Chapter 7, Problem 34P

a.

To determine

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
01-06-2015	goods purchase		$ 85,000
	Accounts payable			$ 85,000
	(to record Purchase of goods and 1,000,000 Francs at the spot rate of $0.085)
01-06-2015	Foreign Currency Option		$ 2,000
	Cash			$ 2,000
	(To record the purchase of foreign currency option at the fair value of $0.002)
30-06-2015	Foreign exchange loss		$ 3,000
	Account Payable			$ 3,000
	(To adjust the value of the Francs at Spot rate of $0.088)
09-11-2015	Foreign Currency Option		$ 2,000
	AOCI			$ 2,000
	(To adjust the fair value of the option from $0.002 to $0.004 with corresponding credit to AOCI (Accumulated Other Comprehensive Income)
	AOCI		$ 11,000
	Gain on Foreign Currency			$ 3,000
	Option Income			$ 5,000
	(To record gain of foreign currency option and the time value change of the option)

Table: (1)

Impact on the net income for quarter ending on 30^th June:

Particulars	Amount	Amount
Purchase		$ 85,000
Foreign Exchange Loss	($ 3,000)
Gain on Foreign currency option	$ 3,000
Net gain	$ 0
Option Income		$ 5,000
Impact on Net Income		$ 90,000

Table: (2)

Journal Entries as on 1^st September:

Date	Particulars	Post Ref.	Debit	Credit
09-01-2015	Account Payable		$ 2,000
	Foreign Exchange Gain			$ 2,000
	(To adjust the value of the Francs payable to new spot rate of $0.090)
	AOCI		$ 5,000
	Foreign exchange option			$ 5,000
	(To adjust the fair value of the option from $0.085 to $0.090 with corresponding credit to AOCI)
30-06-2015	Loss on foreign currency option		$ 2,000
	AOCI			$ 2,000
	(To record gain on foreign currency option to affect the foreign currency loss and account payable with corresponding credit to AOCI)
09-01-2015	Account Payable		$ 90,000
	Foreign Currency			$ 90,000
	(To record payment of Francs 1,000,000 supplied at spot rate)
	Foreign Currency		$ 90,000
	Cash			$ 85,000
	Foreign Currency option			$ 5,000
	(To record exercise of option @$0.085 and conclude foreign currency from accounts)

Table: (3)

Impact on the net income as on 1^st September:

Particulars	Amount	Amount
Foreign exchange gain	$ 5,000
Gain on foreign currency option	($ 5,000)
Net gain/ (loss)	$ 0
Option Income		$ 0
Impact on net income		$ 0

Table: (4)

b.

To determine

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
06-01-2015	Goods Purchase		$ 85,000
	Account Payable			$ 85,000
	(to record Purchase of goods and 1,000,000 Francs at the spot rate of $0.085)
06-01-2015	Foreign Currency Option		$ 2,000
	Cash			$ 2,000
	(To record the purchase of foreign currency option at the fair value of $0.002)
30-06-2015	Foreign exchange loss		$ 3,000
	Account Payable			$ 3,000
	(To adjust the value of the Francs at Spot rate of $0.088)
09-11-2015	Foreign Currency Option		$ 2,000
	AOCI			$ 2,000
	(To adjust the fair value of the option from $0.002 to $0.004 with corresponding credit to AOCI (Accumulated Other Comprehensive Income)

Table: (5)

Impact on net income as on 30^th June:

Particulars	Amount	Amount
Purchase		$ 85,000
Foreign Exchange Loss	($ 3,000)
Gain on foreign currency option	$ 2,000
Net gain/ (Loss)		($ 1,000)
Option Income
Impact on net income		$ 84,000

Table: (6)

Journal entries on 1^st September:

Date	Particulars	Post Ref.	Debit	Credit
09-01-2015	Account Payable		$ 2,000
	Foreign Exchange Gain			$ 2,000
	(To adjust the value of the Francs payable to new spot rate of $0.090)
	Account Payable		$ 5,000
	Foreign Currency			$ 5,000
	(To adjust the fair value of the option from $0.085 to $0.090 with corresponding credit to AOCI)
30-06-2015	Loss on foreign currency option		$ 2,000
	AOCI			$ 2,000
	(To record gain on foreign currency option to affect the foreign currency loss and account payable with corresponding credit to AOCI)
09-01-2015	Account Payable		$ 90,000
	Foreign Currency			$ 90,000
	(To record payment of Francs 1,000,000 supplied at spot rate)
	Foreign Currency		$ 90,000
	Cash			$ 85,000
	Foreign Currency option			$ 5,000
	(To record exercise of option @$0.085 and conclude foreign currency from accounts)

Table: (7)

Impact on net income on 30^th September:

Particulars	Amount
Foreign exchange gain	$ 5,000
Net impact	$ 5,000

Table: (8)