The Budvar Company purchases parts from a foreign customer on December 1, Year 1, with payment of 20,000 crowns 20,000 crowns to be made on March 1, Year 2. Budvar enters into a forward contract on December 1, Year 1, to purchase 20,000 crowns on March 1, Year 2. The parts purchased on December 1, Year 1, become a part of the cost of goods sold on March 15, Year 2.
Relevant exchange rates for the crown on various dates are as follows:
|
Date
|
Spot Rate
|
Forward Rate
|
|
|
|
(to March 1, Year 2)
|
| |
|
|
|
December 1, Year 1
|
$1.00
|
$1.04
|
|
December 31, Year 1
|
1.05
|
1.1
|
|
March 1, Year 2
|
1.12
|
|
udvar's incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent (1 percent per month) is 0.9803. Budvar must close its books and prepare financial statements at December 31.
Required:
a. Assuming that Budvar designates the forward contract as a cash flow hedge of a foreign currency payable, prepare journal entries for these transactions in US dollars. What is the impact on Year 1 net income? What is the impact on Year 2 net income? What is the impact on net income over the two accounting periods?
b. Assuming that Budvar designates the forward contract as a fair value hedge of a foreign currency payable, prepare journal entries for these transactions in US dollars. What is the impact on Year 1 net income? What is the impact on Year 2 net income? What is the impact on net income over the two accounting periods?
| a) |
Forward Contract Cash Flow Hedge of Foreign Currency Receivable |
|
| |
Journal Entries: |
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
| |
Date |
Particulars |
Debit |
Credit |
| |
Year 1 |
|
|
|
|
|
|
|
| |
1-Dec |
Accounts receivable (crowns) [20,000 x $1.00] |
20,000 |
|
| |
|
|
Sales |
|
|
|
|
20,000 |
| |
|
|
|
|
|
|
|
|
| |
31-Dec |
Accounts receivable (crowns) [20,000 x ($1.05-$1.00)] |
1,000 |
|
| |
|
|
Foreign exchange gain |
|
|
1,000 |
| |
|
|
|
|
|
|
|
|
| |
|
Loss on forward contract |
|
|
1,000 |
|
| |
|
|
Accmt other comprehensive income |
|
1,000 |
| |
|
|
|
|
|
|
|
|
| |
|
Accmt other comprehensive income |
|
1,176 |
|
| |
|
|
Forward Contract |
|
|
|
1,176 |
| |
|
([20,000 x ($1.10-$1.04) = $1,200 x .9803 = $1,176.36]) |
|
|
| |
|
|
|
|
|
|
|
|
| |
|
Accmt other comprehensive income |
|
267 |
|
| |
|
|
Premium revenue |
|
|
|
267 |
| |
|
([20,000 x ($1.04-$1.00) = $800 x 1/3 = $266.67]) |
|
|
| |
|
|
|
|
|
|
|
|
| |
Impact on Year 1 Income: |
|
|
|
|
|
| |
Sales |
|
|
|
|
|
20,000 |
|
| |
Foreign Exchange gain |
|
|
|
1,000 |
|
| |
Loss on forward contract |
|
|
|
-1,000 |
|
| |
premium revenue |
|
|
|
|
267 |
|
| |
|
|
|
|
|
|
20,267 |
|
| |
|
|
|
|
|
|
|
|
| |
Year 2 |
|
|
|
|
|
|
|
| |
1-Mar |
Accounts receivable (crowns) [20,000 x ($1.12-$1.05)] |
1,400 |
|
| |
|
|
Foreign exchange gain |
|
|
1,400 |
