Concept explainers
On June 1, Cairns Corporation purchased goods front a foreign supplier at a price of 1,000,000 francs and will make payment in three months on September 1. On June 1, Cairns acquired an option to purchase 1,000,000 francs in three months at a strike price of $0.852. Relevant exchange rates and option premiums for the franc are as follows:
Date | Spot Rate | Call Option Premium for September 1 (strike price $0.852) |
June 1 | $0.852 | $0.002 |
June 30 | 0.858 | 0.007 |
September 1 | 0.872 | N/A |
Cairns must close its books and prepare its second-quarter financial statements on June 30.
- a. Assuming that Cairns designates the foreign currency option as a cash flow hedge of a foreign currency payable, prepare
journal entries for these transactions in U.S. dollars. What is the impact on net income over the two accounting periods? - b. Assuming that Cairns designates the foreign currency option as a fair value hedge of a foreign currency payable, prepare journal entries for these transactions in U.S. dollars. What is the impact on net income over the two accounting periods?
a.
Prepare journal entries for foreign currency option as a cash flow hedge of a foreign currency payable. Identify be the impact on net income over the two accounting periods.
Explanation of Solution
The journal entries read to be passed in year (June month) (Cash flow hedge):
Date | Particulars | Post Ref. | Debit($) | Credit($) |
06/01/2017 | Goods Purchase | 852,000 | ||
Account Payable ( francs) | 852,000 | |||
( To record purchase of goods and 1000,000 francs at the spot rate @ $0.852 ) | ||||
Foreign currency option | 2,000 | |||
Cash | 2,000 | |||
( To record the purchase of the foreign currency option at fair value at the rate of $0.002) | ||||
30/6/2017 | Foreign exchange loss | 6,000 | ||
Account payable | 6,000 | |||
( To adjust the value of the fracas at spot rate @ $0.858 and record the loss resulting from appreciation in francs since June 1) | ||||
09/11/2017 | Foreign currency option | 5,000 | ||
AOCI ( Accumulated other comprehensive Income) | 5,000 | |||
(To adjust the fair value of the option from $0.002 to $0.007 with corresponding credit to AOCI ( Accumulated other comprehensive Income) ) | ||||
AOCI ( Accumulated other comprehensive Income) | 6,000 | |||
Gain on foreign currency option | 6,000 | |||
(To record gain on foreign currency option to affect the loss an account payable) | ||||
AOCI ( Accumulated other comprehensive Income) | 5,000 | |||
Option Income | 5,000 | |||
(To recognized the change in the time value of the option as an increase in net income) |
Table: (1)
Impact on the net income for quarter ending on 30th June:
Particulars | Amount($) | Amount($) |
Purchase | 852,000 | |
Foreign exchange loss | (6,000) | |
Gain on foreign currency option | 6,000 | |
Net gain / ( loss) | - | |
Option income | 5,000 | |
Impact on net income | 857,000 |
Table: (2)
Journal Entries as on 1st September:
Date | Particulars | Post Ref. | Debit($) | Credit($) |
9/1/2017 | Account Payable ( francs) | 14,000 | ||
Foreign exchange gain | 14,000 | |||
( To adjust the value of the fracas payable to new spot rate of $0.872) | ||||
AOCI ( Accumulated other comprehensive Income) | 20,000 | |||
Foreign exchange option | 20,000 | |||
(To adjust the fair value of the option from $0.852 to $0.872 with corresponding credit to AOCI ( Accumulated other comprehensive Income) ) | ||||
30/6/2017 | Loss on foreign currency option | 14,000 | ||
AOCI ( Accumulated other comprehensive Income) | 14,000 | |||
(To record gain on foreign currency option to affect the foreign currency loss an account payable with corresponding credit to AOCI ( Accumulated other comprehensive Income) ) | ||||
9/1/2017 | Account payable | 872,000 | ||
foreign currency | 872,000 | |||
(To record payment of francs 1000,000 so supplied at the spot rate) | ||||
Foreign currency | 872,000 | |||
Cash | 852,000 | |||
foreign currency option | 20,000 | |||
( To record exercise of option @ $0.852 and remove foreign currency from accounts) |
Table: (3)
Impact on the net income as on 1st September:
Particulars | Amount($) | Amount($) |
Foreign exchange gain | 14,000 | |
Gain on foreign currency option | ( 14,000) | |
Net gain / ( loss) | 0 | |
Option income | 0 | |
Impact on net income | 0 |
Table: (4)
b.
