ACCT 5341 Possible Quiz Questions for Class 04

Last Revised on January 25, 2006

ACCT 5341 Syllabus
Bob Jensen at Trinity University

Table of Contents

Possible Quiz Questions for The Next Class

Accounting Theory Helpers and Links

Reading Assignments for This Week

If you are having trouble finding something try a Google search.  Especially note that you can add terms and phrases at http://www.google.com/advanced_search?hl=en
For example, you can add a phrase in the second cell and individual words in the top cell.  You can fill in both cells simultaneously to narrow your search.

Also note that you can seek definitions in Google.  In the top cell type in --- define “phrase” where your phrase can be one word like “contango” or “backwardation” or a phrase like “asian option”.
It is important to first type in the word “define” without quotation marks.

Second try a search within the standard itself.  You can find digital versions of FAS 133 in the fasb folder on Drive J and IAS 39 in the iasb folder.  Both folders are on the path J:\courses\Acct534

Possible Quiz Questions for Class 04

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
What is the "clearly-and-closely" related criterion?   Comment in terms of credit-indexed and commodity-indexed embedded derivatives.

[Hint: See FAS 133 Paragraph 12a and Bob Jensen's SFAS 133 Glossary.] 

Each student must submit an mentor attestation form.  This form is to be signed and turned in each week in class.  These forms can be found at http://www.trinity.edu/rjensen/acct5341/AttestMentor.htm

File 1 Question 03
Explain why a "range floater" cannot usually be separated from the hedged item and accounted for as a derivative instrument under SFAS 133 accounting rules?

[See and Bob Jensen's SFAS 133 Glossary.]

File 1 Question 04
Explain why a "ratchet floater" cannot usually be separated from the hedged item and accounted for as a derivative instrument under SFAS 133 accounting rules?

[See and Bob Jensen's SFAS 133 Glossary.]

File 1 Question 05
Suppose a company swaps a variable rate for a fixed rate of 7% on $10 million.   Embedded in the contract is an adjustment factor that changes the rate to 8% if LIBOR reaches 7% and reduces the rate to 6% if LIBOR drops to 5%.  Can the embedded derivative be accounted for separately under SFAS 133 rules?   Explain the FASB's reasoning on this issue.

[Hint:  Look up "index-amortizing" in Bob Jensen's SFAS 133 Glossary.]

File 1 Question 06
Under what conditions can an equity-indexed embedded derivative be separated and accounted for separately under Paragraph 12 rules of SFAS 133?

[See the term "embedded derivative" in Bob Jensen's SFAS 133 Glossary.]

File 1 Question 07
Paragraph 36 subjects a "hedge of a net investment in a foreign operations" to SFAS 133 hedge accounting rules.  Explain this type of hedge.

[See Bob Jensen's SFAS 133 Glossary.]

File 1 Question 08
How did the FASB counter the argument that there are no significant differences between forecasted transactions and firm commitments?  Why is this distinction of terms important in SFAS 133?

[See Bob Jensen's SFAS 133 Glossary.]

File 1 Question 09
Suppose that a junk bond is issued with a zero coupon rate and a principal payout at maturity that is indexed to the price of soybeans on the CBOT.  Is there an embedded derivative that must be accounted for separately under SFAS 133 rules?

[See Paragraph 12a of SFAS 133.]

File 1 Question 10
Paragraph 529 states that "if a mortgage loan has been the hedged item in a fair value hedge, the loan's "cost" basis used in lower-of-cost-or-market accounting shall reflect the effect of the adjustments of its carrying amount made pursuant to Paragraph 22b of SFAS 133."  Will this also be true for unrealized holding gains on merchandise inventory (say widgets) for which a fair value hedge has locked in $100,000 of the holding gains above original acquisition cost?

[See Paragraph 336 of SFAS 133.]

File 1 Question 11
Explain why a "fixed-to-floating" bond that starts out at a fixed rate and then changes to a variable rate of interest cannot usually be accounted for as having a separable derivative instrument under SFAS 133 accounting rules?

[See and Bob Jensen's SFAS 133 Glossary.]

Partnership Assignment for Week 4 from your Strong textbook:
Problems 26, 27, and 28 on Page 84
Question 1 and Problem 14 on Page 121

These need not be turned in.

 By Yourself Reading  Reading Assignments (take hand-written notes of assigned readings)

• Chapters 4 and 5 of your Strong textbook.

• SFAS 133 Paragraphs (35-42, 267-290, 320-383) and Example 4 beginning in Paragraph 127.
  For class discussion and the quiz, carefully review Paragraphs 12-15.

• Self Tests on Pages 82 and 120 of your Strong textbook.

Hints for the Quiz on Week 4

All of the above assignments are candidates for the Week 4 quiz.  Please do not be late for class since that will reduce your time available for taking the quiz.

In addition, students are responsible for material covered in class on Week 2 and Week 3.  In particular, students are responsible for my extensions of the FAS 133 Appendix B Example 4 (Paragraph 127) and Example 1 (Paragraph 104).  The extensions we went over in class involved performing an 80-125 dollar offset test of hedge effectiveness.  I illustrated the cases where the hedges have no ineffectiveness, moderate ineffectiveness, and heavy ineffectiveness.

You are responsible for knowing how to do all journal entries in the Example 1 and Example 4 spreadsheets in my Excel workbook solutions in the 133ex01a.xls Excel workbook.  You may have to scroll to the right to find the Example 4 spreadsheet.  You can find this file on the following path:
J:\course\Acct5341\calgary\CDfiles\FAS133AppendixB\133ex01a.xls 

Note that in the FASB's original Examples 1 and 4, the inventory selling price was not a hedged item.  Only the inventory purchase (Example 1 cash flow hedge) or inventory value (Example 1 fair value hedge) were hedged.  My extensions illustrate the sale of the sale of the inventory, but the sale price was not hedged.  Hence profit was not fully hedged.

One possible extension for a quiz problem would be to also add in a second hedge that also hedges the sales price.  For example at the beginning of Period 1 another forward contract (say Forward Contract 2) could be entered into that locks in a sales price.

Another possible extension for Example 1 would be where the inventory is not on hand at the beginning of Period 1 but the firm has a purchase contract to buy the inventory at the end of Period 1 for $1,000,000.  You would then be required to show how the Example 1 solution would change.
Hint:  Purchase contracts are not booked.  The accounting is affected by whether the contract meets the test of a firm commitment (where the underlying is contracted) or a forecasted transaction (where the underlying can vary with spot prices).  If the underlying can vary, you then have the cash flow hedge illustrated in Example 4.  If the underlying is contracted at a fixed price, you have a fair value hedge modification of Example 1.  Only in the case of a purchase contract with a specified underlying amount will you use that new account invented by the FASB called "Firm Commitment."

Another possible extension of Examples 1 and 4 would be where the commodity in question is gold.

Another possible extension of Examples 1 and 4 is to delay the sale of the inventory until April 30.

You will not be allowed to use Excel on the quiz.  Please bring calculators to class.

The purpose of this quiz is to extend your knowledge of risk and value via cash flow versus fair value hedges.

Best of luck!  If you want help, you can always stop by my office or contact me at rjensen@trinity.edu 

Of course Chris will have all the answers next Sunday afternoon in the library.

You will not be allowed to use Excel on the quiz.  Please bring calculators to class.

The purpose of this quiz is to extend your knowledge of risk and value via cash flow versus fair value hedges.

Best of luck!  If you want help, you can always stop by my office or contact me at rjensen@trinity.edu 

Of course Chris will have all the answers next Sunday afternoon in the library.