FAR 11 Flashcards
What is the accounting for a cash flow hedge?
1 - Determine the change in the Present value of e expected cash flow of the hedged item
2- The effective portion: recognize the difference in the fair value of the derivative up to the amount of change in the expected cash flow in OCI
3- The INEFFECTIVE portion - the amount different than the change in PV of expected cash flow in current income
What disclosures are required for derivatives
- Info about why they are using derivatives and their purpose
- Also disclose info that distinguishes between fair value derivatives and cash flow hedges
- Must disclose BOTH - net gain and loss recognized in earnings and gain and losses deferred in OCI
Is an option to buy land a derivative?
No - it is specifically excluded from being a treated as a derivative
What is the formula for a non-hedging speculation trade?
The gain or loss is included on the I/S in the income from continuing operations section
The fair Value = the time value + intrinsic value
Example - there is a $200 loss on the time value for holding an option contract
There is also a $6000 gain on the intrinsic value of the option contract. The formula to be posted would be: 6,000 - 200 = 5800 on the I/S
What are 2 inherent risks in an interest rate swap
- The risk of exchanging a lower interest rate for a higher interest rate
- The risk of nonperformance by the counterpart to the agreement
What is the definition of fair value hedge
A hedge designed to mitigate or eliminate a risk associated with an exposure to change in the fair value of a recognized asset or liability or a firm commitment
What must an instrument have in order to be considered a derivative
NUNS Notional Amount- at least 1 (units) Underlying - at least 1 (specific price or rate) No net initial investment Settlement - allow for a net settlement
If the amount invested is material - the financial instrument is not a derivative
What are examples of derivatives
- Option contracts (stock index options)
- Futures contracts (currency futures)
- Interest or foreign currency swaps
What is an underlying
This is the factor that is used in the formula that is then applied to the notional amount to determine the amount that will be exchanged between parties
Example: Interest rate swap paying prime plus 1% based on a principle amount of $1M and will received 7% per year based on the same amount
Prime = underlying
notional amount = $1M
Changes in the effective portion of derivative for Fair Value and cash flow hedge are recognized where each period?
Cash Flow Hedges - Gains and losses - OCI until it occurs and is then recognized in income
Fair Value Hedges:
- changes in fair value of all derivatives NOT recognized as hedges are recognized in income
- changes on the INEFFECTIVE portion of the derivative designated as hedges are also recognized in income
- a fair value hedge is reported at its fair market value with unrealized gains or losses recognized in earnings in the period of change
How do you find the intrinsic value of a stock option
It is the market price less the strike price 100 shares Market price - $10 Strike price -$9 10-9= $1 * 100 = $100 intrinsic value
How should a foreign subsidiary of a US parent company report its assets,liabilities and operations
They should use the subsidiary’s functional currency
- This may be their local current, the US dollar, or some other currency
The financial statements are converted from the local currency to the US dollar through Translation if local currency is the functional currents
Or through Remeasurement if functional currency is the US dollar
What are you required to document in order to account for a futures contract as a fair value hedge
- the relationship between the hedge and the hedged risk
- indicate that the hedge is expected to be highly effective
- explain how effectiveness will be measured
Journal Entries for the purchase of inventory when there is foreign exchange loss
The journal entry on November 15 for the purchase of the inventory on account would be:
Inventory 850
Accounts payable 850
The summarizing journal entry on December 15 to record the payment for the inventory would be:
dr. Accounts payable 850
dr. Foreign exchange loss 50
cr. Cash 900
The above journal entry summarizes the following two December 15 journal entries:
dr. Foreign exchange loss 50
cr. Accounts payable 50
To increase the payable by the loss
dr. Accounts payable 900
cr. Cash 900
To close out the payable.
When you commit to purchasing supplies on Nov. 18th to be paid in Feb 18th how do you handle the booking and the translation at year end
On date you booked it - you incurred the liability - you use the spot rate on that date:
Nov. 18th ($1.27) * 300,000 LCU - which is a liability of $381,000 to be paid of Feb 18th
At balance sheet date the spot rate has increased to ($1.35) so the liability is now $405,000.
This is a loss of $24,000 which would be recognized in earnings (I/S)
If on Dec 18th you enter into a speculation to buy 300,000 LCU’s for forward rate of $1.25 (Feb 18th)
On Dec. 31st the forward rate is now ($1.31) so you expect a gain of ($.06) * 300,000 = $18,000 gain recognized in earning on I/S
You then net these two:
24,000 loss + 18,000 gain = a net loss of $6,000