Prepare journal entries for foreign currency option as a fair value hedge of a foreign currency payable. Identify the impact on net income over the two accounting periods.
Explanation of Solution
The following entries need to be passed in year (June month) (Fair value hedge):
Date | Particulars | Post Ref. | Debit($) | Credit($) |
6/1/2017 | Goods Purchase | 852,000 | ||
Account Payable ( francs) | 852,000 | |||
( To record purchase of goods and 1000,000 francs at the spot rate @ $0.852 ) | ||||
Foreign currency option | 2,000 | |||
Cash | 2,000 | |||
( To record the purchase of the foreign currency option at fair value @ $0.888) | ||||
30/6/2017 | Foreign exchange loss | 6,000 | ||
Account payable (francs) | 6,000 | |||
( To adjust the value of the fracas at new spot rate @ $0.858) | ||||
Foreign currency option | 5,000 | |||
Gain on foreign currency option | 5,000 | |||
(To adjust the fair value of the option from $0.007 and record the gain an foreign currency option) |
Table: (5)
Impact on net income as on 30th June:
Particulars | Amount($) | Amount($) |
Purchase | 852,000 | |
Foreign exchange loss | (6,000) | |
Gain on foreign currency option | 5,000 | |
Net gain / ( loss) | (1,000) | |
Option income | 0 | |
Impact on net income | 851,000 |
Table: (6)
Journal entries on 1st September:
Date | Particulars | Post Ref. | Debit($) | Credit($) |
9/1/year | Account Payable ( francs) | 14,000 | ||
Foreign exchange gain | 14,000 | |||
( To adjust the value of the fracas payable at new spot rate of $0.872) | ||||
Account Payable ( francs) | 872,000 | |||
Foreign currency | 872,000 | |||
( To record payment of francs 1000,000 to supplies at spot rate @ $0.872 ) | ||||
Foreign currency (francs) | 872,000 | |||
Cash | 852,000 | |||
Foreign currency option | 20,000 | |||
( To record exercise of the option and remove foreign currency option from the accounts) |
Table: (7)
Impact on net income on 30th September:
Particulars | Amount($) |
Foreign exchange gain | 14,000 |
Net impact | 14,000 |
Table: (8)
Want to see more full solutions like this?
Chapter 9 Solutions
LooseLeaf for Advanced Accounting (Irwin Accounting) - Standalone book
- Vino Veritas Company, a U.S.-based importer of wines and spirits, placed an order with a French supplier for 2,000 cases of wine at a price of 300 euros per case. The total purchase price is 600,000 euros. Relevant exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 31 Call Option Premiumfor October 31(strike price $1.50) September 15 $ 1.50 $ 1.56 $ 0.035 September 30 1.55 1.59 0.070 October 31 1.60 1.60 0.100 Vino Veritas Company has an incremental borrowing rate of 12 percent (1 percent per month) and closes the books and prepares financial statements at September 30. The wine arrived on September 15, and the company made payment on October 31. On September 15, Vino Veritas purchased a 45-day call option for 600,000 euros. It properly designated the option as a cash flow hedge of a foreign currency payable. Prepare journal entries…arrow_forwardVino Veritas Company, a U.S.-based importer of wines and spirits, placed an order with a French supplier for 2,000 cases of wine at a price of 300 euros per case. The total purchase price is 600,000 euros. Relevant exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 31 Call Option Premiumfor October 31(strike price $1.50) September 15 $ 1.50 $ 1.56 $ 0.035 September 30 1.55 1.59 0.070 October 31 1.60 1.60 0.100 Vino Veritas Company has an incremental borrowing rate of 12 percent (1 percent per month) and closes the books and prepares financial statements at September 30. The company ordered the wine on September 15. It arrived on October 31, and the company made payment on that date. On September 15, Vino Veritas purchased a 45-day call option for 600,000 euros. It properly designated the option as a fair value hedge of a foreign…arrow_forwardPacifico Company, a U.S.-based importer of beer and wine, purchased 1,000 cases of Oktoberfest-style beer from a German supplier for 200,000 euros. Relevant U.S. dollar exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 15 Call Option Premiumfor October 15(strike price $1.05) August 15 $ 1.05 $ 1.11 $ 0.05 September 30 1.10 1.14 0.06 October 15 1.13 1.13 (spot) N/A The company closes its books and prepares third-quarter financial statements on September 30. Assume that the beer arrived on August 15, and the company made payment on October 15. There was no attempt to hedge the exposure to foreign exchange risk. Prepare journal entries to account for this import purchase. Assume that the beer arrived on August 15, and the company made payment on October 15. On August 15, the company entered into a two-month forward contract to purchase 200,000 euros. The company designated the forward contract as a cash…arrow_forward
