Chapter 09

Foreign Currency Transactions and Hedging Foreign Exchange Risk

Multiple Choice Questions
1. Pigskin Co., a U.S. corporation, sold inventory on credit to a British company on April
8, 2008. Pigskin received payment of 35,000 British pounds on May 8, 2008. The
exchange rate was $1 = 0.65 on April 8 and $1 = 0.70 on May 8. What amount of
foreign exchange gain or loss should be recognized? (round to the nearest dollar)
D. $3,846 loss
Norton Co., a U.S. corporation, sold inventory on December 1, 2008, with payment of
10,000 British pounds to be received in sixty days. The pertinent exchange rates were
as follows:
Dec 1 Spot rate $1.7241 Dec 31 Spot rate $1.8182 Jan 30 Spot Rate 1.6666
2. For what amount should Sales be credited on December 1?
D. $17,241
3. What amount of foreign exchange gain or loss should be recorded on December 31?
E. $941 gain
4. What amount of foreign exchange gain or loss should be recorded on January 30?
B. $1,516 loss
Brisco Bricks purchases raw material from its foreign supplier, Bolivian Clay, on May 8.
Payment of 2,000,000 foreign currency units (FC) is due in 30 days. May 31 is Brisco's
fiscal year-end. The pertinent exchange rates were as follows:
May 8 Spot Rate $1.25 May 31 Spot rate $1.26 Jun 7 Spot Rate $1.20
5. For what amount should Brisco's Accounts Payable be credited on May 8?
A. $2,500,000
6. How much Foreign Exchange Gain or Loss should Brisco record on May 31?
C. $20,000 loss
7. How much U.S. $ will it cost Brisco to finally pay the payable on June 7?
E. $2,400,000
8. On June 1, CamCo received a contract to sell inventory for 500,000. The sale would
take place in 90 days. CamCo immediately signed a 90-day forward contract to sell the
yen as soon as they are received. The spot rate on June 1 was $1 = 240 and the 90day forward rate was $1 = 234. At what amount would CamCo record the Forward
Contract on June 1?

B. $0
9. Belsen purchased inventory on December 1, 2008. Payment of 200,000 stickles was
to be made in sixty days. Also on December 1, Belsen signed a contract to purchase
200,000 in sixty days. The spot rate was $1 = 2.80 and the 60-day forward rate was
$1 = 2.60. On December 31, the spot rate was $1 = 2.90 and the 30-day forward rate
was $1 = 2.62. Assume an annual interest rate of 12% and a fair value hedge. The
present value for one month at 12% is .9901.
In the journal entry to record the establishment of a forward exchange contract, at what
amount should the Forward Contract account be recorded on December 1?
E. $0, since there is no cost, there is no value for the contract at this date
10. Meisner Co. ordered parts costing 100,000 for a foreign supplier on May 12 when
the spot rate was $.24 per stickle. A one-month forward contract was signed on that
date to purchase 100,000 at a forward rate of $.25 per stickle. On June 12, when the
parts were received and payment was made, the spot rate was $.28 per stickle. At what
amount should inventory be reported?
B. $28,000

Car Corp. (a U.S.-based company) sold parts to a Korean customer on December 16,
2008, with payment of 10 million Korean won to be received on January 15, 2009. The
following exchange rates applied:
Date
Spot
Forward
December 16, 2008
$.00090 $.00098
December 31, 2008
$.00092 $.00093
January 15, 2009 $.00095 $.00095
11. Assuming a forward contract was not entered into, what would be the net impact on
Car Corp.'s 2008 income statement related to this transaction?
C. $200 gain
12. Assuming a forward contract was entered into, what would be the net impact on Car
Corp.'s 2008 income statement related to this transaction? Assume an annual interest
rate of 12% and a fair value hedge. The present value for one month at 12% is .9901.
E. $295.05 loss
13. Assuming a forward contract was entered into on December 16, what would be the
net impact on Car Corp.'s 2009 income statement related to this transaction?
A. $500 gain

