Accounting 106: Quiz on Forwards, Futures, Options, and Foreign Currency

Problem 1

Hyung company has Philippine peso as the functional currency. On September 1, 2017, the
entity expects to purchase a machinery from Sourth Korea for 3,000,000 won on July 1, 2018.
Accordingly the entity is exposed to foreign currency risk.

On September 1, 2017, the entity also entered into a forward currency contract with a
speculator bank to purchase the machinery at 3,000,000 won for a fixed amount of P465,000
or P1 to 0.155 korean won on July 1, 2018.

The forward currency contract is designated as cash flow hedge of the entity’s exposure to
increase in dollar exchange rate.

On July 1, 2018, the entity purchased on account the machinery for 3,000,000 won when the
exchange rate was P1 to 0.148 won. The machinery is payable on January 31, 2019 for
3,000,000 won.

To protect itself from foreign currency risk, the entity entered into another foreign currency
contract with a speculator bank for a fixed payment of P444,000 or a rate of P1 to 0.148 won.
This forward contract is designated to be fair value hedge.

The pertinent exchange rates are as follows:

September 1, 2017 0.155

December 31, 2017 0.151
July 1, 2018 0.148
December 31, 2018 0.153
January 31, 2019 0.157

Required:

Prepare pertinent journal entries for 2017, 2018 and 2019.

Problem 2

Bitter Company produces authentic cotton blazers and the Company needs 85,000 kilos of
raw materials in the production process. On December 1, 2019, the entity purchased a call
option as a cash value hedge to 75,000 kilos on February 1, 2020. The option strike price is
P120 per kilo. The entity paid P85,000 for the call option. This derivate contract means that if
the market price is higher than P120, the Company can exercise the option and buy the asset
at the strike price of P120. If the market price is lower than P120, the Company can throw
away the option and buy the asset at the cheaper price. The market price and the time value
of option are as follows:

Time
value of
option
December 31,
2019 46,000
February 1, 2020 8,000

a. The market price of the product is P126 and P133 on December 31, 2019 and February
1, 2020, respectively

.
b. The market price of the product is P123 and P117 on December 31, 2019 and February
1, 2020, respectively.
Problem 24-1: FORWARDS

Tagaytay Company is a golf course developer that constructs approximately 5 courses each
year. On July 1, 2019, the entity has agreed to buy 5,000 trees on March 1, 2020 to be planted
in the course it intends to buy.

To protect itself from the variability of the market price of trees, the entity entered into a forward
contract with a reputable bank. The price is set at P1,500 per tree. The forward contract is
designated as a cash flow hedge.

If the market price on March 1, 2020 is more than P1,500, the difference is paid by the bank
to the entity. On the other hand, if the market price is less than P1,500, the entity will pay the
difference to the bank.

The market price is P1,800 on December 31, 2019 and P1,700 on March 1, 2020

Required:

Prepare journal entries for 2019 and 2020.

Problem 24-6: OPTIONS

Legaspi Company produces colorful 100% cotton T-shirts that are very popular among the
youth. The entity uses 150,000 kilos of cotton each month in the production process.

On December 1, 2019, the entity purchased a call option to buy 150,000 kilos of cotton on
July 1,2020. The call option price is P30 per kilo. The entity paid P50,000 for the call option
which was designated as a cash flow hedge.

Required: Prepare journal entries for 2019 and 2020 assuming:

1. The market price of cotton on December 31, 2019 is P32 and the market price on July
1, 2020 is P35 per kilo.

2. The market price of cotton on December 31, 2019 is P32 and the market price on July
1,2020 is P28 per kilo.
Problem 24-3: FUTURES

Quezon Company requires 50,000 kilos of soya beans each month in the manufacturing
operations. To eliminate the price risk associated with the purchase of soya beans, on
December 1, 2019, the entity entered into a futures contract as a cash flow hedge to buy
50,000 kilos of soya beans at P150 per kilo on February 1, 2020.

Required: Prepare journal entries for 2019 and 2020 assuming:

1. The market price per kilo of soya beans is P160 on December 31, 2019 and P165 on
February 1, 2020.

2. The market price per kilo of soya beans on December 31, 2019 and February 1, 2020
is P145.