Question

In: Accounting

Vino Veritas Company, a U.S.-based importer of wines and spirits, placed an order with a French...

Vino Veritas Company, a U.S.-based importer of wines and spirits, placed an order with a French supplier for 1,700 cases of wine at a price of 270 euros per case. The total purchase price is 459,000 euros. Relevant exchange rates for the euro are as follows:

Date Spot Rate Forward Rate
to October 31
Call Option Premium
for October 31
(strike price $1.35)
September 15 $ 1.35 $ 1.41 $ 0.050
September 30 1.40 1.44 0.085
October 31 1.45 1.45 0.100

Vino Veritas Company has an incremental borrowing rate of 12 percent (1 percent per month) and closes the books and prepares financial statements at September 30.

a. Assume that the wine arrived on September 15, and the company made payment on October 31. There was no attempt to hedge the exposure to foreign exchange risk. Prepare journal entries to account for this import purchase.

1 Record purchase of wine from french supplier.
2 Record the entry for changes in the exchange rate.
3 Record the entry for changes in the exchange rate.
4 Record purchase of foreign currency.
5 Record payment made to french supplier.

b. Assume that the wine arrived on September 15, and the company made payment on October 31. On September 15, Vino Veritas entered into a 45-day forward contract to purchase 459,000 euros. It properly designated the forward contract as a fair value hedge of a foreign currency payable.

1 Record purchase of wine from french supplier.
2 Record entry for the forward contract entered into.
3 Record the entry for changes in the exchange rate.
4 Record gain or loss on forward contract.
5 Record the entry for changes in the exchange rate.
6 Record gain or loss on forward contract.
7 Record purchase of foreign currency.
8 Record payment made to french supplier.


c.Vino Veritas ordered the wine on September 15. The wine arrived and the company paid for it on October 31. On September 15, Vino Veritas entered into a 45-day forward contract to purchase 459,000 euros. The company properly designated the forward contract as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the forward rate. Prepare journal entries to account for the foreign currency forward contract, firm commitment, and import purchase.b. Assume that the wine arrived on September 15, and the company made payment on October 31. On September 15, Vino Veritas entered into a 45-day forward contract to purchase 459,000 euros. It properly designated the forward contract as a fair value hedge of a foreign currency payable. Prepare journal entries to account for the import purchase and foreign currency forward contract.

1 Record entry placed for purchase of wine.
2 Record entry for the forward contract entered into.
3 Record gain or loss on forward contract.
4 Record gain or loss on firm commitment.
5 Record gain or loss on forward contract.
6 Record gain or loss on firm commitment.
7 Record gain or loss on firm commitment.
8 Record the receipt of goods and payment made.
9 Record entry to close the firm commitment.

d. The wine arrived on September 15, and the company made payment on October 31. On September 15, Vino Veritas purchased a 45-day call option for 459,000 euros. It properly designated the option as a cash flow hedge of a foreign currency payable. Prepare journal entries to account for the import purchase and foreign currency option.

1 Record purchase of wine from french supplier.
2 Record purchase of foreign currency option as an asset.
3 Record the entry for changes in the exchange rate.
4 Record entry to adjust the fair value of the option.
5 Record the gain or loss on the option.
6 Record option expense.
7 Record the entry for changes in the exchange rate.
8 Record entry to adjust the fair value of the option.
9 Record the gain or loss on the option.
10 Record option expense.
11 Record settlement of forward contract.
12 Record payment made to foreign supplier.

e. The company ordered the wine on September 15. It arrived on October 31, and the company made payment on that date. On September 15, Vino Veritas purchased a 45-day call option for 459,000 euros. It properly designated the option as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the spot rate. Prepare journal entries to account for the foreign currency option, firm commitment, and import purchase.

1 Record purchase of foreign currency option as an asset.
2 Record gain or loss on foreign currency option.
3 Record gain or loss on firm commitment.
4 Record gain or loss on foreign currency option.
5 Record gain or loss on firm commitment.
6 Record settlement of forward contract.
7 Record the receipt of goods and payment made.
8 Record entry to close the firm commitment.

