ACCT 5341 Syllabus
Bob Jensen
at Trinity University
| [06] Omar Akhil | [05] Fendy Wu | [04] Andy Holtman |
| [30] Royce Brewer-Vogt | [29] Andrew Hartley | [28] Brian Cope |
| [31] Erin Welch | [32] Eugene Fan | |
| [12] Scott Vaughan | [11] Kevin Gallagher | [10] Desiree Pratt |
| [21] Caroline Thomas | [20] Cory Cassell | [19] Amanda Platt |
| [09] Matthew Milligan | [08] Quinn Cummins | [07] Curt Kieffer |
| [18] Michael Roye | [17] Marisa Flores | [16] Elvia Laurel |
Notebook File 1 (HTML) Question 01
What are the implications in SFAS 133 for
denomination in a foreign currency of an acquired asset or liability?
[Hint: See Paragraph 29 of SFAS
133.]
Notebook File 1 Question 02
On December 14, 19x1 the HedgedEm Company hedged a forecasted purchase of
10,000 shares of Microsoft Corporation common shares with a forward contract. The
contracted forward price is $130 per unit equal to the market price on December 14.
On December 31, 19x1, the price of the shares increased by $10 per
share. On February 14, 19x2 HedgedEm purchased 8,000 shares with no immediate
intention of purchasing the other 2,000 Microsoft shares. The February 14 price was
$138 per share. The forward contract was settled for cash using the 10,000
notional amount on February 14.
2.1
What are the journal entries on December 14 to record the forward contract?
2.2
What are the journal entries on December 31 under available-for-sale versus trading securities classification of the investment when the share price is $140 per share? Note that the securities have not yet been purchased.[Hint: Look up the term "available-for-sale" in Bob Jensen's SFAS 133 Glossary.]
2.3
What are the journal entries on February 14 under available-for-sale versus trading securities classification of the investment when the securities are acquired?[Hint: Under the available-for-sale classification, only 20% of the gain on the forward contract settlement is to be deferred in OCI until the securities are sold. This is because only 80% of the forecasted 10,000 shares were actually purchased on February 14 and there is no intention of further purchase.]
2.4
Suppose 5,000 shares are sold on June 10 for $133 per share. What are all required journal entries under available-for-sale versus trading securities classification of the investment in Microsoft shares? What must the price of the remaining 3,000 unsold shares fall to in order for the company to break even on all these transactions?[Hint: See Paragraph 31 of SFAS 133.]
Notebook File 1 Question 03
On December 14, 19x1 the HedgedEm Company hedged a forecasted purchase of
10,000 shares of Microsoft Corporation common shares with a call option priced at $15,000.
The strike price is $5 per share higher than the December 14 price of $130 per
share. On December 31, 19x1, the price of the shares increased by $10 per
share. On February 14, 19x2 HedgedEm settled its call option for $30,000 in cash and
immediately purchased 8,000 Microsoft shares. The February 14 price was $138 per
share. Assume that the Microsoft shares will be classified as being available for
sale if and when they are acquired.
[Hint: In addition to FAS 133,
students may find definitions and examples in "Summary of
Derivative Types" --- http://www.rutgers.edu/Accounting/raw/fasb/derivsum.exe
Trinity University students may download from
J:\courses\acct5341\fasb\sfas133\derivsum22
Especially note pp 49-61).
3.1
What are the journal entries on December 14 to record the call option?
[Hint: Look up the term "premium" in Bob Jensen's SFAS 133 Glossary.]
3.2
What are the journal entries on December 31 under available-for-sale securities classification of the investment when the share price is $140 per share? Note that the securities have not yet been purchased. Assume the call option has a market value of $66,154. What are the advantages and disadvantages of the call option in Question 3.2 versus the forward contract in Question 2.2?[Hint: The entire premium of $15,000 on December 14 must be considered time value since the option is out of the money at that time by $5 per share. The intrinsic value is $0 on December 14. On December 31, the intrinsic value (spot price - strike price)(10,000 shares) is ($140-$135)(10,000) = $50,000. Thus the change in intrinsic value is $50,000. Changes in intrinsic value are posted to OCI in available-for-sale classifications. The time value of the option on December 31 is $66,154 - $50,000 = $16,154. The $16,154 - $15,000 = $1,154 change in time value between December 14 and December 31 is posted to current earnings.]