14. Mills Inc. had a receivable from a foreign customer that is due in the local currency
of the customer (stickles). On December 31, 2008, this receivable for 200,000 was
correctly included in Mills' balance sheet at $132,000. When the receivable was
collected on February 15, 2009, the U.S. dollar equivalent was $144,000. In Mills' 2009
consolidated income statement, how much should have been reported as a foreign
exchange gain?
E. $12,000
15. A spot rate may be defined as
A. The price a foreign currency can be purchased or sold today
16. The forward rate may be defined as
B. The price today at which a foreign currency can be purchased or sold in the future
17. Which statement is true regarding a foreign currency option?
D. A foreign currency option gives the holder the right but not the obligation to buy or
sell foreign currency in the future
18. A U.S. company sells merchandise to a foreign company denominated in U.S.
dollars. Which of the following statements is true?
C. No foreign exchange gain or loss will result
19. A U.S. company sells merchandise to a foreign company denominated in the foreign
currency. Which of the following statements is true?
A. If the foreign currency appreciates, a foreign exchange gain will result
20. A U.S. company buys merchandise from a foreign company denominated in U.S.
dollars. Which of the following statements is true?
C. No foreign exchange gain or loss will result
21. A U.S. company buys merchandise from a foreign company denominated in the
foreign currency. Which of the following statements is true?
D. If the foreign currency appreciates, a foreign exchange loss will result
22. SFAS 133 provides guidance for hedges of all the following sources of foreign
exchange risk except
E. Deferred foreign currency gains and losses
23. All of the following data may be needed to determine the fair value of a forward
contract at any point in time except
C. The future spot rate

24. A forward contract may be used for which of the following?

1) A fair value hedge of an asset.
2) A cash flow hedge of an asset.
3) A fair value hedge of a liability.
4) A cash flow hedge of a liability.
E. 1, 2, 3 and 4
25. A company has a discount on a forward contract for an asset. How is the discount
recognized over the life of the contract?
C. It is charged to accumulated other comprehensive income
26. A speculative derivative would be similar to which type of hedge?
B. An option designated as a fair value hedge
27. Which of the following statements is true concerning hedge accounting?
D. Hedges of foreign currency firm commitments are used for future sales or purchases
28. All of the following hedges are used for future purchase/sale transactions except
E. Forward contracts used to hedge a foreign currency denominated liability
On December 1, 2007, Keenan Company, a U.S. firm, sold merchandise to Velez
Company of Spain for 150,000 euro. Payment is due on February 1, 2008. Keenan
entered into a forward exchange contract on December 1, 2007, to deliver 150,000 euro
on February 1, 2008 for $.97. Keenan chose to use a foreign currency option to hedge
this foreign currency asset designated as a cash flow hedge. Relevant exchange rates
follow:
Date
Spot
December 17, 2007
December 31, 2007
February 1, 2008 $.94

Forward
$.97
$.05
$.95
$.04
$.03

29. Compute the value of the foreign currency option at December 1, 2007.
D. $7,500
30. Compute the value of the foreign currency option at December 31, 2007.
A. $6,000
31. Compute the value of the foreign currency option at February 1, 2008.
B. $4,500

32. Compute the U.S. dollars received on February 1, 2008.

C. $145,500
33. Which of the following approaches is used in the United States in accounting for
foreign currency transactions?
B. Two-transaction perspective; accrue foreign exchange gains and losses
34. When a U.S. company purchases parts from a foreign company, which of the
following will result in no foreign exchange gain or loss?
A. The transaction is denominated in U.S. dollars
35. Alpha, Inc., a U.S. company, had a receivable from a customer that was
denominated in pesos. On December 31, 2008, this receivable for 75,000 pesos was
correctly included in Alpha's balance sheet at $8,000. The receivable was collected on
March 2, 2009, when the U.S. equivalent was $6,900. How much foreign exchange gain
or loss will Alpha record on the income statement for the year ended December 31,
2009?
A. $1,100 loss
On April 1, 2007, Shannon Company, a U.S. company, borrowed 100,000 euros from a
foreign lender by signing an interest-bearing note due April 1, 2008. The dollar value of
the loan was as follows:
Date
Amount
April 1, 2007
$ 97,000
Dec 31, 2007
$103,000
April 1, 2008
$105,000
36. How much foreign exchange gain or loss should be included in Shannon's 2007
income statement?
D. $6,000 loss
37. How much foreign exchange gain or loss should be included in Shannon's 2008
income statement?
D. $2,000 loss
38. Angela, Inc., a U.S. company, had a euro receivable from exports to Spain and a
British pound payable resulting from imports from England. Angela recorded foreign
exchange gain related to both its euro receivable and pound payable. Did the foreign
currencies increase or decrease in dollar value from the date of the transaction to the
settlement date?

