On November 10, 2011, King Co. sold inventory to a customer in a foreign country

Question

On November 10, 2011, King Co. sold inventory to a customer in a foreign country. King agreed to accept 96,000 local currency units (LCU) in full payment for this inventory. Payment was to be made on February 1, 2012. On December 1, 2011, King entered into a forward exchange contract wherein 96,000 LCU would be delivered to a currency broker in two months. The two month forward exchange rate on that date was 1 LCU = $.30. Any contract discount or premium is amortized using the straight-line method. The spot rates and forward rates on various dates were as follows:

November 10, 2011 - spot rate - $.35 = 1 LCU

December 1, 2011 - spot rate - $.32 = 1 LCE

December 1, 2011 - 2 month foward rate - $.30 = 1 LCU

December 31, 2011 - spot rate - $.29 = 1 LCU

December 31, 2011 - 1 month foward rate - $.28 = 1 LCU

February 1, 2012 - spot rate - $.27 = 1 LCU

The company's borrowing rate is 12%. The present value factor for one month is .9901.

1. (A.) Assume this hedge is designated as a cash flow hedge. Prepare the journal entries relating to the transaction and the forward contract.?

(B.) Compute the effect on 2011 net income.

?(C.) Compute the effect on 2012 net income

Explanation / Answer

Part A:

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Part B:

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Part C:

Debit Credit Nov. 10, 2011 Accounts Receivables 33600 Sales 33600 Dec. 1, 2011 No Journal Entry Dec. 31, 2011 Foriegn Exchange Loss 5760 Accounts Receivables 5760 Forward Contract 1901 AOCI 1901 AOCI 5760 Gain on Forward Contract 5760 Discount Expense (96000*(-.32-.30)/2) 960 AOCI 960 Foriegn Currency 25920 Accounts Receivables 25920 Feb. 1, 2012 Foriegn Exchange Loss 1920 Accounts Receivables 1920 Forward Contract 979 AOCI 979 AOCI 1920 Gain on Forward Contract 1920 Discount Expense (96000*(-.32-.30)/2) 960 AOCI 960 Foriegn Currency 25920 Accounts Receivables 25920 Cash 25920 Forward Contract 2880 Foriegn Currency 25920

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