Question

On November 1, 20X6, Smith Imports Inc. contracted to purchase teacups from England for £50,000. The teacups were to be delivered on January 30, 20X7, with payment due on March 1, 20X7. On November 1, 20X6, Smith entered into a 120-day forward contract to receive 50,000 pounds at a forward rate of £1 = $1.55. The forward contract was acquired to hedge the financial component of the foreign currency commitment. Additional Information for the Exchange Rate Assume the company uses the forward rate in measuring the forward exchange contract and for measuring hedge effectiveness. Spot and exchange rates follow: Date Spot Rate Forward Rate for March 1, 20X7 November 1, 20X6 £1 = $ 1.60 £1 = $ 1.55 December 31, 20X6 £1 = 1.63 £1 = 1.60 January 30, 20X7 £1 = 1.55 £1 = 1.56 March 1, 20X7 £1 = 1.545 Required: b. Prepare all journal entries from November 1, 20X6, through March 1, 20X7, for the purchase of the teacups, the forward exchange contract, and the foreign currency transaction. Assume Smith’s fiscal year ends on December 31, 20X6. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.) c. Assume that interest is significant and the time value of money is considered in valuing the forward contract and hedged commitment. Use a 12 percent annual interest rate. Prepare all journal entries from November 1, 20X6, through March 1, 20X7, for the purchase of the teacups, the forward exchange contract, and the foreign currency transaction. Assume Smith’s fiscal year ends on December 31, 20X7. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Do not round intermediate calculations.)

Answer 1

The above Question completely based on Foreign Exchange Currency Movement , Forward contract , Hedging principle to cover forward currency movement . Different date ( transaction date) wise movement , spot as well as Forward rate . Forward Exchange receivable , payable, Dollar Payable , receivable ,Firm Commitment , settlement of transaction , Calculate of NPV ( discount factor 14%)

		GBP
01-11-2006	smith wants to Import	50,000
30-01-2007	Delivery date
1-03-2007	Payment due date
01-11-2006	Entered on Forward contract (120 days)to arrest Future price challenge
	forward rate
	I GBP	$1.55

Smith in the month of Nov, entered into 120 days contract ( forward to hedge Future pricing ) . Forward rate has been mentioned

Hedging arrangement			Forward Rate
	Spot Rate
Nov'06	1 GBP	$1.6	1 GBP	$1.55
Dec'06	1 GBP	$1.63	1 GBP	$1.60
Jan'07	1 GBP	$1.55	1 GBP	$1.56
March'07	1 GBP	$1.545

Date wise Spot and forward rate given in the Question

	Journal Entries
Nov'06		Debit ( GBP)	Crebit ( GBP)
( Entered into Forwards Contract
	Foreign Currency Receivable	77,500.00
	Payable to Dollar		77,500.00
	('GBP50000*$/GBP1.55)
Dec'06
( Transaction cost)
Change in Exchange rate
Forward gain - Firm Commitment loss	Foreign Currency Receivable	2,500.00
	Foreign Currency Gain		2,500.00
	('GBP50000*$/GBP1.60-$/gbp1.55)
Record the loss	Foreign Currency Loss	2,500.00
in Financial Transaction	Firm Commitment		2,500.00
Jan'07	Foreign Currency Loss	2,000.00
Forward loss = Firm Commitment gain	Foreign Currency Receivable		2,000.00
	('GBP50000*$/GBP1.60-$/gbp1.56)
Record Gain in Financial Transaction	Firm Commitment	2,000.00
	Foreign Currency Gain		2,000.00
Spot rate Transaction
	Inventory	77,000.00
Net of Gain- Loss	Firm Commitment	500.00
	Account Payable		77,500.00
	('GBP50000*$/GBP1.55)
Mach'07	Foreign Currency Loss	750.00
	Foreign Currency Receivable		750.00
	('GBP50000*$/GBP1.56-$/gbp1.545)
Mach'07	Accounts Payable	250.00
	Foreign Currency Gain		250.00
	('GBP50000*$/GBP1.55-$/gbp1.545)
	Dollar Payable	77,500.00
	Cash		77,500.00
	( Payable as per Forward contract rate
	('GBP50000*$/GBP1.545)
	Change in Foreign Currency	77,250.00
	Foreign Currency Receivable		77,250.00
	Transaction at Spot rate as on 1 March
	('GBP50000*$/GBP1.55)
	Acount Payable	77,250.00
	Change in Foreign Currency		77,250.00
	( Settlement of Foreign Currency Payable )

	Journal Entries	Discount Factor application
Nov'06		Debit ( GBP)	Crebit ( GBP)	Calculation Base
( Entered into Forwards Contract
	Foreign Currency Receivable	77,500
	Payable to Dollar		77,500
	('GBP50000*$/GBP1.55)
Dec'06
( Transaction cost)
Change in Exchange rate
	Foreign Currency Receivable	1,924
	Foreign Currency Gain		1,924
	('GBP50000*$/GBP1.60-$/gbp1.55)			NPV(14%,2/12,2500)
Record the loss	Foreign Currency Loss	1,924
in Financial Transaction	Firm Commitment		1,924
Jan'07	Foreign Currency Loss	1,886		gbp 38 adjusted with earlier Loss GBP 1924
	Foreign Currency Receivable		1,886	( As above)
	('GBP50000*$/GBP1.60-$/gbp1.56)			Change in Forward rate
				('1.55- 1.56)*5000 GBP= GBP 50
Record Gain in Financial Transaction	Firm Commitment	1,886		NPV(14%,2/12,2500)=GBP38
	Foreign Currency Gain		1,886
Spot rate Transaction
	Inventory	77,462
	Firm Commitment	38
	Account Payable		77,500
	('GBP50000*$/GBP1.55)
Mach'07	Foreign Currency Loss	712
	Foreign Currency Receivable		712	( Previously recogmised Loss in terms of Firm commitment ,
	('GBP50000*$/GBP1.56-$/gbp1.545)			adjust with loss'(750-38) GBP
Mach'07	Accounts Payable	250
	Foreign Currency Gain		250
	('GBP50000*$/GBP1.55-$/gbp1.545)
	Dollar Payable	77,500
	Cash		77,500
	( Payable as per Forward contract rate
	('GBP50000*$/GBP1.545)
	Change in Foreign Currency	77,250
	Foreign Currency Receivable		77,250
	Transaction at Spot rate as on 1 March
	('GBP50000*$/GBP1.55)
	Account Payable	77,250
	Change in Foreign Currency		77,250
	( Settlement of Foreign Currency Payable )