Question

Amaretta Company (a U.S.-based company) ordered merchandise from a foreign supplier on November 20 at a price of 1,070,000 rupees when the spot rate was $0.050 per rupee. Delivery and payment were scheduled for December 20. On November 20, Amaretta acquired a call option on 1,070,000 rupees at a strike price of $0.050, paying a premium of $0.001 per rupee. The company designates 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. The option’s time value is excluded from the assessment of hedge effectiveness, and the change in time value is recognized in net income. The merchandise arrives, and Amaretta makes payment according to schedule. Amaretta sells the merchandise by December 31, when it closes its books.

1. Assuming a spot rate of $0.053 per rupee on December 20, prepare all journal entries to account for the foreign currency option, foreign currency firm commitment, and purchase of inventory.

2. Assuming a spot rate of $0.048 per rupee on December 20, prepare all journal entries to account for the foreign currency option, foreign currency firm commitment, and purchase of inventory.

Answer 1

Solution:

Assuming the spot rate is $0.053 on 20th December:

Workings:

Total Amount payable for purchase order of inventory at a strike price of $0.050 per Rupee

Rupees 1,070.000 X $0.050= $53,500

Total Amount payable at the time of delivery of inventory at a strike price of $0.053 per Rupee

Rupees 1,070.000 X $0.053= $56,710

Hence, Profit/(Loss) on Forward Contract = $53500 - $56710= ($3,210)

Premium paid on Call Option = Rupees 1070000 X $0.001 per Rupee

= $1,070

AMRETTA COMPANY

Journal Entries for Forex options/Forward Contract Transactions

Date	Particulars	Debit $	Credit $
Nov-19	Purchases                                                                 Dr.	53500
	To Creditors		53500
	Being purchase ordered at spot rate $.0.050 per rupee
Nov-19	Forex Option                                                           Dr.	1070
	To Bank A/c		1070
	Being premium paid at $0.001 per rupee at a strike price of $0.050
Dec-19	Loss on Firm Commitment                                   Dr.	3210
	To Firm Commitment		3210
	Being change of spot rate lead to loss on firm commitment hence loss booked
Dec-19	Creditors A/c                                                          Dr.	53500
	Firm Commitment A/c                                          Dr.	3210
	To Bank A/c		56710
	Being the material delivered and payment settled

Assuming the Spot Rate is $0.048 on 20th December:

Workings:

Total Amount payable for purchase order of inventory at a strike price of $0.050 per Rupee

Rupees 1,070.000 X $0.050= $53,500

Total Amount payable at the time of delivery of inventory at a strike price of $0.048 per Rupee

Rupees 1,070.000 X $0.048= $51,360

Hence, Profit/(Loss) on Forward Contract = $53500 - $51,360= $2,140

Premium paid on Call Option = Rupees 1070000 X $0.001 per Rupee

= $1,070

AMRETTA COMPANY

Journal Entries for Forex options/Forward Contract Transactions

Date	Particulars	Debit $	Credit $
Nov-19	Purchases                                                                 Dr.	53500
	To Creditors		53500
	Being purchase ordered at spot rate $.0.050 per rupee
Nov-19	Forex Option                                                           Dr.	1070
	To Bank A/c		1070
	Being premium paid at $0.001 per rupee at a strike price of $0.050
Dec-19	Forward Contract A/c                                           Dr.	2140
	To Gain on Forward Contract A/c		2140
	Being change of spot rate lead to gain on firm commitment hence Gain booked
Dec-19	Creditors A/c                                                          Dr.	53500
	To Bank A/c		51360
	To Forward Contract A/c		2140
	Being the material delivered and payment settled