ACC 5116 ACCOUNTING FOR SPECIAL TRANSACTIONS

DERIVATIVES and HEDGING FOREIGN EXCHANGE RISK

DERIVATIVES

PAS 39 par. 9 defines a derivative as a financial instrument:

 Whose value changes in response to the change in an underlying variable such as an interest rate, commodity or security
price, or index;
 That requires no initial investment, or one that is smaller than would be required for a contract with similar response to
changes in market factors; and
 That is settled at a future date.

Common examples of Derivatives:

1. Forward contracts
2. Options
3. Swaps

Hedging – is a risk management technique that involves using one or more derivatives or other hedging instruments to offset changes
in fair value or cash flows of hedged items.

Hedged item – is an asset, liability, firm commitment, highly probable forecast transaction, or net investment in a foreign operation.

Hedging instrument – is a designated derivative or a designated non-derivative financial asset or non-derivative financial liability
whose fair value or cash flows are expected to offset changes in fair value or cash flows of a designated hedged item. Examples of
hedging instruments are foreign exchange forward contracts, interest rate swaps and commodity futures contracts.

Hedge Accounting – is the recognition of the effects on profit or loss of changes in the fair value of the hedging instrument and the
hedged item every accounting period.

Foreign Currency Forward Contract – is an agreement to exchange currencies of different countries on a specified future date at the
specified rate (the forward rate). The fair value of a foreign currency forward contract is determined by reference to changes in the
forward rates over the life of the contract. The changes in the forward rate may be discounted to the present value.

Illustration:

On December 1, 2021, Tanjiro Corporation purchased calculators worth 1,000,000 Yen from a Japanese firm, payable on February 1,
2022. To hedge this foreign currency exposure, Tanjiro Corporation bought 1,000,000 Yen on December 1, 2021 for delivery on
February 1, 2022. The following exchange rates applied:

December 1, 2021 60-day forward rate ¥1 = P0.48

30-day forward rate ¥1 = P0.47
Spot rate ¥1 = P0.46

December 31, 2021 60-day forward rate ¥1 = P0.49

30-day forward rate ¥1 = P0.50
Spot rate ¥1 = P0.48

February 1, 2021 60-day forward rate ¥1 = P0.50

30-day forward rate ¥1 = P0.49
Spot rate ¥1 = P0.51

Required: Prepare all the necessary journal entries to record the above transactions on the books of Tanjiro Corporation.

OPTIONS

Option Contracts – is a financial derivative contract that provides the holder the right to buy or sell an underlying in the future, for a
price set today. The price of the option is separate from the price of the underlying.

Foreign Currency Option – gives the holder of the option the right but not the obligation to trade foreign currency in the future.

Underlying – is the asset, financial instrument or any other basis (e.g., forex rates) to which the option is linked, and from where its
value is derived.

Two Basic Types of Options:

1. Call option – an option granting the right to buy the underlying.
2. Put option – an option granting the right to sell the underlying.

1
Premium – is the option price. This is the sum of money that the option buyer pays the option seller to obtain the right being sold in
the option. This money is paid when the option contract is initiated.

Intrinsic value – is the difference between the current market price and the option price of the hedged item.

Time value – is the difference between the options market price and its intrinsic value. Changes in the time value are taken to profit or
loss.

Strike price – is the price at which the holder has the option to buy or sell the item.

Option to buy “in the money” – exists when the market price is more than the strike price.

Option to buy “out the money” – exists when the market price is less than the strike price.

Option to sell “in the money” – exists when the market price is less than the strike price.

Option to sell “out the money” – exists when the market price is more than the strike price.

Option to buy/sell “at the money” – exists when the market price is equal to the strike price.