B. B above Euro Increase = Pound Decrease

39. Frankfurter Company, a U.S. company, had a ruble receivable from exports to Russia
and a euro payable resulting from imports from Italy. Frankfurter recorded foreign
exchange loss related to both its ruble receivable and euro payable. Did the foreign
currencies increase or decrease in dollar value from the date of the transaction to the
settlement date?
C. C above Ruble Decrease = Euro Increase
Parker Corp., a U.S. company, had the following foreign currency transactions during
2009:
(1.) Purchased merchandise from a foreign supplier on July 5, 2009 for the U.S. dollar
equivalent of $80,000 and paid the invoice on August 3, 2009 at the U.S. dollar
equivalent of $82,000.
(2.) On October 1, 2009 borrowed the U.S. dollar equivalent of $872,000 evidenced by a
non-interest-bearing note payable in euros on October 1, 2009. The U.S. dollar
equivalent of the note amount was $860,000 on December 31, 2009 and $881,000 on
October 1, 2010.
40. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2009?
C. $10,000 gain
41. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2010?
D. $21,000 loss
Winston Corp., a U.S. company, had the following foreign currency transactions during
2008:
(1.) Purchased merchandise from a foreign supplier on July 16, 2008 for the U.S. dollar
equivalent of $47,000 and paid the invoice on August 3, 2008 at the U.S. dollar
equivalent of $54,000.
(2.) On October 15, 2008 borrowed the U.S. dollar equivalent of $315,000 evidenced by
a non-interest-bearing note payable in euros on October 15, 2008. The U.S. dollar
equivalent of the note amount was $295,000 on December 31, 2008 and $299,000 on
October 15, 2009.
42. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2008?
D. $13,000 gain
43. What amount should be included as a foreign exchange gain or loss from the two
transactions for 2009?

E. $4,000 loss
44. Williams, Inc., a U.S. company, has a Japanese yen account receivable resulting from
an export sale on March 1 to a customer in Japan. The exporter signed a forward
contract on March 1 to sell yen and designated it as a cash flow hedge of a recognized
receivable. The spot rate was $.0094 and the forward rate was $.0095. Which of the
following did the U.S. exporter report in net income?
B. Premium revenue
45. Larson Company, a U.S. company, has an India rupee account receivable resulting
from an export sale on September 7 to a customer in India. Larson signed a forward
contract on September 7 to sell rupees and designated it as a cash flow hedge of a
recognized receivable. The spot rate was $.023 and the forward rate was $.021. Which
of the following did the U.S. exporter report in net income?
B. Premium revenue
46. Primo Inc., a U.S. company, ordered parts costing 100,000 rupee from a foreign
supplier on July 7 when the spot rate was $.025 per rupee. A one-month forward
contract was signed on that date to purchase 100,000 rupee at a rate of $.027. The
forward contract is properly designated as a fair value hedge of the 100,000 rupee firm
commitment. On August 7, when the parts are received, the spot rate is $.028. At what
amount should the parts inventory be carried on Primo's books?
E. $2,800
47. Lawrence Company, a U.S. company, ordered parts costing 1,000,000 Thailand
bahts from a foreign supplier on July 7 when the spot rate was $.025 per baht. A onemonth forward contract was signed on that date to purchase 1,000,000 bahts at a rate
of $.027. The forward contract is properly designated as a fair value hedge of the
1,000,000 baht firm commitment. On August 7, when the parts are received, the spot
rate is $.028. What is the amount of accounts payable that will be paid at this date?
E. $28,000
48. On December 1, 2009, Joseph Company, a U.S. company, entered into a threemonth forward contract to purchase 50,000 pesos on March 1, 2010. The following U.S.
dollar per peso exchange rates apply:
Date
Spot
December 1, 2009
December 31, 2009
March 1, 2010
$.089

$.092
$.090

Forward (mar 01, 2010)

