Chapter 6, Problem 1C

1.

To determine

To record journal entries to account for import purchase.

Explanation of Solution

Journalizing:

Journalizing is the process of recording the transactions of an organization in the order of happening of events. Based on these recorded journal entries, the accounts are posted to the relevant ledger accounts.

Accounting rules for journal entries:

• To increase balance of the account: Debit assets, expenses, losses and credit all liabilities, capital, revenue and gains.
• To decrease balance of the account: Credit assets, expenses, losses and debit all liabilities, capital, revenue and gains.

To record the purchase:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/1/Y1	Inventory		50,000
	Accounts payable			50,000
	(to record purchase)

Table (1)

• Since, inventory is an asset and assets are increased. Hence, accounts receivable is debited.
• Since, accounts payable is a liability and liabilities are increased. Hence, accounts payable is credited.

To record foreign exchange loss:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Foreign exchange loss		5,000
	Accounts payable			5,000
	(to record foreign exchange loss)

Table (2)

• Since, foreign exchange loss is a loss and losses are increased. Hence, foreign exchange loss is debited.
• Since, accounts payable is a liability and liabilities are increased. Hence, accounts payable is credited.

To record foreign exchange loss:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Foreign exchange loss		2,500
	Accounts payable			2,500
	(to record foreign exchange loss)

Table (3)

• Since, foreign exchange loss is a loss and losses are increased. Hence, foreign exchange loss is debited.
• Since, accounts payable is a liability and liabilities are increased. Hence, accounts payable is credited.

There is no foreign exchange loss at 31^st January year 2 because the value of exchange rate is the same. Therefore, there will be no journal entry.

To record payment:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Accounts payable		57,500
	Cash			57,500
	(to record accounts payable)

Table (4)

• Since, accounts payable is a liability and liabilities are decreased. Hence, accounts payable is debited.
• Since, cash is an asset and assets are decreased. Hence, cash account is credited.

Working Note:

Computation of number of crowns:

$\begin{array}{c}\mathrm{Total}\text{number}ofcrowns=\text{Number}\text{of}\text{cases}\times \text{Number}\text{of}\text{crowns}\\ =500\times 100\\ =50,000\mathrm{crowns}\end{array}$

Computation of inventory in USD:

$\begin{array}{c}\mathrm{Inventory}(inUSD)=\text{Number}\text{of}\text{crowns}\times \text{Spot}\text{rate}\\ =50,000\times \$1\\ =\$50,000\end{array}$

Computation of foreign exchange loss in year 1:

$\begin{array}{c}\mathrm{Foreign}exchangeloss=\text{Difference}\text{in}\text{spot}\text{rate}\times \text{Number}\text{of}\text{crowns}\\ =\$0.10\times \$50,000\\ =\$5,000\end{array}$

Computation of foreign exchange loss in year 2:

$\begin{array}{c}\mathrm{Foreign}exchangeloss=\text{Difference}\text{in}\text{spot}\text{rate}\times \text{Number}\text{of}\text{crowns}\\ =\$0.05\times \$50,000\\ =\$2,500\end{array}$

Computation of payment:

$\begin{array}{c}\mathrm{Payment}=\text{Inventory}\times \text{Forward}\text{rate}\\ =\$50,000\times \$1.15\\ =\$57,500\end{array}$

2.

To determine

To record journal entries to account for import purchase and foreign currency forward contract.

Explanation of Solution

Fair Value Hedge:

If the fair value of an asset or a liability is affected by the change in exchange rate than it is called fair value hedge. If the fair value is not hedged, the fair value risk must affect the net income to meet the requirements for hedge accounting.

To record purchase:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/1/Y1	Inventory		50,000
	Accounts payable			50,000
	(to record purchase)

Table (5)

• Since, inventory is an asset and assets are increased. Hence, accounts receivable is debited.
• Since, accounts payable is a liability and liabilities are increased. Hence, accounts payable is credited.

To record foreign exchange loss:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Foreign exchange loss		5,000
	Accounts payable			5,000
	(to record foreign exchange loss)

Table (6)

• Since, foreign exchange loss is a loss and losses are increased. Hence, foreign exchange loss is debited.
• Since, accounts payable is a liability and liabilities are increased. Hence, accounts payable is credited.

