Question

It is important for you to demonstrate your understanding of the accounting rules and resulting journal entries that surround these concepts, as especially for multinational corporations, each must determine on an almost a daily basis the impact on their financial statements of these types of foreign currency-related transactions. Create your own specific and detailed example of either one of these types of foreign exchange options from the beginning of the use of an option to the end of the use or the settlement of the option. Show the journal entries required at each respective date, including an explanation of the basis of each of your journal entry calculations and the authoritative support for each entry following the US GAAP.

 

 

Answer 1

DQ - Week Five - Foreign Exchange Options Readings

A foreign exchange hedge is basically a transaction that is implemented with a goal of protecting an anticipated or existing position from unwanted fluctuations in the exchange rates. Businesses, traders, and investors make use of foreign exchange hedge to minimize risks that come alongside with adverse fluctuations in foreign exchange. By using a hedge properly, an entity that expects to be in a future transaction can be insulated or protected from a downward risk. The two major hedges include options and forward contracts. Options set an exchange rate at which an entity may decide to exchange its currencies. In case the current exchange rate is favorable, then an entity can exercise the option. Options are divided into two, i.e., put option and call option. Below I have provided an example of a call option that is intended to hedge an uncertain cash flow alongside with the associated journal entries:

 

On 1stJune 2019, Kentex Cargo, a U.S based company entered into a forward contract to purchase CHF65,200 from Roche, a Switzerland based company. The exchange rate between USD and CHF as at 1stJune 2019 was 0.018 at a cost of 25 per USD. After 2 months, i.e., on 31st August 2019, the exchange rate hiked to 0.416 but the cost remained constant. Provide journal entries in line with the U.S GAAP if the call option was a cash flow hedge.

 

June 1, 2019

Premium expense $28,125

Cash $28,125

($.018 * CHF 62,500 * 25)

 

August 31, 2019

Cash $40,625

Comprehensive income $40,625

{($.416 - $.39) * CHF62,500 * 25}

According to the U.S GAAP, gains or losses on a hedging instrument under cash flow hedge should be disclosed both in the cash flow statement and the comprehensive income statement. Gains/losses should be further categorized into earnings within the period the actual sale took place. This is enumerated in the example above.

{($.416 - $.39) * CHF62,500 * 25}