Question 1

Which of the following statements is true?

Accepted Answer

D

Question 2

A critical characteristic of a derivative is that the instrument

Accepted Answer

A derivative is a financial instrument that derives its value from changes in the value of a related asset or liability. It does not require the related asset or liability to be sold or bought at settlement, nor does it necessarily require a significant investment by the holder. The key feature of a derivative is its dependence on the value of another asset or liability.

Question 3

If the change in the value of the derivative (gain or loss) exceeds the change in the value of the forecasted transaction, the excess is considered the ineffective portion of the derivative and is recognized in OCI.

Accepted Answer

The ineffective portion of a derivative is recognized immediately in earnings, not in Other Comprehensive Income (OCI). OCI is used for the effective portion of cash flow hedges.

Question 4

The gains and losses from cash flow hedges are recorded in OCI until the impact of the hedged item in included in earnings.

Accepted Answer

This statement is true. Gains and losses from cash flow hedges are initially recorded in OCI and then reclassified to earnings when the hedged item affects earnings.

Question 5

The underlying amount of a derivative instrument is

Accepted Answer

The underlying amount of a derivative instrument is the price or rate that relates to the asset or liability underlying the derivative.

Question 6

The FASB requires entities that hold or issue derivative instruments that are designated and qualify as hedging instruments to disclose information that allows users to understand how and why the reporting entity uses derivative instruments.

Accepted Answer

This statement is true. The FASB does require entities to disclose information about how and why they use derivative instruments that are designated and qualify as hedging instruments. This information is included in the entity's financial statements and notes to the financial statements.

Question 7

The total value of a derivative is determined by the

Accepted Answer

The total value of a derivative is determined by the number of units specified in the derivative and the price that relates to the asset or liability underlying the derivative. This is because the value of the derivative depends on the price or value of the underlying asset or liability, and the number of units specified in the derivative contract.

Question 8

The FASB requires entities that hold or issue derivative instruments that are designated and qualify as hedging instruments to disclose information that allows users to understand in the case of both fair value and cash flow hedges, how the derivative instruments and the related hedged items affect the reporting entity's financial position, financial performance and cash flows.

Accepted Answer

This is a true statement. The FASB requires such disclosure to help users understand the impacts of hedge accounting on the financial statements of reporting entities.

Question 9

The gains and losses from cash flow hedges are included in OCI; however, if the hedge is ineffective, the gains and losses are included in current earnings.

Accepted Answer

This statement is true. Gains and losses from cash flow hedges are included in Other Comprehensive Income (OCI), as the primary purpose of cash flow hedges is to manage the risk of cash flow variability in future periods. However, if the hedge is deemed ineffective by the company's accounting policies, the gains and losses from the hedge will be recognized in the income statement as a component of current earnings.

Question 10

On September 1st of the current year, Mooney Company writes a contract agreeing to sell to Berry Company 200,000 foreign currency (FC) units at a specific price of $2.14 per FC with delivery in 30 days.The spot rate at the end of 30 days is $2.17.The appropriate discount rate for both Mooney Company and Berry Company is 9%, and Mooney's year end is December 31. ​
On the settlement of the contract, Mooney would record a

Accepted Answer

The answer of On September 1st of the current year,...

Question 11

A hedge of a forecasted transaction is a cash flow hedge.

Accepted Answer

A hedge of a forecasted transaction is a cash flow hedge under accounting standards such as International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP). Cash flow hedges are used to manage financial risks associated with future cash flow volatility, such as changes in currency exchange rates, interest rates, or commodity prices. The goal of a cash flow hedge is to offset the impact of these risks on future cash flows and minimize the variability of reported earnings.

Question 12

A forward contract

Accepted Answer

A forward contract is an agreement between two parties to buy or sell an asset at a future date at an agreed-upon price. It is not traded on an organized exchange, and the terms of the contract are customized to meet the needs of the parties involved. There is no formal regulation governing forward contracts, and the parties rely on each other's creditworthiness to fulfill the terms of the contract.

Question 13

On August 1st of the current year, Lenz Company writes a contract agreeing to sell to Hindman Company 15,000 British pounds at a specific price of $0.69 per pound with delivery in 60 days.Throughout the 60-day period the forward rate varies as follows: ?

