Question

Based on past experience, Maas Corp. (a U.S.-based company) expects to purchase raw materials from a foreign supplier at a cost of 1,200,000 francs on March 15, 2021. To hedge this forecasted transaction, on December 15, 2020, the company acquires a call option to purchase 1,200,000 francs in three months. Maas selects a strike price of $0.68 per franc when the spot rate is $0.68 and pays a premium of $0.005 per franc. The spot rate increases to $0.686 at December 31, 2020, causing the fair value of the option to increase to $10,000. By March 15, 2021, when the raw materials are purchased, the spot rate has climbed to $0.70, resulting in a fair value for the option of $24,000. The raw materials are used in assembling finished products, which are sold by December 31, 2021, when Maas prepares its annual financial statements.

1. Prepare all journal entries for the option hedge of a forecasted transaction and for the purchase of raw materials.

2. What is the overall impact on net income over the two accounting periods?

3. What is the net cash outflow to acquire the raw materials?

Answer 1