Chapter 11, Problem 11.23AP

a.

To determine

Introduction: A contract or agreement laid between two parties for buying and selling of an asset at a specific rate and on a specific future date is known as forward contract. This is a contract or an agreement between a buyer and a seller to trade an asset at a future date whose price is set when contract is drawn and such agreements settle at the end of the contract on that specific date.

To prepare: Journal entries for forward contract to manage the foreign currency risk.

Explanation of Solution

Use of forward contract to manage the foreign currency risk of exposed foreign currency position, not designated as a hedge.

  

-Purchase of furniture - Settle forward exchange

resulting in foreign contract and receive

currency payable 100,000 Australian

Dollars

-Sign foreign exchange - Pay foreign currency

contract to receive payable

Australian Dollars on

March 31^st

Forward Rate:

A$1 = $0.609 A$1 = $0.612

Spot Rate:

A$1 = $0.600 A$1 = $0.610 A$1 = $ 0.602

Journal entries in the books of M CompFor the year Dec 31st20X1
Date	Particulars	Debit$	Credit$
	Inventory	60,000
Dec 1st	Accounts Payable (1)		60,000
20X1	(To record Accounts payable.)
	Foreign Currency receivable from Exchange Broker (A$)	60,900
	Dollars Payable to Exchange Broker (2)		60,900
	(To record forward contract to manage foreign currency risk.)
Dec 31st	Foreign Currency Transaction Loss (3)	1,000
20X1	Accounts Payable (A$)		1,000
	(To record foreign currency transaction loss.)
	Foreign currency receivable from exchange broker (A$) (4)	300
	Foreign currency transaction gain		300
	(To record foreign currency transaction gain.)

Journal Entries in the books of M CompFor the year Dec 31st20X2
Date	Particulars	Debit$	Credit$
	Foreign Currency Transaction Loss (5)	1,000
March 31st	Foreign Currency receivable from Exchange Broker (A$)		1,000
20X2	(To record revalue of foreign currency receivable.)
	Account Payable (A$) (6)	800
	Foreign currency transaction gain		800
	(To record revalue of foreign currency payable.)
	Dollars payable to Exchange broker	60,900
	Cash		60,900
	(To record cash payment required by forward contract.)
	Foreign Currency Units (A$)	60,200
	Foreign currency receivable from exchange broker (A$)		60,200
	Accounts Payables (A$)	60,200
	Foreign Currency Units (A$)		60,200
	(To record payment to creditor.)

Working Notes:

1.Accounts Payable = $\text{Α\$ 100,000 × 0}\text{.600 = \$ 60,000}$

2.Foreign currency receivable = $\mathrm{{\rm A}}\mathrm{\$}\mathrm{}100,000\mathrm{}\times \mathrm{}0.609\mathrm{}=\mathrm{}\mathrm{\$}\mathrm{}60,900$

  $\begin{array}{l}\text{3}\text{.Foreign currency transaction loss= }\\ \text{A\$ 100,000 × 0}\text{.610}\left(\text{Spot Rate}\right){\text{ 31}}^{\text{st}}\text{Dec 20X1 – Accounts Payable}\end{array}$

  $\text{=\$ 61,000 - \$ 60,000 = \$1,000}$

  $\begin{array}{l}\text{4}\text{.Foreign currency transaction Gain = }\\ {\text{Foreign currency receivable Dec 31}}^{\text{st}}\left(\text{forward rate}\right){\text{ – foreign currency receivable Dec 1}}^{\text{st}}\left(\text{forward rate}\right)\\ \text{A\$ 100,000 × 0}\text{.612 }\left(\text{Spot Rate}\right){\text{ 31}}^{\text{st}}\text{Dec 20X1 – \$60,900}\end{array}$

  $\text{=\$ 61,200 - \$ 60,900 = \$ 300}$

  $\begin{array}{l}\text{ 5}\text{.Foreign currency transaction loss= }\\ \text{A\$ 100,000×0}\text{.612 }\left(\text{Forward Rate}\right){\text{ 31}}^{\text{st}}\text{Dec 20X1 – A\$ 100,000 × 0}{\text{.602 Dec 31}}^{\text{st}}\text{20X2 }\left(\text{Spot rate}\right)\end{array}$

  $\text{=\$ 61,200 - \$ 60,200 = \$ 1,000}$

6.Accounts Payable = $\text{Α\$ 61,200 - \$60,200 = \$ 800}$

b.

To determine

Introduction: A contract or agreement laid between two parties for buying and selling of an asset at a specific rate and on a specific future date is known as forward contract. This is a contract or an agreement between a buyer and a seller to trade an asset at a future date whose price is set when contract is drawn and such agreements settle at the end of the contract on that specific date.

