## What is the impact on net income, Financial Accounting

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The Budvar Company purchases parts from a foreign customer on December 1, Year 1, with payment of 20,000 crowns 20,000 crowns to be made on March 1, Year 2.  Budvar enters into a forward contract on December 1, Year 1, to purchase 20,000 crowns on March 1, Year 2. The parts purchased on December 1, Year 1, become a part of the cost of goods sold on March 15, Year 2.

Relevant exchange rates for the crown on various dates are as follows:

 Date Spot Rate Forward Rate (to March 1, Year 2) December 1, Year 1 \$1.00 \$1.04 December 31, Year 1 1.05 1.1 March 1, Year 2 1.12

udvar'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. Budvar must close its books and prepare financial statements at December 31.

Required:

a.       Assuming that Budvar designates the forward contract as a cash flow hedge of a foreign currency payable, prepare journal entries for these transactions in US 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 payable, prepare journal entries for these transactions in US 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?

 a) Forward Contract Cash Flow Hedge of Foreign Currency Receivable Journal Entries: Date Particulars Debit Credit Year 1 1-Dec Accounts receivable (crowns) [20,000 x \$1.00] 20,000 Sales 20,000 31-Dec Accounts receivable (crowns) [20,000 x (\$1.05-\$1.00)] 1,000 Foreign exchange gain 1,000 Loss on forward contract 1,000 Accmt other comprehensive income 1,000 Accmt other comprehensive income 1,176 Forward Contract 1,176 ([20,000 x (\$1.10-\$1.04) = \$1,200 x .9803 = \$1,176.36]) Accmt other comprehensive income 267 Premium revenue 267 ([20,000 x (\$1.04-\$1.00) = \$800 x 1/3 = \$266.67]) Impact on Year 1 Income: Sales 20,000 Foreign Exchange gain 1,000 Loss on forward contract -1,000 premium revenue 267 20,267 Year 2 1-Mar Accounts receivable (crowns) [20,000 x (\$1.12-\$1.05)] 1,400 Foreign exchange gain 1,400 Loss on forward contract 1,400 Accmt other comprehensive income 1,400 Accmt other comprehensive income 424 Forward contract 424 ([20,000 x (\$1.12-\$1.04) = \$1,600 - 1,176.36]) Accmt other comprehensive income 533 Premium revenue 533 ([20,000 x (\$1.04-\$1.00) = \$800 x 2/3 = \$266.67]) Foreign currency (crown) [20,000 x \$1.12] 22,400 Accounts receivable (crown) 22,400 Cash [20,000 x \$1.04] 20,800 Forward contract 1,600 Foreign currency (crown) 22,400 Impact on Year 2 Income: Foreign Exchange gain 1,400 Loss on forward contract -1,400 premium revenue 533 533 Impact on Net Income over both the periods: 20,800 b) Forward Contract Fair Value Hedge of Foreign Currency Receivable Journal Entries: Date Particulars Debit Credit Year 1 1-Dec Accounts receivable (crowns) [20,000 x \$1.00] 20,000 Sales 20,000 31-Dec Accounts receivable (crowns) [20,000 x (\$1.05-\$1.00)] 1,000 Foreign exchange gain 1,000 Loss on forward contract 1,176 Forward contract 1,176 ([20,000 x (\$1.04-\$1.10) = \$1,200 x .9803 = \$1,176.36]) Impact on Year 1 Income: Sales 20,000 Foreign Exchange gain 1,000 Loss on forward contract -1,176 19,824 Year 2 1-Mar Accounts receivable (crown) [20,000 x (\$1.12-\$1.05)] 1,400 Foreign exchange gain 1,400 Loss on forward contract 424 Forward contract 424 ([20,000 x (\$1.12-\$1.04) = \$1,600 - 1,176.36]) Foreign currency (crown) [20,000 x \$1.12] 22,400 Accounts receivable (crown) 22,400 Cash [20,000 x \$1.04] 20,800 Forward contract 1,600 Foreign currency (crown) 22,400 Impact on Year 2 Income: Foreign Exchange gain 1,400 Loss on forward contract -424 976 Impact on Net Income over both the periods: 20,800

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