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On November 10, 2011, King Co. sold inventory to a customer in a foreign country. King agreed to accept 96,000 local currency units (LCU) in full payment for this inventory. Payment was to be made on February 1, 2012. On December 1, 2011, King entered into a forward exchange contract wherein 96,000 LCU would be delivered to a currency broker in two months. The two month forward exchange rate on that date was 1 LCU = $.30. Any contract discount or premium is amortized using the straight-line method. The spot rates and forward rates on various dates were as follows:

Date Rate Description Exchange Rate
November 10, 2011 Spot Rate $0.35 = 1 LCU
December 1, 2011 Spot Rate $0.32 = 1 LCU
2-Month Forward Rate $0.30 = 1 LCU
December 31, 2011 Spot Rate $0.29 = 1 LCU
1-Month Forward Rate $0.28 = 1 LCU
February 1, 2012 Spot Rate $0.27 = 1 LCU

The company's borrowing rate is 12%. The present value factor for one month is .9901.
Assume this hedge is designated as a cash flow hedge.
Requirement 1:
A. Prepare the journal entries relating to the transaction and the forward contract.
B. Compute the effect on 2011 net income.
C. Compute the effect on 2012 net income.

Requirement 2:
A. Assuming that King Co. entered into the forward contract as a fair value hedge of a firm commitment related to a 96,000 LCU sale that will be made on February 1, 2012, prepare the journal entries relating to the firm commitment and the forward contract.
B. Compute the effect on 2011 net income.
C. Compute the effect on 2012 net income.

 

Accounting Basics, Accounting

  • Category:- Accounting Basics
  • Reference No.:- M971968

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