To record gain on forward contract:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Forward contract		4,455.45
	Gain on forward contract			4,455.45
	(to record gain on forward contract)

Table (7)

• Since, forward contract is a liability and liabilities are decreased. Hence, forward contract is debited.
• Since, gain on forward contract is a gain and gains are increased. Hence, gain on forward contract is credited.

To record foreign exchange loss:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Foreign exchange loss		2,500
	Accounts payable			2,500
	(to record foreign exchange loss)

Table (8)

• Since, foreign exchange loss is a loss and losses are increased. Hence, foreign exchange loss is debited.
• Since, accounts payable is a liability and liabilities are increased. Hence, accounts payable is credited.

To record gain on forward contract:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Forward contract		955.45
	Gain on forward contract			955.45
	(to record gain on forward contract)

Table (9)

• Since, forward contract is a liability and liabilities are decreased. Hence, forward contract is debited.
• Since, gain on forward contract is a gain and gains are increased. Hence, gain on forward contract is credited.

To record receipt of foreign exchange:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y1	Foreign currency		57,500
	Cash			50,000
	Forward contract			7,500
	(to record receipt of foreign exchange)

Table (10)

• Since, foreign currency is an asset and assets are increased. Hence, foreign currency is debited.
• Since, cash is an asset and assets are decreased. Hence, cash account is credited.
• Since, forward contract is a liability and liabilities are increased. Hence, forward contract is credited.

To record payment:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Accounts payable		57,500
	Foreign currency			57,500
	(to record accounts payable)

Table (11)

• Since, accounts payable is a liability and liabilities are decreased. Hence, accounts payable is debited.
• Since, foreign currency is an asset, assets decreased. Hence, foreign currency is credited.

Working Note:

Computation of number of crowns:

$\begin{array}{c}\mathrm{Total}\text{number}ofcrowns=\text{Number}\text{of}\text{cases}\times \text{Number}\text{of}\text{crowns}\\ =500\times 100\\ =50,000\mathrm{crowns}\end{array}$

Computation of inventory in USD:

$\begin{array}{c}\mathrm{Inventory}(inUSD)=\text{Number}\text{of}\text{crowns}\times \text{Spot}\text{rate}\\ =50,000\times \$1\\ =\$50,000\end{array}$

Computation of foreign exchange loss in year 1:

$\begin{array}{c}\mathrm{Foreign}exchangeloss=\text{Difference}\text{in}\text{spot}\text{rate}\times \text{Number}\text{of}\text{crowns}\\ =\$0.10\times \$50,000\\ =\$5,000\end{array}$

Computation of gain on forward contract in year 1:

$\begin{array}{c}\mathrm{Gain}=\mathrm{Change}infairvalue\mathrm{of}crowns\\ =\left(\$50,000\times \$1.17\right)-\left(\$50,000\times \$1.08\right)\\ =\$58,500-\$54,000\\ =\$4,500\end{array}$

Computation of present value of gain on forward contract in year 1:

$\begin{array}{c}\mathrm{Present}valueofgain=\mathrm{Gain}\times \mathrm{Present}valuefactor\\ =\$4,500\times \$0.990099\\ =\$4455.45\end{array}$

Computation of foreign exchange loss in year 2:

$\begin{array}{c}\mathrm{Foreign}exchangeloss=\text{Difference}\text{in}\text{spot}\text{rate}\times \text{Number}\text{of}\text{crowns}\\ =\$0.05\times \$50,000\\ =\$2,500\end{array}$

Computation of gain on forward contract in year 2:

$\begin{array}{c}\mathrm{Gain}onforwardcontract=\mathrm{Previous}gain-\mathrm{Change}infairvalueofcrowns\\ =\$4455.45-(\$57,500-\$54,000)\\ =\$4455.45-\$3,500\\ =955.45\end{array}$

Computation of payment:

$\begin{array}{c}\mathrm{Payment}=\mathrm{Inventory}\times \mathrm{Forward}rate\\ =\$50,000\times \$1.15\\ =\$57,500\end{array}$

3.

To determine

To record journal entries to account for the foreign currency forward contract, firm commitment and import purchase.

