Question

Vino Veritas Company, a U.S.-based importer of wines and spirits, placed an order with a French supplier for 1,900 cases of wine at a price of 290 euros per case. The total purchase price is 551,000 euros. Relevant exchange rates for the euro are as follows:

Date	Spot Rate			Forward Rate to October 31			Call Option Premium for October 31 (strike price $1.45)
September 15	$	1.45		$	1.51		$	0.060
September 30		1.50			1.54			0.095
October 31		1.55			1.55			0.100

Vino Veritas Company has an incremental borrowing rate of 12 percent (1 percent per month) and closes the books and prepares financial statements at September 30.

1. Assume that the wine arrived on September 15, and the company made payment on October 31. There was no attempt to hedge the exposure to foreign exchange risk. Prepare journal entries to account for this import purchase.

2. Assume that the wine arrived on September 15, and the company made payment on October 31. On September 15, Vino Veritas entered into a 45-day forward contract to purchase 551,000 euros. It properly designated the forward contract as a fair value hedge of a foreign currency payable. Prepare journal entries to account for the import purchase and foreign currency forward contract.

3. Vino Veritas ordered the wine on September 15. The wine arrived and the company paid for it on October 31. On September 15, Vino Veritas entered into a 45-day forward contract to purchase 551,000 euros. The company properly designated the forward contract as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the forward rate. Prepare journal entries to account for the foreign currency forward contract, firm commitment, and import purchase.

4. The wine arrived on September 15, and the company made payment on October 31. On September 15, Vino Veritas purchased a 45-day call option for 551,000 euros. It properly designated the option as a cash flow hedge of a foreign currency payable. Prepare journal entries to account for the import purchase and foreign currency option.

5. The company ordered the wine on September 15. It arrived on October 31, and the company made payment on that date. On September 15, Vino Veritas purchased a 45-day call option for 551,000 euros. It properly designated the option as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the spot rate. Prepare journal entries to account for the foreign currency option, firm commitment, and import purchase.

Answer 1

a. Assume that the wine arrived on September 15, and the company made payment on October 31. There was no attempt to hedge the exposure to foreign exchange risk. Prepare journal entries to account for this import purchase.

No.	Date	General Journal	Debit	Credit
1	09/15	Inventory	798,950
		Accounts Payable (euro)		798,950
2	09/30	Foreign Exchange Loss	27,550
		Accounts Payable (euro)		27,550
3	10/31	Foreign Exchange Loss	27,550
		Accounts Payable (euro)		27,550
4	10/31	Foreign Currency (euro)	854,050
		Cash		854,050
5	10/31	Accounts Payable (euro)	854,050
		Foreign Currency (euro)		854,050

Calculation

551000 * Spot rate, Forward rate and call option premium is given in table below:

Date	Spot Rate	Forward Rate	Call Option Premium	Spot Rate	Forward Rate	Call Option Premium
Sep-15	1.45	1.51	0.06	798,950	832,010	33,060
Sep-30	1.5	1.54	0.95	826,500	848,540	523,450
Oct-31	1.55	1.55	0.1	854,050	854,050	55,100

Entry #1:

Purchase of wine = 551,000 * 1.45 = 798,950

Entry #2:

Foreign Exchange Loss = (551,000 * 1.55) - (551,000 * 1.5 ) = 854,050 - 826,500 = 27,550

Entry #4:

Foreign Currency (euro) = 551,000 * 1.55 = 854,050

b.Assume that the wine arrived on September 15, and the company made payment on October 31. On September 15, Vino Veritas entered into a 45-day forward contract to purchase 551,000 euros. It properly designated the forward contract as a fair value hedge of a foreign currency payable. Prepare journal entries to account for the import purchase and foreign currency forward contract.

Answer:

No.	Date	General Journal	Debit	Credit
1	09/15	Inventory	798,950
		Accounts Payable (euro)		798,950
2	09/15	No journal entry needed
3	09/30	Foreign Exchange Loss	27,550
		Accounts Payable (euro)		27,550
4	09/30	Forward Contract	16,366
		Gain on forward contract		16,366
5	10/31	Foreign Exchange Loss	27,550
		Accounts Payable (euro)		27,550
6	10/31	Forward Contract	5,674
		Gain on forward contract		5,674
7	10/31	Foreign Currency (euro)	854,050
		Cash		832,010
		Forward Contract		22,040

8	10/31	Accounts Payable (euro)	854,050
		Foreign Currency (euro)		854,050

Calculation

		Accounts Payable		Forward Rate to 10/31	Forward Contract
Date	Spot Rate	U.S. Dollar Value	Change in U.S. Dollar Value		Fair Value	Change in Fair value
Sep-15	1.45	798,950	0	1.51	0	-
Sep-30	1.5	826,500	27,550	1.54	$16,366.34	16,366.34
Oct-31	1.55	854,050	-27,550	1.55	$22,040.00	5,673.66

n= 1
Rate = 1%=Present Value =

So, PV= 0.9901

Forward Contract Fair Value:

Sep-30 = (551,000* 1.55) - (551,000 * 1.54 ) *0.9901 = 16,366.34

Oct-31 = (551,000* 1.55) - (551,000 * 1.51 ) = 22,040

Entry #7 :

Cash = 854,050 - 22,040 = 832,010

c. Vino Veritas ordered the wine on September 15. The wine arrived and the company paid for it on October 31. On September 15, Vino Veritas entered into a 45-day forward contract to purchase 551,000 euros. The company properly designated the forward contract as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the forward rate. Prepare journal entries to account for the foreign currency forward contract, firm commitment, and import purchase.

