Question

On June 1, Maxwell Corporation (a U.S.-based company) sold goods to a foreign customer at a price of 1,140,000 pesos and will receive payment in three months on September 1. On June 1, Maxwell acquired an option to sell 1,140,000 pesos in three months at a strike price of $0.080. The time value of the option is excluded from the assessment of hedge effectiveness, and the change in time value is recognized in net income over the life of the option. Relevant exchange rates and option premia for the peso are as follows:

Date	Spot Rate			Put Option Premium for September 1 (strike price $0.080)
June 1	$	0.080		$	0.0043
June 30		0.079			0.0031
September 1		0.078			N/A

Maxwell must close its books and prepare its second-quarter financial statements on June 30.

1. a-1. Assuming that Maxwell designates the foreign currency option as a cash flow hedge of a foreign currency receivable, prepare journal entries for the export sale and related hedge in U.S. dollars.

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

3. b-1. Assuming that Maxwell designates the foreign currency option as a fair value hedge of a foreign currency receivable, prepare journal entries for the export sale and related hedge in U.S. dollars.

4. b-2. What is the impact on net income over the two accounting periods?

Answer 1

JOURNAL ENTRIES :

Date	Particular	L.f	Debit	Credit
June 1	purchase a/c ( $11,40,000 * 0.080) To supplier a/c (Being purchase goods from supplier)		$91,200	$91,200
June 1	Forward francs receivable a/c Dr To forward dollar payable ( being forward francs receivable )		$91,200	$91,200
June 1	Option premium a/c (11,40,000*0.0043) Dr To bank (Being option premium paid )		$4,902	$4,902
June 30	Forward francs receivable a/c Dr To gain on currency options (11,40,000x(0.08-0.079)) ( Being gain on currency option)		$1,140	$1,140
June 30	Loss on foreign exchange a/c Dr To supplier a/c ( Being loss on foreign exchange )		$1,140	$1,140

a-2 Impact on Net Income:

Option premium $ 4,902

Gain currency option $ 1,140

Loss on foreign exchange $ 1,140

Net impact on income $ 7,182

b-1 Journal entries

Date	particular	L.F	Debit	Credit
sep 1	Forward dollar payable a/c Dr Loss on currency option Dr   To Forward francs receivable a/c (Being forward receivable )		$91,200 $4,902	$96,102
sep 1	Supplier a/c Dr To bank To gain on foregin exchange (being supplier a/c)		$96,102	$91,200 $4,902

b-2 Impact on Net Income:

Loss on currency option $4,902

Gain on foreign exchange $4,902

Net impact on income $ 0

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