- On June 1, Parker-Mae Corporation (a U.S.-based company) received an order to sell goods to a foreign customer at a price of 165,000 francs. Parker-Mae will ship the goods and receive payment in three months, on September 1. On June 1, Parker-Mae purchased an option to sell 165,000 francs in three months at a strike price of $1.04. The company designated the option as a fair value hedge of a foreign currency firm commitment. The option's time value is excluded in assessing hedge effectiveness, and the change in time value is recognized in net income. The fair value of the firm commitment is measured by referring to changes in the spot rate (discounting to present value is ignored). Relevant exchange rates and option premiums for the franc are as follows: Date Spot Rate Put Option Premiumfor September 1(strike price $1.04) June 1 1.04 0.020 June 30 0.98 0.072 September 1 0.93 N/A Parker-Mae Corporation must close its books…arrow_forwardOn November 1, 2019, Flower Company, a U.S. company, entered into a four-month forward contract to sell 50,000 liras on February 1, 2020. The following U.S. dollar per lira exchange rates apply: Date Spot rate Forward Rate (to Feb 1st 2020) November 1, 2019 $0.092 $0.105 December 31, 2019 $0.090 $0.095 February 1, 2020 $0.089 N/A Flower's incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent is .9803. Which of the following is included in Flower's December 31, 2019 balance sheet for the forward contract?arrow_forwardPacifico Company, a U.S.-based importer of beer and wine, purchased 1,100 cases of Oktoberfest-style beer from a German supplier for 242,000 euros. Relevant U.S. dollar exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 15 Call Option Premiumfor October 15(strike price $1.10) August 15 $ 1.10 $ 1.16 $ 0.05 September 30 1.15 1.19 0.06 October 15 1.18 1.18 (spot) N/A The company closes its books and prepares third-quarter financial statements on September 30. Assume that the company ordered the beer on August 15. The beer arrived and the company paid for it on October 15. On August 15, the company purchased a two-month call option on 242,000 euros. The company designated the option as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the spot rate. The…arrow_forward
- Pacifico Company, a U.S.-based importer of beer and wine, purchased 1,100 cases of Oktoberfest-style beer from a German supplier for 242,000 euros. Relevant U.S. dollar exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 15 Call Option Premiumfor October 15(strike price $1.10) August 15 $ 1.10 $ 1.16 $ 0.05 September 30 1.15 1.19 0.06 October 15 1.18 1.18 (spot) N/A The company closes its books and prepares third-quarter financial statements on September 30 Assume that, on August 15, the company forecasted the purchase of beer on October 15. On August 15, the company acquired a two-month call option on 242,000 euros. The company designated the option as a cash value hedge of a forecasted foreign currency transaction. The time value of the option is excluded from the assessment of hedge effectiveness, and the change in time value is recognized in net income over the life of the option. Prepare journal entries…arrow_forwardPacifico Company, a U.S.-based importer of beer and wine, purchased 1,100 cases of Oktoberfest-style beer from a German supplier for 242,000 euros. Relevant U.S. dollar exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 15 Call Option Premiumfor October 15(strike price $1.10) August 15 $ 1.10 $ 1.16 $ 0.05 September 30 1.15 1.19 0.06 October 15 1.18 1.18 (spot) N/A The company closes its books and prepares third-quarter financial statements on September 30. Assume that the beer arrived on August 15, and the company made payment on October 15. There was no attempt to hedge the exposure to foreign exchange risk. Prepare journal entries to account for this import purchase. Record purchase of foreign currency for settling the accounts payable. Record payment made to the German supplier. Record the transfer of inventory to cost of goods sold.arrow_forwardPacifico Company, a U.S.