No.	Date	General Journal	Debit	Credit
1	09/15	No journal entry needed
2	09/15	No journal entry needed
3	09/30	Forward Contract	16,366
		Gain on forward contract		16,366
4	09/30	Loss on firm commitment	16,366
		Firm commitment		16,366
5	10/31	Forward Contract	5,674
		Gain on forward contract		5,674
6	10/31	Loss on firm commitment	5,674
		Firm commitment		5,674
7	10/31	Foreign Currency (euro)	854,050
		Cash		832,010
		Forward Contract		22,040
8	10/31	Inventory	854,050
		Foreign Currency (euro)		854,050
9	10/31	Firm commitment	22,040
		Adjustment to net income		22,040

Explanation

Entry #1&2:

There is no formal entry for the forward contract or the purchase order. for the forward contract or the purchase order.

d. The wine arrived on September 15, and the company made payment on October 31. On September 15, Vino Veritas purchased a 45-day call option for 551,000 euros. It properly designated the option as a cash flow hedge of a foreign currency payable. Prepare journal entries to account for the import purchase and foreign currency option.

Answer:

No.	Date	General Journal	Debit	Credit
1	09/15	Inventory	798,950
		Accounts Payable (euro)		798,950
2	09/15	Foreign Currency Option	33,060
		Cash		33,060
3	09/30	Foreign Exchange Loss	27,550
		Accounts Payable (euro)		27,550
4	09/30	Foreign Currency Option	490,390
		Accumulated other comprehensive income		490,390
5	09/30	Accumulated other comprehensive income	27,550
		Gain on Foreign Currency Option		27,550
6	09/30	Option expense	462,840
		Accumulated other comprehensive income		462,840
7	10/31	Foreign Exchange Loss	27,550
		Accounts Payable (euro)		27,550
8	10/31	Foreign Currency Option	(468,350)
		Accumulated other comprehensive income		(468,350)
9	10/31	Accumulated other comprehensive income	27,550
		Gain on Foreign Currency Option		27,550
10	10/31	Option expense	495,900
		Accumulated other comprehensive income		495,900
11	10/31	Foreign Currency (euro)	854,050
		Cash		798,950
		Foreign Currency Option		55,100
12	10/31	Accounts Payable (euro)	854,050
		Foreign Currency (euro)		854,050

Calculation

Date	Spot Rate	Option Premium	Fair Value	Change in Fair Value	Intrinsic Value	Time Value	Change in Time Value
Sep-15	1.45	0.060	33,060		-	33,060
Sep-30	1.5	0.950	523,450	490,390	27,550	495,900	462,840
Oct-31	1.55	0.100	55,100	(468,350)	-	-	(495,900)

Entry #11 :

Cash = 854,050 - 55,100 =798,950

e. The company ordered the wine on September 15. It arrived on October 31, and the company made payment on that date. On September 15, Vino Veritas purchased a 45-day call option for 551,000 euros. It properly designated the option as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the spot rate. Prepare journal entries to account for the foreign currency option, firm commitment, and import purchase.

Answer:

No.	Date	General Journal	Debit	Credit
1	09/15	Foreign Currency Option	33,060
		Cash		33,060
2	09/15	Foreign Currency Option	490,390
		Gain on Foreign Currency Option		490,390
3	09/30	Loss on firm commitment	27,277
		Firm commitment		27,277
4	09/30	Foreign Currency Option	(468,350)
		Gain on Foreign Currency Option		(468,350)
5	09/30	Loss on firm commitment	27,823
		Firm commitment		27,823
6	09/30	Foreign Currency (euro)	854,050
		Cash		798,950
		Foreign Currency Option		55,100
7	10/31	Inventory	854,050
		Foreign Currency (euro)		854,050
8	10/31	Firm commitment	55,100
		Adjustment to net income		55,100

Calculation

Date	Spot Rate	Fair Value	Change in Fair Value	Option Premium for 10/31	Fair Value	Change in Fair value
Sep-15	1.45	0	0	0.06	33,060	-
Sep-30	1.5	$27,277.23	($27,277.23)	0.95	523,450	490,390
Oct-31	1.55	$55,100.00	($27,822.77)	0.1	55,100	(468,350)

Forward Contract Fair Value:

Sep-30 = (551,000* 1.45) - (551,000 * 1.5) *0.9901 = 27,277.23

Entry # 6:

Cash = 854,050 - 55,100 =798,950