On October 1, 2017, Sharp Company (based in Denver, Colorado) entered into a for
ID: 2563170 • Letter: O
Question
On October 1, 2017, Sharp Company (based in Denver, Colorado) entered into a forward contract to sell 100,000 rubles in four months (on January 31, 2018) and receive $39,000 in U.S. dollars. Exchange rates for the ruble follow:
Sharp's incremental borrowing rate is 12 percent. The present value factor for one month at an annual interest rate of 12 percent (1 percent per month) is 0.9901. Sharp must close its books and prepare financial statements on December 31.
Prepare journal entries, assuming that Sharp entered into the forward contract as a fair value hedge of a 100,000 ruble receivable arising from a sale made on October 1, 2017. Include entries for both the sale and the forward contract.
Prepare journal entries, assuming that Sharp entered into the forward contract as a fair value hedge of a firm commitment related to a 100,000 ruble sale that will be made on January 31, 2018. Include entries for both the firm commitment and the forward contract. The fair value of the firm commitment is measured by referring to changes in the forward rate.
Date Spot Rate Forward Rate(to January 31, 2018) October 1, 2017 $ 0.35 $ 0.39 December 31, 2017 0.38 0.41 January 31, 2018 0.40 N/A
Explanation / Answer
a. Hedge of a receivable
10/1/17 Ruble receivable [100,000 x $.35]........................... $35,000
Sales......................................................................... $35,000
No entry related to the forward contract.
12/31/17 Ruble receivable [100,000 x ($.38-$.35)]............ $3,000
Foreign exchange gain....................................... $3,000
Loss on forward contract......................................... $2,000
Forward contract [100,000 x ($.41-$.39)]......... $2,000
2/1/18 Ruble receivable [100,000 x ($.40-$.38)]................... $2,000
Foreign exchange gain....................................... $2,000
Forward contract [100,000 x ($.40-$.41)]............... $1,000
Gain on forward contract.................................... $1,000
Foreign currency (Ruble)............................................ $40,000
Ruble receivable...................................................... $40,000
Cash............................................................................... $39,000
Forward contract........................................................ 1,000
Foreign currency (Ruble)...................................... $40,000
Note that the net effect on income is $39,000 which is equal to the amount of Cash received:
Sales—2017 ....................................................................................................... $35,000
Foreign exchange gain--2017......................................................................... 3,000
Loss on forward contract--2017................................................................... (2,000)
Foreign exchange gain--2018......................................................................... 2,000
Gain on forward contract--2018..................................................................... 1,000
Net effect on income......................................................................................... $39,000
b. Hedge of commitment
10/1/17 No entries related to the forward contract or firm commitment.
12/31/17 Loss on forward contract......................................... $2,000
Forward contract [100,000 x ($.41-$.39)].................. $2,000
Firm commitment........................................................ $2,000
Gain on firm commitment.................................... $2,000
2/1/18 Forward contract [100,000 x ($.40-$.41)]............... $1,000
Gain on forward contract.................................... $1,000
Loss on firm commitment......................................... $1,000
Firm commitment.................................................. $1,000
Foreign currency (Ruble)............................................ $35,000
Sales......................................................................... $35,000
Cash............................................................................... $39,000
Forward contract........................................................ 1,000
Foreign currency (Ruble)...................................... $40,000
Sales............................................................................... $1,000
Firm commitment.................................................. $1,000
Note that as a result of these entries, gains and losses offset; Sales revenue is recognized at $39,000 which is equal to the amount of Cash received.
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