FAR 49 - Fair Value, Cash Flow, and Foreign Currency Hedges Flashcards Preview

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Flashcards in FAR 49 - Fair Value, Cash Flow, and Foreign Currency Hedges Deck (23):
1

A derivative designated as a fair value hedge must be:

I. Specifically identified to the asset, liability, or firm commitment being hedged.
II. Expected to be highly effective in offsetting changes in the fair value of the hedged item.

Both. A derivative designated as a fair value hedge must both be expected to be highly effective in offsetting changes in the fair value of the hedged item, and be specifically identified to the asset, liability, or firm commitment being hedged.

2

Which one of the following is least likely to be a characteristic of a firm commitment?
A. It is evidenced by a contractual obligation.
B. It can be the hedged item in a fair value hedge.
C. It has been recorded as an asset or liability.
D. It is subject to the risk of change in fair value.

C. A firm commitment has not been recorded (yet) as an asset or liability. A firm commitment occurs when an entity has a contractual obligation or contractual right, but no transaction has been recorded (and no asset or liability recognized) because GAAP requirements for recognition have not yet been met. Nevertheless, the subject matter of the firm commitment is at risk of change in fair value and can be hedged.

3

A derivative cannot be used as a fair value hedge for:
A. A recognized asset.
B. A recognized liability.
C. An unrecognized forecasted transaction.
D. An unrecognized firm commitment.

C. For GAAP purposes, a derivative cannot be used to hedge the risk associated with an unrecognized forecasted transaction, primarily because, since the transaction is only "forecasted," there is no established fair value to hedge. A derivative can be used to hedge the risk associated with a recognized asset, recognized liability, or unrecognized firm commitment, but not an unrecognized forecasted transaction.

4

T/F: The asset, liability, or firm commitment hedged by a derivative instrument must be adjusted to fair value at the end of each fiscal period.

True

5

T/F: An "unrecognized firm commitment" exists when an entity has a contractual obligation that has not yet been recognized in the accounting records.

True

6

T/F: Derivative instruments may not be used to hedge change in the fair value of an unrecognized firm commitment.

False.
They can be used.

7

T/F: Changes in the fair value of derivative instruments used as fair value hedges will always exactly offset the change in the fair value of the asset, liability, or firm commitment being hedged.

False.
They will rarely exactly offset.

8

A derivative related to a fair value hedge and a separate derivate related to a cash flow hedge both experience gains in the value of the instruments due to a change in interest rates. Which financial statements is each gain recorded in?

Fair value hedge = IS
Cash flow hedge = OCI
When the fair value of a financial instrument is hedged, gains (and losses) from changes in the value of the hedged item and the hedging instrument (derivative) are recognized in current income.

When the cash flow of a financial instrument is hedged, gains (and losses) from changes in the value of the hedged item are recognized in other comprehensive income, along with the change in the value of the hedging instrument (derivative) up to the change in amount of the hedged item. Any change in the value of the hedging instrument in excess of the change in the hedged item is recognized in current income.

9

Qualified derivatives may be used to hedge the cash flow associated with which (if any) of the following:
I. Asset
II. Liabilities
III. Forecasted transaction

All 3. Derivative instruments may be used to hedge the cash flows associated with assets, liabilities, or forecasted transactions.

10

Which one of the following is not a characteristic of a cash flow hedge?
A. Can be used to hedge the risk of variability in cash flow of a forecasted transaction.
B. Measures the hedged item using the present value of expected cash flows.
C. The derivative used as the hedging instrument is measured at fair value.
D. All difference between the change in value of the hedged item and the change in value of the hedging instrument is recognized in current income.

D. All difference between the change in value of the hedged item and the change in value of the hedging instrument is not recognized in current income. To the extent the change in the fair value of the hedging instrument offsets the change in the fair value of the hedged item, the hedge is effective, and that amount is recognized in other comprehensive income, not current income. To the extent the change in the fair value of the hedging instrument is different than the change in the fair value of the hedged item, the hedge is ineffective, and that amount is recognized in current income.

