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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