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 $0.72 per mark, paying a premium of $0.002 per unit, when the spot rate is $0.72. The spot rate increases to $0.724 at December 31, 2017, causing the fair value of the option to increase to $6,500. By March 15, 2018, when the raw materials are purchased, the spot rate has climbed to $0.74, 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.

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

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

Answer 1

	Date	Account Titles and explanation	Debit	Credit
	Dec 15, 2017	Option to purchase marks	$            2,600		(1300000*0.002)
		Cash		$        2,600
		(To record purchase of a call option)
	Dec31, 2017	Option to purchase marks	$            3,900		(6500-2600)
		Foreign exchange gain-other comprehensive income(balance sheet equity)		$        3,900
		(To record gain on the change in option value)
	March 15, 2018	Option to purchase marks	$          19,500		(26000-6500)
		Foreign exchange gain-other comprehensive income(balance sheet equity)		$     19,500
		(To record gain on the change in option value)
	March 15, 2018	Foreign exchange gain-other comprehensive income	$          23,400		(3900+19500)
		Revenue		$     23,400
		(To revlassify total exchange gains into earnings)
	B	Overall impact on net income in two periods
		In 2017 , there is no change in net income
		In 2018, Foreign exchange gain	$23,400
		Net income	$23,400
	C	Net Cash Flow:
		Cost of materials=1300000*0.74	$        962,000
		Less:Net gain from hedging	$23,400
		Net Cash Flow:	$        938,600