Illustration: CALL OPTION CONTRACT

On October 1, 2018, Hunt Philippines took delivery from Thailand firm of inventory costing 1,140,000 baht. Payment is due on
January 30, 2019. Concurrently, Hunt Philippines paid P15,700 cash to acquire an at-the-money call option for 1,140,000 baht. Strike
price is P12.40

November 1, 2018 December 31, 2018 January 30, 2019

Market price P12.40 P12.423 P12.427
Fair value of call option P28,200 P30,780

Questions:
1. The foreign exchange gain/loss on hedging instrument due to change in the ineffective portion on December 31, 2018?
2. The foreign exchange gain/loss on hedging instrument due to change in the effective portion on December 31, 2018?
3. The December 31, 2018 net foreign exchange gain/loss in the hedging activity amounted to:
4. The foreign exchange gain/loss on hedging instrument in 2019 if changes in the time value will be included from the
assessment of hedge effectiveness is:

Illustration: PUT OPTION CONTRACT

On December 1, 2018, Kraft Corporation acquired 4,600 shares of Quest Company at a cost of P28 per share. Kraft classifies them as
available-for-sale securities. On this same date, Kraft decides to hedge against a possible decline in the value of the securities by
purchasing at a cost of P11,900, an at-the-money put option to sell the 4,600 shares. The option expires on April 1, 2019. The fair
values of the investment and the option follow:

December 1, 2018 December 31, 2018 April 1, 2019

Quest Company shares:
Per share P28 P26.50 P23.50
Put Option (4,600 shares)
Market value P15,400 P20,700

Questions:
1. The gain/loss on option contract due to change in time value on December 31, 2018:
2. The gain/loss on option contract due to change in intrinsic value in 2019:
3. The 2019 net gain/loss in the hedging activity amounted to:
4. The gain/loss on option contract on December 31, 2018:

Illustration: CASH FLOW HEDGE

On August 1, Escrow Company forecasted the purchase of 60,000 units of inventory from Thailand Company. The purchase would
probably occur on November 2 and require the payment of 2,340,000 baht. It is anticipated that the inventory could be further
processed and delivered to customer by early December. On August 1, the company purchased a call option to buy 2,340,000 baht at a
strike price of 1FC=P7.95. An option premium of P8,850 was paid. Changes in the value of the option will be excluded from the
assessment of hedge effectiveness.

Spot rates and option values are as follows:

Aug 1 Aug 31 Sept. 30 Nov. 2
Spot rate P7.93 P7.952 P7.963 P7.97
Fair value of call option P8,850 P15,690 P34,410 P46,800

2
On November 2, Escrow Company purchased 60,000 units of inventory at a cost of 2,367,000 baht. The option was settled/sold on
November 2 at its fair value. After incurring further processing costs of P240,000, the inventory was sold for P29,400,000 on
December 7.

Questions:
1. The foreign exchange gain/loss on option contract on August 31 that would affect earnings:
2. The foreign exchange gain/loss on option contract on September 30 presented as other comprehensive income:
3. The foreign exchange gain/loss on option contract on November 2 that would affect earnings:
4. What is the net income effect of the above transactions?

EXERCISES
Accounting for Foreign Currency Transactions

FORWARD CONTRACT TO SELL

Problem 1: Zest Company sold merchandise for 111,200 euros to a customer in France on November 02, 2018.
Collection in euros was due on January 31, 2019. On the same date, to hedge this foreign currency exposure, Zest
Company entered into a futures contract to sell 111,200 euros to Metro bank for delivery on January 31, 2019.

Exchange rates for euros on different dates are as follows:

November 2, 2018 December 31, 2018 January 31, 2019

Spot rates P81.90 P80.70 P80.10
30-day futures P82.30 P80.40 P83.90
60-day futures P81.80 P80.30 P82.60
90-day futures P80.60 P81.60 P83.40
120-day futures P80.10 P81.40 P82.80

Questions:
1. What amount will affect profit or loss regarding the hedged item on the financial statement date in 2018?
2. What amount will affect profit or loss regarding the hedging instrument on the settlement date in 2019?
3. As a result of all foregoing transactions, what amount will affect current earnings on the settlement date in
2019?

FORWARD CONTRACT TO PURCHASE

Problem 1: Return Company acquired machinery for $169,200 from a vendor in New York on December 1, 2018.
Payment in US Dollars was due on March 31, 2019. On the same date, to hedge this foreign currency exposure, Return
entered into a futures contract to purchase $169,200 from a BDO for Delivery on March 31, 2019.

