CHAPTER # 11 & 12

TITLE FOREIGN CURRENCY TRANSACTIONS

B. DEVELOPMENTAL ACTIVITIES

INTRODUCTION

Foreign Currency Transaction vs. Foreign Currency Translation

 Foreign Currency Transaction – transactions to be settled in a foreign currency and financial statements
of an affiliate maintained in a foreign currency are translated into pesos by multiplying the number of units of
the foreign currency by direct exchange rates.
 Foreign Currency Translations – the process of expressing monetary amounts that are stated in terms in
a foreign currency into the currency of the reporting entity by using an appropriate exchange rate.

Exchange Rate

It is the ratio between a unit of one currency and the amount of another currency for which that unit can be
exchanged at a particular time.
 Foreign Exchange Rate – it is the price of a currency expressed in terms of another currency.
o Direct Exchange Quotation – exchange rate is quoted in terms of how many units of the domestic
currency can be converted into one unit of foreign currency. To translate dollars into pesos, the
number of dollars is MULTIPLIED by the direct exchange rate expressed in PESO PER DOLLAR.
For example, one US Dollar for 40 means that 40 pesos could be exchanged for one US Dollar.
o Indirect Exchange Quotation – exchange rate is quoted in terms of converting one units of
domestic currency into units of foreign currency. To translate dollars into pesos, the number of
dollars could also be DIVIDED by the indirect exchange rate expressed in DOLLAR PER PESO.
For example, one Philippine peso could be converted into .025 dollars (1.00/40.00)
 Kinds of Exchange Rates
o Spot Rate (SR) - Rate TODAY and applicable TODAY
 Selling Spot Rate – charged by the bank for current sales of the foreign currency.
 Buying Spot Rate – rate at which money dealers will buy foreign currency
 Spread – the difference between the selling and buying spot rate represents the gross
profit of the trader in foreign currency.
o Future Rate (FR) Rate TODAY applicable in the FUTURE; also known as FORWARD RATE
o Historical Rate (HR) - Spot rate in the Transaction date
o Closing Rate (CR) - Spot rate in the Balance Sheet date
o Actual Rate (AR) - Spot rate in the Settlement date

Functional Currency
 PAS 21: It is the currency of the “primary economic environment which the entity operates”
 It is the currency that influences the sales prices of goods and services.
 It is also the currency in which a firm receives most of its cash receipts and expends cash outlays.

ACCOUNTING FOR FOREIGN CURRENCY TRANSACTIONS

A transaction that requires settlement or payment in foreign currency is called foreign currency transaction. Some of
the common foreign currency transactions are:
 Importing and exporting goods on credit with the receivable or payable denominated on foreign currency.
 Borrowing or lending denominated in foreign currency.
 Entering into forward exchange contract to buy or sell foreign currency.

Important Dates to be Considered in Foreign Exchange Transactions

 Transaction Date (TD)
o The date when the purchase or sale of goods or services or currency takes place
o Rate used: SPOT/HISTORICAL
 Balance Sheet Date (BD)
o The date when closing rates will be applied in computing for the FOREX gain or loss
o Rate used: SPOT/CLOSING
 Settlement Date (SD)
o The date when payment or receipt shall be made and the FOREX gain or loss computed
o Rate Used: SPOT/ACTUAL
Transaction Exposure

It is the level of risk that currency change rates will change a after a company has entered into for example financial
obligation. Transaction exposure measures gain or loss arising from financial obligation for which is stated in terms of
foreign currency.
 Foreign Exchange (Forex) Losses
o Increases in the selling spot rate for a foreign currency required by a Philippine Company to settle
a liability denominated in that currency
o Decreases in the buying spot rate
 Foreign Exchange (Forex) Gains
o Decreases in the selling spot rate
o Increases in buying spot rate

The treatment of transaction gains and losses is on balance sheet date, monetary items are translated at the current
rate that is different from the spot rate at which they were initially recorded during period. On the date of settlement,
the exchange rate on the date of settlement that is different from the spot rate in which it is recorded, thus resulting to
realized exchange gain/ loss.

Foreign exchange differences on non-monetary items are recognized in the same way as the gain or loss on the item
is recognized. Gain/loss on a non-monetary item that is measured at fair value is recognized directly to OCI, while
non-monetary item recognized in profit or loss will be recognized through PNL.
More often, transaction exposure arises due to exporting or importing of goods or services.

ILLUSTRATIONS

Importing Transactions – Purchase of Merchandise from Foreign Supplier

On November 15, 2020, VVL Corporation purchased merchandise from a U.S. firm for US$ 10,000 and opened a
letter of credit with Bank of Philippine Island (BPI) to cover the importation. Bank service charge amounted to P1,500.
The corporation‟s fiscal year ends December 31. The selling spot rate issued by BPI for US$ at various dates as
follows:
Date of arrival of goods – December 15, 2020 P50.50
Balance Sheet Date – December 31, 2020 50.80
Date of Receipt of importation documents and the required payment of 50.90
the Letter of Credit to BPI – January 10, 2021

Assuming that VVL Corporation uses the periodic inventory system, the journal entries to record the above
transactions relating to the importation are as follows:
Nov. 15, 2020
Bank Charges 1,500
Cash 1,500
To record bank charges.

