Question

Hedging Exposed Asset Position with Adjusting Entries

On November 3, 2020, 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 November 3, 2020, Robin entered a forward contract for delivery of £8,000,000 to the broker on February 3, 2021. On February 3, 2021, 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 February 3, 2021
November 3, 2020	$ 1.3168	$1.3166
December 31, 2020	1.3164	1.3163
February 3, 2021	1.3162	--

a. Prepare the journal entries Robin Franchises made on November 3, 2020 and February 3, 2021, as well as the required end of year adjusting entry. (7 total entries)

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

Answer 1

Answer (a) : -   Journal Entries in books of Robin Franchises

Nov 3,2020- Foreign Debtors A/c Dr $10534400 ( Spot Rate on Nov 3- $1.3168)

To Sales A/c $10534400

( Being Sale Recorded to UK )

No Entry For entering into Forward Contract

Dec 31, 2020 -   Exchange Difference A/c Dr $ 3200 ( $1.3168-$1.3164 )* £ 8000000

To Foreign Debtors $3200

( Being Foreign Debtors revalued on Closing Date as per Accounting Standards )

Dec 31, 2020 - Forward Contract receivable A/c Dr $ 2400 (Forward Contract revalued at (1.3163-1.3166) *  £8,000,000 )

To Exchange Difference $ 2400

(Being Forward Contract revalued )

Dec 31, 2020 -    Profit & Loss A/c Dr. $800

To Exchange Difference $800

(Being Amount transferred to  Profit & Loss A/c)

Feb 3,2021 -   Bank A/c Dr $ 10529600 ( Received at Spot Rate of 1.3162 Per Pound)

Exchange Difference Dr $ 1600 ( Balancing Figure )

To Foreign Debtors $10531200 ( Balance Amount)

   ( Being Amount received by selling £8,000,000 Spot)

Feb 3,2021 - Bank A/c Dr $2400

To Forward Contract Receivable $ 2400

( Being Difference of Spot Rate & Contractual Forward Rate received)

Dec 31,2021 -    Profit & Loss A/c Dr $1600

To Exchange Difference A/c $1600

( Being Loss transferred to Profit & Loss A/c)

Answer (b) : -  Rate at which Robin Franchises sold the  £8,000,000 forward on Nov 3 2020 is = $1.3166 Per £.

Rate at which Robin Franchises has to sold the £8,000,000 spot on Feb 3,2021 if the exposure has not been taken = $1.3162

Therefore , Profit realized by hedging the risk is = (1.3166-1.3162)* £8,000,000 = $ 3200.