Exchange rates for US Dollars on different dates are as follows:

December 1, 2018 December 31, 2018 March 31, 2019
Spot rates P41.40 P42.30 P43.70
30-day futures P42.30 P41.80 P43.20
60-day futures P41.80 P42.20 P42.60
90-day futures P40.60 P42.50 P43.40
120-day futures P42.20 P42.80 P42.90

Questions:
1. What amount will affect profit or loss regarding the hedged item on its settlement date in 2019?
2. What amount will affect profit or loss regarding the hedging instrument on the settlement date in 2018?
3. As a result of all foregoing transactions, what amount will affect current earnings on the settlement date in
2018?

QUIZZER

THEORIES:

1. IAS 39 enumerated the following three types of hedging relationships, except

a. Fair value hedge: a hedge of the exposure to changes in fair value of a recognized asset (AFS Securities) or
liability or an unrecognized firm commitment, or an identified portion of such an asset, liability, or firm
commitment, that is attributable to a particular risk and could affect profit or loss.

3
 b. Cash flow hedge: a hedge of the exposure to variability in cash flows that (1) is attributable to a particular risk
associated with a recognized asset or liability (such as all or some future interest payments on variable rate
debt) or (2) a highly probable forecast transaction and (2) could affect profit or loss.
c. Hedge of the net investment in foreign operation which is the hedge of the amount of the reporting entity's
interest in the net assets of the operation.
d. Undesignated hedge such as hedge of foreign currency denominated payable or receivable.

2. In case of transaction designated as fair value hedge, which of the following statements is correct?

a. The gain or loss from remeasuring the hedging instrument/derivative designated as fair value hedge shall be
recognized in profit or loss.
b. The gain or loss on changes in fair value hedge item (AFS Securities) attributable to the hedged risk shall
adjust the carrying amount of the hedged item and be recognized in profit or loss.
c. Both A and B
d. Neither A nor B

3. In case of hedging transactions designated as cash flow hedge, which of the following statements is correct?
a. The portion of the gain or loss on hedging instrument/derivative designated as cash flow hedge that is
determined to be an effective hedge or the change in intrinsic value of the derivative designated as cash flow
hedge shall be recognized in other comprehensive income.
b. The ineffective portion of the gain or loss on the hedging instrument/derivative designated as cash flow hedge
or the change in time value of the derivative designated as cash flow hedge shall be recognized in profit or
loss.
c. The cumulative other comprehensive income recognized in equity arising from cumulative changes in intrinsic
value of derivatives designated as cash flow hedge shall be reclassified from equity/cumulative OCI to profit or
loss as a reclassification adjustment in the same period during which hedged forecast cash flows affects profits
or loss.
d. All of the above.

4. In case of hedging transaction designated as hedge of net investment in a foreign operation, which of following
statements is correct?
a. The portion of the gain or loss on the hedging instrument/designated as hedge of net investment in foreign
operation that is determined to be an effective hedge shall be recognized in other comprehensive income.
b. The ineffective portion of the gain or loss on the hedging instrument/derivative designated as hedge of net
investment in foreign shall be recognized in profit or loss.
c. Both A and B
d. Neither A nor B

5. In case of hedging transaction considered as “undesignated hedge” such as hedge of foreign currency
denominated accounts payable or foreign currency denominated accounts receivable, which of the following
statements is correct?
a. The exchange differences arising from the changes in measurement of hedged item or foreign currency
denominated accounts payable/receivable shall be recognized in profit or loss.
b. The exchange differences arising from the changes in measurement of hedging instruments/derivative shall be
recognized in profit or loss.
c. Both A and B
d. Neither A nor B

6. How shall an entity account for hedging transaction as hedge of firm commitment?
a. Cash flow hedge only
b. Fair value hedge only
c. Undesignated hedge only
d. IAS 39 gives the entity the option to elect either cash flow hedge or fair value for hedge of firm commitment.