Explanation of Solution

To record gain on forward contract:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Forward contract		4,455.45
	Gain on forward contract			4,455.45
	(to record gain on forward contract)

Table (12)

• Since, forward contract is a liability and liabilities are decreased. Hence, Forward contract is debited.
• Since, gain on forward contract is a gain and gains are increased. Hence, gain on forward contract is credited.

To record loss on firm commitment:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Loss on firm commitment		4455.45
	Firm commitment			4455.45
	(to record loss on firm commitment)

Table (13)

• Since loss on firm commitment is a loss and losses are increased. Hence, loss on firm commitment account is debited.
• Since firm commitment is a liability and liabilities are increased. Hence, firm commitment is credited.

To record loss on forward contract:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
10/31/Y2	Loss on forward contract		955.45
	Forward contract			955.45
	(to record loss on forward contract)

Table (14)

• Since loss on forward contract is a loss and losses are increased. Hence, loss on forward contract is debited.
• Since forward contract is a liability and liabilities are increased. Hence, forward contract is credited.

To record gain on firm commitment:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Firm commitment		955.45
	Gain on firm commitment			955.45
	(to record gain on firm commitment)

Table (15)

• Since firm commitment is a liability and liabilities are decreased. Hence, firm commitment is debited.
• Since gain on firm commitment is a gain and gains are increased. Hence, gain on firm commitment account is credited.

To record receipt of foreign exchange:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y1	Foreign currency		57,500
	Cash			54,000
	Forward contract			3,500
	(to record receipt of foreign exchange)

Table (16)

• Since foreign currency is an asset and assets are increased. Hence, foreign currency is debited.
• Since cash is an asset and assets are decreased. Hence, cash account is credited.
• Since forward contract is a liability and liabilities are increased. Hence, forward contract is credited.

To record payment:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Accounts payable		57,500
	Foreign currency			57,500
	(to record accounts payable)

Table (17)

• Since accounts payable is a liability and liabilities are decreased. Hence, accounts payable is debited.
• Since foreign currency is an asset and assets are decreased. Hence, foreign currency is credited.

To record adjustment to net income:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Firm commitment		3,500
	Adjustment to net income			3,500
	(to record adjustment to net income)

Table (18)

• Since firm commitment is a liability and liabilities are decreased. Hence, firm commitment is debited.
• Since adjustment to net income is revenue and revenues are increased. Hence adjustment to net income is credited.

Working Note:

Computation of number of crowns:

$\begin{array}{c}\mathrm{Total}\text{number}ofcrowns=\text{Number}\text{of}\text{cases}\times \text{Number}\text{of}\text{crowns}\\ =500\times 100\\ =50,000\mathrm{crowns}\end{array}$

Computation of gain on forward contract in year 1:

$\begin{array}{c}\mathrm{Gain}=\mathrm{Change}infairvalue\mathrm{of}crowns\\ =\left(\$50,000\times \$1.17\right)-\left(\$50,000\times \$1.08\right)\\ =\$58,500-\$54,000\\ =\$4,500\end{array}$

Computation of present value of gain on forward contract in year 1:

$\begin{array}{c}\mathrm{Present}valueofgain=\mathrm{Gain}\times \mathrm{Present}valuefactor\\ =\$4,500\times \$0.990099\\ =\$4,455.45\end{array}$

Computation of loss on forward contract in year 2:

$\begin{array}{c}\mathrm{Loss}onforwardcontract=\mathrm{Previous}gain-\mathrm{Change}infairvalueofcrowns\\ =\$4,455.45-(\$57,500-\$54,000)\\ =\$4,455.45-\$3,500\\ =\$955.45\end{array}$

4.

To determine

Record journal entries to account for the import purchase and foreign currency option.

Explanation of Solution

Cash Flow Hedge:

Companies use cash flow hedge to minimize the variability in cash flows. It is used by the companies to minimize or eliminate the risk arising from change in the flow of cash.

To record purchase:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/1/Y1	Inventory		50,000
	Accounts payable			50,000
	(to record purchase)

Table (19)

• Since, inventory is an asset and assets are increased. Hence, accounts receivable is debited.
• Since, accounts payable is a liability and liabilities are increased. Hence, accounts payable is credited.