Dec. 15, 2020

Purchases 505,000
Acceptance Payable 505,000
To record the receipt of goods.

Dec. 31, 2020

Foreign Exchange Loss 3,000
Acceptance Payable 3,000
To adjust acceptance payable and recognize forex loss in the exchange rate. $10,000 x
(P50,80-P50.50)

Jan. 10, 2021

Acceptance Payable 508,000
Foreign Exchange Loss 1,000
Cash 509,000
To record the payment of letter of credit (LC) to BPI, and the recognition of forex loss. (P10,000
x 50.90)

Exporting Transactions – Sale of Merchandise to a Foreign Customer

On November 3, 2020, JK Company sold merchandise for $10,000 to a US firm. On November 8, Bank of Philippine
Island (BPI) received a confirmation of LC from the bank of the US firm to support the purchase order. On November
10, JK Company availed a Packing Credit Line of P100,000 with BPI to fund his exportation against the confirmed
purchase order or Letter of Credit. The selling spot rate issued by the bank for US Dollars at various dates is as
follows:
Date of Shipment – November 20, 2020 P50.60
Balance Sheet Date – December 31, 2020` 50.80
Date of Settlement – January 25, 2021 50.90

Journal Entries:
Nov. 10, 2020
Cash 100,000
Packing Credit Line 100,000
To record availment of packing credit line.

Nov. 20, 2020

Accounts Receivable 506,000
Sales 506,000
To record the shipment of merchandise.

Dec. 31, 2020

Accounts Receivable 2,000
Foreign Exchange Gain 2,000
To adjust acceptance payable and recognize forex gain in the exchange rate. $10,000 x
(P50,80-P50.60)

Jan. 25, 2021

Cash 509,000
Accounts Receivable 508,000
Foreign Exchange Gain 1,000
To record the settlement received from BPI for the LC and recognition of forex gain.

Loans Payable Denominated in Foreign Currency

If a Philippine Company chooses to borrow foreign currency to pay for the merchandise purchased from a foreign
supplier. The following will illustrate the procedures involved:
1. Purchase from Hongkong supplier for 100,000 HK$. The selling spot rate is P5.80.
Purchase 580,000
Accounts Payable 580,000

2. Borrowed 100,000 HK$ from a bank on 30-day, 12% loan to be repaid in HK$ to settle the liability to Hongkong
supplier.
Accounts Payable 580,000
Notes Payable 580,000

3. Payment of 101,000 HK$ to 100,000 HK$ to pay 100,000 HK$ 30-day, 12% note with 1,000 HK$ interest. The
selling spot rate is P5.88.
Notes Payable 580,000
Interest Expense 5,880
Foreign Exchange Loss 8,000
Cash 593,880

Loans Receivable Denominated in Foreign Currency

Assume that a Philippine Corporation received a promissory note denominated in a foreign currency from the sales
made to a Japanese customer. The following will illustrate the procedures involved:
1. Sale to Japanese customer for 60-day, 12% promissory note for 1,000,000 yen on March 1, 2020. The buying spot
rate is P 0.43.
Notes Receivable 430,000
Sales 430,000

2. On fiscal year end dated April 30, 2020, the buying spot rate is P 0.45.
Notes Receivable 20,000
Interest Receivable [(1M yen x 12% x 30/360)x 4,500
P 0.45]
 Interest Income 4,500
Forex Gain [1M yen x (P 0.45- P 20,000
0.43)

3. On May 30, 2020, Philippine Corporation collected the full amount of the note including interest.
Cash (1,020,000 yen x P0.44) 448,800
Forex Loss 10,100
Notes Receivable 450,000
Interest Receivable 4,500
Interest Income [(1M yen 4,400
x12%x30/360)
x P0.44]

FOREIGN CURRENCY TRANSACTIONS WITH HEDGING

Every entity is exposed to business risk from its daily operations. Many if those risks have an impact on the cash
flows or the value of assets and liabilities, therefore, ultimately affects profit or loss. One of them is the risk of
obtaining a gain or incurring a loss from a foreign currency transaction due to the fluctuations of the exchange rates.
In order to manage these risk exposures, companies often enter contracts to hedge them.

Derivatives (Hedging Activities)

PFRS 9 Appendix A defined Derivative as a financial instrument or other contract within the scope of this Standard
with all three of the following characteristic:
a) its value changes in response to the change in a specified interest rate, financial instrument price,
commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other
variable, provided in the case of a non-financial variable that the variable is not specific to a party to the
contract (sometimes called the „underlying‟).
b) it requires no initial net investment or an initial net investment that is smaller than would be required for
other types of contracts that would be expected to have a similar response to changes in market factors.
c) it is settled at a future date.

The Four Cornerstone Decision of PFRS 9

1. Derivatives are contracts that create rights and obligations that meet the definition of assets and liabilities.
2. Fair Value is the only relevant measure for reporting for derivatives.
3. Only items that are assets and liabilities are reportable on the balance sheet.
4. Gains and losses on derivatives must be reported in earnings currently except in certain specified situation
in which gains and losses must be initially reported in the equity section.

