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My CPA-FARmodule19

Notecards I made from Wiley's 2012 CPA Exam Review

QuestionAnswer
What is a foreign currency transaction? The US company enters into a transaction with a foreign entity, and transaction is denominated in foreign currency units. May cause a foreign currency transaction gain or loss to be recognized in US companies income statement
In a foreign currency transaction, what are the accounts receivable and sales measured at on the date of the transaction? US dollars, using the current spot rate of the foreign currency to convert
In a foreign currency transaction, what happens if there is an accounts receivable of a foreign currency on the date of the financial statements are created? restate the accounts receivable to show the change in the spot rate (if there is one) and recognize a foreign currency transaction gain or loss
In a foreign currency transaction, does a change in interest amount paid or received because of a change in spot rate also result in a foreign currency gain or loss? Yes, by difference of spot rate
What are derivative instruments? instrument that derives its value as a financial instrument from something outside the instrument. (i.e. call option because value is derived by market price of its related stock)
In regards to derivative instruments, what is the underlying? the notional amount? 1. underlying is the stock price that exists outside the derivative instrument that is used to determine its value 2. notional amount is the number of units related to the derivative instrument
What are derivative instruments measured at for inclusion of an entitys financial statements? What happens to gains or losses as a result of a change in this value? 1. Fair value 2. appear in comprehensive income or reported in current earnings
What is a fair value hedge? Cash flow hedge? foreign currency hedge? 1. FV protects against changes in FV of an asset/liability or unrecognized firm commitment 2. Cash flow protects against change in cash flows of an asset/liability or a forecasted transaction 3. Foreign currency protects transactions in a foreign curren
What three characteristics of a derivative instrument must be present for it to be considered a derivative instrument? 1. Must contain an underlying (financial or physical variable that has observable changes) and notional amount (units) 2. no initial net investment is required or it is smaller than normal 3. at settlement can be settled with cash or an asset
What specific instruments are thought of as derivatives? Call/Put options, futures contracts, interest rate swaps, currency swaps, swaptions (an option on a swap) credit indexed contracts, interest rate caps/floors/collars
What is an interest rate swap? two companies decide to swap interest payments on debt. One has fixed debt and thinks rates will drop, One has variable debt and thinks rates will rise
What accounting is done when there is a hybrid instrument where there host contract has an embedded aspect that would be a derivative if it were to stand alone? May have to separate ('bifurcate') derivative from host. Host would be accounted for as if derivative were never apart of and derivative accounted for using rules for derivatives
How would you know if bifurcation (separation of host contract and dividend aspect) must occur? 1. embedded derivative meets definition of derivative 2. hybrid instrument not regularly recorded at FV 3. economic characteristics/risks of embedded derivative are not clearly and closely related to to those of the host contract
If the holder of a hybrid instrument chooses not to bifurcate the instrument, how is it accounted for then? at FV, election is irrevocable and made on instrument by instrument basis, change in FV recognized at year end to earnings. Show on balance sheet as separate lines for FV and non FV instruments or total amount of hybrid instruments with FV in parentheses
What criteria must be met for a derivative instrument to be classified as a hedging instrument? 1. Documentation at the beginning must provide the objective and strategy of the hedge, the hedging instrument and the hedged item, how the effectiveness will be assessed 2. must be highly effective throughout its life
What is meant by a hedge having to be highly effective? how often is it measured? 1. hedge's ability to offset changes in value of the hedged item 2. every 3 months and when earnings or financial statements are reported
What criteria must be met for a hedge to be classified as a FV hedge? Where are gains and losses recognized? 1. hedged item must be all or a specific portion of a recognized asset/liability or an unrecognized firm commitment (must be binding on both parties, specific terms, contain nonperformance clause- makes performance probable) 2. in current earnings
How is the time value of a fair value put option calculated? the intrinsic value? 1.Diff between option price and intrinsic value. Zero at exercise date. 2. Greater of zero or diff between stock (exercise) price and exercise (stock) price in call (put)
What are the specific criteria for a hedge to be classified as a cash flow hedge? 1hedged asset/liability must be linked(basis for change in cash flow is the same) to hedged instrument 2must be highly effective 3if forecasted transaction must be considered probable 4if forecasted is series of transactions, must share same risk expos
What is the accounting necessary for a cash flow hedge? 1. effective portion is reported in OCIncome 2.ineffective/excluded portion reported on cumulative basis, report lesser of cumulative gain/loss- of derivative since creation of hedge or from change expected cash flows from hedged instrument since creatio
For a foreign currency hedge to be applied to an available-for-sale security, what criteria must be met? 1. cannot be traded on an exchange in the investor's functional currency 2. dividends must be denominated in same foreign currency as is expected to be received on sale of the security
How are foreign currency hedges accounted for if they are classified as unrecognized firm commitments? available-for-sale? foreign currency denominated forecasted transactions? net investments in foreign operations? 1. as a fair value hedge 2. as a fair value hedge 3. as cash flow hedge (distinguish from from commitments because timing of cash flows remains uncertain) 4. change in FV of derivative recorded as translation adjustment to OCIncome closed to AOCIncome
What do you use to estimate the FV of a forward exchange contract? Use the forward exchange rate for the remaining term of the contract
What disclosures are needed for both derivative and nonderivative financial instruments? (hedging instruments specifically) 1. objectives and strategies for achieving 2. context to understand the instrument 3. risk management policies 4. list of the hedged instruments
Created by: Bsantoro