ACCT 5341 Syllabus
Bob Jensen
at Trinity University
| [04] Douglas Stein | [03] Melissa Johnson | [05] Trip Larzelere |
| [28] Shapar Ali | [27] Stevan Falk | [29] Natalie Martinez |
| [25] Curtis Emerson | [24] Daniel Price | |
| [22] Brian Clarke | [21] Jack Doran | |
| [19] Natalie Luna | [18] Mandeep Ahluwalia | |
| [16] Rebecca Hannon | [15] Raed Elaydi | |
| [14] Chanda Brotemarkle | [13] E. G. Lewis | |
| [11] Russell Doran | [10] Ryan Glowacki | |
| [08] Sara Johnston-Halperin | [07] Michael Clark |
1. You should check your email daily in case there are revisions of this assignment!
2. Each student partnership must turn in one floppy disc containing the Excel file assignment. Your partnership must also meet with the ACCT 5342 teaching assistant.
File 1 is for study purposes. I recommend that each partnership import the document you are reading now into Microsoft FrontPage or Word and then add answers to this document with partner names at the top. Each partner should save the file on a floppy disk. File 1 need not be turned in during class.
File 2 is to start with a reproduction of any EXCEL file that is assigned this week. Each partnership should put in both dialog and computational answers in Sheets 1 and 2 of the assigned Excel file. File 2 must be turned in at the start of class. File 2 is due at the start of class. Since the answers will be given out in class, no credit can be give for late File 2 homework. Each partner should save the file on a floppy disk.
Prior to the next class, your partnership is required to have your File 1 and File 2 examined by the ACCT 5341 Teaching Assistant. Your files need not be fully complete, and the TA is not going to assign a grade to your work. The TA will, however, try to help you in places where you are having difficulties. Try to meet with the TA during scheduled lab hours. Details for contacting the TA are given in the syllabus.
You are to report on your meeting with Ryan in the ACCT 5342 partnership attestation form. Each partnership must print and submit an attest.htm form before class begins.
Quizes, examinations, and class discussions provide incentives to understand the answers to all questions. Do not rely upon a partner's answer that you do not fully understand. The question may come back to haunt you.
4. You are required to bring at least five floppy disks to every class. In some cases your quiz will be turned in on a disk.
International Accounting Theory Helpers and Links
Reading Assignments for This Week
Please keep your answers to all possible quiz questions for the entire semester. They may reappear in future quizzes and they may help in your course project.
If a case assignment or other question points to a particular section of a textbook chapter or other reading section, you are responsible to take notes on that particular section in its entirety.
If a case assignment or other question points to a particular section of a textbook chapter or other reading section, you are responsible to take notes on that particular section in its entirety.
The Excel questions for this week are on the TUCC Drive J:\courses\acct5341\0assign\sfas133
Remember that your partnership must go over some or all these questions with the ACCT 5341 Teaching Assistant and fill out the attest.htm form.
File 1 Question 01
Under what conditions can gains and losses on a cash flow hedge of a firm commitment be
deferred in other comprehensive income (OCI)? Under what conditions can a fair value
hedge affect OCI?
[Hint: See Paragraph 4 on Page 2 of SFAS 133. Also see Paragraph 23.]
Firm commitment cash flow hedges can affect OCI only to the extent that they hedge foreign currency risk. See Paragraph 4.
Fair value hedges can affect OCI if changes in the fair value of the hedged item are posted to OCI. See Paragraph 23.
PWC Example 4.14 beginning on Page 128.
File 1 Question 02
When is hedge accounting between related parties (e.g., a parent and a subsidiary company)
allowed? When is it not allowed between related parties under SFAS 133 rules?
Explain the FASB's reasoning on this issue.
[Hint: See Paragraphs 40c and 40d on Page 26 and Paragraph 485 on Page 211 of SFAS 133. Also see Paragraphs 471 and 487. Paragraph 29a may also enter into the picture.]
Quote from Bob Jensen's SFAS 133 Glossary for the term "related parties."
A related party transaction is a transaction between related entities that may not act independently of one another. For example, a forecasted transaction between a parent company and its subsidiary or between subsidiaries having a common parent is a related party transaction. Related party forecasted transactions cannot be designated for cash flow hedges according to Paragraph 29c on Page 20 of SFAS 133. The one exception is for a foreign currency risk exposure in a currency other than than the functional currency and other criteria listed in Paragraph 40 on Pages 25-26. Also see Paragraphs 471 and 487.