To prepare: Journal entries for forward contract as fair value of hedge of foreign currency firm commitment.

Explanation of Solution

  

-Sign foreign exchange -Purchase of furniture - Settle forward exchange

contract to hedge foreign resulting in foreign contract and receive

currency payable firm currency payable. 100,000 Australian

commitment dollars.

-Pay foreign currency

Forward Rate:

A$1 = $0.609 A$1 = $0.612 A$1 = $0.605

Spot Rate:

A$1 = $0.600 A$1 = $0.610 A$1 = $0.608A$1 = $ 0.602

Journal Entries in the books of M CompFor the year Dec 31st20X1
Date	Particulars	Debit$	Credit$
Dec 1st	Foreign Currency receivable from Exchange Broker (A$)	60,900
20X1	Dollars Payable to Exchange Broker (1)		60,900
	(To record forward contract to manage foreign currency risk.)
Dec 31st	Foreign currency receivable from exchange broker (A$)	300
20X1	Foreign currency transaction gain (2)		300
	(To record foreign currency transaction gain.)
	Foreign currency transaction loss (3)	300
	Firm commitment		300
	(To record the loss on the financial instrument.)

Journal Entries in the books of M CompFor the year Dec 31st20X2
Date	Particulars	Debit$	Credit$
	Foreign Currency Transaction Loss (4)	700
Jan 30th	Foreign Currency receivable from Exchange Broker (A$)		700
20X2	(To record revalue of foreign currency receivable.)
	Firm commitment (5)	700
	Foreign currency transaction gain		700
	(To record the gain on the financialinstrument.)
	Inventory (purchases)	61,200
	Accounts payable (A$) (6)		60,800
	Firm Commitment		400
	(To record acquirement of furniture initially.)

Journal Entries in the books of M CompFor the year Dec 31st20X2
Date	Particulars	Debit$	Credit$
March 31st	Foreign Currency transaction loss (A$) (7)	300
20X2	Foreign currency receivable from exchange broker (A$)		300
	(To record revalue of foreign currency receivable.)
	Accounts Payable (A$) (8)	600
	Foreign currency transaction gain		600
	(To record revalue of foreign currency payable.)
	Dollars payable to exchange broker (A$)	60,900
	Cash		60,900
	(to record the delivery of US dollars to exchange broker.)
	Foreign Currency units (A$) (9)	60,200
	Foreign currency receivable from exchange broker (A$)		60,200
	(To record the delivery of US dollars from exchange broker.)
	Accounts Payable (A$)	60,200
	Foreign currency unit (A$)		60,200
	(To record the payment of A$ 100,000 to foreign creditor.)

Working Notes:

1. Foreign currency receivable

  = $\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times \mathrm{\$}0.609\\ \text{= \$60,900}\end{array}$

  $\begin{array}{l}\text{ 2}\text{.Foreign currency transaction Gain =}\\ {\text{ Foreign currency receivable Dec 31}}^{\text{st}}\left(\text{forward rate}\right){\text{ – foreign currency receivable Dec 1}}^{\text{st}}\left(\text{forward rate}\right)\\ \text{A\$ 100,000 × 0}\text{.612 }\left(\text{Spot Rate}\right){\text{ 31}}^{\text{st}}\text{Dec 20X1 – \$60,900}\end{array}$

  $\text{= \$61,200 - \$60,900 = \$300}$

3. Foreign currency transaction loss = $\mathrm{{\rm A}}\mathrm{\$}100,000\times (0.612-0.609)=\mathrm{\$}300$

  $\begin{array}{l}\text{4}\text{.Foreign currency transaction loss= }\\ \text{A\$ 100,000 × 0}\text{.612 }\left(\text{Forward Rate}\right){\text{ 31}}^{\text{st}}\text{Dec 20X1 – A\$ 100,000 × 0}{\text{.605 Dec 31}}^{\text{st}}\text{20X2 }\left(\text{forward rate}\right)\end{array}$

  $\text{= \$61,200 - \$60,500 = \$700}$

  $\begin{array}{l}\text{ 5}\text{.Firm commitment=}\\ \text{ A\$ 100,000 × 0}\text{.612 }\left(\text{Forward Rate}\right){\text{ 31}}^{\text{st}}\text{Dec 20X1 – A\$ 100,000 × 0}{\text{.605 Dec 31}}^{\text{st}}\text{20X2 }\left(\text{forward rate}\right)\end{array}$

  $\text{=\$61,200 - \$60,500 = \$700}$

6.Accounts Payable =

  $\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times 0.608\\ \text{= \$60,800}\end{array}$

