Question

The Miller Company sells tires to a customer in Canada on December 1, 20x1 with a payment of 100,000 Canadian dollars to be received on February 1, 20x2. Miller enters into a forward contract on December 1, 20x1 to sell 100,000 Canadian dollars on February 1, 20x2. Exchange rates for the Canadian dollars are as follows:

December 1, 20x1 ‐ Spot rate: 1.10; Forward rate: 1.15

December 31, 20x1 – Spot rate: 1.12; Forward rate:1.13

February 1, 20x2 – 1.16

Miller’s incremental borrowing rate is 12%. The present value factor for one month of interest at an annual rate of 12% is .9901.

(a)Assuming that Miller Company designates the forward contract as a cash flow hedge of a foreign currency receivable, prepare journal entries for these transactions in U.S. dollars. What is the impact on 20x1 net income? What is the impact on net 20x2 income?

(b)Calculate the impact on 20x1 and 20x2 net income assuming Miller designates the forward contract as a fair value hedge of foreign currency receivable. Prepare journal entries for these transactions.

Answer 1

Forward Contract Cash Flow Hedge of Foreign Currency Receivable
Journal Entries:
Date	Particulars					Debit	Credit
Year 1
1-Dec	Accounts receivable   [100,000 x $1.10]					110,000
		Sales					110,000

31-Dec	Accounts receivable   [100,000 x ($1.12-$1.10)]					12,000
		Foreign exchange gain					12,000

	Loss on forward contract					12,000
		Accmt other comprehensive income					12,000

	Accmt other comprehensive income					1,980
		Forward Contract					1,980
	([100,000 x ($1.15-$1.13) = $2,000 x .9901 = $1,980.2])

	Accmt other comprehensive income					1,667
		Premium revenue					1,667
	([100,000 x ($1.15-$1.10) = $5,000 x 1/3 = $1666.67])

Impact on Year 1 Income:
Sales						110,000
Foreign Exchange gain						12,000
Loss on forward contract						(12,000)
premium revenue						1,667
						111,667

Year 2

1-Feb	Accounts receivable   [100,000 x ($1.16-$1.12)]					4,000
		Foreign exchange gain					4,000

	Loss on forward contract					4,000
		Accmt other comprehensive income					4,000

	Forward contract					980
		Accmt other comprehensive income					980
	([100,000 x ($1.16-$1.15) = $1,000 - 1,980.2])

	Accmt other comprehensive income					1,667
		Premium revenue					1,667
	([100,000 x ($1.15-$1.10) = $5,000 x 1/3 = $1666.67])

	Foreign currency (crown) [100,000 x $1.16]					116,000
		Accounts receivable (crown)					116,000

	Cash [100,000 x $1.15]					115,000
	Forward contract					1,000
		Foreign currency (crown)					116,000

Impact on Year 2 Income:
Foreign Exchange gain						4,000
Loss on forward contract						(4,000)
premium revenue						1,667
						1,667

Impact on Net Income over both the periods:

113,333

Forward Contract Fair Value Hedge of Foreign Currency Receivable
Journal Entries:

Date	Particulars					Debit	Credit
Year 1
1-Dec	Accounts receivable   [100,000 x $1.10]					110,000
		Sales					110,000

31-Dec	Accounts receivable   [100,000 x ($1.12-$1.10)]					2,000
		Foreign exchange gain					2,000

	Loss on forward contract					1,980
		Forward contract					1,980
	([100,000 x ($1.15-$1.13) = $2,000 x .9901 = $1,176.36])

Impact on Year 1 Income:
Sales						110,000
Foreign Exchange gain						2,000
Loss on forward contract						(1,980)
						110,020

Year 2
1-Feb	Accounts receivable (crown) [100,000 x ($1.16-$1.12)]					4,000
		Foreign exchange gain					4,000

	Forward contract					980
		Gain on forward contract					980
	([100,000 x ($1.16-$1.15) = $1,000 - 1,980.2])

	Foreign currency (crown) [100,000 x $1.16]					116,000
		Accounts receivable (crown)					116,000

	Cash [100,000 x $1.15]					115,000
	Forward contract					1,000
		Foreign currency (crown)					116,000

Impact on Year 2 Income:

Foreign Exchange gain						4,000
Gain on forward contract						980
						4,980

Impact on Net Income over both the periods:

115,000