$.105
$.095
N/A

Joseph's incremental borrowing rate is 12 percent. The present value factor for two
months at an annual interest rate of 12 percent is .9803. Which of the following is
included in Joseph's December 31, 2009 balance sheet for the forward contract?
E. $490.15 liability
49. On April 1, Quality Corporation, a U.S. company, expects to order merchandise from
a German supplier in three months, denominating the transaction in euros. On April 1,
the spot rate is $1.19 per euro and Quality enters into a three-month forward contract
to purchase 400,000 euros at a rate of $1.20. At the end of three months, the spot rate
is $1.21 per euro and Quality orders and receives the merchandise, paying 400,000
euros. What are the effects on net income from these transactions?
C. $4,000 Premium Expense plus a $4,000 negative Adjustment to Net Income when the
merchandise is received
50. On August 31, Ram Corporation, a U.S. company, expects to order merchandise
from a German supplier in three months, denominating the transaction in euros. On
August 31, the spot rate is $1.19 per euro and Quality enters into a three-month forward
contract to purchase 600,000 euros at a rate of $1.20. At the end of three months, the
spot rate is $1.21 per euro and Ram orders and receives the merchandise, paying
600,000 euros. What are the effects on net income from these transactions?
C. $6,000 Premium Expense plus a $6,000 negative Adjustment to Net Income when the
merchandise is sold
51. Woolsey Corporation, a U.S. company, expects to order goods from a British supplier
at a price of 250,000 pounds, with delivery and payment to be made on October 24. On
July 24, Woolsey purchased a three-month call option for 250,000 British pounds and
designated this option as a cash flow hedge of a forecasted foreign currency
transaction. The following exchange rates apply:
Option strike price
$2.17
Option cost
$4,000
July 24 spot rate $2.17
October 24 spot rate
$2.13
What amount will Woolsey include as an option expense in net income during the period
July 24 to October 24?
A. $4,000
52. Atherton, Inc., a U.S. company, expects to order goods from a foreign supplier at a
price of 100,000 lira, with delivery and payment to be made on April 17. On January 17,
Atherton purchased a three-month call option on 100,000 lira and designated this option

as a cash flow hedge of a forecasted foreign currency transaction. The following

exchange rates apply:
Option strike price
$4.34
Option cost
$5,000
July 24 spot rate $4.34
October 24 spot rate
$4.26
What amount will Atherton include as an option expense in net income during the
period January 17 to April 17?
D. $5,000
On May 1, 2007, Mosby Company received an order to sell a machine to a customer in
Canada at a price of 2,000,000 Mexican pesos. The machine was shipped and payment
was received on March 1, 2008. On May 1, 2007, Mosby purchased a put option giving it
the right to sell 2,000,000 pesos on March 1, 2008 at a price of $190,000. Mosby
properly designates the option as a fair value hedge of the peso firm commitment. The
option cost $3,000 and had a fair value of $3,200 on December 31, 2007. The following
spot exchange rates apply:
Date
May 1, 2007
Dec 31, 2007
March 1, 2008

Spot rate
$0.095
$0.094
$0.089

Mosby's incremental borrowing rate is 12 percent and the present value factor for two
months at a 12 percent annual rate is .9803.
53. What was the net impact on Mosby's 2007 income as a result of this fair value
hedge of a firm commitment?
A. $1,760.60 decrease

54. What was the net impact on Mosby's 2008 income as a result of this fair value
hedge of a firm commitment?
D. $188,760.60 increase
55. What was the net increase or decrease in cash flow from having purchased the
foreign currency option to hedge this exposure to foreign exchange risk?
C. $9,000 increase

On March 1, 2007, Mattie Company received an order to sell a machine to a customer