Cash flow hedges must have the possibility of affecting net earnings. For example, Paragraph 485 on Page 211 of SFAS 133 bans foreign currency risk hedges of forecasted dividends of foreign subsidiary. The reason is that these dividends are a wash item and do not affect consolidated earnings. For reasons and references, see equity method.
PWC 23.09c on Page 268.
File 1 Question 03
Under what conditions can a company hedge expected dividend payments in a foreign currency
from a nonrelated company? Under what conditions are such hedges not allowed hedge
accounting treatment under SFAS 133? Be specific in terms of paragraph citations of
the rules. Explain the FASB's reasoning on this issue.
One key paragraph is Paragraph 40 beginning on Page 25 of SFAS 133. Another key paragraph is Paragraph 29d. Paragraph 29d would not allow hedge accounting for equity method investments since dividends do not directly impact upon earnings under the equity method. I
PWC 23.05 and q23.06 on Page 265.
File 1 Question 04
Under what conditions can a company hedge expected intercompany dividend payments in a
foreign currency? Under what conditions are such hedges not allowed hedge accounting
treatment under SFAS 133? Be specific in terms of paragraph citations of the rules.
Under all conditions these are not allowed. Paragraph 485 of the Basis for Conclusions states that intercompany dividends do not affect earnings; therefore, a forecasted intercompany dividend cannot qualify as a hedgeable forecasted transaction.
PWC q24.07 on Page 266.
File 1 Question 05
Can a parent company enter into a forward contract on behalf of a subsidiary company to
hedge that subsidiary's forecasted transaction? Explain the FASB's reasoning on this
issue.
[Hint: See Paragraph 40 beginning on Page 25 of SFAS 133.]
No. Paragraph 41(a) of SFAS 133 requires that the entity that has the foreign currency exposure be a party to the hedging instrument. However, the subsidiary company could enter into a hedging transaction with either Parent or a third party. If the subsidiary were to enter into a derivative hedging instrument with Parent, it could use hedge accounting in its stand-alone financial statements because it entered into a derivative hedging instrument with a party external to the reporting entity. Pursuant to Paragraph 36 of SFAS 133, to qualify for cash flow hedge accounting at the consolidated level, Parent must offset the risk acquired through the intercompany derivative contract by entering into an offsetting contract with an unrelated party.
PWC q23.08 on Page 266.
File 1 Question 06
Suppose a company owns 10% of the voting shares in a foreign corporation. Under what
conditions can a forecasted purchase of additional shares be denied hedge accounting
treatment under SFAS 133? Under what conditions can hedge accounting be allowed?
The hedged item must not be adjusted for future value changes. If the forecasted transaction will make the total holdings less than 20%. then the equity method need not be used and the forecasted purchase can be hedged. See Paragraph 29f. If the holdings will become more than 20%, then the forecasted transaction cannot be a hedged item under SFAS 133 rules due to the equity method treatment.
The exception is foreign currency hedging of a net investment in a subsidiarly. An investor may designate the recognized net investment as a hedged item. Paragraph 42 permits hedging an existing net investment in a foreign operation with either a derivative financial instrument or a nonderivative financial instrument.
An investor also cannot designate the forecasted net income as a hedged item. Paragraph 485 of the Basis for Conclusions states that hedges of future earnings are not permitted. The prohibition exists because net income represents the netting of many dissimilar transactions, rather than a series of individual but similar transactions sharing the same risk exposure (see Paragraph 40(d)). Therefore, the expected future net income of 500 million won, although it may be accurately estimable and probable, is not eligible to be designated as a hedged item. Moreover, Paragraph 29(f) of SFAS 133 prohibits a forecasted dividend involving an equity-method investment from being designated as a hedged item.
PWC q25.11 and q25.12 on Page 270.
File 1 Question 07
Suppose Americana Corporation in the U.S. has a Canadian subsidiary called Canadiana.
Suppose Americana issues Canadian-dollar bonds to hedge its net investment in
Canadiana but uses the funds to finance wheat purchases for Americana flour mills in
Pennsylvania. Can this hedge be accounted for under SFAS 133 rules? Explain
the FASB's reasoning on this issue.
Yes. Paragraph 42 of SFAS 133 permits a nonderivative financial instrument to be used as the hedging instrument in a hedge of a net investment in a foreign operation.
