Question

ALEXANDER Inc. CASE:

On December 1, Y1, Alexander Inc., a US based importer of olive oil placed an order for 500 cases of olive oil at a price of 100 Euros per case. The pertinent exchange rates are given below.

DATE              SPOT              FORWAR RATE                         CALL OPTION PREMIUM FOR

                        RATE           (to January 31, Y2)                        1/31/Y2 (Strike price of $1)

12/1/Y1           $1.00                       $1.08                                                       $0.04

12/31/Y2         $1.12                       $1.20                                                       $0.12

1/31/Y2           $1.15                       $1.15                                                       $0.15

Alexander Inc. has effective borrowing rate of 12% (1% per month). The company’s fiscal year ends on December 31. Present value factor at 1% per month is 0.9901.

1. The olive oil was received on December 1, Y1 and payment was made on January 31, Y2. On December 31, Y1, Alexander Inc. purchased a two-month call option for 50,000 Euros. The option was properly designated as a cash flow hedge of a foreign currency payable. Prepare journal entries to account for the import purchase and foreign currency option.

2. The olive oil was ordered on December 1, Y1. It was received and paid for on December 31, Y2. On December 1, Y1, Alexander Inc. purchased a two-month call option for 50,000 Euros. The option was properly designated as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured through reference to change in the spot rate. Prepare journal entries to account for foreign currency option, firm commitment, and import purchase.

Answer 1

1th Scenario:Options Hedging (Fair Value)

Journal entries in the books of Alexander Inc.
Date	Particular	LF	Amount ($)	Amount ($)
01-Dec	Purchases A/c                                                 dr.		50,000
	To Account Payable A/c [500 x (100*1)]			50,000
	(Being Olive oil purchased on credit)
31-Jan	Premium Expenses A/c Dr. (50000*.04)		2,000
	To Bank A/c			2,000
	( Being premium paid on purchase of call)
31-Dec	Foreign Currency Transaction Loss A/c      dr.		6,000
	To Account Payable A/c [500 x (100*(1.12-1))]			6,000
	(Being loss adjusted in the year end)
31-Jan	Foreign Currency Transaction Loss A/c     dr. [500 x (100*(1.15-1.12))]		1,500
	Accounts Payable A/c                                   dr.		56,000
	To Bank A/c			57,500
	(Being payment done in full)
31-Jan	Premium Expenses A/c Dr. [50000*(0.15-0.04)]		5,500
	To Bank A/c			5,500
	( Being premium paid on purchase of call)
31-Jan	Bank A/c    dr.                 [500 x (100*1)]		50,000
	Call Option Asset A/c

3rd Scenario: Options Hedging (Fair Value with year end Adjustments)

Journal entries in the books of Alexander Inc.
Date	Particular	LF	Amount ($)	Amount ($)
01-Dec	Asset Receivable A/c [500 x (100*1)]                    dr.		50,000
	Premium on options Contract A/c            dr.    [500*100(1.08-1.00)]		4,000
	To Account Payable A/c			54,000
	(Being entry for option purchase of olive oil and forward contract purchased)
31-Dec	Premium on options Contract A/c     dr. [500*100*(1.2-1.08)*0.9901]		5,941
	Profit on options Contract A/c			5,941
	(Being year end Adjustments made)
31-Jan	Purchases A/c        dr. [500 x (100*1.15)]		57,500
	Accounts Payable A/c     dr.		54,000
	Profit on options Contract A/c   [500*100*(1.15-1.08)]			3,500
	Asset Receivable A/c			50,000
	Premium on options Contract A/c			4,000
	Bank A/c   [500 x (100*1.08)]			54,000
	(Being Trade and options Contract settled)

please appreciate the work