Question

34. On 1 November 2019 Pippen Ltd contacts Jordan Inc to enquire about US$20m worth of machinery that Jordan Inc is manufacturing. By the 30 November the two companies have agreed sale terms after making extensive enquiries, including those on finance terms, exchange rates and forward rates. The eventual sale is concluded on 1 December 2019, whereby Jordan Inc of the USA sells machinery to Pippen Ltd of Portugal for the payment amount of €20m to be made on 1 March 2020.

On the sale date of 1 December, Jordan Inc also enters into a forward contract with its bank to sell €20m in exchange for US Dollars on 1 March 2020.

The relevant spot and forward exchange rates for the Euro/US$ on the various dates are as follows:

1-Dec-19: Spot €1=US$1 & Forward Rate to 1-Mar-20 €1=US$1.04

31-Dec-19: Spot €1=US$1.05 & Forward Rate to 1-Mar-20 €1=US$1.10

1-Mar-20: Spot €1=US$1.12

Jordan Inc’s incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent (1 percent per month) is 0.9803.

Assume that the forward contract discount or premium is allocated on a straight-line basis.

1. How many US$ does Jordan Inc expect to receive under the Forward Contract on 1 March 2020? [2 marks]

2. Assuming that Jordan Inc designates the forward contract as a cash flow hedge of a foreign currency receivable, provide the journal entries for these transactions in US$ on each of the dates (1-Dec-19, 31-Dec-19 (year-end) and 1-Mar-20). [6 marks]

3. Show the impact on Net Income for these transactions in 2019 and 2020 under Cash Flow Hedge accounting. [4 marks]

4. Now assume that Jordan Inc designates the forward contract as a fair value hedge of a foreign currency receivable. In this case, prepare the journal entries for these transactions in US$ on each of the dates (1-Dec-19, 31-Dec-19 (year-end) and 1-Mar-20). [6 marks]

5. Show the impact on Net Income for these transactions in 2019 and 2020 under Fair Value Hedge accounting. [4 marks]

Answer 1

Solution (a)

On the sale date of 1 December, Jordan Inc enters into a forward contract with its bank to sell €20m in exchange for US Dollars on 1 March 2020. Thus, Jordan Inc. entered into the contract using Forward Rate to 1-Mar-20, i.e. €1=US$1.04

Jordan Inc expect to receive under the Forward Contract on 1 March 2020

                 = € 20m*US$1.04 = US$20.8

Solution (b)

Journal entries for the transactions in US$ if Jordan Inc designates the forward contract as a Cash flow hedge of a foreign currency receivable on each of the dates:

                                                               In the books of Jordan Inc

                                                                        Journal Entries

                                                                                                                                                       (in US$)

Date	Particulars	Debit	Credit
2019
Dec 1	Pippen Ltd.                                                                                     DR.	20
	To Sales A/C		20
	(Being machine worth US$20m sold to Pippen Ltd. on credit basis and converted on the spot rate of €1=US$1)
31 Dec	Other comprehensive income A/C                                                  DR.	0.2
	To Forward contract (Liabiltity) A/C		0.2
	(Being spot rate at the reporting date shows the adverse movement in the cash flows due to currency fluctuation amounts to € 20m*($1.05 - $1.04).
2020
Mar 1	Cash A/C (€ 20m*US$1.04)                                                           DR.	20.8
	Forward contract (Liabiltity) A/C                                                    DR.	0.2
	To Pippen Ltd.		20
	To Profit & Loss A/C (B/F)		1
	(Being Pippen Ltd. paid € 20m and converted the same at the forward rates taken on 1 Dec 2019)
Mar 1	Profit & Loss A/C                                                                            DR.	0.2	0.2
	To Other comprehensive income A/C
	(Being balance of Other comprehensive income account related to realised gains or losses on cash flow hedges reclassified to Profit & Loss account )

Solution (c)

Impact on Net Income for these transactions in 2019 and 2020 under Cash Flow Hedge accounting.               

                                                                                                                                                            (in US$)

Particulars	2019	2020
Sales	20
Other comprehensive income	0.2	(0.2)
Profit and loss		0.8 (1-0.2)

Solution (d)

Journal entries for the transactions in US$ if Jordan Inc designates the forward contract as a fair value hedge of a foreign currency receivable on each of the dates:

                                                               In the books of Jordan Inc

                                                                        Journal Entries

                                                                                                                                                       (in US$)

Date	Particulars	Debit	Credit
2019
Dec 1	Pippen Ltd.                                                                                     DR.	20
	To Sales A/C		20
	(Being machine worth US$20m sold to Pippen Ltd. on credit basis and converted on the spot rate of €1=US$1)
Dec 31	Profit and loss A/C                                                                          DR.	0.2
	To Forward contract (Liabiltity) A/C		0.2
	(Being spot rate at the reporting date shows the adverse movement in the cash flows due to currency fluctuation amounts to € 20m*($1.05 - $1.04).
Dec 31	Pippen Ltd.                                                                                     DR.	1
	To Profit and loss A/C		1
	(Being account receivable Pippen Ltd bought on its fair value,i.e. € 20m*($1.05 - $1.00).
2020
Mar 1	Cash A/C (€ 20m*US$1.04)                                                           DR.	20.8
	Forward contract (Liabiltity) A/C                                                    DR.	0.2
	To Pippen Ltd.		21
	(Being Pippen Ltd. paid € 20m and converted the same at the forward rates taken on 1 Dec 2019)

Solution (e)

Impact on Net Income for these transactions in 2019 and 2020 under Fair Value Hedge accounting.               

                                                                                                                                                            (in US$)

Particulars	2019	2020
Sales	20	-
Profit and loss	1.02 (1+0.2)	-