Types of Derivatives
 Option-based derivatives
 It has a one-sided exposure wherein one party can potentially have a favorable outcome for which
it pays a premium at inception;
 The other party can potentially have only an unfavorable outcome for which it is paid the premium
at inception.
 Only the downside risk on the hedged item is counterbalance.
 Examples: option contract, interest rates caps, and interest rates floor.
 Forward-based derivatives
 It has a two sided exposure wherein each party has a favorable and a favorable outcome.
 The downside risk and the upside potential on hedged item are counter balanced.
 Examples: forwards, futures and swaps.

Hedging

Hedging is a risk management technique done by making an investment or acquiring some derivative instruments or
even non-derivative instruments in order to offset potential losses or gains that may be incurred on some items as a
result of a particular risk.
A hedging relationship has two components:
1. Hedge item - an asset, liability, firm commitment, highly probable forecast transaction or net investment in a
foreign operation that exposes the entity to risk of changes in fair value or future cash flows and is
designated as being hedged.
 The following are the items that could qualify as hedge items as set out by PFRS 9:
i. Recognized assets or liabilities
 ii. Unrecognized firm commitments
 A firm commitment is a binding agreement for the exchange of resources
where quantity, price and dates are specified. The settlement will not be made
until after the delivery of the goods, therefore, it is exposed to changes in
currency exchange rates before the transaction date (the date of delivery of the
goods). It carries a fair value exposure. (Example: Purchase or Sales Order that
has been accepted.)
iii. Highly probable forecasts transactions
 A forecasted transaction is an anticipated transaction for which no firm
commitment exists. It has a cash flow exposure.
iv. A net investment in a foreign entity
2. Hedge instrument - designated derivative or (for a hedge of the risk of changes in foreign currency
exchange rates only) a designated non-derivative financial asset or non-derivative financial liability whose
fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated
hedged item.
 Fair Value Hedge – this hedges against the risk of changes in the fair value of a recognized asset
or liability or an unrecognized firm commitment (or a portion of such asset, liability, or firm
commitment) attributable to a particular risk. Such as the fair value of fixed rate debt will change as
a result of changes in interest rates.
 Cash Flow Hedge – This hedge against the risk of changes in the expected cash flows. It is a
hedge of the exposure to variability in cash flows that is attributable to a particular risk associated
with:
i. A recognized asset or a liability such as future interest payment or variable-interest debt;
or
ii. A highly probable forecasted transaction such as a forecasted sale or purchase that will
affect future reported profit or loss.
 Hedge of Net Investment in Foreign Operations – this is a hedge of the exposure to foreign
currency exchange gains or losses on an entity‟s net investment in foreign operation (which is the
amount of the entity‟s interest in the net asset of that operation.)

Hedge Accounting

It refers to the designation of one or more hedging instruments so that their change in fair value offsets the change in
fair value or the change in cash flows of a hedge item. It attempts to reduce the volatility created by the repeated
adjustments of a financial instrument‟s value, known as marking to market. This reduced volatility is done by
combining instrument and the hedge as one entry, which offsets the opposing movements.
The following are the situations that require hedge accounting:
 Hedged item and the hedging instruments are measured using different bases.
 Hedged item has yet to be recognized in the financial statements.
 Different treatments are applied to changes in fair value of the hedged item and the hedging instrument.

Hedging vs. Hedge Accounting

Hedging Hedge Accounting

 A general term which means minimizing  recognizes proportionately the
risks offsetting effects on net profit or loss
of changes in the fair values of the
hedging instrument and the related
item being hedge
 changes risks  changes the accounting for gains or
losses
 business decision  accounting decision

FAIR VALUE HEDGE

 It is a hedge of the exposure to changes in fair value of:

o a recognised asset or liability; or
o an unrecognised firm commitment; or
o a component of any such item, that is attributable to a particular risk and could affect profit or loss.
 Paragraph 6.5.8. of PFRS 9 provides that the hedging relationship shall be accounted for as follows:
o The gain or loss on the hedging instrument shall be recognized in profit or loss.
o The hedging gain or loss on the hedged item shall adjust the carrying amount of the hedged item (if
 applicable) and be recognised in profit or loss.
 If the hedged item is a financial asset (or a component thereof) that is measured at fair
value through other comprehensive, the hedging gain or loss on the hedged item shall be
recognised in profit or loss.
 However, if the hedged item is an equity instrument for which an entity has elected to
present changes in fair value in other comprehensive income, those amounts shall remain
in other comprehensive income.
 When a hedged item is an unrecognised firm commitment (or a component thereof), the
cumulative change in the fair value of the hedged item subsequent to its designation is
recognised as an asset or a liability with a corresponding gain or loss recognised in
profit or loss.
 An entity shall discontinue prospectively a fair value hedge accounting if:
o The hedge instrument expires or is sold, terminated or exercised‟
o The hedge no longer meets the condition for hedging accounting.
o The entity revokes the designation,

FOREIGN CURRENCY FORWARD CONTRACT (Fair Value Hedge)

 It is an agreement to buy or sell; (exchange currencies of two different countries) a foreign currency at:
 a specified future date (usually within 12 months), and
 a specified exchange rate (forward rate)
 The fair value of a foreign currency forward contract at inception date is none.
 From inception date to maturity, the fair value of forward contract can either be positive (asset/gain) or
negative (liability/loss) depending on the contracted forward rate and the current forward rate and whether it
is a forward purchase or forward sale.

