Chapter 7, Problem 18EP

a.

To determine

To record journal entries of sale and 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 sales:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
10/01/Y1	Accounts receivable		6,900
	Sales			6,900
	(to record sales)

Table (1)

• Since, accounts receivable is an asset and assets are increased. Hence, accounts receivable is debited.
• Since, sales are revenue and revenues are increased. Hence, sales are credited.

To record foreign exchange gain:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Accounts receivable		200
	Foreign exchange gain			200
	(to record foreign exchange gain)

Table (2)

• Since, accounts receivable is an asset and assets are increased. Hence, accounts receivable is debited.
• Since, foreign exchange gain is a gain and gains are increased. Hence, foreign exchange account is credited.

To record loss on forward contract:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Loss on forward contract		891.09
	Forward contract			891.09
	(to record loss on forward contract)

Table (3)

• 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 foreign exchange gain:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Accounts receivable		100
	Foreign exchange gain			100
	(to record foreign exchange gain)

Table (4)

• Since, accounts receivable is an asset and assets are increased. Hence, accounts receivable is debited.
• Since, foreign exchange gain is a gain and gains are increased. Hence, foreign exchange gain is credited.

To record gain on forward contract:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Forward contract		191.09
	Gain on forward contract			191.09
	(to record gain on forward contract)

Table (5)

• 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 account receivable:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
4/30/Y2	Foreign currency		7,200
	Accounts receivable			7,200
	(to record accounts receivable)

Table (6)

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

To record cash received:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Cash		6,500
	Forward contract		700
	Foreign currency			7,200
	(to record cash received)

Table (7)

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

Computation of impact on net income is below:

The formula to calculate net income is:

$\mathrm{Net}income=\mathrm{Sales}+\mathrm{Income}+\mathrm{Gains}-\mathrm{Expense}-\mathrm{Loss}$

Substitute $6,900 for sales, $300 for income, $191.09 for gain and $891.09 for loss in the above formula.

$\begin{array}{c}\mathrm{Net}income=\$6,900+\$300+\$191.09-\$891.09\\ =\$6,500\end{array}$

Thus, net income is increased by $6,500.

Working Note:

Computation of sale in USD:

$\begin{array}{c}\mathrm{Sales}(inUSD)=\mathrm{Sale}value(in\mathrm{rupee})\times \mathrm{USD}\text{}per\mathrm{rupee}\\ =100,000\times \$0.069\\ =\$6,900\end{array}$

Computation of foreign exchange gain in USD:

$\begin{array}{c}\mathrm{Foreign}exchangegain=\text{Difference}\times \mathrm{Sale}value\\ =(\$0.071-\$0.069)\times 100,000\\ =\$200\end{array}$

Computation of loss on forward contract:

$\begin{array}{c}\mathrm{Loss}onforwardcontract=\text{Difference}\times \text{Sale}\text{value}\\ =(\$0.074-\$0.065)\times 100,000\\ =\$900\end{array}$

$\begin{array}{c}\mathrm{Present}valueofloss=\text{Present}\text{value}\text{factor}\times \text{Loss}\\ =0.9901\times 900\\ =\$891.09\end{array}$

b.

To determine

To record journal entries of sale and forward contract.

Explanation of Solution

Sales agreement and forward contract are both executor contract so, there is no entry for both.

To record loss on forward contract:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Loss on forward contract		891.09
	Forward contract			891.09
	(to record loss on forward contract)

Table (8)

• 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 ($)	Credit ($)
12/31/Y1	Firm commitment		891.09
	Gain on firm commitment			891.09
	(to record gain on form commitment)

Table (9)

• 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 gain on forward contract:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
1/31/Y2	Forward contract		191.09
	Gain on forward contract			191.09
	(to record gain on forward contract)

Table (10)

• 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		191.09
	Firm commitment			191.09
	(to record loss on firm commitment)

Table (11)

• 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 sales:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
4/30/Y2	Foreign currency		7,200
	Sales			7,200
	(to record sales)

Table (12)

• Since, foreign currency is an asset and assets are increased. Hence, foreign currency is debited.
• Since, sales are revenue and revenues are increased. Hence, sales account is credited.

To record cash received:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
12/31/Y1	Cash		6,500
	Forward contract		700
	Foreign currency			7,200
	(to record accounts receivable)

Table (13)

• Since, cash is an asset and assets are increased. Hence, cash account is debited.
• Since, forward contract is a liability and liabilities are decreased. Hence, forward contract 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	Adjustment to net income		700
	Firm commitment			700
	(to record adjustment to net income)

Table (14)

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

Computation of impact on net income is below:

The formula to calculate net income is,

$\mathrm{Net}income=\mathrm{Sales}+\mathrm{Income}+\mathrm{Gains}-\mathrm{Expense}-\mathrm{Loss}$

Substitute $7,200 for sales, $700 for gain and $700 and $700 for loss in the above formula.

$\begin{array}{c}\mathrm{Net}income=\$7,200+\$700-\$700-\$700\\ =\$6,500\end{array}$

Thus, net income is increased by $6,500

Working Note:

Computation of sale in USD:

$\begin{array}{c}\mathrm{Sales}(inUSD)=\mathrm{Sale}value(in\mathrm{rupee})\times \mathrm{USD}\text{}per\mathrm{rupee}\\ =100,000\times \$0.072\\ =\$7,200\end{array}$

Computation of loss on forward contract:

$\begin{array}{c}\mathrm{Loss}onforwardcontract=\text{Difference}\times \text{Sale}value\\ =(\$0.074-\$0.065)\times 100,000\\ =\$900\end{array}$

$\begin{array}{c}\mathrm{Present}valueofloss=\text{Present}\text{value}\text{factor}\times \text{Loss}\\ =0.9901\times 900\\ =\$891.09\end{array}$