Question

Based on past experience, Leickner Company expects to purchase raw materials from a foreign supplier at a cost of 1,200,000 marks on March 15, 2018. To hedge this forecasted transaction, the company acquires a three-month call option to purchase 1,200,000 marks on December 15, 2017. Leickner selects a strike price of $0.68 per mark, paying a premium of $0.005 per unit, when the spot rate is $0.68. The spot rate increases to $0.686 at December 31, 2017, causing the fair value of the option to increase to $10,000. By March 15, 2018, 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.

Prepare all journal entries for the option hedge of a forecasted transaction and for the purchase of raw materials, assuming that December 31 is Leickner's year-end and that the raw materials are included in the cost of goods sold in 2018.

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

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

Answer 1

Part 1

No.	date	account titles and explanation	debit	credit
1.	12/15/2017	Foreign currency option	6000
		Cash (1200000*0.005)		6000
2.	12/15/2017	No journal entry required
3.	12/31/2017	Foreign currency option	4000
		Accumulated other comprehensive income (10000-6000)		4000
4.	12/31/2017	option expense	1200
		Accumulated other comprehensive income (1200000*(0.686-0.68))-6000		1200

Part 2

Impact on

Net Income

2017

Option expense (overall impact on net income over the first accounting period)....... $ (1,200)

2018

Cost of goods sold (1200000*0.70)......... (840,000)

Option expense (6000-1200)........................ (4800)

Adjustment to net income............................ 24,000

Overall impact on net income over the second accounting period............................................................ $(820,800)

overall impact on net income over the two accounting periods........................................................... $(822,000)

Part 3

Net cash outflow for parts: $585,000 = ($5,000 + $580,000)