To record foreign currency option:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/1/Y1	Foreign currency option		2,000
	Cash			2,000
	(to record foreign currency option)

Table (20)

• Since, foreign currency option is a liability and liabilities are decreased. Hence, foreign currency option is debited.
• Since, cash is an asset and assets are decreased. Hence, cash account is credited.

To record foreign exchange loss:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Foreign exchange loss		5,000
	Accounts payable			5,000
	(to record foreign exchange loss)

Table (21)

• Since, foreign exchange loss is a loss and losses are increased. Hence, Foreign exchange loss is debited.
• Since, accounts payable is a liability and liabilities are increased. Hence, accounts payable is credited.

To record gain on foreign currency option:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	AOCI		5,000
	Gain on foreign currency option			5,000
	(to record gain on foreign currency option)

Table (22)

• Since, AOCI is a liability and liabilities are decreased. Hence, AOCI is debited.
• Since, gain on foreign currency option is a gain and gains are increased. Hence, gain on foreign currency option is credited.

To record transfer of foreign currency option to AOCI:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Foreign currency option		4,000
	AOCI			4,000
	(to record transfer of foreign currency option to AOCI)

Table (23)

• Since, foreign currency option is a liability and liabilities are decreased. Hence, foreign currency option is debited.
• Since, AOCI is a liability and liabilities are increased. Hence, AOCI is credited.

To record option expenses:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Option expenses		1,000
	AOCI			1,000
	(to record option expenses)

Table (24)

• Since, option expense is an expense and expenses are increased. Hence, foreign option expense is debited.
• Since, AOCI is a liability and liabilities are increased. Hence, AOCI account is credited.

To record foreign exchange loss:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Foreign exchange loss		2,500
	Accounts payable			2,500
	(to record foreign exchange loss)

Table (25)

• Since, foreign exchange loss is a loss and losses are increased. Hence, foreign exchange loss is debited.
• Since, accounts payable is a liability and liabilities are increased. Hence, accounts payable is credited.

To record gain on foreign currency option:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	AOCI		2,500
	Gain on foreign currency option			2,500
	(to record gain on foreign currency option)

Table (26)

• Since, AOCI is a liability and liabilities are decreased. Hence, AOCI is debited.
• Since, gain on foreign currency option is a gain and gains are increased. Hence, gain on foreign currency option is credited.

To record transfer of foreign currency option to AOCI:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Foreign currency option		1,500
	AOCI			1,500
	(to record transfer of foreign currency option to AOCI)

Table (27)

• Since, foreign currency option is a liability and liabilities are decreased. Hence, foreign currency option is debited.
• Since, AOCI is a liability and liabilities are increased. Hence, AOCI is credited.

To record option expenses:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Option expenses		1,000
	AOCI			1,000
	(to record option expenses)

Table (28)

• Since, option expense is an expense and expenses are increased. Hence, foreign option expense is debited.
• Since, AOCI is a liability and liabilities are increased. Hence, AOCI account is credited.

To record receipt of foreign exchange:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y1	Foreign currency		57,500
	Cash			50,000
	Foreign currency option			7,500
	(to record receipt of foreign exchange)

Table (29)

• Since, foreign currency is an asset and assets are increased. Hence, foreign currency is debited.
• Since, cash is an asset and assets are decreased. Hence, cash account is credited.
• Since, foreign currency option is a liability and liabilities are increased. Hence, foreign currency option is credited.

To record payment for purchase of inventory:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Inventory		57,500
	Foreign currency			57,500
	(to record accounts payable)

Table (30)

• Since, inventory is an asset and assets are increased. Hence, inventory is debited.
• Since, foreign currency is an asset and assets are decreased. Hence, foreign currency is credited.

