Currency Foreign Transaction:
On 12/1/10 Bush Company sells goods to Blair Company on account.
Blair will pay Bush 10,000 British pounds in two months (2/1/11).
Assume the following exchange (spot) rates:
12/1/2010 1 = $1.7950
12/31/2010 1 = $1.8150
2/1/2011 1 = $1.7000
Bush Company Journal Entries
12/1/2010 To record the sale.
12/31/2010 To remeasure A/R value at balance sheet date spot rate.
(10,000 x $1.8150 = $18,150 minus $17,950 = $200)
2/1/2011 To remeasure A/R value of to new spot rate.
(10,000 x $1.7000 = $17,000 minus $18,150 = $1,150)
2/1/2011 To record the receipt of 10,000 and conversion to US$.
Forward Contract Designated as Cash Flow Hedge
On 12/1/10 New York Company sells goods to Rome Company for 100,000 .
The spot rate on 12/1/10 is 1 = $1.25 US.
Rome will pay New York 100,000 on 3/1/11
New York enters into a forward contract on 12/1/10 to sell 100,000 on 3/1/11
to State Bank. The three month forward rate on 12/1/10 is 1 = $1.20 US.
Assume New York Company has a discount rate of 12% per year (1% per month)
A/R ()
Date
12/1/2010
12/31/2010
3/1/2011
Spot
Change in
Rate
U.S. $ Value U.S. $ Value
$1.25
1.28
1.18
Forward Contract
Forward
Rate to
Change in
3/1/11
Fair Value Fair Value
$1.20
1.22
1.18
New York Company Journal Entries
12/1/2010 To record the sale and 100,000 A/R at spot rate of $1.25.
NOTE: No entry for forward contract (no cash exchanged, no fair value)
12/31/2010 To remeasure A/R value at balance sheet date spot rate.
To record loss on forward contract to offset foreign exchange gain on A/R.
To record the forward contract as a liability at its fair value of $1961
To allocate the forward contract discount to net income over the life
of the contract using the straight line allocation method. ($125,000-$120,000=$5,000)
Impact on Net Income for 2010
Sales
Foreign Exchange Gain
Loss on Forward Contract
Net Gain (Loss)
Discount Expense
Impact on Net Income
Effect on December 31, 2010 Balance Sheet:
Assets
Accounts Receivable
Liabilities & Equity
Forward Contract
Retained Earnings
AOCI
3/1/2011 To remeasure A/R value of to new spot rate.
To record a gain on forward contract to offset the foreign exchange loss on A/R.
To adjust the carrying value of forward contract to current fair value of $2,000
To allocate the remaining forward contract discount to net income
AOCI BALANCE AFTER ALL ENTRIES: Zero
Debits:
To record the receipt of 100,000 at 3/1/11 spot rate of $1.18.
To record settlement of forward contract and remove it from books.
Impact on Net Income for 2011:
Sales
Foreign Exchange Loss
Gain on Forward Contract
Net Gain (Loss)
Discount Expense
Impact on Net Income
Effect on December 31, 2011 Balance Sheet:
Assets
Cash
Liabilities & Equity
Forward Contract
Retained Earnings
AOCI
NOTE: Discount expense is cost of extending Italian customer credit
($125,000-$120,000=$5,000)
Net Benefit from entering into forward contract:
Reflected in Net Income:
Net Gain on forward contract
Total Discount Expense
Forward Contract Designated as Fair Value Hedge
Gain/loss on forward contract taken directly to Net Income
No separate amortization of original discount on forward contract
On 12/1/10 New York Company sells goods to Rome Company for 100,000 .
The spot rate on 12/1/10 is 1 = $1.25 US.
Rome will pay New York 100,000on 3/1/11
New York enters into a forward contract on 12/1/10 to sell 100,000 on 3/1/11
to State Bank. The three month forward rate on 12/1/10 is 1 = $1.20 US.