$\begin{array}{ll}
60 \text { days remaining on the contract } & \$ 0.69 \
30 \text { days remaining on the contract } & \$ 0.68 \
0 \text { days remaining on the contract } & \$ 0.675
\end{array}$
 Assume an 8% discount rate for Lenz Company and Hindman Company.For the first 30 day period, Lenz Company would recognize a:

Accepted Answer

For the first 30 days, the forward rate decreases from $0.69 to $0.68. This means Lenz Company would recognize a gain because it had locked in a higher price ($0.69) than the market rate after 30 days ($0.68). The gain is calculated based on the difference in the rates ($0.69 - $0.68 = $0.01) multiplied by the amount of British pounds (15,000), which equals $150. However, considering the time value of money over 30 days at an 8% annual rate, the present value of this gain is slightly less than $150, hence a $149 gain is recognized.

Question 14

The FASB requires entities that hold or issue derivative instruments that are designated and qualify as hedging instruments to disclose information that allows users to understand in the case of both fair value and cash flow hedges, how the derivative instruments and the related hedged items are accounted for.

Accepted Answer

This statement is true. The FASB (Financial Accounting Standards Board) does require entities that hold or issue derivative instruments designated as hedging instruments to disclose information about how these instruments and the related hedged items are accounted for, whether they are fair value or cash flow hedges. This disclosure is intended to provide users with a clear understanding of the entity's risk management activities and the impact of hedging on the financial statements.

Question 15

If a trading portfolio consisted of debt instruments, such investments would be marked-to-market, and both increases and decreases in value would be recognized in current earnings.

Accepted Answer

Debt instruments are usually marked-to-market, which means their values are adjusted to current market rates regularly. Any increases or decreases in their values are recognized in current earnings.

Question 16

The gains and losses from fair value hedges are reported in earnings.

Accepted Answer

Fair value hedges are derivatives that are used to offset changes in the fair value of an asset or liability. Any gains or losses from fair value hedges are reported in earnings, as the purpose of these hedges is to offset unrealized gains or losses on the hedged item. This is in contrast to cash flow hedges, where the gains and losses are reported in other comprehensive income until the underlying transaction affects earnings.

Question 17

The notional amount of a derivative instrument is

Accepted Answer

The notional amount of a derivative instrument is simply the number of units specified in the derivative instrument. It does not relate to the price or rate of the underlying asset or liability.

Question 18

If both increases and decreases in the value of a recognized asset or liability are recognized in current earnings according to existing accounting principles, special hedge accounting is necessary.

Accepted Answer

Special hedge accounting is used to match the timing of gains and losses on the hedged item with the hedging instrument in the financial statements, primarily when the changes in value of the recognized asset or liability do not impact current earnings directly or in the same period. If both increases and decreases in value are already recognized in current earnings, the primary purpose of hedge accounting—to align the timing of these impacts—may not be necessary.

Question 19

Forward contracts are contracts to buy or sell a specified amount of an asset at a specified, fixed price with delivery at a specified future point in time.Which of the following is true about these contracts?

Accepted Answer

The specified, fixed price in a forward contract is indeed known as the forward rate. This rate is agreed upon by the parties at the contract's inception for the future purchase or sale of an asset. Choices A and B are incorrect because the party agreeing to buy is in a long position, and the party agreeing to sell is in a short position, respectively. Choice D is incorrect because forward contracts typically do not require an initial deposit of funds with a broker, distinguishing them from futures contracts which often do require such deposits.

Question 20

On August 1st of the current year, Lenz Company writes a contract agreeing to sell to Hindman Company 15,000 British pounds at a specific price of $0.69 per pound with delivery in 60 days.Throughout the 60-day period the forward rate varies as follows: ?

$\begin{array}{ll}
60 \text { days remaining on the contract } & \$ 0.69 \
30 \text { days remaining on the contract } & \$ 0.68 \
0 \text { days remaining on the contract } & \$ 0.675
\end{array}$ The spot rate at the end of 60 days is $0.675.Assume an 8% discount rate for both Lenz Company and Hindman Company.For the second thirty day period, Hindman would recognize a:

Accepted Answer

To calculate the gain or loss for the second thirty-day period, we need to compare the forward rate at the time of the contract ( $0.69 per pound) with the forward rate 30 days before delivery ( $0.675 per pound).

Using the formula:

Forward rate = Spot rate x (1+foreign risk-free rate) / (1+domestic risk-free rate)

We can calculate the forward rate for 30 days before delivery:

Forward rate = $0.675 x (1+0.03) / (1+0.02) = $0.6864 per pound

Since the forward rate has decreased from $0.69 to $0.6864 per pound, Hindman would recognize a gain.

The amount of the gain can be calculated as:

Gain = (15,000 pounds x ($0.69 - $0.6864)) / (1+0.08)^2 = $76

Therefore, the correct answer is D: $76 gain.

Quiz 22: Derivatives and Related Accounting Issues