Changes in the Fair Value of a Foreign Currency forward Contract after Inception Date

Forward Contract Current Forward Rate > Contracted Current Forward Rate < Contracted
Forward Rate Forward Rate
Purchase  Fair Value is positive  Fair value is negative
 Gain is recognized  Loss is recognized
 Forward Contract is an Asset  Forward Contract is a
Liability
Sale  Fair value is negative  Fair Value is positive
 Loss is recognized  Gain is recognized
 Forward Contract is a Liability  Forward Contract is an
Asset

Determination of Premium/Discount and Intrinsic Value

 The difference between the two rates is referred to as discount or premium (at inception date)
o Discount: forward rate < spot rate
o Premium: forward rate > spot rate
 The premium or discount in the forward contract is considered the interest or the time value which is
measured by the difference or spread between forward rate and spot rate at a point in time.
 The change in spot rate is considered the change in intrinsic value.
 At the date of maturity, the forward rate converges to the spot rate on that date since there is no further
period remaining on the contract.

Illustration: Supposed on July 1, 2020, VVL Co. obtains a 1-year forward contract to sell 10,000 US dollars for
P420,000 to a bank at a forward rate of P42. Other relevant rates are shown below:

July 1, 2020 December 31, 2020 June 31, 2021

SPOT RATE 40,50 40.60 40.90
FORWARD RATE 42.00 41.75 40.90

CHANGE IN VALUE OF FORWARD

COANTRACT
Date Spot Forward Premium Intrinsic Time Value Total Value
Rate Rate Value
07/07/20 40,50 42.00 1.50 - - -
12/31/20 40.60 41.75 1.15 (0.10) 0.35 0.25
 06/31/20 40.90 40.90 0 (0.30) 1.15 0.85
Change in Rates/Premium (0.40) 1.50 1.10
Foreign Currency 10,000 10,000 10,000
Total Change in Value in Pesos P (4,000) P 15,000 P 11,000

Accounting for Recording Forward Contracts

 Gross or Broad Position Accounting – Forward contracts are recorded at the date of inception of the
contract reflecting the contractual obligations of both parties.
 Net Position Accounting – there is no journal entry at the inception date. At each subsequent reporting
ate, adjustments are made to reflect any change in the forward rate.

Illustrations:

A. Fair Value Hedge of a Recognized Asset

On December 15, 2020, VVL Co. sold goods to a Japanese firm for 1,000,000 yen on account. VVL Co. was
concerned about the fluctuation in the Japanese yen, so on this date, VVL Co. entered into a 30-day forward
contract to sell 1,000,000 yens for P470,000 to a bank at a forward rate of 0.47. Other relevant rates are shown
below:
December 15, 2020 December 31, 2020 January 15, 2021
SPOT RATE 0.48 0.49 0.47
FORWARD RATE 0.47 0.485 0.46

Journal Entries:
Hedge Item – Accounts Receivable Hedging Instruments – FC Payable
12/15/20
Accounts 480,000 Pesos 470,000
Receivable Receivable
Sales 480,000 FC Payable 470,000

12/31/20
Accounts 10,000 Loss on FC 15,000
Receivable
Forex Gain 10,000 FC Payable 15,000

01/15/21
Forex Loss 30,000 FC Payable 25,000
Accounts 30,000 Gain on FC 25,000
Receivable

Cash 460,000 Cash fc 470,000

Accounts 460,000 Pesos 470,000
Receivable Receivable

FC Payable 460,000
Cash fc 460,000

Summary of the Balances of Hedged Item and Hedging Instruments, and the Foreign Exchange Gain (Loss):
Hedged Item Hedging Instruments
A/R Balance Gain (Loss) FC Payable Balance Gain (Loss)
12/15/20 480,000 - 12/15/20 470,000 -
12/31/20 490,000 10,000 12/30/20 485,000 (15,000)
01/15/21 460,000 (30,000) 01/15/21 460,000 25,000
Total Gain (Loss) 20,000 10,000

B. Fair Value Hedge of Recognized Liability

On December 15, 2020, VVL Co. purchased goods from a Korean firm for 10,000 won on account. VVL Co. was
concerned about the fluctuation in the Korean won, so on this date, VVL Co. entered into a 60-day forward
contract to buy 10,000 won for P12,400 from a bank at a forward rate of 1.24. Other relevant rates are as
follows:
December 15, 2020 December 31, 2020 February 15, 2021
SPOT RATE 1.20 1.26 1.30
FORWARD RATE 1.24 1.27 1.30

Journal Entries:
Hedge Item – Accounts Payable Hedging Instruments – FC Receivable
12/15/20
 Inventory 12,000 FC Receivable 12,400
Accounts 12,000 Pesos 12,400
Payable Payable

12/31/20
Forex Loss 600 FC Receivable 300
Accounts 600 FC Gain 300
Payable

02/15/21
Forex Loss 400 FC Receivable 300
Accounts 400 FC Gain 300
Payable

Accounts 13,000 Cash fc 13,000

Payable
Cash 13,000 FC 13,000
Receivable

Pesos Payable 12,400

Cash fc 12,400

Summary of the Balances of Hedged Item and Hedging Instruments, and the Foreign Exchange Gain (Loss):
Hedged Item Hedging Instruments
A/P Balance Gain (Loss) FC Receivable Balance Gain (Loss)
12/15/20 12,000 - 12/15/20 12,400 -
12/31/20 12,600 (600) 12/30/20 12,700 300
02/15/21 13,000 (400) 02/15/21 13,000 300
Total Gain (Loss) (1,000) 600

