Question

Based on past experience, Leickner Company expects to purchase raw materials from a foreign supplier at a cost of 1,900,000 marks on March 15, 2018. To hedge this forecasted transaction, the company acquires a three-month call option to purchase 1,900,000 marks on December 15, 2017. Leickner selects a strike price of $0.78 per mark, paying a premium of $0.002 per unit, when the spot rate is $0.78. The spot rate increases to $0.787 at December 31, 2017, causing the fair value of the option to increase to $16,000. By March 15, 2018, when the raw materials are purchased, the spot rate has climbed to $0.80, resulting in a fair value for the option of $38,000. 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. What is the overall impact on net income over the two accounting periods? What is the net cash outflow to acquire the raw materials?

Answer 1

Answer :

Date	Account title	Debit	Credit
15-Dec-15	Foreign currency option	3800
	Cash		3800
	(1.9 million marks * .002)
	(To record the purchase of foreign currency option)
15-Dec-15	No entry
	(No entry for order placed with foreign supplier)
31-Dec-15	Foreign currency option	12200
	AOCI		12200
	(To recognize the increase in the value of the foreign
	currency option with the counterpart recorded in
	AOCI)
	The fair value has increased from 1200 to 9000
31-Dec-15	Option expense	1100
	AOCI ((0.787-0.78)*1900000)-12200		1100
15-Mar-16	Foreign currency option	22000
	AOCI		22000
	(To recognize the increase in the value of the foreign
	currency option with the counterpart recorded in
	AOCI)
	(38000-16000)
15-Mar-16	Option expense	2700
	AOCI ((0.80-0.78)*1900000)-22000		2700
	(To recognize the decrease in time value of the option
	expense)
15-Mar-16	Foreign currency(marks)	1,520,000
	Cash		1482000
	Foreign currency options		38000
	(To record exercise of the foreign currency option at
	the strike price of $0.71 and close out the foreign currency
	option account)
15-Mar-16	Parts Inventory	1520000
	Foreign currency(marks)		1520000
15-Mar-16	AOCI	38000
	Adjustment to net income		38000
	(to transfer the amount accumulated in AOCI as an
	adjustment to net income in the period in which the
	fore casted transaction occurs.)
2015
	Option expense		$(1,100)
	(Overall impact on net income over the first accounting period)
2016
	Cost of goods sold(.80 * 1900000)		$(1,52,000)
	Option expense		$(2,700)
	Adjustment to net income		$38,000
	Overall impact of net income over the two accounting periods		$1,485,800)
	Net cash outflow for parts
	$3,800
	$1,482,000
Total	$1,485,800