LOS c: Provide a simplified description of the accounting treatment for derivatives being used: to hedge exposure to changes in the value of assets and liabilities, to hedge exposure to variable cash flow, and to hedge a foreign currency exposure of an instrument in a foreign corporation.

Q1. What value is used in the balance sheet when reporting a derivative instrument used in a cash flow hedge and where are the

    unrealized gains and losses on the derivative instrument reported?

              Balance sheet    Unrealized gains and losses

A)      Cost         Other comprehensive income

B)     Fair value         Income statement

C)     Fair value         Other comprehensive income

Q2. Recently, Firebird Corporation purchased 1,000 shares of GTO Corporation for $50 per share. GTO is a non-dividend paying

stock and Firebird expects to sell the investment in the near term. To hedge the investment, Firebird purchases a put option and

designates the option as a fair value hedge. Ignoring the premium paid for the option, what is the net effect on Firebird’s total

assets and net income if GTO declines $5 per share at year-end?

      Total assets             Net income

A)       Decrease         No net effect

B)       No net effect    Decrease

C)       No net effect    No net effect

Q3. If the effectiveness criterion of a cash flow hedge and a net investment hedge of a foreign subsidiary are not met, where are

the gains and losses from the ineffective portions recognized?

     Cash flow hedge         Net investment hedge of a foreign subsidiary

A)       Net income      Net income

B)       Other comprehensive income          Other comprehensive income

C)       Net income      Other comprehensive income

Q4. MSH Corporation uses gold to manufacture jewelry. MSH anticipates the need for gold on June 30^th for goods that will be sold

   on September 30^th. Concerned that the price of gold will increase, MSH purchases a futures contract and designates the contract  

   as a cash flow hedge. As it turns out, the spot price of gold was lower at the end of June when the contract was settled. When

should MSH recognize the loss on the futures contract in the income statement and should the loss be included in income from

continuing operations (IFCO)?

Date loss is recognized   Loss included in IFCO

A)       September 30th        No

B)       June 30^th                    Yes

C)       September 30^th        Yes

LOS c: Provide a simplified description of the accounting treatment for derivatives being used: to hedge exposure to changes in the value of assets and liabilities, to hedge exposure to variable cash flow, and to hedge a foreign currency exposure of an instrument in a foreign corporation. fficeffice" />

Q1. What value is used in the balance sheet when reporting a derivative instrument used in a cash flow hedge and where are the

    unrealized gains and losses on the derivative instrument reported?

              Balance sheet    Unrealized gains and losses

A)      Cost         Other comprehensive income

B)     Fair value         Income statement

C)     Fair value         Other comprehensive income

Correct answer is C)

A derivative instrument used in a cash flow hedge is reported on the balance sheet at fair value and the unrealized gains and losses are recognized in the other comprehensive income.

Q2. Recently, Firebird Corporation purchased 1,000 shares of GTO Corporation for $50 per share. GTO is a non-dividend paying

stock and Firebird expects to sell the investment in the near term. To hedge the investment, Firebird purchases a put option and

designates the option as a fair value hedge. Ignoring the premium paid for the option, what is the net effect on Firebird’s total

assets and net income if GTO declines $5 per share at year-end?

      Total assets             Net income

A)       Decrease         No net effect

B)       No net effect    Decrease

C)       No net effect    No net effect

Correct answer is C)

Total assets do not change. The decrease in the value of the investment is exactly offset by the increase in value of the option. Net income is also unaffected. The unrealized loss on the investment is offset by the unrealized gain on the option.

Q3. If the effectiveness criterion of a cash flow hedge and a net investment hedge of a foreign subsidiary are not met, where are

the gains and losses from the ineffective portions recognized?

     Cash flow hedge         Net investment hedge of a foreign subsidiary

A)       Net income      Net income

B)       Other comprehensive income          Other comprehensive income

C)       Net income      Other comprehensive income

Correct answer is A)

In both hedge types, any portion of the hedge that is not effective is recognized in the net income.

Q4. MSH Corporation uses gold to manufacture jewelry. MSH anticipates the need for gold on June 30^th for goods that will be sold

   on September 30^th. Concerned that the price of gold will increase, MSH purchases a futures contract and designates the contract  

   as a cash flow hedge. As it turns out, the spot price of gold was lower at the end of June when the contract was settled. When

should MSH recognize the loss on the futures contract in the income statement and should the loss be included in income from

continuing operations (IFCO)?

Date loss is recognized   Loss included in IFCO

A)       September 30th        No

B)       June 30^th                    Yes

C)       September 30^th        Yes

Correct answer is C)

On June 30^th, the loss on the futures contract should be reported in other comprehensive income. When the goods are sold on September 30^th, the loss should be recognized in the income statement along with the cost of goods sold which is lower since the price of gold declined. The loss is neither extraordinary nor related to a discontinued operation. Thus, the loss is reported “above the line” as a part of income from continued operations.