  $\begin{array}{l}\text{7}\text{.Foreign currency transaction loss= }\\ \text{A\$ 100,000 × 0}\text{.605 }\left(\text{Forward Rate}\right){\text{ 31}}^{\text{th}}\text{Jan – A\$ 100,000 × 0}{\text{.602 Mar 31}}^{\text{st}}\text{20X2 }\left(\text{Spot rate}\right)\end{array}$

  $\text{=\$60,500 - \$60,200 = \$300}$

8.Accounts Payable = $\mathrm{{\rm A}}\mathrm{\$}100,000\times (0.608-0.602)=\mathrm{\$}600$

9 Foreign Currency Units = $\text{Α\$ 100,000 × 0}\text{.602 = \$60,200}$

c.

To determine

Introduction: A contract or agreement laid between two parties for buying and selling of an asset at a specific rate and on a specific future date is known as forward contract. This is a contract or an agreement between a buyer and a seller to trade an asset at a future date whose price is set when contract is drawn and such agreements settle at the end of the contract on that specific date.

To prepare: Journal entries for forward contract as cash flow hedge of forecasted foreign currency transaction.

Explanation of Solution

Use of forward contract as cash flow hedge of forecasted foreign currency transaction.

  

-Sign foreign exchange-Purchase of furniture - Settle forward exchange

Contract to hedge resulting in foreign contract and receive

Forecasted foreign Currency Payable 100,000 Australian

Currency transaction. Dollars.

- Pay foreign currency

payable.

Forward Rate:

A$1 = $0.609 A$1 = $0.612 A$1 = $0.605

Spot Rate:

A$1 = $0.600 A$1 = $0.610 A$1 = $0.608 A$1 = $ 0.602

Journal Entries in the books of M CompFor the year Dec 31st20X1
Date	Particulars	Debit$	Credit$
Dec 1st	Foreign currency receivable from exchange broker (A$)	60,900
20X1	Dollars payable to exchange broker		60,900
	(To record forward contract to manage foreign currency risk
Dec 31st	Foreign currency receivable from exchange broker (A$)	300
20X1	Other comprehensive income		300
	(To record OCI for effective portion of change in fair value)

Journal Entries in the books of M CompFor the year Dec 31st20X2
Date	Particulars	Debit$	Credit$
	Other comprehensive income (OCI)	700
Jan 30th	Foreign currency receivable from exchange broker (A$)		700
20X2	(To record revalue of foreign currency receivable and OCI)
	Inventory (Purchases)	60,800
	Account payable (A$)		60,800
	(To record furniture acquired and value at spot rate)
March 31st	Other comprehensive income	300
20X2	Foreign currency receivable from exchange broker (A$)		300
	(To record revalue of foreign currency and OCI)
	Accounts Payable (A$)	600
	Foreign currency transaction gain		600
	(To record change in current earning as specified by FASB 52)
	Foreign currency transaction loss	600
	Other comprehensive income		600
	(To record reclassify amount from OCI to offset foreign currency transaction gain)
	Dollars payable to exchange brokers (A$)	60900
	Cash		60900
	(To record the delivery of US dollars to exchange broker)
	Foreign currency units (A$)	60200
	Foreign currency receivable from exchange broker (A$)		60200
	(To receive $100,000 from broker in accordance with forward contract signed on December 1st)
	Accounts payable (A$)	60200
	Foreign currency units (A$)		60200
	(To deliver $100,000 to foreign creditor)

Working Notes:

1. Foreign currency receivable = $\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times \mathrm{\$}0.609(\mathrm{F}\mathrm{o}\mathrm{r}\mathrm{w}\mathrm{a}\mathrm{r}\mathrm{d})\\ \text{= \$60,900}\end{array}$

  $\begin{array}{l}\text{2}\text{.Foreign currency transaction Gain = }\\ {\text{Foreign currency receivable Dec 31}}^{\text{st}}\left(\text{forward rate}\right){\text{ – foreign currency receivable Dec 1}}^{\text{st}}\left(\text{forward rate}\right)\end{array}$

A$ 100,000 × 0.612 (Spot Rate) 31^st Dec 20X1 − $60,900

  $\text{\$61,200 - \$60,900 = \$300}$

  $\begin{array}{l}\text{ 3}\text{.OCI=}\\ \text{ A\$ 100,000 × 0}\text{.612 }\left(\text{Forward Rate}\right){\text{ 31}}^{\text{st}}\text{Dec 20X1 – A\$ 100,000 × 0}{\text{.605 Dec 31}}^{\text{st}}\text{20X2 }\left(\text{forward rate}\right)\end{array}$

