Based on past experience, Leickner Company expects to purchase raw materials fro

Question

Based on past experience, Leickner Company expects to purchase raw materials from a foreign supplier at a cost of 1,200,000 marks on March 15, 2016. To hedge this forecasted transaction, the company acquires a three-month call option to purchase 1,200,000 marks on December 15, 2015. Leickner selects a strike price of $0.71 per mark, paying a premium of $0.001 per unit, when the spot rate is $0.71. The spot rate increases to $0.717 at December 31, 2015, causing the fair value of the option to increase to $9,000. By March 15, 2016, when the raw materials are purchased, the spot rate has climbed to $0.73, resulting in a fair value for the option of $24,000.

a. 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 2016. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

b. What is the overall impact on net income over the two accounting periods? (In case of negative impact on net income, answer should be entered with a minus sign.)

c. What is the net cash outflow to acquire the raw materials?

Explanation / Answer

Journal Entry Date Account Titles and explanation Debit Credit 15-Dec-15 Option to purchase marks $1,200 Cash ( 1200000*0.001) $1,200 (To record purchase of a call option, 31-Dec-15 Option to purchase marks ($9000-$1200) $7,800 Foreign exchange gain-other comprehensive income $7,800 (To record gain on the change in option value) 15-Mar-16 Option to purchase marks ($24000-$9000) $15,000 Foreign exchange gain-other comprehensive income $15,000 (To record gain on the change in option value) 15-Mar-16 Foreign exchange gain-other comprehensive income $22,800 Revenue $22,800 (To revlassify total exchange gains into earnings) B Computation of Overall impact on net income in two periods In 2015 , there is no change in net income In 2018, Foreign exchange gain $22,800 Net income $22,800 C Computation of Net Cash Flow: Cost of materials (1200000*0.73) $876,000 Less:Net gain from hedging -$22,800 Net Cash Flow: $853,200

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.