Question

On November 1, 2017, Bernard Company (a U.S.-based company) sold merchandise to a foreign customer for 250,000 FCUs with payment to be received on April 30, 2018. At the date of sale, Bernard entered into a six-month forward contract to sell 250,000 FCUs. The company properly designates the forward contract as a cash flow hedge of a foreign currency receivable. The following exchange rates apply: Date Spot Rate Forward Rate (to April 30, 2018) November 1, 2017 $ 0.36 $ 0.35 December 31, 2017 0.34 0.32 April 30, 2018 0.33 N/A Bernard's incremental borrowing rate is 12 percent. The present value factor for four months at an annual interest rate of 12 percent (1 percent per month) is 0.9610. Prepare all journal entries, including December 31 adjusting entries, to record the sale and forward contract. What is the impact on net income in 2017? What is the impact on net income in 2018

Answer 1

On the date of sale (November 1,2017)

Bernard Company (a U.S.-based company) sold merchandise to a foreign customer for 250,000 FCUs with payment to be received on April 30, 2018. Spot rate was USD/FCU 0.36 and it is expected t settle the account in 6 month.

Goods are sold to the customer

Account Debit Credit

Accounts receivable 90,000

Revenue   90,000

Total 90,000 90,000

To reduce its exposure to foreign exchange risk the Bernard Company enters into a 6 month foreign exchange forward contract at USD/FCU 0.35 and will therefore receive/pay the difference between this rate and the rate on the settlement date. The effect of this contract is to fix the value of the FCU 250,000 the business will receive at USD 87,500.

Balance Sheet Date (December 31, 2017)

At the balance sheet date of December 31, 2017 the exchange rate has changed. The USD/FCU spot rate is now 0.34 and the forward rate is 0.32. The business must now record the changes in fair value of the asset (in this case the accounts receivable) and the foreign exchange forward contract.

USD/FCU spot rate at the date of sale = 0.36

USD/FCU spot rate at balancesheet date = 0.34

Amount = FCU 250000

Loss = 250000* (0.36-0.34) = 5000

Journal Enry:

Account Debit Credit

Foreign Exchange 5,000

Account Receivable 5,000

Total 5,000 5,000

Effect on Foreign Exchange Forward Contract:

USD/FCU forwatd rate at the date of sale = 0.35

USD/FCU forward rate at balancesheet date = 0.32

Amount = FCU 250000

Loss = 250000* (0.35-0.32) = 7500

Journal Enry:

Account Debit Credit

Foreign Exchange     7,500

Foreign Contract 7,500

Total 7,500 7,500

The foreign exchange loss is posted to the Profit and loss statement and a forward contract asset is established representing the net amount due to the business under the contract at the balance sheet date. It should be noted that under a foreign exchange forward contract only the difference resulting from changes in exchange rates is accounted for not the principal amount.

Settlement Date April 30, 2018:

Effect on Accounts Receivable

USD/FCU spot rate at balancesheet date = 0.34

USD/FCU spot rate at settlement date = 0.33

Amount = FCU 250000

Loss = 250000* (0.34-0.33) = 2500

Journal Enry:

Account Debit Credit

Cash 82,500

Foreign Exchange 2,500

Account Receivable 85,000

Total 85,000 85,000

Effect on Foreign Exchange Forward Contract Liability

USD/FCU forwatd rate at the contract date = 0.35

USD/FCU spot rate at settlement date = 0.33

Amount = FCU 250000

Loss = 250000* (0.35-0.33) = 5000

Journal Enry:

Account Debit Credit

Foreign Exchange     5,000

Foreign Contract    5,000

Total 5,000 5,000