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IFR - Tutorial W4 - Extra Exercise

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15 views2 pages

IFR - Tutorial W4 - Extra Exercise

Uploaded by

s.h.j.braamhaar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Tutorial W4: Extra Exercise

The Budvar Company sold parts to a foreign customer on December 1, Year 1, with a payment of 20,000 crowns to be received on March 1,
Year 2.
Budvar enters into a forward contract on December 1, Year 1, to sell 20,000 crowns on March 1, Year 2. Relevant exchange rates for the crown
on various dates are as follows:
Date Spot Rate Forward rate (March 1, Year 2)
December 1, Year 1 $1.00 $1.04
December 31, Year 1 $1.05 $1.10
March 1, Year 2 $1.12
Budvar’s incremental borrowing rate is 12 percent. The present value factor for two months at an interest rate of 12 percent (1 percent per
month) is 0.9803. Budvar must close its books and prepare financial statements on December 31.
Required:
a- Assuming that Budvar designates the forward contract as a cash flow hedge of a foreign currency receivable, prepare journal entries for
these transactions in U.S. dollars. What is the impact on year 1 net income? What is the impact on Year 2 net income? What is the impact
on net income over the two accounting periods?
b- Assuming that Budvar designates the forward contract as a fair value hedge of a foreign currency receivable, prepare journal entries for
these transactions in U.S. dollars. What is the impact on year 1 net income? What is the impact on Year 2 net income? What is the impact
on net income over the two accounting periods?
Solutions:
Account Receivable ($) Forward Rate Forward Contract
Date Spot Rate
K Value Change in K Value to 3/1/Y2 Fair Value Change in Fair Value
12/01/Y1 $1.00 $20,000 — $1.04 $0 —
*
12/31/Y1 1.05 21,000 $1,000 1.10 -$1,176.4 -$1,176.4
03/01/Y2 1.12 22,400 $1,400 1.12 -1,600† -$423.6

*
K20,000 x ($1.04 - $1.10) = $1,200 x 0.9803 = $-1,176.4, where 0.9803 is the present value factor for two months at an annual interest rate of
12 percent (1 percent per month) calculated as 1/1.012.
†
K20,000 x (1.04 - 1.12) = -1,600 (-1,600 – (1,176.4) = - 423.6)
a. Forward Contract Cash Flow Hedge of Foreign Currency Receivable b. Forward Contract Fair Value Hedge of Foreign Currency Receivable

12/1/Y1 Accounts receivable (crowns) [20,000 x $1.00] $20,000 12/1/Y1 Accounts receivable (crown) [20,000 x $1.00] $20,000
Sales $20,000 Sales $20,000
No entry for the forward contract. No entry for the forward contract.

12/31/Y1 Accounts receivable (crowns) [20,000 x ($1.05-$1.00)] $1,000 12/31/Y1 Accounts receivable (crowns) [20,000 x ($1.05-$1.00)] $1,000
Foreign exchange gain $1,000 Foreign exchange gain $1,000
Loss on forward contract $1,000
AOCI $1,000
AOCI [20,000 x ($1.04-$1.10) = -$1,200 x .9803 = -$1,176.36] $1,176.36 Loss on forward contract $1,176.36
Forward contract $1,176.36 Forward contract [20,000 x ($1.04-$1.10) = -$1,200 x .9803 = -$1,176.36] $1,176.36

AOCI [20,000 x ($1.04-$1.00) = $800 x 1/3 = $266.67] $266.67


Premium revenue $266.67
Impact on Year 1 income: Impact on Year 1 income:
Sales $20,000.00 Sales $20,000.00
Foreign exchange gain 1,000.00 Foreign exchange gain 1,000.00
Loss on forward contract -1,000.00 Loss on forward contract -1,176.36
Premium revenue 266.67 Total $19,823.64
Total $20,266.67
3/1/Y2 Accounts receivable (crowns) [20,000 x ($1.12-$1.05)] $1,400 3/1/Y2 Accounts receivable (crowns) [20,000 x ($1.12-$1.05)] $1,400
Foreign exchange gain $1,400 Foreign exchange gain $1,400
Loss on forward contract $1,400
AOCI $1,400
AOCI $423.63 Loss on forward contract $423.64
Forward contract [20,000 x ($1.12-$1.04) = $1,600 – 1,176.36] $423.64 Forward contract [20,000 x ($1.12-$1.04) = $1,600 – 1,176.36] $423.64

AOCI [$800 x 2/3 = $533.33] $533.33


Premium revenue $533.33
Foreign currency (crown) [20,000 x $1.12] $22,400 Foreign currency (crown) [20,000 x $1.12] $22,400
Accounts receivable (crown) $22,400 Accounts receivable (crown) $22,400
Cash [20,000 x $1.04] $20,800 Cash [20,000 x $1.04] $20,800
Forward contract 1,600 Forward contract 1,600
Foreign currency (crown) $22,400 Foreign currency (crown) $22,400

Impact on Year 2 income: Impact on Year 2 income:


Foreign exchange gain $1,400.00 Foreign exchange gain $1,400.00
Loss on forward contract -1,400.00 Loss on forward contract -423.64
Premium revenue 533.33 Total $ 976.36
Total $ 533.33
Impact on net income over both periods: $20,266.67 + $533.33 = $20,800; equal Impact on net income over both periods: $19,823.64 + $976.36 = $20,800; equal to
to cash inflow. (20,000 x 1.04) cash inflow. (20,000 x 1.04)

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