-based importer of beer and wine, purchased 1,100 cases of Oktoberfest-style beer from a German supplier for 242,000 euros. Relevant U.S. dollar exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 15 Call Option Premiumfor October 15(strike price $1.10) August 15 $ 1.10 $ 1.16 $ 0.05 September 30 1.15 1.19 0.06 October 15 1.18 1.18 (spot) N/A The company closes its books and prepares third-quarter financial statements on September 30. Assume that the beer arrived on August 15, and the company made payment on October 15. There was no attempt to hedge the exposure to foreign exchange risk. Prepare journal entries to account for this import purchase. Assume that the beer arrived on August 15, and the company made payment on October 15. On August 15, the company entered into a two-month forward contract to purchase 242,000 euros. The company designated the forward contract as a cash…arrow_forward
- Pacifico Company, a U.S.-based importer of beer and wine, purchased 1,100 cases of Oktoberfest-style beer from a German supplier for 242,000 euros. Relevant U.S. dollar exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 15 Call Option Premiumfor October 15(strike price $1.10) August 15 $ 1.10 $ 1.16 $ 0.05 September 30 1.15 1.19 0.06 October 15 1.18 1.18 (spot) N/A The company closes its books and prepares third-quarter financial statements on September 30 Assume that, on August 15, the company forecasted the purchase of beer on October 15. On August 15, the company acquired a two-month call option on 242,000 euros. The company designated the option as a cash value hedge of a forecasted foreign currency transaction. The time value of the option is excluded from the assessment of hedge effectiveness, and the change in time value is recognized in net income over the life of the option. Prepare journal entries…arrow_forwardPacifico Company, a U.S.-based importer of beer and wine, purchased 1,100 cases of Oktoberfest-style beer from a German supplier for 242,000 euros. Relevant U.S. dollar exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 15 Call Option Premiumfor October 15(strike price $1.10) August 15 $ 1.10 $ 1.16 $ 0.05 September 30 1.15 1.19 0.06 October 15 1.18 1.18 (spot) N/A The company closes its books and prepares third-quarter financial statements on September 30. Assume that the company ordered the beer on August 15. The beer arrived and the company paid for it on October 15. On August 15, the company entered into a two-month forward contract to purchase 242,000 euros. The company designated the forward contract as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to…arrow_forwardPacifico Company, a U.S.-based importer of beer and wine, purchased 1,100 cases of Oktoberfest-style beer from a German supplier for 242,000 euros. Relevant U.S. dollar exchange rates for the euro are as follows: Date Spot Rate Forward Rateto October 15 Call Option Premiumfor October 15(strike price $1.10) August 15 $ 1.10 $ 1.16 $ 0.05 September 30 1.15 1.19 0.06 October 15 1.18 1.18 (spot) N/A The company closes its books and prepares third-quarter financial statements on September 30. Assume that the beer arrived on August 15, and the company made payment on October 15. On August 15, the company entered into a two-month forward contract to purchase 242,000 euros. The company designated the forward contract as a cash flow hedge of a foreign currency payable. Forward points are excluded in assessing hedge effectiveness and amortized to net income using a…arrow_forward
- AccountingAccountingISBN:9781337272094Author:WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.Publisher:Cengage Learning,Accounting Information SystemsAccountingISBN:9781337619202Author:Hall, James A.Publisher:Cengage Learning,
- Horngren's Cost Accounting: A Managerial Emphasis...AccountingISBN:9780134475585Author:Srikant M. Datar, Madhav V. RajanPublisher:PEARSONIntermediate AccountingAccountingISBN:9781259722660Author:J. David Spiceland, Mark W. Nelson, Wayne M ThomasPublisher:McGraw-Hill EducationFinancial and Managerial AccountingAccountingISBN:9781259726705Author:John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting PrinciplesPublisher:McGraw-Hill Education