EXAMINATION about INVESTMENT 19

General Rule: Read the following carefully and answer it wisely. All solutions are needed, so put it in the last
page. (10 Points)

1. RGH Company issues 6% P4,000,000 face bonds on January 2, 2010 which will mature 2012. The term of issue
includes a clause that RGH Company to extend the debt’s term beyond the original maturity for 2 more years and
for an issue of an instrument which has a term extending option the market rate of interest is 7%. On date of
issue, the fair value of the term-extending option is P72,300 while its fair value on December 31, 2011 is P37,400.

Question 1: If interest will not be reset at the time of extension, what amount of derivative should be recognized
separately on the date the instrument was issued?
a. None c. P37,400
b. P34,900 d. P72,300
Answer: D
Note: Term extending options could be valuable to the entity as it allows the issuer to refinance the debt at the same rate
at the time interest rates are rising, conversely, if interest rates are falling, the entity would not exercise its options to
extend separation is required even though its value is closely related to interest rate that also affect the value of the
underlying.

Question 2: If interest rate will be reset at the market rate at the time of extension, what amount of derivative should be
recognized separately on the date the instrument was issued?
a. None c. P37,400
b. P34,900 d. P72,300
Answer: A
Note: As to the option to extend the term to causes the interest rate to reset to current market rates, the option is regarded
as closely related to the host debt. Such an option has no real value to the entity, because if the market rate at the time of
extension is 8%, the company cannot extend the term without paying additional2% interest anyway. On the other hand, if
market rate drops to 4%, the extension is equivalent to taking out a new loan at 4%.

2. On January 2, 2008, Cinderella Company enters into a forward contract to purchase on January 2, 2010, a
specified number of barrels of oil at a fixed price. Cinderella Company is speculating that the price of oil will
increase and plans to net settle the contract if the price increases. Cinderella Company does not pay anything to
enter into the forward contract on January 2, 2008. Cinderella Company does not designate the forward contract
as a hedging instrument. At the end of 2008, the fair value of the forward contract has increased to P400,000 at
the end of 2009 its fair value has declined to P350,000. What amount of forward loss should Cinderella Company
recognize at the end of the year 2009?
a. None c. P350,000
b. P50,000 d. P400,000
Answer: B
Fair value as of 12.31.09 P350,000
Less: Fv as of 12.31.08 P400,000
Forward loss to P/L in 2009 P 50,000

3. On January 31, 2011, MBC Company enters into a contract with ABS Company to receive the fair value of 2,000
of MBC Company’s own outstanding ordinary shares as of February 1, 2012 in exchange for a payment of
P212,000 in cash or an equivalent of P106 per shares on February 1, 2012. The contract will be settled net in
 cash. At the time of the contract, shares of MBC Company are selling at P100 per share; the present value of the
forward contract is zero.

On December 31, 2011, shares of MBC Company are selling at P115 and the forward contract has a fair value of P13,800.
On February 1, 2012, shares of MBC Company are selling at P108 and the fair value of the forward contract is P4,000.
Question 1: What amount should MBC Company recognize as forward asset on January 31, 2011?
a. None c. P13,800
b. P4,000 d. P17,800
Answer: A
Note: The price per share when the contract is agreed on Jan 31, 2011 is P100. The initial FV of the forward contract on
Jan 31, 2011 is zero. No entry is required because the FV of the derivatives is zero and no cash is paid or received.
Question 2: what amount of gain on forward contract should MBC Company recognized on December 31, 2011?
a. None c. P 9,800
b. P4,000 d. P13,800
Answer: D
FV of forward – 12.31.11 P13,800
Less: Fv of forward – 01.31.11 -0-
Forward gain P13,800

4. On July 1, 2011, MTV Company enters into a contract with LBC Company to receive the fair value of 3,000 of
MTV company’s own outstanding ordinary shares as of February 1, 2012 in exchange for a payment of P318,000
in cash or an equivalent of P106 per share on February 1, 2012. The contract will be settled net in shares. At the
time of the contract, shares of MTV Company are selling at P100 per share; the present value of the forward
contract is zero.

On December 31, 2011, shares of MTV Company are selling at P115 and the forward contract has a fair value of P20,700.
On February 1, 2012, shares of MTV Company are selling at P109 and the fair value of the forward contract is P9,000.
What is the effect of MTV company’s shareholders’ equity as a result of the settlement?
a. Not affected c. Will decrease by P11,700
b. Will decrease by P9,000 d. Will decrease by P20,700
Answer: B
Note: The contract is settled net in shares. MTV Company has an obligation to deliver P318,000 (P106,000 x 3,000)
worth of its shares to LBC Company and LBC has an obligation to deliver P327,000 (P109 x 3,000) worth of shares to
MTV Company. Thus, LBC company delivers a net amount of P9,000 (P327,000 – P318,000) worth of shares to MTV
Company or 82.56 shares (P9,000/P109).

5. On March 1, 2011 CTV Company enters into a contract with HGQ Company to pay the fair value of 4,000 of
CTV Company’s own outstanding shares as of February 28, 2012 in exchange for P440,000 or P110 per share on
February 28, 2012. The contract will be settled net in cash. On March 1, 2011, CTV Company shares are selling
at P100 per share, the fair value of the forward contract is nil. On December 31, 2011, CTV shares are selling at
P115 and the forward contract has a fair value of P50,000. On February 28, 2012, CTV shares are selling at
P112,50 and the forward contract has a fair value of P10,000. Question 1: What amount should CTV Company
recognize as forward liability on March 1, 2011?
a. None c. P40,000
b. P10,000 d. P50,000
Answer: A
Note: No entry is required because the FV of the derivatives is zero and no cash is paid or received.

Question 2: What amount gain or loss on forward contract should CTV Company recognize on December 31, 2011?
 a. None c. P40,000
b. P10,000 d. P50,000
Answer: D
FV of forward liability – 12.31.12 P50,000
Less: FV of forward liability – 03.1 11 -0-
Forward gain to P/L in 2011 P50,000

Question 3: What amount of gain or loss on forward contract should CTV recognize on February 28, 2012?
a. None c. P40,000
b. P10,000 d. P50,000
Answer: C
FV of forward liability – 02.28.12 P10,000
Less: FV of forward liability – 12.31. 11 P50,000
Forward gain to P/L in 2012 P40,000