Question

Based on past experience, Leickner Company expects to purchase raw materials from a foreign supplier at a cost of 1,300,000 marks on March 15, 2018. To hedge this forecasted transaction, the company acquires a three-month call option to purchase 1,300,000 marks on December 15, 2017. Leickner selects a strike price of $0.83 per mark, paying a premium of $0.002 per unit, when the spot rate is $0.83. The spot rate increases to $0.833 at December 31, 2017, causing the fair value of the option to increase to $6,000. By March 15, 2018, when the raw materials are purchased, the spot rate has climbed to $0.85, resulting in a fair value for the option of $26,000.

a.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.

1.Record purchase of foreign currency option as an asset.

2.Record entry for order placed with foreign supplier.

3.Record the entry to recognize the increase in the value of the foreign currency option.

4.Record entry to recognize the decrease in the time value of the option as an expense

5.Record the entry to recognize the increase in the value of the foreign currency option.

6.Record gain or loss on the foreign currency option.

7.Record the sale.

8.Record the receipt of marks.

9.Record entry to transfer the amount accumulated in AOCI.

b.What is the overall impact on net income over the two accounting periods (2017 & 2018)?

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

Answer 1

Given:

(a) Journal entries:

(b) Impact on net income:

(c) Net cash flow:

Net cash flow is $1,081,600 ($2,600 + $1,079,000)