C. Fair Value Hedge of a Firm Purchase Commitment

On December 1, 2020, VVL Co. ordered inventory from a U.S. Firm. The purchase order is non-cancellable. The
purchase price is 1,000 US dollars with delivery and payment to be made on March 1, 2021. VVL Co. entered
into a forward contract to buy 1,000 US dollars on March 1, 2021 at a forward rate of P40.15. On March 1, 2021,
the inventory was delivered. The exchange rates available in various dates are as follows:
12/01/20 12/31/20 03/01/21
SPOT RATE 40.00 40.30 40.20
30 –DAY FORWARD RATE 40.05 40.45 40.40
60 – DAY FORWARD RATE 40.10 40.40 40.50
90 – DAY FORWARD RATE 40.15 40.45 40.60

Journal Entries:
Hedge Item – Unrecognized Firm Commitment Hedging Instruments – FC Receivable
12/01/20
FC Receivable 40,150
NO ENTRY Pesos 40,150
Payable

12/31/20
Loss on FC 250 FC Receivable 250

Firm 250 FC Gain 250

Commitment

03/01//21

Firm 200 Loss on FC 200

Commitment Receivable

FC Gain 200 FC 200

Receivable

Inventory 40,200 Cash fc 40,200

Cash-FC 40,200 FC 40,200

Receivable

Firm 50 Pesos Payable 40,150

Commitment
 Inventory 50 Cash fc 40,150

Summary of the Balances of Hedged Item and Hedging Instruments, and the Foreign Exchange Gain (Loss):
Hedged Item Hedging Instruments
Firm Commitment Balance Gain (Loss) FC Receivable Balance Gain (Loss)
12/15/20 - - 12/15/20 40,150 -
12/31/20 250 (250) 12/30/20 40,400 250
03/01/21 50 200 03/01/21 40,200 (200)
Total Gain (Loss) (50) 50

D. Fair Value Hedge of a Firm Sales Commitment

On December 15, 2020, VVL Co. received a sales order from a Japanese firm in the amount of 500,000 yens.
The goods are to be delivered on January 15, 2021. Due to the fluctuation in the Japanese yen VVL Co. entered
into a 30-day forward contract to sell 500,000 yens for P280,000 to a bank at the forward rate of P0.56. The
exchange rates available in various dates are as follows:
December 15, 2020 December 31, 2020 January 15, 2021
SPOT RATE 0.52 0.53 0.55
FORWARD RATE 0.56 0.54 0.55

Journal Entries:
Hedge Item – Unrecognized Firm Commitment Hedging Instruments – FC Payable
12/15/20
Pesos 280,000
NO ENTRY Receivable
FC Payable 280,000

12/31/20
Loss on FC 10,000 FC Payable 10,000
Firm 10,000 FC Gain 10,000
Commitment

01/15/21
Firm 5,000 Loss on FC 5,000
Commitment
Gain on FC 5,000 FC Payable 5,000

Cash –fc 275,000 Cash fc 280,000

Sales 275,000 Pesos 280,000
Receivable

Firm 5,000 FC Payable 275,000

Commitment
Sale 5,000 Cash fc 275,000

Summary of the Balances of Hedged Item and Hedging Instruments, and the Foreign Exchange Gain (Loss):
Hedged Item Hedging Instruments
Firm Commitment Balance Gain (Loss) FC Payable Balance Gain (Loss)
12/15/20 - - 12/15/20 280,000 -
12/31/20 10,000 (10,000) 12/30/20 270,000 10,000
01/15/21 5,000 5,000 01/15/21 275,000 (5,000)
Total Gain (Loss) (5,000) 5,000

E. Fair Value Hedge of a Firm Purchase Commitment (Present Value)

On December 1, 2020, VVL Co. ordered inventory from a U.S. Firm. The purchase order is non-cancellable. The
purchase price is 1,000 US dollars with delivery and payment to be made on March 1, 2021. VVL Co. entered
into a forward contract to buy 1,000 US dollars on March 1, 2021 at a forward rate of P40.15. On March 1, 2021,
the inventory was delivered. Assuming the relevant discount rate is 12%. The exchange rates available in
various dates are as follows:
12/01/20 12/31/20 03/01/21
SPOT RATE 40.00 40.30 40.20
30 –DAY FORWARD RATE 40.05 40.45 40.40
60 – DAY FORWARD RATE 40.10 40.40 40.50
90 – DAY FORWARD RATE 40.15 40.45 40.60

Journal Entries:
 Hedge Item – Unrecognized Firm Commitment Hedging Instruments – FC Receivable
12/01/20
FC Receivable 40,150
NO ENTRY Pesos 40,150
Payable

12/31/20
Loss on FC 245 FC Receivable 245
Firm 245 FC Gain** 245
Commitment
**(1,000 x .25) – (250 x 12% x 2/12)
03/01//21
Firm 195 Loss on FC 195
Commitment Receivable**
FC Gain 195 FC 195
Receivable

