Question

On November 1, 2017, Bernard Company (a U.S.-based company) sold merchandise to a foreign customer for 120,000 FCUs with payment to be received on April 30, 2018. At the date of sale, Bernard entered into a six-month forward contract to sell 120,000 FCUs. The company properly designates the forward contract as a cash flow hedge of a foreign currency receivable. The following exchange rates apply:

Date	Spot Rate			Forward Rate (to April 30, 2018)
November 1, 2017	$	0.23		$	0.22
December 31, 2017		0.21			0.19
April 30, 2018		0.20			N/A

Bernard's incremental borrowing rate is 12 percent. The present value factor for four months at an annual interest rate of 12 percent (1 percent per month) is 0.9610.

1. Prepare all journal entries, including December 31 adjusting entries, to record the sale and forward contract.
2. What is the impact on net income in 2017?
3. What is the impact on net income in 2018?

Answer 1

On the date of sale (November 1,2017)

Bernard Company (a U.S.-based company) sold merchandise to a foreign customer for 120,000 FCUs with payment to be received on April 30, 2018. Spot rate was USD/FCU 0.23 and it is expected to settle the account in 6 month.

Goods are sold to the customer

Account Debit Credit

Accounts receivable 27,600

Revenue   27,600

Total 27,600 27,600

To reduce its exposure to foreign exchange risk the Bernard Company enters into a 6 month foreign exchange forward contract at USD/FCU 0.22 and will therefore receive/pay the difference between this rate and the rate on the settlement date. The effect of this contract is to fix the value of the FCU 120,000 the business will receive at USD 26,400.

Balance Sheet Date (December 31, 2017)

At the balance sheet date of December 31, 2017 the exchange rate has changed. The USD/FCU spot rate is now 0.21 and the forward rate is 0.19. The business must now record the changes in fair value of the asset (in this case the accounts receivable) and the foreign exchange forward contract.

USD/FCU spot rate at the date of sale = 0.23

USD/FCU spot rate at balancesheet date = 0.21

Amount = FCU 120000

Loss = 120000* (0.23-0.21) = 2400

Journal Enry:

Account Debit Credit

Foreign Exchange 2400

Account Receivable 2400

Total 2400 2400

Effect on Foreign Exchange Forward Contract:

USD/FCU forwatd rate at the date of sale = 0.22

USD/FCU forward rate at balancesheet date = 0.19

Amount = FCU 120000

Loss = 120000* (0.22-0.19) = 3600

Journal Enry:

Account Debit Credit

Foreign Exchange 3,600

Foreign Contract 3,600

Total     3,600 3,600

The foreign exchange loss is posted to the Profit and loss statement and a forward contract asset is established representing the net amount due to the business under the contract at the balance sheet date. It should be noted that under a foreign exchange forward contract only the difference resulting from changes in exchange rates is accounted for not the principal amount.

Settlement Date April 30, 2018:

Effect on Accounts Receivable

USD/FCU spot rate at balancesheet date = 0.21

USD/FCU spot rate at settlement date = 0.20

Amount = FCU 120000

Loss = 120000* (0.21-0.20) = 1200

Journal Enry:

Account Debit Credit

Cash 24000

Foreign Exchange 1200

Account Receivable 25,200

Total 25,200 25,200

Effect on Foreign Exchange Forward Contract Liability

USD/FCU forwatd rate at the contract date = 0.22

USD/FCU spot rate at settlement date = 0.20

Amount = FCU 120000

Loss = 120000* (0.22-0.20) = 2400

Journal Enry:

Account Debit Credit

Foreign Exchange 2400

Foreign Contract    2400

Total 2400 2400