  $\text{\$61,200 - \$60,500 = \$700}$

4.Accounts Payable =

  $\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times \mathrm{\$}0.608\\ \text{= \$60,800}\end{array}$

  $\begin{array}{l}\text{5}\text{.Foreign currency receivable }\left(\text{OCI}\right)\text{=}\\ \text{ A\$ 100,000 × 0}\text{.605 }\left(\text{Forward Rate}\right){\text{ 31}}^{\text{th}}\text{Jan – A\$ 100,000 × 0}{\text{.602 Mar 31}}^{\text{st}}\text{20X2 }\left(\text{Spot rate}\right)\end{array}$

  $\text{\$60,500 - \$60,200 = \$300}$

  $\begin{array}{l}\text{ 6}\text{.Foreign currency transaction loss=}\\ \text{ A\$ 100,000 × 0}\text{.608 }\left(\text{Spot Rate}\right){\text{ 30}}^{\text{th}}\text{Jan – A\$ 100,000 × 0}{\text{.602 Mar 31}}^{\text{st}}\text{20X2 }\left(\text{Spot rate}\right)\text{ =}\end{array}$

  $\begin{array}{l}\text{\$60,800 - \$60,200}\\ =\mathrm{\$}600\end{array}$

7 Foreign Currency Units =

  $\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times 0.602\\ \text{= \$60,200}\end{array}$

d.

To determine

Introduction: A contract or agreement laid between two parties for buying and selling of an asset at a specific rate and on a specific future date is known as forward contract. This is a contract or an agreement between a buyer and a seller to trade an asset at a future date whose price is set when contract is drawn and such agreements settle at the end of the contract on that specific date.

To prepare: Journal entries for forward contract used for speculative purpose only.

Explanation of Solution

Use of forward contract for speculative purpose only

  

-Sign 120 day speculative - Settle forward exchange

Contract to purchasecontract and receive

100,000 Australian 100,000 Australian Dollar. Dollar.

Forward Rate:

A$1 = $0.609 A$1 = $0.612

Spot Rate:

A$1 = $0.600 A$1 = $0.610 A$1 = $ 0.602

Journal Entries in the books of M CompFor the year Dec 31st20X1
Date	Particulars	Debit$	Credit$
Dec 1st	Foreign currency receivable from exchange broker (A$)	60,900
20X1	Dollars payable to exchange broker		60,900
	(To record 120 forward contracts for speculation)
Dec 31st	Foreign currency receivable from exchange broker (A$)	300
20X1	Foreign currency transaction gain		300
	(To record foreign currency transaction gain)

Journal Entries in the books of M CompFor the year Dec 31st20X2
Date	Particulars	Debit$	Credit$
	Foreign currency transaction loss	1,000
March 31st	Foreign currency receivable from exchange broker (A$)		1,000
20X2	(To record revalue of foreign currency receivable)
	Dollars payable to exchange broker	60,900
	Cash		60,900
	(To record delivery of US $ to forward exchange broker)
	Foreign currency units (A$)	60,200
	Foreign currency receivable from exchange broker (A$)		60,200
	(To receive A$ 100,000 from exchange broker)

Working Notes:

1. Foreign currency receivable =

$\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times 0.609(\mathrm{F}\mathrm{o}\mathrm{r}\mathrm{w}\mathrm{a}\mathrm{r}\mathrm{d})\\ \text{= \$60,900}\end{array}$

  $\begin{array}{l}\text{ 2}\text{.Foreign currency transaction Gain = }\\ {\text{Foreign currency receivable Dec 31}}^{\text{st}}\left(\text{forward rate}\right){\text{ – foreign currency receivable Dec 1}}^{\text{st}}\left(\text{forward rate}\right)\end{array}$

  $\begin{array}{l}\text{Α\$100,000 × 0}\text{.612 - \$60,900}\\ \text{=\$61,200 - \$60,900}\\ =\mathrm{\$}300\end{array}$

  $\begin{array}{l}\text{ 3}\text{. Foreign currency transaction loss }\\ \text{ = A\$ 100,000 × 0}\text{.612 (Forward Rate) 31st Dec 20X1 – A\$ 100,000× 0}\text{.602 Mar 31st 20X2(Spot Rate)}\end{array}$

  $\begin{array}{l}\text{=\$61,200 - \$60,200}\\ =\mathrm{\$}1,000\end{array}$

7 Foreign Currency Units =

  $\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times \mathrm{\$}0.602(\mathrm{S}\mathrm{p}\mathrm{o}\mathrm{t})\\ \text{= \$60,200}\end{array}$

e.