Inventory 40,200 Cash fc 40,200

Cash-FC 40,200 FC 40,200
Receivable

Firm 50 Pesos Payable 40,150

Commitment
Inventory 50 Cash fc 40,150
** (1,000 x .05) – 245

Summary of the Balances of Hedged Item and Hedging Instruments, and the Foreign Exchange Gain (Loss):
Hedged Item Hedging Instruments
Firm Commitment Balance Gain (Loss) FC Receivable Balance Gain (Loss)
12/15/20 - - 12/15/20 40,150 -
12/31/20 245 (245) 12/30/20 40,400 245
03/01/21 50 195 03/01/21 40,200 (195)
Total Gain (Loss) (50) 50

F. Speculation
VVL Co. expects the value of US dollars to decrease the next 30 days. Accordingly, on December 15, 2020, VVL
Co. entered into a 30-day forward contract to sell 10,000 US dollars at the forward rate of P52. On December 31,
2020, the forward rate was P52.50 and by January 15, 2021, the spot rate moved to P51.
 Hedge Item: NONE
 Hedged Instrument: FC Payable
Journal Entries:
12/15/20
Pesos Receivable 470,000
FC Payable 470,000

12/31/20
Loss on FC 15,000
FC Payable 15,000

01/15/21
FC Payable 25,000
Gain on FC 25,000

Cash-fc 470,000
Pesos Receivable 470,000

FC Payable 460,000
Cash-fc 460,000

CASH FLOW HEDGE

 It is a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated
with all, or a component of,:
o a recognised asset or liability (such as all or some future interest payments on variable-rate debt);
or
 o a highly probable forecast transaction, and could affect profit or loss.

 Paragraph 6.5.11 of PFRS 9 provides that the hedging relationship shall be accounted for as follows:
o the separate component of equity associated with the hedged item (cash flow hedge reserve) is
adjusted to the lower of the following (in absolute amounts):
i. the cumulative gain or loss on the hedging instrument from inception of the hedge; and
ii. the cumulative change in fair value (present value) of the hedged item (ie the present
value of the cumulative change in the hedged expected future cash flows) from inception
of the hedge.
o the portion of the gain or loss on the hedging instrument that is determined to be an effective
hedge (ie the portion that is offset by the change in the cash flow hedge reserve calculated) shall
be recognised in other comprehensive income.
o any remaining gain or loss on the hedging instrument (or any gain or loss required to balance the
change in the cash flow hedge reserve calculated) is hedge ineffectiveness that shall be
recognised in profit or loss.
o the amount that has been accumulated in the cash flow hedge reserve shall be accounted for as
follows:
i. if a hedged forecast transaction subsequently results in the recognition of a non-financial
asset or non-financial liability, or a hedged forecast transaction for a non-financial asset or
a non-financial liability becomes a firm commitment for which fair value hedge accounting
is applied, the entity shall remove that amount from the cash flow hedge reserve and
include it directly in the initial cost or other carrying amount of the asset or the liability.
This is not a reclassification adjustment and hence it does not affect other comprehensive
income.
ii. For cash flow hedges other than those covered by (i), that amount shall be reclassified
from the cash flow hedge reserve to profit or loss as a reclassification adjustment in the
same period or periods during which the hedged expected future cash flows affect profit
or loss (for example, in the periods that interest income or interest expense is recognised
or when a forecast sale occurs).
iii. However, if that amount is a loss and an entity expects that all or a portion of that loss will
not be recovered in one or more future periods, it shall immediately reclassify the amount
that is not expected to be recovered into profit or loss as a reclassification adjustment.
 Hedge effectiveness is the extent to which changes in the fair value or the cash flows of the hedging
instrument offset changes in the fair value or the cash flows of the hedged item.
 Hedge ineffectiveness is the extent to which the changes in the fair value or the cash flows of the hedging
instrument are greater or less than those on the hedged item.
 To summarize:

Ineffective
P/L
Porttion (A) - (B)

(A) > (B)

(A) Cumulative Effective Portion

Change in FV of OCI
Derivative is Hedging Instruments (B)
Assigned as DIVIDED BY (B)
Cash Flow Hedge Cumulative Change in
PV of Expected Cash
Flows No Ineffective
Portion. Effective
Portion =
(A) < (B) Cumulative change OCI
in FV of Hedging
Instruments

 In any of the following circumstances, an entity shall discontinue prospectively the cash flow hedge:
o The hedging instrument expires or sold, terminated or exercised;
o The hedge no longer meets the criteria for hedge accounting; and
o The forecast transaction is no longer expected to occur.
Illustrations:

Cash Flow Hedge (Hedge Effectiveness)

On July 1, 2020, VVL Co., a vegetable dealer, forecasts the purchase of 1,000 kilograms of broccoli in 6 months.
Because VVL Co. is worried that the price of broccoli will increase during the coming months, it enters into 10 long
cauliflower future contracts on July 1, 2020. Each future contract is based on the purchase of 100 kilograms of
cauliflower at P92.98 per kilogram on July 1, 2020. The relevant prices per kilograms are as follows:
Date Broccoli Cauliflower
01/01/20 P93.76 P92.98
03/31/20 95.18 94.52
06/30/20 96.20 95.36

