Question

Brandlin Company of Anaheim, California, purchases materials from a foreign supplier on December 1, 2017, with payment of 18,000 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 18,000 korunas on March 1, 2018. Relevant exchange rates for the koruna on various dates are as follows:

Date	Spot Rate			Forward Rate (to March 1, 2018)
December 1, 2017	$	3.60		$	3.675
December 31, 2017		3.70			3.800
March 1, 2018		3.85			N/A

Brandlin’s incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent (1 percent per month) is 0.9803. Brandlin must close its books and prepare financial statements at December 31.

a-1. 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.

a-2. Assuming that the purchased parts became a part of the cost of goods sold in 2017, what is the impact on net income in 2017 and in 2018?

a-3. What is the impact on net income over the two accounting periods?

Answer 1

Part A-1

Date	General Journal	Debit	Credit
12/1/17	Accounts receivable (K)	64800
	Sales (18000*3.60)		64800
	No journal entry required
	No journal entry required
12/31/17	Accounts receivable (K)	1800
	Foreign exchange gain (18000*(3.70-3.60))		1800
	AOCI	2206
	Forward contract (18000*(3.675-3.800))*0.9803		2206
	Loss on forward contract	1800
	AOCI		1800
	AOCI	450
	Premium revenue (18000*(3.675-3.600))*1/3		450
3/1/18	Accounts receivable (K)	2700
	Foreign exchange gain (18000*(3.85-3.70))		2700
	AOCI	890
	Forward contract (18000*(3.85-3.675))-2206		890
	Loss on forward contract	2700
	AOCI		2700
	AOCI	900
	Premium revenue (18000*(3.675-3.600))*2/3		900
	Foreign currency (K)	69300
	Accounts receivable (K) (18000*3.85)		69300
	Cash	66150
	Forward contract (18000*3.675)	3150
	Foreign currency (K)		69300

Part A-2

Impact on 2017 income:

Sales	64800
Foreign Exchange Gain	1800
Loss on Forward Contract	(1800)
Premium Revenue	450
Total	65250

Impact on 2018 income:

Foreign Exchange Gain	2700
Loss on Forward Contract	(2700)
Premium Revenue	900
Total	900

Part A-3

Impact on net income over both periods: $65250 + $900 = $66150; equal to cash inflow