Question

Brandlin Company of Anaheim, California, purchases materials from a foreign supplier on December 1, 2017, with payment of 17,000 korunas to be made on March 1, 2018. The materials are consumed immediately and recognized as cost of goods sold at the date of purchase. On December 1, 2017, Brandlin enters into a forward contract to purchase 17,000 korunas on March 1, 2018. Relevant exchange rates for the koruna on various dates are as follows:

Date	Spot Rate			Forward Rate (to March 1, 2018)
December 1, 2017	$	3.50		$	3.575
December 31, 2017		3.60			3.700
March 1, 2018		3.75			N/A

Brandlin’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. Brandlin must close its books and prepare financial statements at December 31.

1. a-1. Assuming that Brandlin designates the forward contract as a cash flow hedge of a foreign currency payable and recognizes any premium or discount using the straight-line method, prepare journal entries for these transactions in U.S. dollars.

2. a-2. Assuming that the purchased parts became a part of the cost of goods sold in 2017, what is the impact on 2017 net income?

3. a-3. What is the impact on 2018 net income?

4. a-4. What is the impact on net income over the two accounting periods?

5. b-1. Assuming that Brandlin designates the forward contract as a fair value hedge of a foreign currency payable, prepare journal entries for these transactions in U.S. dollars.

6. b-2. Assuming that the purchased parts became a part of the cost of goods sold in 2017, what is the impact on net income in 2017 and in 2018?

7. b-3. What is the impact on net income over the two accounting periods?

Answer 1

Answer-

Part A-1

Date	General Journal	Debit	Credit
12/1/17	Accounts receivable (K)	59500
	Sales (17000*3.50)		59500
	No journal entry required
	No journal entry required
12/31/17	Accounts receivable (K)	1700
	Foreign exchange gain (17000*(3.60-3.50))		1700
	AOCI	2083
	Forward contract (17000*(3.575-3.700))*0.9803		2083
	Loss on forward contract	1700
	AOCI		1700
	AOCI	425
	Premium revenue (17000*(3.575-3.500))*1/3		425
3/1/18	Accounts receivable (K)	2550
	Foreign exchange gain (17000*(3.75-3.60))		2550
	AOCI	892
	Forward contract (17000*(3.75-3.575))-2083		892
	Loss on forward contract	2550
	AOCI		2550
	AOCI	850
	Premium revenue (17000*(3.575-3.500))*2/3		850
	Foreign currency (K)	63750
	Accounts receivable (K) (17000*3.75)		63750
	Cash (17000*3.575)	60775
	Forward contract	2975
	Foreign currency (K)		63750

Part A-2

Impact on 2017 income:

Sales	59500
Foreign Exchange Gain	1700
Loss on Forward Contract	(1700)
Premium Revenue	425
Total	59925

Part A-3

Impact on 2018 income:

Foreign Exchange Gain	2550
Loss on Forward Contract	(2550)
Premium Revenue	850
Total	850

Part A-4

Impact on net income over both periods: $59925 + $850 = $60775; equal to cash inflow

Part B-1

Date	General Journal	Debit	Credit
12/1/17	Accounts receivable (K)	59500
	Sales (17000*3.50)		59500
	No journal entry required
	No journal entry required
12/31/17	Accounts receivable (K)	1700
	Foreign exchange gain (17000*(3.60-3.50))		1700
	Loss on forward contract	2083
	Forward contract (17000*(3.575-3.700))*0.9803		2083
3/1/18	Accounts receivable (K)	2550
	Foreign exchange gain (17000*(3.75-3.60))		2550
	Loss on forward contract	892
	Forward contract (17000*(3.75-3.575))-2083		892
	Foreign currency (K)	63750
	Accounts receivable (K) (17000*3.75)		63750
	Cash (17000*3.575)	60775
	Forward contract	2975
	Foreign currency (K)		63750

Part B-2

Impact on 2017 income:

Sales	59500
Foreign Exchange Gain	1700
Loss on Forward Contract	(2083)
Total	59117

Impact on 2018 income:

Foreign Exchange Gain	2550
Loss on Forward Contract	(892)
Total	1658

Part B-3

Impact on net income over both periods: $59117 + $1658 = $60775; equal to cash inflow