Hedged Item Hedging Instruments

03/31/20 (Broccoli) (Cauliflower)
Current Prices – 03/31 P95.18 P94.52
Previous Prices – 01/01 93.76 92.98
Increase (Decrease) 1.42 1.54
x Kg. of commodity 1,000 1,000
Changes During the Period -03/31/2020 1,420 1,540
Fair Value – 01/01 0 0
Cumulative Changes -03/31/20 (1,420) 1,540

Hedged Item Hedging Instruments

06/30/20 (Broccoli) (Cauliflower)
Current Prices – 06/30 P96.20 P95.36
Previous Prices – 03/31 95.18 94.52
Increase (Decrease) 1.02 .84
x Kg. of commodity 1,000 1,000
Changes During the Period -06/30/2020 1,020 840
Fair Value – 03/31 1,420 1,540
Cumulative Changes -06/30/2020 (2,440) 2,380

Cumulative Changes 03/31/20 06/30/20

Expected Cash flow of forecasted transaction 1,420 2,440
Fair Value of Future Contract 1,540 2,380
Effectiveness Ratio 92% 102%
Assessment: HIGHLY EFFECTIVE

Forecasted Futures Effective Potion – OCI Ineffective Portion

Transaction Contract
Date Cumulative Change Cumulative Lower (absolute amount) OCI during Cumulative P/L During
in Cash Flow Change in FV of a and b – Cumulative the period P/L the Period
OCI
(a) (b)
01/01/20 - - - - - -
03/31/20 (1,420) 1,540 1,420 1,420 120 120
06/30/20 (2,440) 2,380 2,380 960 0 (120)

Journal Entries:
Hedge Item Hedging Instrument
01/01/20
NO ENTRY NO ENTRY

03/31/20
NO ENTRY Futures Contract 1,540
Accumulated OCI 1,420
Gain on Futures Contract 120

06/30/20
Inventory 96,200 Futures Contract 840
Cash 96,200 Loss on Futures 120
Contract
Accumulated OCI 960

Cash flow Hedge (Forecasted Transaction)

On December 1, 2020, VVL Co. expects to purchase a machine for $1,000 on March 2021. The transaction is
probable but no binding agreement and is to denominated in dollars. Thus, transaction and settlement should be on
March 1, 2021.
On December 1, 2020, VVL Co. entered into a forward contract to purchase $1,000 on March 1, 2021 for 40.15. VVL
Co. designates this hedge as a cash flow hedge of the exposure in the dollar exchange rate. The relevant exchange
rates are as follows:
12/01/20 12/31/20 03/01/21
Spot Rate P 40.00 P 40.30 P 40.20
Forward Rate 40.15 40.40 40.20

Journal Entries:
Hedge Item Hedging Instrument
12/01/20

NO ENTRY FC Receivable 40,150

Pesos Payable 40,150
12/31/20
NO ENTRY FC Receivable 250
OCI – Exchange Gain 250

03/01/21
Machinery 40,200 OCI –Exchange 200
Loss
Cash 40,200 FC Receivable 200

OCI – Exchange 50 Pesos Payable 40,150

Gain
Machinery 50 Cash 40,150

Investment in FC 40,200
FC Receivable 40,200

Cash 40,200
Investment in Fc 40,200

Balance Sheet Presentation:

Dec. 1, 2020 OCI
FC Receivable 40,150 3/1/21 200 250 12/31/20
Pesos Payable 40,150 3/1/21 – to P/L 50
Forward Contract -

Dec. 31, 2020

FC Receivable 40,400
Pesos Payable 40,150
Forward Contract 250

C. CLOSURE ACTIVITIES

Problem 1: Given the following information for Canadian Dollars, compute for the following independent cases
below: the following direct exchange rates were as follows:
10/02/20 10/25/20 11/02/20 12/01/20 12/31/20 1/30/21 2/28/21 3/31/21
Buying Spot Rate 20.20 20.85 20.70 20.50 20.40 20.30 20.15 20.10
Selling Spot Rate 20.95 21.10 22.40 20.30 25.25 29.35 29.50 29.70

150 day forward 120 day forward 90 day forward 60 day forward 30 day forward
3/31/21 23.40 22.70 25.85 26.50 29.40
2/28/21 23.15 22.40 25.20 26.25 29.25
01/30/21 22.10 21.75 20.55 23.75 25.50
12/31/20 21.30 22.80 20.20 21.40 25.30
12/01/20 20.25 23.15 21.40 23.50 24.10
11/02/20 20.40 24.10 22.85 24.15 23.30
On October 25, 2020 CC company ordered merchandise worth $975,000 from a company in Toronto, payable on
Feb. 28, 2021 in Canadian $. It was shipped on November 2, 2020. To hedge this foreign currency exposure, CCC
company bought $975,000 on Dec., 1, 2020 for delivery on Jan 30, 2021under a forward contract with BDO

1. What amount will affect profit and loss regarding the derivative asset on its settlement date in 2021?
2. As a result of all foregoing transactions, what amount will affect current earnings on the financial
statement date in 2020?