Working Note:

Computation of number of crowns:

$\begin{array}{c}\mathrm{Total}\text{number}ofcrowns=\text{Number}\text{of}\text{cases}\times \text{Number}\text{of}\text{crowns}\\ =500\times 100\\ =50,000\mathrm{crowns}\end{array}$

Computation of inventory in USD:

$\begin{array}{c}\mathrm{Inventory}(inUSD)=\mathrm{Inventory}\times \mathrm{Spot}rate\\ =50,000\times \$1\\ =\$50,000\end{array}$

Computation of foreign currency option:

$\begin{array}{c}\mathrm{Foreign}currencyoption=\mathrm{Inventory}\times \mathrm{Option}premium\\ =\$50,000\times \$0.04\\ =\$2,000\end{array}$

Computation of foreign exchange loss in year 1:

$\begin{array}{c}\mathrm{Foreign}exchangeloss=\mathrm{Difference}inspotrate\times \mathrm{Inventory}\\ =\$0.10\times \$50,000\\ =\$5,000\end{array}$

Computation of foreign exchange loss in year 2:

$\begin{array}{c}\mathrm{Foreign}exchangeloss=\mathrm{Difference}inspotrate\times \mathrm{Inventory}\\ =\$0.05\times \$50,000\\ =\$2,500\end{array}$

5.

To determine

To record journal entries to account for the foreign currency option, firm commitment and import purchase.

Explanation of Solution

To record payment of foreign currency option:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/1/Y1	Foreign currency option		2,000
	Cash			2,000
	(to record payment of foreign currency option)

Table (31)

• Since, foreign currency option is a liability and liabilities are decreased. Hence, foreign currency option is debited.
• Since, cash is an asset and assets are decreased. Hence, cash account is credited.

To record loss on firm commitment:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Loss on firm commitment		4,950.50
	Firm commitment			4,950.50
	(to record loss on firm commitment)

Table (32)

• Since, loss on firm commitment is a loss and losses are increased. Hence, loss on firm commitment account is debited.
• Since, firm commitment is a liability and liabilities are increased. Hence, firm commitment is credited.

To record gain on foreign currency option:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Foreign currency option		1,500
	Gain on foreign currency option			1,500
	(to record gain on foreign currency option)

Table (33)

• Since, foreign currency option is a liability and liabilities are decreased. Hence, foreign currency option is debited.
• Since, gain on foreign currency option is a gain and gains are increased. Hence, gain on foreign currency option is credited.

To record loss on firm commitment:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Loss on firm commitment		2,550
	Firm commitment			2,550
	(to record loss on firm commitment)

Table (34)

• Since, loss on firm commitment is a loss and losses are increased. Hence, loss on firm commitment account is debited.
• Since, firm commitment is a liability and liabilities are increased. Hence, firm commitment is credited.

To record receipt of foreign exchange:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y1	Foreign currency		57,500
	Cash			50,000
	Foreign currency option			7,500
	(to record receipt of foreign exchange)

Table (35)

• Since, foreign currency is an asset and assets are increased. Hence, foreign currency is debited.
• Since, cash is an asset and assets are decreased. Hence, cash account is credited.
• Since, foreign currency option is a liability and liabilities are increased. Hence, foreign currency option is credited.

To record payment for purchase of inventory:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Inventory		57,500
	Foreign currency			57,500
	(to record accounts payable)

Table (36)

• Since, inventory is an asset and assets are increased. Hence, inventory is debited.
• Since, foreign currency is an asset and assets are decreased. Hence, foreign currency is credited.

Working Note:

Computation of inventory in USD:

$\begin{array}{c}\mathrm{Inventory}(inUSD)=\text{Inventory}\times \mathrm{Spot}rate\\ =\$50,000\times \$1.15\\ =\$57,500\end{array}$

Computation of foreign currency option:

$\begin{array}{c}\mathrm{Inventory}(inUSD)=\text{Inventory}\times \mathrm{Spot}rate\\ =50,000\times \$1\\ =\$50,000\end{array}$

Computation of loss on firm commitment in year 1:

$\begin{array}{c}\mathrm{Loss}\mathrm{on}firmcommitment=\text{Difference}\text{in}\text{spot}\text{rate}\times \mathrm{Inventory}\\ =\$0.10\times \$50,000\\ =\$5,000\end{array}$

Computation of present value of loss on firm commitment:

$\begin{array}{c}\mathrm{Present}valueofloss=\text{Loss}\times \mathrm{Present}valuefactor\\ =\$5,000\times 0.990099\\ =\$4,950.50\end{array}$

Computation of loss on firm commitment in year 2:

$\begin{array}{c}\mathrm{Loss}\mathrm{on}firmcommitment=\text{Fair}\text{value}-\mathrm{Loss}onfirmcommitment\\ =\$7,500-\$4,950\\ =\$2,550\end{array}$