| |
|
|
|
|
|
|
|
|
| |
|
Loss on forward contract |
|
|
1,400 |
|
| |
|
|
Accmt other comprehensive income |
|
1,400 |
| |
|
|
|
|
|
|
|
|
| |
|
Accmt other comprehensive income |
|
424 |
|
| |
|
|
Forward contract |
|
|
|
424 |
| |
|
([20,000 x ($1.12-$1.04) = $1,600 - 1,176.36]) |
|
|
| |
|
|
|
|
|
|
|
|
| |
|
Accmt other comprehensive income |
|
533 |
|
| |
|
|
Premium revenue |
|
|
|
533 |
| |
|
([20,000 x ($1.04-$1.00) = $800 x 2/3 = $266.67]) |
|
|
| |
|
|
|
|
|
|
|
|
| |
|
Foreign currency (crown) [20,000 x $1.12] |
|
22,400 |
|
| |
|
|
Accounts receivable (crown) |
|
|
22,400 |
| |
|
|
|
|
|
|
|
|
| |
|
Cash [20,000 x $1.04] |
|
|
20,800 |
|
| |
|
Forward contract |
|
|
|
1,600 |
|
| |
|
|
Foreign currency (crown) |
|
|
22,400 |
| |
|
|
|
|
|
|
|
|
| |
Impact on Year 2 Income: |
|
|
|
|
|
| |
Foreign Exchange gain |
|
|
|
1,400 |
|
| |
Loss on forward contract |
|
|
|
-1,400 |
|
| |
premium revenue |
|
|
|
|
533 |
|
| |
|
|
|
|
|
|
533 |
|
| |
|
|
|
|
|
|
|
|
| |
Impact on Net Income over both the periods: |
|
20,800 |
|
| |
|
|
|
|
|
|
|
|
| b) |
Forward Contract Fair Value Hedge of Foreign Currency Receivable |
|
| |
Journal Entries: |
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
| |
Date |
Particulars |
Debit |
Credit |
| |
Year 1 |
|
|
|
|
|
|
|
| |
1-Dec |
Accounts receivable (crowns) [20,000 x $1.00] |
20,000 |
|
| |
|
|
Sales |
|
|
|
|
20,000 |
| |
|
|
|
|
|
|
|
|
| |
31-Dec |
Accounts receivable (crowns) [20,000 x ($1.05-$1.00)] |
1,000 |
|
| |
|
|
Foreign exchange gain |
|
|
1,000 |
| |
|
|
|
|
|
|
|
|
| |
|
Loss on forward contract |
|
|
1,176 |
|
| |
|
|
Forward contract |
|
|
|
1,176 |
| |
|
([20,000 x ($1.04-$1.10) = $1,200 x .9803 = $1,176.36]) |
|
|
| |
|
|
|
|
|
|
|
|
| |
Impact on Year 1 Income: |
|
|
|
|
|
| |
Sales |
|
|
|
|
|
20,000 |
|
| |
Foreign Exchange gain |
|
|
|
1,000 |
|
| |
Loss on forward contract |
|
|
|
-1,176 |
|
| |
|
|
|
|
|
|
19,824 |
|
| |
|
|
|
|
|
|
|
|
| |
Year 2 |
|
|
|
|
|
|
|
| |
1-Mar |
Accounts receivable (crown) [20,000 x ($1.12-$1.05)] |
1,400 |
|
| |
|
|
Foreign exchange gain |
|
|
1,400 |
| |
|
|
|
|
|
|
|
|
| |
|
Loss on forward contract |
|
|
424 |
|
| |
|
|
Forward contract |
|
|
|
424 |
| |
|
([20,000 x ($1.12-$1.04) = $1,600 - 1,176.36]) |
|
|
| |
|
|
|
|
|
|
|
|
| |
|
Foreign currency (crown) [20,000 x $1.12] |
|
22,400 |
|
| |
|
|
Accounts receivable (crown) |
|
|
22,400 |
| |
|
|
|
|
|
|
|
|
| |
|
Cash [20,000 x $1.04] |
|
|
20,800 |
|
| |
|
Forward contract |
|
|
|
1,600 |
|
| |
|
|
Foreign currency (crown) |
|
|
22,400 |
| |
|
|
|
|
|
|
|
|
| |
Impact on Year 2 Income: |
|
|
|
|
|
| |
Foreign Exchange gain |
|
|
|
1,400 |
|
| |
Loss on forward contract |
|
|
|
-424 |
|
| |
|
|
|
|
|
|
976 |
|
| |
|
|
|
|
|
|
|
|
| |
Impact on Net Income over both the periods: |
|
20,800 |
|