Chapter 9, Problem 32P

Use the same facts as in Problem 31 except that Brandlin Company purchases materials from a foreign supplier on December 1, 2017, with payment of 16,000 korunas to be made on March 1, 2018. The materials are consumed immediately and recognized as cost of goods sold at the date of purchase. On December 1, 2017, Brandlin enters into a forward contract to purchase 16,000 korunas on March 1, 2018.

1. a. Assuming that Brandlin designates the forward contract as a cash flow hedge of a foreign currency payable and recognizes any premium or discount using the straight-line method, prepare journal entries for these transactions in U.S. dollars. What is the impact on 2017 net income? What is the impact on 2018 net income? What is the impact on net income over the two accounting periods?
2. b. Assuming that Brandlin designates the forward contract 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 in 2017 and in 2018? What is the impact on net income over the two accounting periods?

To determine

Prepare journal entries for transaction of forward contract as a cash flow hedge of foreign currency payable and what is the impact on net income as 2017 and 2018. What is the impact on overall net income of two accounting period?

Explanation of Solution

Pass the journal entries and identify impact on net income:

Date	Particulars	Post Ref.	Debit($)	Credit($)
12/1/17	Parts (COGS –Cost of goods sold)		43,200
	Account Payable			43,200
	( To record Purchase as part on spot rate)
	( No formal entry for forward contract because it an executor contract)
12/3/17	Foreign exchange loss		1,600
	Account Payable			1,600
	(To relevant the foreign currency account payable and recognized exchange loss) $\left(\$2.8-\$2.7\right)\times 16000\text{k}$
12/3/17	Forward contact		1960.6
	AOCI ( Accumulated other comprehensive Income)			1960.6
	( To record change in fair value of the forward contract as a liability )$\begin{array}{l}\left(\$2.9-\$2.775\right)\times 16,000\text{k}\\ =\$2,000\\ =\$2,000\times 0.9803=\$1960.6\end{array}$
12/31/17	AOCI ( Accumulated other comprehensive Income)		1,600
	Gain on forward contract			1,600
	(To record a gain on forward contract option to affect the loss)
12/31/17	Discount as expense		400
	AOCI ( Accumulated other comprehensive Income)			400
	(To allocate the premium on forward contract as revenue over the life of contract) $\$43200\left[1-3\sqrt{\frac{\left(2.775\right)}{\left(2.7\right)}}\right]$

Table: (1)

Impact on net income of 2017:

Particular	Amount($)	Amount($)
Part Expense		(43,200)
Foreign exchange loss	(1,600)
Gain on forward contract	1,600
Discount as Expense	-	(400)
Total		(43,600)

Table: (2)

Journal entries in year 2018: (Cash flow hedge):

Date	Particulars	Post Ref.	Debit($)	Credit($)
03/01/18	Foreign exchange loss		2,400
	Account Payable			2,400
	( To revalue at spot rate as on 3/1/2108
12/03/17	Forward contact		839.4
	AOCI ( Accumulated other comprehensive Income)			839.4
	( To adjust the carrying value change of the forward contract at fair value on 3/1/2018) $\begin{array}{l}\left(\$2.95-\$2.775\right)\times 16,000\text{k}\\ \$2800-\$1960.6=839.4\end{array}$
12/31/17	AOCI ( Accumulated other comprehensive Income)		2,400
	Gain on forward contract			2,400
	(To record a gain on forward contract to affect the loss on foreign exchange) $\begin{array}{l}\left(\$2.95-\$2.8\right)\times 16,000\text{k}\\ \text{=\$2,400}\end{array}$
12/31/17	Discount Expense		800
	AOCI ( Accumulated other comprehensive Income)			800
	To allocate the Discount as Expenses over the life of contract) $\begin{array}{l}\left[\left(\$2.775-\$2.7\right)\times 16,000\text{k}\right]-\$400\\ =\$800\end{array}$
	Account Payable		47,200
	Foreign currency (k)			47,200
	( To record the settlement of forward contract ) $\left(\$2.95\times 16,000\text{k}\right)=\$2,800$
	Cash		44,400
	Forward contract		2,800
	Foreign currency			47,200
	( To record the settlement of forward contract ) $\begin{array}{l}\left(\$2.775-\$2.95\right)\times 16,000\text{k}\\ \text{=\$2,800}\end{array}$

Table: (3)

Impact on net income for year 2018:

Particular	Amount($)	Amount($)
Foreign exchange loss	(2,400)
Gain on foreign exchange	2,400
Net gain/(loss)		0
Discount as expenses	-	(800)
No Impact on income		(800)

Table: (4)

Working note:

Net income over the two accounting period:

Particular	Amount($)
Loss in 2017	(1,600)
Loss in 2018	2,400
Discount,2018$\left(2.775-2.7\right)\times 16,000$	1,200
Net loss	5,200

Table: (5)

To determine

Prepare journal entries for forward contract as a fair value hedge of foreign currency payable and what is the impact on net income as 2017 and 2018. What is the impact on overall net income of two accounting period?

Explanation of Solution

Pass the journal entries and impact on net income:

Journal entries (fair value hedge) in 2017

Date	Particulars	Post Ref.	Debit($)	Credit($)
12/01/17	Parts (COGS –Cost of goods sold)		43,200
	Account Payable			43,200
	( To record Purchase as part on spot rate)
12/31/17	Foreign exchange loss		1,600
	Account Payable			1,600
	(To relevant the foreign currency account payable and recognized loss on foreign exchange) $\left(\$2.8-\$2.7\right)\times 16000\text{k}$
	Forward contact		1960.6
	Gain on forward contract			1960.6
	( To record the forward contract as an assets)

Table: (6)

Impact on net income of 2017:

Particular	Amount($)	Amount($)
Parts Purchase		(43,200)
Foreign exchange loss	(1,600)
Gain on forward contract	1,960.6
Net gain/(loss)	-	360.6
Impact on net income		42,839.4

Table: (7)

Journal entries in 2018:

Date	Particulars	Post Ref.	Debit($)	Credit($)
3/1/18	Foreign exchange loss		2,400
	Account Payable			2,400
	( To revalue at spot rate as on 3/1/2108)
12/3/17	Forward contact		839.4
	Gain on forward contact			839.4
	( To adjust the carrying value change of forward contact at fair value)
12/31/17	Account Payable		47,200
	Foreign currency			47,200
	( To record the Payment to supplier of COGS )
	Foreign currency		47,200
	Cash			44,400
	Forward contract			2,800
	( To record the settlement of forward contract )

Table: (8)

Impact on net income for year 2018:

Particular	Amount($)
Foreign exchange loss	(2,400)
Gain on foreign exchange	839.4
Impact on net income (loss)	(1,560.6)

Table: (9)

Overall impact on net income during two accounting period:

Particular	Amount($)
2017 Income loss/gain	360.6
2018 Gain/(Loss)	(1,560.6)
Net impact loss	(1,200)

Table: (10)