in England at a price of 200,000 British pounds. The machine was shipped and payment
was received on March 1, 2008. On March 1, 2007, Mattie purchased a put option giving
it the right to sell 200,000 British pounds on March 1, 2008 at a price of $380,000.
Mattie properly designates the option as a fair hedge of the pound firm commitment.
The option cost $2,000 and had a fair value of $2,200 on December 31, 2007. The
following spot exchange rates apply:
Date
Spot rate
March 1, 2007
$1.90
Dec 31, 2007
$1.89
March 1, 2008
$1.84
Mattie's incremental borrowing rate is 12 percent and the present value factor for two
months at a 12 percent annual rate is .9803.
56. What was the net impact on Mattie's 2007 income as a result of this fair value
hedge of a firm commitment?
B. $1,760.60 decrease
57. What was the net impact on Mattie's 2008 income as a result of this fair value
hedge of a firm commitment?
E. $379,760.60 increase
58. What was the net increase or decrease in cash flow from having purchased the
foreign currency option to hedge this exposure to foreign exchange risk?
B. $10,000 increase
On October 1, 2007, Eagle Company forecasts the purchase of inventory from a British
supplier on February 1, 2008, at a price of 100,000 British pounds. On October 1, 2007,
Eagle pays $1,800 for a three-month call option on 100,000 pounds with a strike price of
$2.00 per pound. The option is considered to be a cash flow hedge of a forecasted
foreign currency transaction. On December 31, 2007, the option has a fair value of
$1,600. The following spot exchange rates apply:
Date
Spot rate
October 1, 2007 $2.00
Dec 31, 2007
$1.97
February 1, 2008 $2.01
59. What journal entry should Eagle prepare on October 1, 2007?
E. E above
Foreign Currency Option $1,800
Cash
$1,800

60. What journal entry should Eagle prepare on December 31, 2007?
D. D above
Option expense $200
Foreigh Curency Option $200
61. What is the amount of option expense for 2008 from these transactions?
B. $1,600
62. What is the amount of Adjustment to Accumulated Other Comprehensive Income
for 2008 from these transactions?
A. $1,000
63. What is the amount of Cost of Goods Sold for 2008 as a result of these transactions?
C. $201,000
64. What is the 2008 effect on net income as a result of these transactions?
B. $201,600
Essay Questions
65. Yelton Co. just sold inventory for 80,000 lira, which Yelton will collect in sixty days.
Briefly describe a hedging transaction Yelton could engage in to reduce its risk of
unfavorable exchange rates.
Yelton could sign a forward exchange contract to sell the lira in 60 days after they are
received. Alternatively, Yelton could purchase an option to sell the lira in 60 days after
they are received.66. Where can you find exchange rates between the U.S. dollar and
most foreign currencies?
Foreign exchange rates are published in the Wall Street Journal, major U.S. newspapers
and several Internet sites.
67. What is meant by the spot rate?
The spot rate is the price at which a foreign currency can be purchased or sold today.
68. How is the fair value of a Forward Contract determined under SFAS 133?
The fair value of a Forward Contract is determined by comparing the difference between
the contracted forward rate and the currently available forward rate for contracts
expiring on the same date. On the initial date of the contract, this would result in a fair
value of $0. As time passes, the currently available forward rate will likely fluctuate
relative to the "fixed" contracted forward rate, creating a difference that must be
accounted for as a gain or loss on the forward contract. A contract with a net gain over

its life is recorded on the balance sheet as a Forward Contract Asset. A contract with a
net loss over its life is recorded on the balance sheet as a Forward Contract Liability.
69. What is the major assumption underlying the one-transaction perspective?
The one-transaction perspective assumes that an export sale is not complete until the
foreign currency receivable has been collected and converted into U.S. dollars.
70. What is meant by the term hedging?
"Hedging is the process of eliminating exposure to foreign exchange risk so as to avoid
potential losses from fluctuations in exchange rates. In addition to avoiding possible
losses, companies hedge foreign currency transactions and commitments to introduce
an element of certainty into the future cash flows resulting from foreign currency
activities. Hedging involves establishing a price today at which foreign currency can be
sold or purchased at a future date".
71. How does a foreign currency forward contract differ from a foreign currency option?
"Whereas the owner of a foreign currency option can choose whether to exercise the
option and exchange one currency for another or not, a party to a foreign currency
forward contract is obligated to deliver one currency in exchange for another at a
specified future date".
72. What factors create a foreign exchange gain?
"Foreign exchange gains and losses are created by two factors: having foreign currency
exposures (foreign currency receivables and payables) and changes in exchange rates".
73. What happens when a U.S. company purchases goods denominated in a foreign
currency and the foreign currency depreciates?
The event results in a foreign exchange gain.
74. What happens when a U.S. company purchases goods denominated in a foreign
currency and the foreign currency appreciates?
The event results in a foreign exchange loss.
75. What happens when a U.S. company sells goods denominated in a foreign currency
and the foreign currency depreciates?
The event results in a foreign exchange loss.
76. What happens when a U.S. company sells goods denominated in a foreign currency
and the foreign currency appreciates?
The event results in a foreign exchange gain.