7. It refers to the degree to which changes in the fair value or cash flows of the hedged item that are attributable to
a hedged risk are offset by changes in the fair value or cash flows of hedging instrument.
a. Hedge effectiveness c. Hedge imperfectness
b. Hedge ineffectiveness d. Hedge inappropriateness

8. Under PAS 21, which of the following statements pertains to functional currency?
a. It refers to the currency of the primary economic environment in which the entity operates.
b. It refers to the currency in which the financial statements are presented.
c. It refers to the currency other than the functional currency of the entity.
d. It refers to the type of currency in a given jurisdiction which a creditor may be compelled to accept.

9. Under PAS 21, monetary items are cash or elements of financial statements which are receivable or payable in a
fixed amount of cash. Which of the following is a monetary item?
a. Sales b. Income tax payable c. Unearned revenue d. Inventory

4
10. Which of the following is a nonmonetary item?
a. Prepaid asset b. Loan receivable c. Accounts payable d. Interest payable

11. Under PAS 21, what is the initial measurement of foreign currency denominated transaction?
a. Both monetary and nonmonetary items are measurement initially at transaction or historical rate.
b. Monetary items are measured at closing rate while nonmonetary items are measured at transaction rate.
c. Monetary items are measured at transaction rate while nonmonetary items are measured at closing rate.
d. Both monetary and nonmonetary items are measurement initially at closing rate.

12. Under PAS 21, what is the subsequent measurement of nonmonetary items?
a. Closing rate b. Transaction rate c. Average rate d. Monthly rate

13. Under PAS 21, what is the subsequent measurement of monetary items?
a. Closing rate b. Transaction rate c. Average rate d. Monthly rate

14. Under PAS 21, what is the subsequent measurement of nonmonetary items subsequently measured at fair value?
a. Closing rate c. Exchange rate at the date when the fair value was determined
b. Transaction rate d. Average rate

15. PAS 21 provides that the exchange differences/(gain/loss) arising on the settlement or translating foreign
currency transaction shall be recognized in
a. Profit or loss c. Share premium
b. Other comprehensive income d. Retained earnings

16. Which of the following items will result to foreign currency transaction gainl/loss due to settlement or translation?
a. Foreign currency denominated income statements accounts such as revenue, income, expense or loss.
b. Foreign currency denominated non-monetary assets such as inventory, PPE, intangible asset or prepaid asset.
c. Foreign currency denominated monetary items such as accounts payable, accounts receivable, notes payable,
loans receivable or interest payable.
d. Foreign currency denominated non-monetary liabilities such as unearned revenue, warranty liability, deferred
tax liability.
e. Foreign currency denominated equity accounts such as ordinary shares, preference shares, treasury shares and
share premium.

PROBLEMS:

Use the following data for questions 1 and 2:

Bulacan Company buys goods from Tokyo Company of Japan, worth 2,500,000 yen. The prevailing exchange rate
is P0.1302136/Yen. Bulacan Company settles the account 60 days later when the exchange rate is going at
P0.118376/Yen.

1. What is the forex gain or loss of Bulacan?

a. P29,594 gain b. P29,594 loss c. P1,920,000 loss d. P1,920,000 gain

2. What is the forex gain or loss of Tokyo?

a. P29,594 gain b. P29,594 loss c. P -0- d. Yen 2,500,000

3. On November 15, 2018, Pasig Company, a Philippine trader ordered merchandise FOB shipping point from a
foreign company for 200,000 local currency units, the currency of the foreign company. The merchandise was
shipped and invoiced to Pasig Company on December 10, 2018. Pasig Company paid the invoice on January 10,
2019. The spot rates for each local currency unit on the respective dates are as follows:
November 15, 2018 P4.955 December 31, 2018 P4.875
December 10, 2018 P4.675 January 10, 2019 P4.475

In Pasig Company’s December 31, 2018 income statement, what is the foreign exchange gain or loss?
a. P40,000 gain b. P40,000 loss c. P16,000 loss d. P16,000 gain

4. Pangasinan Holdings, Inc. is the parent company of a group of companies. But also does its own trading. It
bought its fixed asset for $36,000 on November 1, 2012 when the exchange rate was P44.00 to $1.00. At
December 31, 2012, the supplier of the fixed asset has not been paid and the exchange rate at that time was
P46.00 = $1.00. The company has not taken out a forward exchange contract for this payment to hedge adverse
exchange rate movements.