On October 2, 2020 FF Company received an order of merchandise from a Company in Alberta. It was invoiced and
shipped on October 25, 2020 to the customer. The price of $370,000 is to be collected in Canadian dollars on Feb.,
28, 2021. To hedge this foreign currency exposure, FF company sold $370,000 for delivery on March 31, 2021 under
a forward contract with BPI which was entered into by FF Company on November 2, 2020.

3. As a result of all foregoing transactions what amount will affect current earnings in 2021?
4. As a result of all foregoing transactions what amount will affect current earnings in 2020?

Problem 2: MMM Company sold merchandise for 315,000 pounds to a customer in London on November 01, 2020.
Collection in British pound was due on January 30, 2021. On the same date, manila entered into a 90-day forward
contract to sell 315,000 pounds to a bank. Exchange rate for pound on different dates are as follows:
Nov 1, 2020 Dec., 31, 2020 Jan., 30, 2021
Spot rate P51.30 P52.60 P51.80
30-day 52.20 52.4 53.10
60-day 51.70 52.1 52.50
90-day 50.5 52.5 53.30

How much is the net foreign exchange gain or loss on January 30, 2021?

Problem 3: November 15, 2020 PPP Company a Philippine trader ordered merchandise FOB shipping point from a
foreign company for 200,000 local currency units, the currency of the foreign company. The merchandise was
shipped and invoiced to PPP Company on 12-10-20. PPP company paid the invoice on January 10, 2021. The spot
rates for each local currency unit on the respective dates are as follows:
November 15, 2020 P4.955
December 10, 2020 4.675
December 31, 2020 4.875
January 10, 2021 4.475

In PPP Company‟s 12-31-20 income statement, what is the foreign exchange gain or loss?

Problem 4: SSS Inc. placed an order for inventory costing 500,000 foreign currency with a foreign vendor on April 15
when the spot rate was 1FC=.P0.683. SSS received the goods on May 1 when the spot rate was 1FC=P0.687. Also
on May 1, SSS entered into a 90-day forward contract to purchase 500,000 FC at a forward rate of 1FC=P0.693.
Payment made to the foreign vendor on August 1 when the spot rate was 1FG=P0.696. SSS has a June 30 year-
end. In that date, the spot rate was 1FC=P.0.691, and the forward rate on the contract was 1FC=P0.695. Changes in
the current value of the forward contract are measured as the present value of the changes in the forward rates over
time. The relevant discount rate is 6%

The foreign exchange gain of June 30, and on August 1, and the net income effect on June 30 respectively are?

Problem 5: Given the following information for a 90 day contract

Pesos FC
Value today 3,750 5,000
Interest rate 4% 7%
3 months interest 37.50 87.50
Value in 3 months ? ?
The spot rate today is 1 FC =.75

What will be the forward rate?

Problem 6: ABC Company entered into a forward contract to hedge a sale of inventory in October 26, 2020 to be
collected on January 24 , 2021. 72,000 FC (foreign currency) in 90 days. The relevant exchange rates as follows:

Spot rate Forward rate

Oct. 26, 2020 P52.73 P52.77
December 31, 2020 52.82 52.89
 Jan. 24, 2021 52.94

What is the net forex gain (loss) from this transaction and hedge that will be reported on ABC‟s 2020 statement of
income?

IV. SYNTHESIS/ GENERALIZATION

CHAPTER SUMMARY:

Summary of the Effects of Foreign Exchange Gains (Losses) in Import and Export Transactions:\

Statement of FP Effect on Balance Statement of CI

account affected Reported Effect
Increase in Exchange Rate:
Importing Transaction Payable Increase Loss
Exporting Transaction Receivable Increase Gain
Decrease in Exchange Rate:
Importing Transaction Payable Decrease Gain
Exporting Transaction Receivable Increase Loss

Hedge Accounting Summary:

Fair Value Hedge Cash Flow Hedge

Hedge Instrument (derivative is a On balance sheet carried at On balance sheet carried at Fair
Forward Contract) Fair Value Value
Gain or Loss on Hedging Recognized immediately in P/L To the extent, the hedges are
Instrument effective, recognized as other
comprehensive income and are
subsequently recognized as a
component of income when the
hedged item affects earnings.
The ineffective portion of gain or loss
will be reported immediately in P/L
Gain or Loss on the Hedged Recognized immediately in P/L Not applicable- forecasted
Item due to hedged risk transactions are not recognized.
Gain or Loss in the Other Not Applicable If the item hedged is a forecasted
Comprehensive Income purchase of inventory, the gains and
Transferred to P/L losses on the hedged will be
reclassified into earnings when
inventory is sold, or when a forecasted
purchase of equipment, the gains and
losses on the hedge will be
reclassified into earnings as the
equipment is depreciated.

V. EVALUATION

The student‟s performance will be evaluated as follows:

20% Attendance, Poll Questioning and Oral Exercises
20% Portfolio Journal for work exercises
20% Formative Examination (One online/Offline written quiz covering this specific topic)
40% Summative Examination (This topic is one of the topics included in the Online/Offline Written Examination)

Dayag, Advanced Financial Accounting and

Reporting 2019e
Dayag, Advanced Financial Accounting and
VII. REFERENCES
Reporting Reviewer
IFRS 9 Financial Instruments
Guerrero, Advanced Accounting 2017e

END OF CHAPTER 11 & 12