Question

Palmer Company purchases materials from a foreign supplier on December 1, 2017, with payment of 12,000 FCUs to be made on March 1, 2018. On December 1, 2017, Palmer enters into a forward contract to purchase 12,000 FCUs on March 1, 2018. Relevant exchange rates for the FC on various dates are as follows:

                                     Date     Spot Rate    Forward Rate (to march 1,2018)

                            Dec 1, 2017     $2.70                          $2,775

                           Dec 31, 2017     $2.80                         $2,900

                           March 1,2018    $2.95                           N/A

Palmer’s incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent (1 percent per month) is 0.9803. Palmer must close its books and prepare financial statements at December 31.

1.Assume that Palmer designates the forward contract as a fair value hedge of a foreign currency payable,

Required:

 a)Prepare journal entries for these transactions in U.S. dollars.

b) What is the impact on 2017 net income?

 c)What is the impact on 2018 net income?

 d)What is the impact on net income over the two accounting periods?

Answer 1

Fair Value Hedge
Date	Accounts	Debit	Credit
Dec. 1 2015	Accounts Receivable (K) (12,000 x $2.70]	$32,400
	Sales		$32,400
	No Entry Forward contract
Dec. 31 2015	Accounts Receivable (K)	$1,200
	Foreign Exchange Gain (12000 x ($2.80 -$2.70)		$1,200
	Accumulated Other Comprehensive Income (AOCI)	$1,470.45
	Forward Contract		$1,470.45
	(12000 x (2.900-2.775) = 1500 x .9803
Mar. 1 2016	Accounts Receivable (K)	$1,800
	Foreign Exchange Gain (12000 x ($2.95 -$2.80)		$1,800
	Loss on Forward Contract	$629.55
	Forward Contract		$629.55
	(12000 x (2.95-2.775) = 2100 -1470.45
	Foreign Currency (K) (12,000 x $2.95]	$35,400
	Accounts Receivable (K)		$35,400
	Cash (12000 x 2.775)	$33,300
	Forward Contract	$2,100
	Foreign Currency (K)		$35,400
2)
Impact on 2017 net income
Sales	$32,400
Foreign Exchange Gain	$1,200
Loss on Forward Contract	-1470.45
Total	$32,129.55
3)
Impact on 2018 net income
Sales	$1,800
Loss on Forward Contract	-629.55
Total	$1,170.45
4)
Impact on net income over the two accounting period = $32,129.55+$1170.45	$33,300