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On June 1, Cairns Corporation purchased goods from a foreign supplier at a price of 1,000,000 francs and will make payment in three months on...

On June 1, Cairns Corporation purchased goods from a foreign supplier at a price of 1,000,000 francs and will make payment in three months on September 1. On June 1, Cairns acquired an option to purchase 1,000,000 francs in three months at a strike price of $0.852. Relevant exchange rates and option premiums for the franc are as follows:

 

Date Spot Rate Call Option Premium

for September 1

(strike price $0.852) June 1 $ 0.852   $ 0.002  

June 30   0.858     0.007  

September 1   0.872     N/A    

Cairns must close its books and prepare its second-quarter financial statements on June 30.

 

  1. a-1. Assuming that Cairns designates the foreign currency option as a cash flow hedge of a foreign currency payable, prepare journal entries for these transactions in U.S. dollars.
  2. a-2. What is the impact on net income over the two accounting periods?
  3. b-1. Assuming that Cairns designates the foreign currency option as a fair value hedge of a foreign currency payable, prepare journal entries for these transactions in U.S. dollars.
  4. b-2. What is the impact on net income over the two accounting periods?

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