On the statement of financial position of Pangasinan Holdings, Inc., what will be the year-end value for Accounts
Payable to the creditor?
a. P1,584,000 b. P1,656,000 c. P1,854,000 d. P1,566,000

5
5. The following information is available with regard to QC Company’s sale of 10,000 foreign currency units under a
forward contract dated November 1, 2017, for delivery on January 31, 2018:
Nov. 1, 2017 Dec. 31, 2017
Spot rate P 8.00 P 8.30
30-day future rate 7.80 8.20
90-day future rate 7.90 8.10

QC Company entered into the forward contract in order to speculate in the foreign currency. In QC Company’s
income statement for the year ended December 31, 2017, what amount of gain or loss should be reported from
this forward contract?
a. P1,000 loss b. P1,000 gain c. P3,000 loss d. P3,000 gain

6. Manila Company sold merchandise for 90,000 rupees to a customer in India on November 2, 2017. Collection in
India rupees was due on January 31, 2018. On the same date, to hedge this foreign currency exposure, Manila
Company entered into a futures contract to sell 90,000 rupees to a bank for delivery on January 31, 2018.
Exchange rates for rupees on different dates are as follows:
Nov. 2 Dec. 31 Jan. 31
Bid spot rate 81.90 80.70 80.10
30-day futures 82.30 80.40 83.90
60-day futures 81.80 80.30 82.60
90-day futures 80.60 81.60 83.40

What was the net impact in Manila Company’s income in 2018 as a result of this hedging activity?
a. P27,000 loss b. P27,000 gain c. P36,000 gain d. P36,000 loss

7. On November 1, Navotas Co. entered into a firm commitment to acquire machinery. Delivery and passage of title
would be on February 28, 2018 at the price of 12,000 Singaporean dollars. On the same date, to hedge against
unfavorable changes in the exchange rate, S entered into a 120-day forward contract with China bank for 12,000
Singaporean dollars. Exchange rates were as follows:
Spot Rates Forward Rates
November 1, 2017 P 36.25 P 34.30
December 31, 2017 37.40 36.70
February 28, 2018 39.50 39.50

How much is the forex gain or loss recognized by the Navotas Company on the firm commitment on December
31, 2017?
a. P13,800 gain b. P28,800 loss c. P13,800 loss d. P28,800 gain

Use the following data for questions 8 to 10:

Malabon, Inc. imports machinery from a foreign supplier. On June 1, the company received delivery of the
machinery with a cost of 450,000 FC when the spot rate was 1 FC = P1.370. Malabon had paid 50,000 FC, when
the spot rate was 1 FC = P1.350 at the time of placing the order, and the balance was due in 60 days after
delivery. On June 15, Malabon purchased an option to buy FC on July 31 at a strike price of 1 FC = P1.375. The
hedge was designated as a fair value hedge. At the time of the purchase, the out-of-the-money option has a
value of P1,400 and a value of P2,600 at June 30. FC spot rates are as follows:

June 15 1 FC = P1.373
June 30 1 FC = P1.381
July 31 1 FC = P1.385

On July 31, the option was settled and the foreign currency was remitted to the foreign supplier.

8. What is the net forex gain (loss) on the purchase of machinery?

a. P(6,000) b. P6,000 c. P(1,600) d. P(4,400)

9. What is the net gain (loss) on option?

a. P(1,200) b. P(1,400) c. P(2,600) d. P2,600

10. What is the cost of the machinery in the statement of financial position on July 31?
a. P615,500 b. P607,500 c. P616,500 d. P548,000

11. Manila Company purchased merchandise for 300,000 pounds from a vendor in London on November 30, 2017.
Payment in British pounds was due on January 30, 2018. The exchange rates for the British pound were as
follows:
November 30, 2017 December 31, 2017
Spot rate £1.65 £1.62

6
 30-day forward rate 1.64 1.59
60-day forward rate 1.63 1.56

In its December 31, 2017 income statement, what is the amount to be reported by Manila Company as foreign
exchange difference?
a. P9,000 gain b. P3,300 loss c. P3,300 gain d. P9,000 loss

12. Makati Trading sells goods to MBK Co. of Bangkok, for 1,000,000 Baht. The exchange rate at this time is
P0.9875/baht. MBK Co. pays 31 days later when the prevailing exchange rate is P1 = 1 baht.