3.3
What are the journal entries on February 14 under available-for-sale versus trading securities classification of the investment when the securities are acquired? The strike price is $135 per share.[Hint 1: The problem does not specify the value of the option on February 14. Hence, the change in the option's value cannot be computed unless the option expires on that date. The balance in OCI can be derived in another way on the date of settlement. On February 14, the option's settlement brings in ($138-$135)(10,000 shares) = $30,000. The option's cash premium was $15,000. The gain on the option is thus $15,000. This $15,000 would have been deferred in OCI until the 10,000 shares were sold if the company had purchased all 10,000 shares.
[Hint 2: Under the available-for-sale classification, only 20% of the gain on the option contract settlement is to be deferred in OCI until the securities are sold. This is because only 80% of the forecasted 10,000 shares were actually purchased on February 14 and there is no intention of further purchase.]
3.4
Suppose 5,000 shares are sold on June 10 for $133 per share. What are all required journal entries under available-for-sale classification of the investment in Microsoft shares? What must the price of the remaining 3,000 unsold shares become in order for the company to break even on all these transactions?
3.5
Suppose the strike price has been $145 instead of $135 per share. How would this affect the December 31 entries in your answers to Question 3.2? Assume the call option has a market value of $10,000.[Hint: The entire premium of $15,000 on December 14 must be considered time value since the option is out of the money at that time by $5 per share. On December 31, the intrinsic value (spot price - strike price)(10,000 shares) is ($140-$145)(10,000) = -$50,000. Thus the change in intrinsic value is negative. Changes in intrinsic value are posted to OCI in available-for-sale classifications only if they are positive since options only hedge in one directions. The time value of the option on December 31 is its entire value of $10,000. The -$5,000 loss in time value is posted to current earnings.]
3.6
Suppose the strike price has been $145 instead of $135 per share. How would this affect the February 14 entries (in your Question 3.3 answers) to settle the call option and to purchase 8,000 shares for $138 per share? What would the future price Microsoft have to become for 8,000 shares for HedgedEm Company to break even on all these transactions assuming a $145 strike price? If 5,000 shares are sold for $133 on June 10, what is the break even price for the remaining 3,000 shares?
Notebook File 1 Question 04
On December 14, 19x1 the HedgedEm Company hedged a forecasted purchase of
10,000 units of raw material inventory with a forward contract. The contracted
forward price is $130 per unit equal to the market price on December 14. On December
31, 19x1, the price increased by $10 per unit. On February 14, 19x2, HedgedEm
purchased 8,000 units with no immediate intention of purchasing the other 2,000 units of
inventory. The February 14 price was $138 per unit.
4.1
What are the journal entries on December 14 to record the forward contract?
4.2
What are the journal entries on December 31?
4.3
What are the journal entries on February 14?
4.4
Suppose 5,000 units of the raw material are used in production on June 10. What are all required journal entries on June 10?
4.5
Suppose the merchandise had been gold or silver?. Would the cash flow hedge of a forecasted inventory purchase differ from the forecasted sale of existing inventory of gold or silver?[Hint: See Paragraph 405 of SFAS 133.]
Notebook File 1 Question 05
On January 10, a wholesale distributor called Hopeful Corporation entered into a
sales contract with a retail firm called ABC Company for 1,000 units of product on at
retail market prices on July 10. The current spot market price was $100
per unit on January 10. The contract specified a 75% penalty escrow account for
damages if either party reneges on the deal. As an economic hedge on January 10,
Hopeful pays $5,000 for a European-style put option to sell 1,000 units on July 10.
The strike price is $100 per unit.
The above sales contract was not a short sale. On January 10, prior to signing the sales contract with ABC Company, Hopeful Corporation entered into a firm commitment its foreign supplier, Barker Manufacturing, Ltd.., to purchase the 1,000 units for $90 on June 10. Under the perpetual inventory method, Hopeful Corporation had those 1,000 units of the product inventoried at $80 per unit on the morning of July 10. All journal entries required in this problem are from the perspective of Hopeful Corporation's accounting records.
5.1
Record the Hopeful Corporation January 10 journal entries for the sales contract, purchase contract, and put option if the contracted price was the July 10 spot price.