11

In a cash flow hedge, the item being hedged is measured using:
A. The nominal value of expected cash inflows.
B. The present value of expected cash inflows.
C. The nominal value of expected cash inflows or outflows.
D. The present value of expected cash inflows or outflows.

D. The item being hedged in a cash flow hedge is measured using the present value of expected cash inflows or cash outflows. The item being hedged in a cash flow hedge may be associated with an asset, a liability, or a forecasted transaction. The value of such items is measured using the present value of either cash inflows (e.g., receivable) or cash outflows (e.g., payable), depending on the nature of the item being hedged.

12

T/F: Derivative instruments used as cash flow hedges must be adjusted to fair value at the end of each fiscal period.

True

13

T/F: Changes in the fair value of derivative instruments used as cash flow hedges are always fully recognized as gains or losses in the period of the change in fair value.

False.
An amount equal to the cumulative change in the present value of cash flows associated with the hedged item is the "effective portion" of the hedge - recognized in OCI.

An amount by which the cumulative change in the derivative is different from the cumulative change in the present value of cash flows associated with the hedged item is the "ineffective portion" of the hedge - recognized as a G/L in current income.

14

T/F: The "effective portion" of a cash flow hedge will be recognized in other comprehensive income.

True

15

T/F: The "ineffective portion" of a cash flow hedge will be recognized in current income.

True

16

T/F: In order to be accounted for as a cash flow hedge, a derivative instrument must be highly effective in offsetting changes in the present value of expected cash flow of the hedged item.

True

17

T/F: The cash flow associated with the asset, liability, or forecasted transaction hedged by a derivative instrument must be adjusted to fair value at the end of each fiscal period.

False.

18

T/F: Changes in the fair value of derivative instruments used as cash flow hedges may be allocated between other comprehensive income and current income.

True

19

Which of the following statements concerning derivatives used as foreign currency hedges is/are correct?

I. Can be used to hedge the risk of exchange rate changes on planned transactions.
II. Can be used to hedge the risk of exchange rate changes on available-for-sale investments.
III. Can be used to hedge the risk of exchange rate changes on accounts receivable and accounts payable.

All 3. Foreign currency hedges can be used to hedge the risk of exchange rate changes on planned (forecasted) transactions, available-for-sale investments, and accounts receivable/accounts payable (and unrecognized firm commitments and net investments in foreign operations).

20

If a firm used a derivative to hedge the risk of exchange rate changes between the time a liability is recorded and the time it is settled in a foreign currency, which one of the following is being hedged?
A. Unrecognized firm commitment.
B. Forecasted transaction.
C. Recognized liability.
D. Net investment in a foreign entity.

C. A foreign currency hedge of a recognized liability hedges the risk of exchange rate changes on the cash flow (or fair value) of a liability between the time it is recorded (recognized) and the time it is settled in a foreign currency.

21

Which one of the following is not a characteristic of a foreign currency hedge?
A. Hedges the risk due to change in foreign currency exchange rates.
B. Can hedge net investments in a foreign entity.
C. Are all treated as fair value hedges.
D. Can be used to hedge forecasted intercompany transactions.

C. All foreign currency hedges are not treated as fair value hedges. While foreign currency hedges of unrecognized firm commitments, investments in available-for-sale securities, and net investments in foreign operations are treated as fair value hedges, foreign currency hedges of forecasted transactions are treated as cash flow hedges, and foreign currency hedges of recognized assets or liabilities may be treated either as fair value hedges or cash flow hedges, depending on management's designation.

22

T/F: Derivative instruments may be used to hedge changes in the dollar value of planned (forecasted) transactions that will be denominated in a foreign currency.

True

23

T/F: Derivative instruments may be used to hedge changes in the dollar value of account balances denominated in a foreign currency.

True

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