By reason of exchange fluctuation, how much is the foreign exchange gain or loss if the agreed currency is
Thailand Baht?
a. P12,500 loss b. P12,500 gain c. P12,658 loss d. P12,658 gain

13. Alabang Trading buys goods from Kowloon, Inc. of Hong Kong payable in Hong Kong dollars at a credit term of
60 days. On June 30, 2017, the Statement of Financial Position of Alabang Trading reflects a payable to Kowloon,
Inc. representing purchase of goods worth HK$250,000 when Hong Kong Dollars was going at HK$1 = P1.

What will be Alabang Trading’s foreign exchange gain or loss on June 30, 2017, if the prevailing exchange rate is
HK$0.975/P1?
a. P6,250 loss b. P6,250 gain c. P6,410.25 loss d. P6,410.25 gain

14. Cebu Company entered into a forward contract for speculation. On December 7, 2017, Cebu Company entered
into a forward contract to purchase 48,000 FC in 90 days. The relevant exchange rates are as follows:
Spot rate Forward rate (03/07/13)
December 7, 2017 P 52.59 P 52.65
December 31, 2017 52.63 52.69
March 7, 2018 52.70

At December 31, 2017, what amount of foreign exchange (forex) gain/(loss) should Cebu Company include in the
income statement from this forward contract?
a. P(1,920) b. P960 c. P1,920 d. P(960)

15. Manila Company sold merchandise for 90,000 rupees to a customer in India on November 2, 2017. Collection in
India rupees was due on January 31, 2018. On the same date, to hedge this foreign currency exposure, Manila
Company entered into a futures contract to sell 90,000 rupees to a bank for delivery on January 31, 2018.
Exchange rates for rupees on different dates are as follows:
Nov. 2 Dec. 31 Jan. 31
Bid spot rate 81.90 80.70 80.10
30-day futures 82.30 80.40 83.90
60-day futures 81.80 80.30 82.60
90-day futures 80.60 81.60 83.40

What was the net impact in Manila Company’s income in 2018 as a result of this hedging activity?
a. P27,000 loss b. P27,000 gain c. P36,000 gain d. P36,000 loss

16. Bacolod Company acquired machinery for 150,000 lira from a vendor in Turkey on December 1, 2017. Payment in
Turkey was due on March 31, 2018. On the same date, to hedge this foreign currency exposure, Bacolod
Company entered into a futures contract to purchase 150,000 lira from a bank for delivery on March 31, 2018.
Exchange rates for pounds on different dates are as follows:
Dec. 1 Dec. 31 March 31
Selling spot rate 41.40 42.30 43.70
30-day futures 42.30 41.80 43.20
60-day futures 41.80 42.20 42.60
90-day futures 40.60 42.50 43.40
120-day futures 42.20 42.80 42.90

What was the net impact in Bacolod Company’s income in 2017 as a result of this hedging activity?
a. P75,000 loss b. P75,000 gain c. P90,000 gain d. P90,000 loss

17. On October 31, 2017, Pyramid Philippines took delivery from a British firm of inventory costing £725,000.
Payment is due on January 31, 2018. At the same time, Pyramid paid P8,250 cash to acquire a 90-day call option
for £725,000.
Oct. 31 Dec. 31 Jan. 31
Strike price P 3.60 P 3.60 P 3.60
Spot rate 3.61 3.62 3.64
Forward rate 3.72 3.77 3.78
Fair value of call option P8,250 P17,000 ?

