F7_T1_lecture - F7 T1 TURE F? : Financial Instruments,...

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Unformatted text preview: F7 T1 TURE F? : Financial Instruments, Stockholders' Equity, and Cash Flows (Topic 1 Hymn d iration 1. CPA-00029 On September 30 of the current year, a U.S. company entered into a futures contract to hedge the value of its inventory. The inventory was reported on the balance sheet at its cost of $250,000 on September 30. On December 31r the market value of the inventory had decreased to $1‘f51000. The entity had a gain of $751,500 on the futures contract at December 31. What is the proper accounting for this hedging transaction on the December 31 year-end financial statements, assuming that the hedge is considered to be highly effective? a. Dther comprehensive income will increase by $704,500. b. Other comprehensive income will decrease by $500. c. Net income will increase by $4.500. -c __ d. Net income will decrease by $500. 3’? CLASS QUESTION answER 1. CPA-00929 Choice "d" is correct. This hedge is classified as a fair value hedge because it is being used to hedge the value ofthe inventory. Therefore, the gain on the fair value hedge must be recognized in earnings. along with the loss on the inventory-1 for a net decrease in net income of $500: Gain on derivative = $701,500 Loss on inventory = $1?5,000 FV — $250,000 ev = $05,000) Net loss on fair value hedge = $05,000) loss + $T4,500 gain = ${500J loss Choice "a" is incorrect. This hedge is classified as a fair value hedge because it is used to hedge the “'11 'Ilfiillh nvFl-Ihn. in-pnfilnn: TIP-n hfiin nu Jhn Fh:l‘|.:filllh Irina-{ha "hum-Ir inn Hhhnhnfu-AH In hhl‘nir’lfift filhr’lfi llf:l’h 4hr. TURE F? : Financial Instruments, Stockholders' Equity, and Cash Flows (Topic 1 Hymn -- -n 2. CPA-00943 A derivative designated as a fair value hedge must be: “ l. Specifically identified to the hedged asset. liability or unrecognized firm commitment. ll. Expected to be highly effective in offsetting changes in the fair value of the hedged item. a | only. b. H only. :3. Both | and H. d Neither I nor ll. 2. CPA-00943 Choice "c" is correct. Both | and II. A derivative may be designated and qualify as a fair value hedge if a set of criteria relating to the derivative and the hedged item are met. The most significant criteria are: 1. There is formal documentation ofthe hedging relationship between the derivative and the hedged item. 2. The hedge must be expected to be highly effective in offsetting changes in the fair value ofthe hedged item and the effectiveness is assessed at least every 3 months. 3. The hedged item is specifically identified. 4. The hedged item presents exposure to changes in fair value that could affect income. ...
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