ACC-302-Ch-18-solutions-practice

ACC-302-Ch-18-solutions-practice - EXERCISES DERIVATIVES...

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EXERCISES DERIVATIVES 18–24. The sugar futures contract does not hedge against movements in the price of sugar. Because Yelrome must buy 100,000 pounds of sugar during September to use in the production process, to hedge against sugar price movements Yelrome should enter into a futures contract that obligates it to buy sugar at a fixed price. Instead, Yelrome purchased a futures contract obligating it to sell 100,000 pounds of sugar. As a result, Yelrome is in a very risky position. Consider what will happen to Yelrome on September 30 if the price of sugar is $0.22, $0.24, and $0.26: Sugar Price on September 30 $0.22 $0.24 $0.26 Cost to purchase 100,000 pounds ........... $(22,000) $(24,000) $(26,000) Yelrome receipt (payment) to settle futures contract ....................... 2,000 0 (2,000 ) Net cost of September sugar ................... $ (20,000 ) $(24,000 ) $(28,000 ) Because Yelrome purchased the wrong kind of sugar futures contract, the effect of movements in sugar prices is not hedged but instead is made worse. 18–25. 2005 Jan. 1 Cash ................................................................ 600,000 Loan Payable ............................................ 600,000 No entry is made to record the swap agreement because, as of January 1, 2005, the swap has a fair value of $0. Dec. 31 Interest Expense ............................................ 48,000 Cash ($600,000 × 0.08) ............................ 48,000 31 Other Comprehensive Income ...................... 5,607 Interest Rate Swap (liability) ................... 5,607 * * South Platte must make a $6,000 payment [$600,000 × (8% – 7%)] at the end of 2006 under the swap agreement. This payable has a present
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value of $5,607 (FV = $6,000, N = 1, I = 7% $5,607).
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18–25. (Concluded) 2006 Dec. 31 Interest Expense ............................................ 42,000 Cash ($600,000 × 0.07) .......................... 42,000 31 Interest Rate Swap (liability) ......................... 5,607 Other Comprehensive Income ...................... 393 * Cash (for swap agreement) ................... 6,000 * $5,607 × 0.07 = $393 ($392.49, but rounded up because of effects of prior rounding). 31 Interest Expense ............................................ 6,000 Other Comprehensive Income .............. 6,000 31 Loan Payable ................................................. 600,000 Cash ......................................................... 600,000 18–26. 2005 Sept. 1 Inventory ........................................................ 779,221 HK$ Payable (HK$6,000,000/7.7) ........... 779,221 No entry is made to record the forward contract because, as of September 1, 2005, the forward has a fair value of $0. Dec. 31 HK$ Payable ................................................... 29,221* Gain on Foreign Currency ..................... 29,221 * HK$6,000,000/7.7 – HK$6,000,000/8.0 = $29,221 31 Loss on Forward Contract ............................ 29,221 Forward Contract (liability) .................... 29,221* * Under the forward contract, Ramus must pay $779,221 to purchase HK$6,000,000 on January 1, 2006. Equivalently, Ramus can make a settlement payment if the U.S. dollar value of HK$6,000,000 on January 1, 2006, is less than $779,221, and it can receive a payment if the value is more. In this case, the value is $750,000 (HK$6,000,000/8.0), so Ramus must make a payment. ( Note : In this case, the foreign currency forward contract is technically not accounted for as a fair value hedge. Instead, it is accounted for as a speculation, with gains
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and losses on the derivative being recognized immediately in income. However, because the foreign currency payable is remeasured using the current exchange rate at December 31, with the resulting gain being recognized in income, the gain on the foreign currency payable and the loss on the derivative cancel out one another, and the net effect is the same as if the derivative had been accounted for as a fair value hedge under Statement No. 133 .) 18–26. (Concluded) 2006 Jan. 1 HK$ Payable ................................................... 750,000 Cash (HK$6,000,000/8.0) ........................
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