7
 Given the information above, compute for the following:

Foreign exchange gain or loss on option contract due to change in time value on December 31, 2017 if changes
in the time value will be excluded from the assessment of hedge effectiveness, and foreign exchange gain or loss
due to change in intrinsic value on January 31, 2018 if changes in the time value will be excluded from the
assessment of hedge effectiveness.
a. P1,500 gain; P14,500 gain c. P5,250 loss; P14,500 gain
b. P5,250 loss; P7,250 gain d. P1,500 gain; P7,250 gain

18. On May 1, 2017, Palawan Co. anticipated the purchase of 70,000 units of merchandise from a foreign vendor.
The purchase would probably occur on September 25, 2017 and require the payment of 1,250,000 foreign
currencies (FC). On May 1, 2017, the company purchased a call option to buy 1,250,000 FC at a strike price of
1FC = P0.47. An option premium of P14,000 was paid. Changes in the value of the option will be excluded from
the assessment of hedge effectiveness. For the year 2017, the following rates were as follows:
May 1 May 31 June 30 Sep. 25
Spot rate P0.45 P0.49 P0.51 P0.52
FV of call option ? P29,500 P52,000 ?

The foreign exchange gain (loss) on option contract in (1) equity and (2) earnings on June 30:
a. P50,000; P(2,500) b. P(50,000); P(12,000) c. P25,000; P2,500 d. P25,000; P(2,500)

19. On November 1, Navotas Company entered into a firm commitment to acquire machinery. Delivery and passage
of title would be on February 28, 2018 at the price of 12,000 Singaporean dollars. On the same date, to hedge
against unfavorable changes in the exchange rate, S entered into a 120-day forward contract with China bank for
12,000 Singaporean dollars. Exchange rates were as follows:
Spot Rates Forward Rates
November 1, 2017 P 36.25 P 34.30
December 31, 2017 37.40 36.70
February 28, 2018 39.50 39.50

How much is the forex gain or loss recognized by the Navotas Company on the firm commitment on December
31, 2017?
a. P13,800 gain b. P28,800 loss c. P13,800 loss d. P28,800 gain

20. On December 1, 2017, Caloocan Corporation acquired 6,900 shares of Eastwood Company at a cost of P42 per
share. Caloocan classifies them as available-for-sale securities. On this same date, Caloocan decides to hedge
against a possible decline in the value of the securities by purchasing, at a cost of P17,850, an at-the-money put
option to sell the 6,900 shares. The option expires on April 1, 2018. The fair values of the investment and the
options follow:
December 1 December 31 April 1
Eastwood Company shares: Per share P42 P39.75 P35.25
Put option (6,900 shares) Market value P23,100 P46,575

21. The gain/loss on option contract due to change in time value on December 31, 2017 if split accounting is used in
the assessment of hedge effectiveness should be:
a. P15,525 gain b. P10,275 gain c. P10,275 loss d. P15,525 loss

The 2018 net gain/loss in the hedging activity amounted to:

a. P7,575 loss b. P23,475 gain c. P7,575 gain d. P23,475 loss

22. X Trading purchased goods from Y, a company based in France for 1,200,000 Euros (€). The exchange rate at
this time is P1 = €12.5. X paid 30 days later when the prevailing exchange rate is P1 = €16.

How much is the foreign currency gain/loss on the books of X and Y respectively?
a. 21,000 gain and 21,000 loss c. 4,200,000 gain and NIL
b. 21,000 gain and NIL d. 4,200,000 gain and 4,200,000 loss

23. Manila Company purchased merchandise for 300,000 pounds from a vendor in London on November 30, 2018.
Payment in British pounds was due on January 30, 2019. The exchange rates for the British pounds were as
follows:
November 30, 2018 December 31, 2018
Spot rate ฿1.65 ฿1.62
30-day rate 1.64 1.59
60-day rate 1.63 1.56

In its December 31, 2018 income statement, what is the amount to be reported by Manila Company as foreign
exchange difference?
a. 9,000 gain b. 3,367 loss c. 3,367 gain d. 9,000 loss

8
24. Uragon Company and warehouse facilities for $8,340,000 to a customer in Oregon, USA on November 02, 2016.
Collection in US dollars was due on January 31, 2017. On the same date, to hedge this foreign currency
exposure, Uragon Company entered into a forward contract to sell $8,340,000 to Export bank for delivery on
January 31, 2017. Indirect exchange rates on different dates were as follows:

