Question

Minto Ltd. imports specialty area rugs from Peru. The rugs must be ordered several months in advance as they are made to order. On November 1, 2012, Minto ordered a shipment of rugs (a firm commitment). The shipment is set to arrive on March 1, 2013, and a payment of 300,000 Peruvian Nuevo Sol (PEN) will be made on that day. On November 1, 2012, Minto entered into a forward contract with a bank to hedge the commitment. Minto agreed to buy 300,000 PEN on March 1, 2013 in exchange for Canadian dollars (CAD) at a rate of 1 PEN = 0.373 CAD. On March 1, 2013, Minto settled the forward contract, took delivery of the rugs, and paid for the rugs. Minto has designated this as a cash flow hedge and it fully qualifies for cash flow hedge accounting. Minto’s year end is December 31, 2012.

Exchange rates are as follows: Spot Rates     Forward Rates

November 1, 2012   1 PEN = 0.367 CAD 1 PEN = 0.373 CAD

December 31, 2012 1 PEN = 0.375 CAD   1 PEN = 0.385 CAD

March 1, 2013 1 PEN = 0.388 CAD 1 PEN = 0.388 CAD

Required Prepare the journal entries from November 1, 2012 to March 1, 2013 for the events described above. Explain the allocation of the premium or discount. Use the net method.

Answer 1

We need to pay the premium of CAD 900 & CAD 3600 in this contract whereas we receive the gain of CAD 4500 from the forward contract by doing hedging we finally settle the transaction at CAD 111,900.

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