To determine

Introduction: A contract or agreement laid between two parties for buying and selling of an asset at a specific rate and on a specific future date is known as forward contract. This is a contract or an agreement between a buyer and a seller to trade an asset at a future date whose price is set when contract is drawn and such agreements settle at the end of the contract on that specific date.

To prepare: Journal entries for forward contract to manage the foreign currency position, considering time value of money.

Explanation of Solution

Use of forward contract to manage the exposed foreign currency positionconsidering the time value of money at a 12% annual rate. Forward contract not designed as a hedge.

  

-Purchase of Furniture - Settle forward exchange

resulting in Foreign contract and receive

currency payable. 100,000 Australian

Dollar.

-Sign hedging foreign - Pay foreign Currency

exchange contract to Payable

receive Australian Dollars

on March 31^st.

Forward Rate:

A$1 = $0.609 A$1 = $0.612

Spot Rate:

A$1 = $0.600 A$1 = $0.610 A$1 = $ 0.602

Journal Entries in the books of M CompFor the year Dec 31st20X1
Date	Particulars	Debit$	Credit$
	Inventory (purchases)	60,000
Dec 1st	Accounts payable (A$)		60,000
20X1	(To record foreign currency payable)
	Foreign currency receivable from exchange broker (A$)	60,900
	Dollars payable to exchange broker		60,900
	(To record forward contract to hedge foreign currency)
Dec 31st	Foreign currency transaction loss	1,000
20X1	Accounts payable (A$)		1,000
	(To record foreign currency transaction loss)
	Foreign currency receivable from exchange broker (A$)	291
	Foreign currency transaction gain		291
	(To record revalue of foreign currency receivable)

Journal Entries in the books of M CompFor the year Dec 31st20X2
Date	Particulars	Debit$	Credit$
	Foreign currency transaction loss	991
March 31st	Foreign currency receivable from exchange broker (A$)		991
20X2	(To record revalue of foreign currency receivable)
	Account payable (A$)	800
	Foreign currency transaction gain		800
	(To record revalue of foreign currency payable)
	Dollars payable to exchange broker	60,900
	Cash		60,900
	(To record cash payment required by forward contract)
	Foreign currency units (A$)	60,200
	Foreign currency receivable from exchange broker (A$)		60,200
	(to receive $100,000 from exchange broker as per forward contract)
	Accounts payables (A$)	60,200
	Foreign currency units (A$)		60,200
	(To record payment to creditor)

Working Notes:

1.Accounts Payable =

  $\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times 0.608(\mathrm{S}\mathrm{p}\mathrm{o}\mathrm{t})\\ \text{= \$60,800}\end{array}$

2. Foreign currency receivable =

  $\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times 0.609(\mathrm{F}\mathrm{o}\mathrm{r}\mathrm{w}\mathrm{a}\mathrm{r}\mathrm{d})\\ \text{= \$ 60,900}\end{array}$

3.Foreign currency transaction loss =

  $\begin{array}{l}\mathrm{{\rm A}}\mathrm{\$}100,000\times 0.610(\mathrm{S}\mathrm{p}\mathrm{o}\mathrm{t})-\mathrm{{\rm A}}\mathrm{\$}100,000\times 0.600(\mathrm{S}\mathrm{p}\mathrm{o}\mathrm{t})\\ \text{=\$ 61,000 - \$ 60,000}\\ =\mathrm{\$}1,000\end{array}$

4.Foreign currency transaction Gain = Foreign currency receivable Dec 31^st (forward rate) − foreign currency receivable Dec 1^st (forward rate)

  $\begin{array}{l}\text{=Α\$ 100,000 × 0}\text{.612 - \$ 60,900}\\ \text{=\$ 61,200 - \$ 60,900}\\ =\mathrm{\$}300\end{array}$

  $\begin{array}{l}\mathrm{{\rm N}}\mathrm{{\rm P}}\mathrm{V}=\mathrm{\$}300-(.12\times \frac{3}{12}\times \mathrm{\$}300)\\ =\mathrm{\$}291\end{array}$

5 Foreign Currency Transaction Loss $=\mathrm{\$}700+\mathrm{\$}291=\mathrm{\$}991.$

6. Accounts Payable =

  $\begin{array}{l}\text{=\$ 61,000 - \$ 60,200}\\ \text{= \$ 800}\end{array}$

7 Foreign Currency Units =

  $\begin{array}{l}=\mathrm{{\rm A}}\mathrm{\$}100,000\times \mathrm{\$}0.602(\mathrm{S}\mathrm{p}\mathrm{o}\mathrm{t})\\ \text{=\$ 60,200}\end{array}$