Nov. 2 Dec. 31 Jan. 31

Spot rate .02387 .02457 .02494
30-day futures .02364 .02475 .02278
60-day futures .02392 .02481 .02437
90-day futures .02463 .02403 .02304

How much is the effect on earnings due to hedged item in the December 31, 2016 profit and loss statement?
a. (10,008,000) b. (5,838) c. 10,008,000 d. 5,838

How much is the effect on earnings due to hedged instrument in the 2017 profit and loss statement?
a. 2,502,000 b. 1,585 c. (2,502,000) d. (1,585)

25. On October 1, 2018, the company took delivery from a Bahrain firm of inventory costing 850,000 dinar. Payment
is due on January 30, 2019. Concurrently the company paid P11,700 to acquire an at-the-money call option for
850,000 Bahrain dinar. The strike price is P9.40.

Market Price Fair value of the call

option
October 1, 2018 9.400 11,700
December 31, 2018 9.423 23,200
January 30, 2019 9.435 29,750

If changes in the time value will be excluded from the assessment of hedge effectiveness, what is the forex gain
(loss) on the hedging instrument due to change in the ineffective portion on December 31, 2018?
a. 8,050 b. (8,050) c. 19,550 d. (19,550)

If changes in the time value will be included in the assessment of hedge effectiveness, what is the forex gain
(loss) in the hedging instrument in 2019?
a. 5,250 b. 7,650 c. (4,300) d. 6,550

If split accounting is used in the assessment of hedge effectiveness, what is the forex gain (loss) on the option
contact due to change in intrinsic value on December 31, 2019?
a. 10,200 b. 5,100 c. 12,750 d. (7,500)

26. On May 1, 2018, GYM Co. anticipated the purchase of 245,000 of merchandise from a foreign vendor. The
purchase would probably occur on September 25, 2018 and require the payment of 4,375,000 foreign currencies
(FC).

On May 1, 2018, the company purchased a call option to buy 4,375,000 FC at a strike price of 1FC = P0.77.

An option premium of P49,000 was paid. Changes in the value of the option will be excluded from the
assessment of hedge effectiveness.

For the year 2018, the following rates are as follows:

May 1 May 31 June 30 September 25

Spot Rate P0.75 P0.79 P0.81 P0.82
FV of call option ? P103,250 P182,000 ?

What is the gain (loss) on option contract that would affect equity on June 30?
a. 175,000 b. 175,000) c. (87,500) d. 87,500

What is the gain (loss) on option contract that would affect earnings on June 30?
a. (8,750) b. 42,000 c. 4,200 d. 87,500

27. On October 1, 2018, Manila Philippines took delivery from Ohio, USA firm of inventory costing $1,425,000.
Payment is due on January 30, 2019.

Concurrently, Manila Philippines paid an amount of cash to acquire an at-the-money call option for the
$1,425,000.

 The option premium paid is P19,625

 The spot price at the inception date is P44.40
9
  The spot price at the statement of financial date is P44.423
 The effective portion of the option contract on January 30, 2019 amounts to P38,475
 The gain on the derivative instrument on January 30, 2019 using non-split accounting amounts is to
P3,225

What is the gain (loss) on hedging instrument due to change in the ineffective portion on December 31, 2018?
a. 17,150 b. 5,700 c. (17,150) d. (5,700)

What is the gain (loss) on hedging instrument due to change in the effective portion on December 31, 2019?
a. 5,700 b. (5,700) c. 3,225 d. (3,225)

SOLUTION – Tanjiro Corporation:

December 1, 2021:

Purchases (1M x P0.46) P 460,000

A/P P460,000

FC receivable (1M x P0.48) P 480,000

FC payable P 480,000

December 31, 2021:

Forex loss [(P0.48 – P0.46) x 1M] P 20,000

A/P P 20,000

FC receivable (P0.50 – P0.48) P 20,000

Forex gain P 20,000

February 1, 2022:

A/P (P460,000 + P20,000) P 480,000

Forex loss 30,000
Cash P 510,000

Cash (P0.51 x 1M) P 510,000

Forex gain (P0.51 – P0.50) x 1M P 10,000
FC contract receivable 500,000

FC payable P 480,000
Cash P 480,000

10