Palmer Company purchases materials from a foreign supplier on December 1, 2017,
ID: 2548175 • Letter: P
Question
Palmer Company purchases materials from a foreign supplier on December 1, 2017, with payment of 12,000 FCUs to be made on March 1, 2018. On December 1, 2017, Palmer enters into a forward contract to purchase 12,000 FCUs on March 1, 2018. Relevant exchange rates for the FC on various dates are as follows:
Date Spot Rate Forward Rate (to march 1,2018)
Dec 1, 2017 $2.70 $2,775
Dec 31, 2017 $2.80 $2,900
March 1,2018 $2.95 N/A
Palmer’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. Palmer must close its books and prepare financial statements at December 31.
1. Assume that Palmer 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.
Required:
a)Prepare journal entries for these transactions in U.S. dollars.
b)What is the impact on 2017 net income?
c)What is the impact on 2018 net income?
d) What is the impact on net income over the two accounting periods?
Explanation / Answer
a)Prepare journal entries for these transactions in U.S. dollars.
Date
Accounts title
Debit
Credit
12/01/2017
Accounts receivable (12,0000*2.70)
Sales
32,400
32,400
No entry for forward contract
12/31/2107
Accounts receivable
Foreign exchange gain ((2.8-2.7)*12,000)
1,200
1,200
Accumulated other comprehensive income (AOCI)
Forward contract
((2.900-2.775)*12,000)0.9803
1,470.45
1,470.45
Loss on forward contract
AOCI
1,200
1,200
AOCI
Premium revenue
((2.775-2.70)*12,000)*1/3
300
300
03/01/2018
Accounts receivable
Foreign exchange gain ((2.95-2.80)*12,000)
1,800
1.800
Accumulated other comprehensive income (AOCI)
Forward contract
((2.95-2.775)*12,000)-1,470.45
629.55
629.55
Loss on forward contract
AOCI
1,800
1,800
AOCI
Premium revenue
((2.775-2.70)*12,000)*2/3
600
600
Foreign currency
Accounts receivable (12,000*2.95)
35,400
35,400
Cash (12,000*2.775)
Forward contract
Forward currency
33,300
2,100
35,400
b)What is the impact on 2017 net income?
Sales
32,400
Add: Foreign exchange gain
1,200
Less: Loss on forward contract
(1,200)
Add: Premium revenue
300
Total
32,700
c)What is the impact on 2018 net income?
Foreign exchange gain
1,800
Less: Loss on forward contract
(1,800)
Add: Premium revenue
600
Total
600
d) What is the impact on net income over the two accounting periods?
Impact on net income over the two accounting periods = 32,700+600 = $33,300
Date
Accounts title
Debit
Credit
12/01/2017
Accounts receivable (12,0000*2.70)
Sales
32,400
32,400
No entry for forward contract
12/31/2107
Accounts receivable
Foreign exchange gain ((2.8-2.7)*12,000)
1,200
1,200
Accumulated other comprehensive income (AOCI)
Forward contract
((2.900-2.775)*12,000)0.9803
1,470.45
1,470.45
Loss on forward contract
AOCI
1,200
1,200
AOCI
Premium revenue
((2.775-2.70)*12,000)*1/3
300
300
03/01/2018
Accounts receivable
Foreign exchange gain ((2.95-2.80)*12,000)
1,800
1.800
Accumulated other comprehensive income (AOCI)
Forward contract
((2.95-2.775)*12,000)-1,470.45
629.55
629.55
Loss on forward contract
AOCI
1,800
1,800
AOCI
Premium revenue
((2.775-2.70)*12,000)*2/3
600
600
Foreign currency
Accounts receivable (12,000*2.95)
35,400
35,400
Cash (12,000*2.775)
Forward contract
Forward currency
33,300
2,100
35,400
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