Based on past experience, Leickner Company expects to purchase raw materials fro
ID: 2517355 • Letter: B
Question
Based on past experience, Leickner Company expects to purchase raw materials from a foreign supplier at a cost of 1,600,000 marks on March 15, 2018. To hedge this forecasted transaction, the company acquires a three-month call option to purchase 1,600,000 marks on December 15, 2017. Leickner selects a strike price of $0.75 per mark, paying a premium of $0.005 per unit, when the spot rate is $0.75. The spot rate increases to $0.755 at December 31, 2017, causing the fair value of the option to increase to $15,000. By March 15, 2018, when the raw materials are purchased, the spot rate has climbed to $0.77, resulting in a fair value for the option of $32,000. 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?
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
Solution b:
Cost of foreign currency option = 1600000 * 0.005 =$8,000
Fair value of option at the end of 2017 = $15,000
Fair value of option on Mar 15 2018 = $32,000
Impact on net income in 2017 = $15,000 - $8,000 = $7000 increase in net income through OCI
Impact on net income in 2018 = $32,000 - $15,000 = $17,000 increase in net income
Solution c:
Net cash outflow for purchase of raw materials = Purchase cost - Gain on foreign currency option
= 1600000 * $0.77 - $24,000 = $1,208,000
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