PWC q25.13 on Page 271.
File 1 Question 08
This afternoon Americana intends to borrow 10 million British pounds sterling from a
London bank with interest payments indexed to LIBOR. In order to hedge against both
interest rate and foreign currency risk, Americana will also enter into an interest rate
swap in a rather simple combination of transactions. Americana will lend 10
million British pounds to Chase Bank in a note that pays variable interest rate indexed to
LIBOR. Americana will at the same time borrow U.S dollars from Chase Bank and pay a
fixed interest rate. Americana thereby receives U.S. funds at a fixed interest rate.
Can this swap receive favorable cash flow hedge accounting under SFAS 133 rules for
foreign currency risk exposure? Can all or part of this swap receive
favorable interest rate hedge accounting under SFAS 133 rules for foreign currency risk
exposure?
[Hint: See Paragraphs 18 and 36 of SFAS 133. Note that the interest rate swap and the foreign currency swap are combined into one hedging swap. Also note that the hedged item (the original 10 million pound sterling note and the hedging swap receipts are in different currencies. The hedged item is in pounds and the swap payments from Chase are in dollars. Assume the 10 million pound sterling note will be restated at fair value each period .]
No since the hedged item (the 10 million pound orginal debt) is remeasured to fair value since it is variable rate debt. When a liability that will be remeasured at spot exchange rates with changes in its value attributable to movements in spot rates being recognized currently through earnings (i.e., the debt obligation gives rise to foreign currency transaction gains and losses under SFAS 52). Paragraph 36 specifically prohibits transactions that result in such assets and liabilities from being designated as hedged items. However, Americana could get a partial earnings offset by entering into a separate interest rate hedging instrument and a foreign currency derivative instrument. The debt obligation and the foreign-currency derivative instrument will be remeasured for changes in exchange rates (using spot and forward rates, respectively), and although the remeasurement basis is different, there likely will be a significant degree of foreign currency gains and losses offset in earnings.
q25.14 on Page 271.
File 1 Question 09
Can a firm commitment be hedged for foreign currency risk?. For example, can a
company using the U.S. dollar as a functinal currency enter into a SFAS 133-compliant firm
commitment in Euros?
As a rule, firm commitments cannot have cash flow hedges. Paragraph 477 on Page 208 of SFAS 133 makes an exception for a portfolio of differing risk exposures for financial instruments designated in foreign currencies so not to conflict with Paragraph 20 of SFAS 52. It allows hedging under "net investment" criteria under Paragraph 20 of SFAS 52.
File 1 Question 10
Tomorrow morning Americana intends to borrow 10 million British pounds sterling from an
Irish bank with interest payments indexed to LIBOR. In order to hedge against both
interest rate and foreign currency risk, Americana will also enter into an interest rate
swap in a rather complicated succession of independent transactions. Americana
will first enter into an interest rate swap in which it pays a fixed rate and receives a
variable rate of interest indexed to LIBOR in amounts equal to the interest payment
obligations to the Irish bank. Then Americana will purchase options to hedge
the foreign currency risk exposure. Can this swap receive favorable cash flow hedge
accounting under SFAS 133 rules for interest rate risk exposure? Can the options
receive favorable hedge accounting under SFAS 133 rules for foreign currency risk
exposure?
[Hint: See Paragraph 36 beginning on Page 23 of SFAS 133. Note that the interest rate swap and the foreign currency swap are independent trasactions. Assume that the hedged item (the debt to the Irish bank need not be adjusted to fair value each period.]
Yes. The Irish bank debt obligation will not be remeasured to fair value for changes in interest rates and, therefore, cash flows of the debt obligation presenting an interest rate exposure may qualify as a hedged item. In this instance the interest rate swap is denominated in the same currency as the debt obligation, therefore, there is no need to separate the derivative instrument into components
q25.15 on Page 272
File 1 Question 11
What are various ways that a company can hedge foreign currency risk exposures and
interest rate fluctuation risks? What are the advantages of swaps that account, in
large measure, for the fact that interest rate swaps comprise nearly 80% of hedging
contracts in financial instruments derivatives?
[Hint: See Chapter 6 of Managing Financial Risk handed out in class.]
See Page 126 of Chapter 6. Common advantages are ease of financial arbitrage, tax and regulatory arbitrage, exchage risk exposure, and separation of currency risk from credit risk.
