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PROBLEM: ACCOUNTING FOR DERIVATIVES & HEDGES Problem 1 (Deri !"i e Fi#!#$i!

l I#%"r&me#"' (P 1)*1+ The treasurer of Miller Co. has read on the internet that the price of Wade Inc. ordinary shares is about to take off. In order to profit from this potential development, Miller Co. purchased a call option on Wade shares on July 7, 2 ! , for "2# . the call option is for 2 shares $notional value% and the strike price is "7 . The market price of a Wade share on that date is "7 . The option e&pires on January '!, 2 !!. The follo(in) data are available (ith respect to the call option *ate ,eptember ' , 2 ! *ecember '!, 2 ! January #, 2 !! Market +rice of Wade ,hares "77 per shares 7- per shares 7. per shares The value of call option "!/ .'

I#%"r&$"io#% +repare the 0ournal entry for Miller Co. for the follo(in) dates. a. July 7, 2 ! 1 investment in call option on Wade shares b. ,eptember ' , 2 ! 1 Miller prepares financial statement c. *ecember '!, 2 ! 1 Miller prepares financial statement d. January #, 2 !! 1 Miller settles the call option on the Wade shares Problem , (F!ir V!l&e He-.e I#"ere%" R!"e S/!0' (P 1)*11 2n *ecember '!, 2 ! , 34,tore Inc. had a "! , , , /5 fi&ed rate note outstandin), payable in 2 years. 34,tore decides to enter into a 24year s(ap (ith Chica)o 6ank to convert the fi&ed4rate debt to variable 1rate debt. The term of the s(ap indicate that 34,tore (ill receive interest at a fi&ed rate of /5 and (ill pay rate e7ual to the .4month 8I629 rate, based on the "!, , amount. The 8I629 rate on *ecember '!, 2 ! , is 75. The 8I629 rate (ill be reset every . month and (ill be used to determine the variable rate to be paid for the follo(in) .4month period 34,tore desi)nates the s(ap as a fair value hed)e. :ssume that the hed)in) relationship meets all the condition necessary for hed)e accountin). The .4month 8I629 rate and the s(ap and debt fair value are as follo(s. *ate $'!=!2=! % $' =.=!!% $'!=!2=!!% .4Month 8I629 9ate 7. 5 7.-5 .. 5 ,(ap ;air <alue 4. "$2 , % . , *ebt ;air <alue "!, , >,/ , ! , . ,

I#%"r&$"io#% a. +resent the 0ournal entries to record the follo(in) transaction !% The entry $if any% to record the s(ap on *ecember '!, 2 ! . 2% The entry to record the semiannual debt interest payment on June ' , 2 !!. '% The entry to record the settlement of the semiannual s(ap amount receivables atl debt interest payment on June ' , 2 !!./5, less amount payable at 8629, 75. #% The entry to record the chan)e in the fair value of the debt on June ' , 2 !!. -% The entry to record the chan)e in the fair value of the s(ap on June ' , 2 !! b. Indicate the amount$s% reported on the statement of financial position and income statement related to the debt and s(ap on *ecember '!, 2 ! . c. Indicate the amount$s% reported on the statement of financial position and income statement related to the debt and s(ap on June ' , 2 !!. d. Indicate the amount$s% reported on the statement of financial position and income statement related to the debt and s(ap on *ecember '!, 2 !! Problem + (C!%2 Flo/ He-.e' (P 1)*1) Choi ?olf Co. uses titanium in the production of its specialty drivers. Choi anticipates that it (ill need to purchase 2 $- % ounces of titanium in 2ctober 2 ! , for clubs that (ill be shipped in the holiday shoppin) season. @o(ever, if the price of titanium increases, this (ill increase the cost to produce the clubs, (hich (ill result in lo(er profit mar)ins. To hed)e the risk of increased titanium prices, on May, 2 ! , Choi enters into a titanium futures contract and desi)nates this futures contract as cash flo( hed)e of the anticipated titanium purchase. The

notional amount of the contract is 2 ounces, and the terms of the contract )ive Choi the ri)ht and the obli)ation to purchase titanium at a price of A- , per ounces. The price (ill be )ood until the contract e&pires on Bovember ' ,2 ! . :ssume the follo(in) data (ith respect to the price of the call option and the titanium inventory purchase. *ate May !, 2 ! June ' , 2 ! ,eptember ' , 2 ! A- , -2, -2,,pot +rice for Bovember *elivery per ounce $' , per ounce $'!, per ounce $'!,% % %

I#%"r&$"io#% +repare the 0ournal entries for the follo(in) dates. a. May !, 2 ! 1 inception of futures contract, no premium paid b. June ' , 2 ! 1 Choi prepares financial statement c. ,eptember ' , 2 ! 1 Choi prepares financial statement d. 2ctober -, 2 ! 1 Choi purchases 2 ounces of titanium at A-2,- per ounce and settles the futures contract. e. *ecember !-, 2 ! 1 Choi sells clubs containin) titanium purchased in 2ctober 2 ! for A2-, , . The cost of the finished )ood inventory is A!#, , . f. Indicate the amount$s% reported in the income statement related to the futures contract and the inventory transactions on *ecember '!, 2 ! . ?ood 8uck