaction Gain 25,920
To reclassify 80% of OCI to
earnings (720,000 /900,000) =
80% ; (80% × P32,400 = P25,920)

On December 31, 20x4 (the transaction date and the settlement date), the journal entries are:

December 31, 20x4

Date of Transaction and Settlement Settlement Date/Date of Expiration of Contract

FC Transaction Loss…………………. 16,800

Investment in FC Call Option… 16,800
[(P1.17 – P1.14) x 1,200,000
baht = P36,000 – P52,800]
To record a loss on call option

OCI – FC Transaction Gain (B/S)…. 6,480

FC Transaction Gain………….… 6,480
To record reclassify the
remaining P6,480 of FC gain
from OCI to earnings
(180,000/900,000 x P32,400).n
This entry is recorded if PAS 39
par. 98b is adopted.
Cash……………………………………. 36,000
Investment in FC Call Option… 36,000
[(P1.17 – P1.14) x 1,200,000 baht]
To record the derecognition of
call option on realization.

X - Appendix: Options

Lion Corporation, a Philippine firm, entered into several foreign currency transactions during the year. Determine
the effect of each transaction on net income for that current accounting year only. Bear has a June 30 year end.

Required:
a. On January 15, Lion sold $30,000 (Canadian) in merchandise to a Canadian firm, to be paid for on February 15
in Canadian dollars. Canadian dollars were worth P41.85 on January 15 and P41.82 on February 15.

b. On June 1, Lion purchased and received a computer costing 100,000 foreign currencies (FCs) from a foreign
firm. Bear paid for the computer on August 1. On June 1, to reduce exchange risks, Lion purchased a contract
to buy 100,000 FCs in 60 days. Exchange rates are as follows:

Spot Forward
6/1 P0.53 P0.60
6/30 P0.54 P0.58

Discount rate = 6%

c. On June 1, Lion purchased an option to sell 100,000 FC in 60 days to hedge a forecasted sale to a customer.
The option sold for a premium of P6,500 and a strike price of P1.20. The value of the option 6/30 was
P12,500. The spot rate on June 1 was P1.19 and P1.25 on June 30.
Given the following information for a 90-day contract:
Pesos FC
Value Today 3,750 5,000
Interest Rate 4% 7%
3 months interest 37.50 87.50
Value in 3 months ? ?
The sport rate today is 1 FC = .75

What will be the forward rate?

A. 1FC = .75 pesos
B. 1FC = .57 pesos
C. 1FC = .745 pesos
D. 1FC = .70 pesos

Peso Value in 3 months = 3,750 + 37.50 = 3,787.50

FC Value in 3 months = 5,000 + 87.50 = 5,087.50
Fwd rate 3,787.50 ÷ 5,087.50 = .745

IV. Loans Payable Denominated in Foreign Currency

On July 15, 2009, Animo Company borrowed 24,000 Hkg $ from a bank on a 30-day, 15% loan to be repaid in Hkg $.
On August 16, Animo Company settled its loan including interest. Relevant exchange rates (selling spot rates) are
as follows:

July 15, 2009 Hkg$1 = P7.50

August 15, 2009 Hkg$1 = P9.50

Required: Prepare the required journal entries to record the above transactions.

Loans payable

Jul 15 Dr. C ash 180,000

C r. Loans payable 180,000
(24,000 x 7.5)

Aug. 15 Dr. Interest expense 2,250

C r. Interest payable 2,250
(180,000 x 15% x 1/12)

Dr. Forex loss 48,000

C r. Loans payable 48,000

Dr. Forex loss 600

C r. Interest payable 600

Dr. Loans payable 228,000

Dr. Interest payable 2,850
C r. C ash 230,850

24,000 9.5 228,000

300 9.5 2,850
V. Notes Receivable Denominated in Foreign Currency

On December 1, 2009, Maroons Company sold merchandise to a Singaporean customer receiving a 60-day, 12%
promissory note for Sing$32,000. On January 30, 2010 settlement of the note was received from the Singaporean
customer. Relevant exchange rates (buying spot rate) are as follows:

December 1, 2009 - Transaction date Sing$ 1 = P34.20

December 31, 2009 - Balance sheet date Sing$ 1 = P34.85
January 30, 2010 - Settlement date Sing$ 1 = P33.75

Required: Prepare all entries related to the above transactions.

Notes receivable

Dec. 1 Dr. Note receivable 1,094,400

C r. Sales 1,094,400
(32,000 x P34.20)

12/31 Dr. Interest receivable 10,944

C r. Interest income 10,944
32,000 x 12% x 1/12 = (320x34.20)

12/31 Dr. Notes receivable 20,800

C r. Forex gain 20,800

Dr. Interest receivable 208

C r. Forex gain 208

(3,200 x 34.85) 111,520

(320 x 34.85) 11,152

Jan. 30 Dr. Interest receivable 10,800

C r. Interest income 10,800
(32,000 x 12% x 1/12)= 320 x 33.75

Dr. Interest receivable 10,800

C r. Interest income 10,800

Dr. Forex loss 35,200

C r. Note receivable 35,200

Dr. Forex loss 352

C r. Interest receivable 352

Dr. C ash 1,101,600

C r. Note receivable 1,080,000
C r. Interest receivable 21,600