Assume New York Company has a discount rate of 12% per year (1% per month)
A/R ()
Date
12/1/2010
12/31/2010
3/1/2011
Spot
Change in
Rate
U.S. $ Value U.S. $ Value
$1.25
1.28
1.18
Forward to
Change Contract
Forward
Rate in
3/1/11
Fair Value Fair Value
$1.20
1.22
1.18
New York Company Journal Entries
12/1/2010 To record the sale and 100,000 A/R at spot rate of $1.25.
NOTE: No entry for forward contract (no cash exchanged, no fair value)
12/31/2010 To remeasure A/R value at balance sheet date spot rate.
To record the forward contract as a liability at its fair value of $1961
Impact on Net Income for 2010:
Sales
Foreign Exchange Gain
Loss on Forward Contract
Net Gain (Loss)
Impact on Net Income
Effect on December 31, 2010 Balance Sheet:
Assets
Accounts Receivable
Liabilities & Equity
Forward Contract
Retained Earnings
3/1/2011 To remeasure A/R value of to new spot rate.
To adjust the carrying value of forward contract to current fair value of $2,000
To record the receipt of 100,000 at 3/1/11 spot rate of $1.18.
To record settlement of forward contract and remove it from books.
Impact on Net Income for 2011:
Sales
Foreign Exchange Loss
Gain on Forward Contract
Net Gain (Loss)
Impact on Net Income
Effect on December 31, 2011 Balance Sheet:
Assets
Cash
Net Benefit from entering into forward contract:
Reflected in Net Income:
Loss in 2010
Gain in 2011
Liabilities & Equity
Forward Contract
Retained Earnings
Forward Contract Used as a Fair Value Hedge of a Firm Commitment
Gain/loss on forward contract recognized currently in Net Income
Gain/loss on firm commitment attributable to the hedged risk is also recognized currently in net income.
On 12/1/10 L.A. Company receives an order from Manheim Company
The delivery date is March 1, 2011, when L.A. Company will receive immediate payment.
The sale is 3 months away, L.A. has a firm commitment to make the sale and collect 100,000 .
L.A. decides to hedge this commitment.
A forward contract was entered into to sell the euros at a price of 1=$1.31.
L.A.'s discount rate is 12%.
On 12/31/10, the currently available forward rate is 1 =US $1.34.
L.A. elects to measure the fair value of the firm commitment through changes in the forward rate.
Forward Contract
Date
12/1/2010
12/31/2010
3/1/2011
Forward
Rate
$1.31
1.34
1.28
Fair Value
Change in
Fair Value
Firm Commitment
Fair Value
Change in
Fair Value
Fair Value of Forward Contract 12/31/06: $131,000-134,000 = ($3,000) * .9803
.9803 = pv factor 2 months, 1% per month
L.A. Company Journal Entries
12/1/2010 EXECUTORY CONTRACTS ONLY
No entry for sale because at this point it is just a firm commitment.
No entry for forward contract (no cash exchanged, no fair value)
12/31/2010 To record the forward contract as a liability at its fair value of $2,941
To record the firm commitment as an asset at its fair value of $2,941
Impact on Net Income for 2010:
Sales
Loss on Forward Contract
Gain on Firm Commitment
Net Gain (Loss)
Impact on Net Income
Effect on December 31, 2010 Balance Sheet:
Assets
Firm Commitment
Liabilities & Equity
Forward Contract
Retained Earnings
3/1/2011 To adjust the fair value of forward contract from ($2941) to $3000.
To adjust the fair value of the firm commitment from $2941 to $(3000).
To record the sale and receipt of 100,000 as an asset at the spot rate of $1.28.
To record settlement of forward contract and remove it from books.
To close the firm commitment as an adjustment to net income
Impact on Net Income for 2011:
Sales
Gain on Forward Contract
Loss on Firm Commitment
Net Gain (Loss)
Adjustment to Net Income
Impact on Net Income
Effect on December 31, 2011 Balance Sheet:
Assets
Cash
Net Benefit from entering into forward contract:
Reflected in Net Income:
Loss in 2010
Gain in 2011
Liabilities & Equity
Forward Contract
Retained Earnings