Solutions

Expert Solution

b)

Date

General Journal

Debit

Credit

09/15

Inventory

437,500

Accounts payable (euro)

437,500

(To record purchase of goods on account using the spot rate on September 15, 2015)

Note: The accounts payable for the inventory purchase is recorded using the spot rate on the transaction date (on September 15, 2015)

09/15

No journal entry required

09/30

Foreign exchange loss

17,500

Accounts payable (euro)

17,500

(To record a loss on the liability denominated in foreign currency

Current value of accounts payable (350,000 euros x $1.30) = $455,000

Less: Recorded value of accounts payable   =   $437,500

Adjustment needed to accounts payable $17,500

or [350,000 euros x ($1.30 - $1.25)] = $17,500

Note: On September 30, 2015, the spot rate increases from $1.25 to $1.30 resulting in an increase of $17,500 to accounts payable. The spot rate is used for accounts payable since that is the amount needed to settle the liability.

09/30

Forward contract

10,500

Gain on forward contract

10,500

(To record a gain on foreign currency to be received from exchange dealer [350,000 euros x ($1.34 - $1.31) = $10,500])

Note: The value of the forward contract is determined using the change in the forward rates. The forward rate increased to $1.34 from $1.31. This results in an increase of $10,500 to the receivable from the exchange dealer. Note that the payable to the foreign exchange dealer is fixed by the forward contract at $458,500 (350,000 euros x $ 1.31). Thus the forward contract has a positive $10,500 (350,000 euros x ( $ 1.34 - $ 1.31)).value at this point (Sep 30).

10/31

Foreign exchange loss

17,500

Accounts payable (euro)

17,500

To record a loss from Sep 30, 2015 to Oct 31, 2015 on liability denominated in foreign currency. The current value of the payable $472,500, (350,000 euros x $1.35) less the recorded value of the payable on Sep 30 of $455,000 is $17,500.

Note: the spot rate increases to $1.35 from $1.30 resulting in an increase in accounts payable of $17,000, (($1.35-$1.30) x 350,000)

10/31

Forward contract

3,500

Gain on forward contract

3,500

To record a gain from Sep 30 to Oct 31 on foreign currency to be received from exchange dealer [(350,000 euros x ($1.35 - $ 1.34) = $3,500].

Note: On the settlement date, the forward rate on this date and the spot rate are identical, the change in the Oct 31 forward rate on December 31 to the spot rate on March 1, 2003 is $.01, or ($1.34 to $1.35)

10/31

Foreign currency (euro)

472,500

Cash

458,500

Forward contract

14,000

To record payment to exchange dealer and receipt of 350,000 euros (350,000 euros x $1.35 = $472,500).

10/31

Accounts payable (euro)

472,500

Foreign currency (euro)

472,500

To record payment of liability upon transfer of 350,000 euros.

c)

Date

General Journal

Debit

Credit

09/15

No journal entry required

ü

(There would be a memorandum entry made on September 15, 2015 documenting the existence of the hedging relationship. The financial records of Vino Veritas would not otherwise be impacted as of this date because the foreign currency forward contract was at market rates)

09/15

No journal entry required

09/30

Forward contract

10,500

Gain on forward contract

10,500

(To record gain on foreign currency to be delivered to exchange dealer using the change in forward rates (350,000 euros x ($1.34-1.31)).

09/30

Loss on firm comittment

10,500

Firm commitment

10,500

(To record loss on firm commitment using the change

                using the change in the forward rate)

10/31

Forward contract

3,500

Gain on forward contract

3,500

10/31

Loss on firm comittment

3,500

Firm commitment

3,500

  (To record loss on firm commitment using the change

                using the change in the forward rate)

10/31

Foreign currency (euro)

472,500

Cash

458,500

Forward contract

14,000

(to record payment)

10/31

Firm commitment

472,500

Adjustment to net income

472,500

(To record cost of equipment sold.)


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