5.2
On March 31, Hopeful Corporation closed its books. What adjusting entries were made under SFAS 133 rules for the sales contract and the put option assuming the March 31 spot price was $90 per unit? Also assume the put option had a market value of $12,400 on March 31.[Hint: The intrinsic value of the put option on March 31 is ($100-$90)(1,000 units) = $10,000. The time value becomes $12,400-$10,000 = $2,400. The time value on January 10 was $5,000.]
5.3
Record the July 10 journal entries for the sale to ABC Company at the July 10 spot price of $85 per unit. Assume that the inventory was previously acquired under the firm commitment with Barker and that this is already booked to the Merchandise Inventory account for $8,000. Also make the entry to take the goods out of inventory with a debit to Cost of Goods Sold. In addition, record the cash settlement of the put option. Assume no adjusting entries were made to the put option account since March 31. Show the closing entries for Cost of Goods Sold and Sales.
5.4
Revise all your journal entries for January 10 (Question 5.1) if there was a contracted sales price with ABC at $100 per unit for the 1,000 units to be sold on July 10. Assume the penalty clause remains at 75%. Although there is no longer a need for the put option, assume that Hopeful enters into the put option as a speculation rather than a hedge.[Hint: See Paragraph 29c of SFAS 133.]
5.5
On March 31, Hopeful Corporation closed its books. What adjusting entries were made under SFAS 133 rules for the sales contract and the put option assuming the March 31 spot price was $90 per unit? For this part of the problem, assume the sales contract had a firm price of $100 per unit for the July 10 deal. Also assume that that the put option speculation had a market value of $12,400 on March 31. Your assignment here is to revise all your previous Question 5.2 journal entries.
5.6
Record the July 10 journal entry to record the sale of the units to ABC Company for a contracted price of $100 per unit for 1,000 units to be sold on July 10. In other words revise all Question 5.3 journal entries if the ABC sales contract is a firm commitment.
5.7
Please review your answer to Question 5.2 above. Now you are to assume that Hopeful Corporation really gambled on the sales contract with ABC Company by selling short. In other words, assume for the moment that there was no purchase contract Barker Manufacturing, Inc. What are the March 31 adjusting entries in this short sale situation? You are to assume that the put option is still in effect.[Hint: Look up the term "short sale" in Bob Jensen's SFAS 133 Glossary.]
5.8
Please review your answer to Question 5.4 above. Would your answer change if the penalty clause is reduced from 75% to 2%? Please revise all of your Question 5.4 journal entries if you conclude changes are necessary.
[Hint: Look up the term "firm commitment" in Bob Jensen's SFAS 133 Glossary.]
5.9
Please review your answer to Question 5.5 above. Would your answer change if the penalty clause is reduced from 75% to 2%? Please revise all of your Question 5.4 journal entries if you conclude changes are necessary.
5.10
Please review your answers to Questions 5.2 above. Would your answers change if the contracted amount of 1,000 units is changed to a contracted range between 500 and 1,000 units of inventory at the discretion of the seller (Hopeful Corporation). In other words, the sales quantity may fall anywhere in the specified range at the discretion of the seller? Assume the seller still forecasts a 1,000 unit sale.[Hint: Look up the term "forecasted transaction" in Bob Jensen's SFAS 133 Glossary.]
5.11
Would your answer in 5.10 change if only the buyer (ABC Company) had the contractual discretion of altering the sales quantity with the specified range?
5.12
Please review your answer to Question 5.2 above. Would your answer change if the seller, Hopeful Corporation, hoped as of March 31 but no longer expected the spot price to rise above in June and July. Show your revised Question 5.2 journal entires in light of the dismal expectations of the product's selling price.
[Hint: Look up the term "impairment" in Bob Jensen's SFAS 133 Glossary.].
5.13
Please review your answer to Question 5.4 above. Would your answer change if Hopeful Corporation wrote an European-style call option instead of purchasing the put option? In other words assume that there is still sales contract with ABC Company for 1,000 units at July 10 spot prices. In addition, you are now to assume that some unknown company through a broker paid $5,000 on January 10 to Hopeful Corporation for a call option to buy 1,000 units on July 10 from Hopeful at $100 per unit. The option is to be settled in cash rather than priduct units. What are Hopeful Corporation's January 10 journal entries? Do you think that, in theory, your revised January 10 solution adequately accounts for Hopeful Corporation's financial risk as the writer of this call option?