File 1 Question 12
Why are interest rate swaps the most poorly accounted for
under SFAS 133 vis-a-vis other types of derivatives? In other words,
what major ingredient required for swaps accounting receives very little explanation and
guidance under the standard?
[Hint: First take a look at Pages 128 and 129 of Managing Financial
Risk handed out in class. Then see Bob Jensen's Working Paper 231 at http://www.trinity.edu/rjensen/231wp/231wp.htm
.]
File 1 Question 13
How can swaps be used to separate credit risk from interest rate risk? How is credit
risk accounted for in SFAS 133?
[Hint: See Chapter 6 of Managing Financial Risk handed out in class. Also see ]
PWC q23.14a on Page 271 and 23.14b on Page 272.
File 1 Question 14
Suppose a company has a firm commitment to purchase 50,000 units of raw material in June
and another 30,000 units in July at 500 Mexican pesos per unit. The company
purchases a forward contract for 25 million pesos. Can the forward contract be a
foreign currency hedge of half of the firm commitment on raw material?
No, at least not according to Paragraph 21a beginning on Page 13 of SFAS 133. The hedged item (i.e., the firm commitment) has a foreign currency risk on 50 million pesos. According to Paragraph 21a, the specific portion of the firm commitment must be designated in advance as a hedged item. This would not be too difficult, however, if the June or July portion were designated in advance. There is a gray zone if all 100,000 units are to be purchased on June 30 and none in July. In substance, it seems rather irrelevant which portion of the 100,000 units becomes the hedged item. A literal interpretation of Paragraph 21a, however, would require advanced designation of which portion.
PWC q22.01b on Page 262.
File 1 Question 15
Provide the journal entries that accompany each transaction listed on Page 124 of Managing
Financial Risk handed out in class. You need only provide the journal entries for
American National and Halle Brands. Please apply rules of SFAS 133 in this
assignment. Assume all bonds are issued at par for cash. For Transactions 7
and 8 you need only provide entries for one time period, say the period ended at the end
of the third year. Assume the spot exchange rate is DM1.75/U.S.$ throughout Year 3.
You may supply your own inputs for any other missing data in this assignment.
[Hint: You may want to look a the ACCT 5341 project of Brian T. Simmons at http://www.resnet.trinity.edu/users/bsimmons/ .]
PWC 23.15 on Page 272.
File 1 Question 16
Why might the IASC's history be divided into two periods --- pre- and post- the IOSCO
agreement? What impact do you think this agreement had upon the 1998 FASB's
"International Accounting Standard Setting: A Vision for the Future"?
What roles will might FASB and other national standard setting bodies play in in
order to survive the IOSCO agreement?
[Hint: See Chapter 6 of the S&C textbook. For more details, see my pacter.htm file. The FASB Vision Statment is available at J:\courses\acct5341\fasb\intnacct.htm.]
File 1 Question 17
In SFAS 133, comment on possible inconsistencies between Paragraph 337 on Page 161 versus
Paragraph 411d on Page 185. Do you think it is misleading for Paragraph 337 to
claim that derivatives are being reported at "fair value" if variations in
credit risk do not enter into the fair value calculations? Explain the impacts on
the balance sheet and income statements if complete fair value adjustment were to be
required rather than only adjustments for interest rate movements on value? How does
estimation of full fair value differ from Paragraph 337 fair value adjustment?
Partnering Research Question on SFAS 133: Provide answers to questions
listed in Sheet 1 of 133ex10q.xls in the
TUCC Network Path J:\courses\acct5341\0assign\sfas133
Each student should make his or her own copy of the solution on an Excel file on a floppy
disc. A solution disc should also be turned in at the beginning of class. Only
one solution disc should be turned in for each partnership. On that disc, please
note the names of the partners on on the front of the disc and at the top of Sheet 1 in
the answer spreadsheet. Professor Jensen will place partnership solution files in
the TUCC Network Path J:\courses\acct5341\0assign\students
By Yourself Reading Reading Assignments (take hand-written notes of assigned readings)
S&C Chapter 6 (pp. 271-320).
SFAS 133 Paragraphs (35-42, 267-290, 320-383) and Example 10 beginning in Paragraph 165 on Page 87.
Also review Paragraphs 37-42 and Paragraph 18 for possible quiz questions.Chapter 6 (Managing Risk with Swaps) of Managing Financial Risk (handed out in class).