Question

On November 10, 2018, Kane Co. sold inventory to a customer in a foreign country. Kane agreed to accept 80,000 local currency units (LCU) in full payment for this inventory. Payment was to be made on February 1, 2019. On December 1, 2018, Kane entered into a forward exchange contract wherein 80,000 LCU would be delivered to a currency broker in two months. Any contract discount or premium is amortized using the straight-line method. The spot rates and forward rates on various dates were as follows:

Date	Rate Description	Exchange Rate
November 10, 2018	Spot Rate	1 LCU = $0.34
December 1, 2018	Spot Rate	1 LCU = $0.31
	2-Month Forward Rate	1 LCU = $0.29
December 31, 2018	Spot Rate	1 LCU = $0.28
	1-Month Forward Rate	1 LCU = $0.27
February 1, 2019	Spot Rate	1 LCU = $0.26

The company's borrowing rate is 12%. The present value factor for one month is .9901.

Required:

A. Assume this hedge is designated as a cash flow hedge. Prepare the journal entries relating to the transaction and the forward contract.

B. Assume this hedge is designated as a fair value hedge. Prepare the journal entries relating to the forward contract.

C. What are the differences between a foreign currency forward contract and a foreign currency option? Consider contractual terms and accounting requirements in your response.

Answer 1

Part A

Date	Account titles and explanation	Debit	Credit
11/10/18	Accounts receivable (80000*0.34)	272000
	Sales		272000
12/01/18	No entry
12/31/18	Foreign Exchange Loss (80000*(0.34-0.31)*2)	4800
	Accounts receivable		4800
	AOCI	4800
	Gain on Forward Contract		4800
	Forward Contract (80000*(0.29-0.27)*0.9901)	1584
	AOCI		1584
	Discount expense (1-(((80000*0.29)/(80000*0.31))^0.5))*(80000*0.31)	813
	AOCI		813
02/01/19	Foreign Exchange Loss (80000*(0.28-0.26))	1600
	Accounts receivable		1600
	AOCI	1600
	Gain on Forward Contract		1600
	Forward contract (80000*(0.29-0.26))-1584	816
	AOCI		816
	Discount expense (80000*(0.31-0.29))-813	787
	AOCI		787
	Foreign currency (80000*0.26)	20800
	Accounts receivable		20800
	Cash (80000*0.29)	23200
	Forward contract		2400
	Foreign currency		20800

Part B

Date	Account titles and explanation	Debit	Credit
11/10/18	Accounts receivable (80000*0.34)	272000
	Sales		272000
12/01/18	No entry
12/31/18	Foreign Exchange Loss (80000*(0.34-0.31)*2)	4800
	Accounts receivable		4800
	Forward Contract (80000*(0.29-0.27)*0.9901)	1584
	Gain on Forward Contract		1584
02/01/19	Foreign Exchange Loss	1584
	Accounts receivable		1584
	Forward contract (80000*(0.28-0.26))	1600
	Gain on Forward Contract		1600
	Forward contract (80000*(0.29-0.26))-1584	816
	AOCI		816
	Foreign currency (80000*0.26)	20800
	Accounts receivable		20800
	Cash (80000*0.29)	23200
	Forward contract		2400
	Foreign currency		20800

Part C

Foreign currency forward contract is considered to be an agreement whereby both parties to contract have contract obligation either to buy or sell spot rate foreign currency at fixed future date and at a fixed exchange rate.

Foreign currency option contract is considered to be an agreement whereby parties do not have obligation but have rights to buy or sell spot rate foreign currency at fixed future date and at a fixed exchange rate.