Notebook File 1 Question 06
Can forecasted transactions with a minority interest company be hedged items by the parent
of a subsidiary company? Can the subsidiary company have a forecasted transaction
with a minority interest owner?
[Hint: Look up the term "minority interest" in Bob Jensen's SFAS 133 Glossary.]
Notebook File 1 Question 07
Suppose that Texaco has a take-or-pay contract to purchase 1 million gallons of crude from
a joint venture in which it has a 30% interest. If the price can vary with spot
rates, can this contract be a hedged item under SFAS 133 rules?
[Hint: Look up the term "take-or-pay" in Bob Jensen's SFAS 133 Glossary.]
Notebook File 1 Question 08
What are the SFAS 133 rules regarding hedged items and their hedges that have unequal
maturity dates?
[Hint: Look up the term "forecasted transaction" in Bob Jensen's SFAS 133 Glossary.]
Notebook File 1 Question 09
Minigates Company trades in technology securities. Can Minigates use SFAS 133 rules
for a hedge of a forecasted transaction for 100,000 shares of Microsoft Corporation where
the hedge is an an exchange-traded option on Microsoft's common share prices? Assume
the option will have a net cash settlement rather than delivery of shares.
Explain the FASB's reasoning on this issue.
[Hint: See Paragraph 29d of SFAS 133.]
Notebook File 1 Question 10
Can a pork belly futures contract be used to hedge a forecasted sale of pork sausage from
the inventory of a sausage making company?
[Hint: See Paragraph 29g of SFAS 133.]
Notebook File 1 Question 11
Suppose an interest rate swap indexed to LIBOR is designated as a cash flow hedge of a
variable interest rate portfolio linked to the U.S. prime rate of interest. Can this
be a cash flow hedge under SFAS 133 rules? Explain the FASB's reasoning on
this issue.
[Hint: Look up the term "index" in Bob Jensen's SFAS 133 Glossary.]
Notebook File 1 Question 12
What is a swaption? Can a an instrument that contains a swaption qualify as a cash
flow hedge under SFAS 133 rules?
[Hint: See Paragraph 18c of SFAS 133 and Bob Jensen's SFAS 133 Glossary.]
Notebook File 1 Question 13
Question 10 from Chapter 7 of your PHB textbook.
Partnership Teaching Assignment
| [31] Erin Welch | [32] Eugene Fan |
Be prepared to discuss 133ex04q.xls
in the TUCC Network Path J:\courses\acct5341\answers\partnerships\
(You will mostly be interested in the Example 4 spreadsheet of this particular Excel workbook)
[Hint: In addition to FAS 133,
students may find definitions and examples in "Summary of
Derivative Types" --- http://www.rutgers.edu/Accounting/raw/fasb/derivsum.exe
Trinity University students may download from
J:\courses\acct5341\fasb\sfas133\derivsum22
Especially note pp. 23-25, 65-68 (Especially Example 1).]
By Yourself Reading Reading Assignments (take hand-written notes of assigned readings)
Pages 41-50 in http://www.trinity.edu/rjensen/fraud.htm
(Keep your printout of this file since reading portions will be assigned each week from the file.)PHB Chapter 7
SFAS 133 Paragraphs (27-35, 293-311, 244-266, 371-383) and Example 9 beginning in Paragraph 162.
Also review Paragraphs 28-36 for possible quiz questions.Background reading: Chapters 4 and 5 on "Managing Risk With Options" (Handed out in class). Some parts of this chapter are outside the scope of this course. This is being handed out for reference and background reading. Students are responsible for the following:
How do purchased options differ fundamentally from virtually all other types of derivative financial instruments?
How do risks differ between purchased versus written options?
What is a covered call/put?
How do American options differ from European options?
Explain Exhibits 4-4 and 4-5.
What factors will increase the value of a purchased call option?
What factors will decrease the value of a purchased put option?
What is the distinction between intrinsic value versus time value?
[Hint: See Bob Jensen's SFAS 133 Glossary.]
What are Eurodollar options?
How does Delta differ from Gamma in the theory of financial options?
(You are required to bring your textbooks and extra floppy discs to class)