Question

On September 3, 2017, Robin Franchises, a U.S. company, sold merchandise to a franchisee in the U.K., at a price of £8,000,000, payable in three months in pounds. To hedge its exposed asset position, on September 3, 2017, Robin entered a forward contract for delivery of £8,000,000 to the broker on December 3, 2017. On December 3, 2017, Robin received payment from the franchisee, and delivered the pounds to the broker to close the forward contract. Robin’s accounting year ends December 31. Exchange rates ($/£) are as follows:

	Spot rate	Forward rate for delivery December 3, 2017
September 3, 2017	$1.6168	$1.6155
December 3, 2017	1.6150	----

Required

a. Prepare the journal entries Robin Franchises made on September 3, 2017 and December 3, 2017.

b. Calculate the cash gain or loss realized by Robin Franchises by hedging compared with not hedging.

Answer 1

Journal Entries
3-Sep	Foreign exchange	$10,400
	Forward Contract		$10,400
	(To record exchange difference in spot and forward rate)
3-Dec	Cash	12,920,000
	Foreign exchange	4,000
	Forward Contract	10,400
	Accounts receivable		12,934,400
	(To record settlement of transaction)

b. Cash gain or loss realized without hedging
	Exchange rate on the date of transaction=1.6168
	Exchange rate on the date of settlement=1.6150
	Exchange difference=0.0018
	loss=8000000*0.0018
	= $14,400
	Cash gain or loss with hedging
	Exchange rate on the date oof transaction=1.6168
	Exchange rate on the date of settlement=1.6150
	Exchange rate of forward contract=1.6155
	Exchange difference=0.0005 (1.6155-1.6150)
	Gain=8000000*0.0005
	= $4000