On November 1, 20X6, Smith Imports Inc. contracted to purchase teacups from England for 30,000. The teacups

On November 1, 20X6, Smith Imports Inc. contracted to purchase teacups from England for £30,000. The teacups were to be delivered on January 30, 20X7, with payment due on March 1, 20X7. On November 1, 20X6, Smith entered into a 120-day forward contract to receive 30,000 pounds at a forward rate of £1 = $1.59. The forward contract was acquired to hedge the financial component of the foreign currency commitment.

Additional Information for the Exchange Rate

1. Assume the company uses the forward rate in measuring the forward exchange contract and for measuring hedge effectiveness.

2. Spot and exchange rates follow:

Required
a. What is Smith's net exposure to changes in the exchange rate of pounds for dollars between November 1, 20X6, and March 1, 20X7?
b. Prepare all journal entries from November 1, 20X6, through March 1, 20X7, for the purchase of the subassemblies, the forward exchange contract, and the foreign currency transaction. Assume Smith's fiscal year ends on December 31, 20X6.
c. Assume that interest is significant and the time value of money is considered in valuing the forward contract and hedged commitment. Use a 12 percent annual interest rate. Prepare all journal entries from November 1, 20X6, through March 1, 20X7, for the purchase of the subassemblies, the forward exchange contract, and the foreign currency transaction. Assume Smith's fiscal year ends on December 31,20X7.

Transcribed Image Text:

Forward Rate for March 1, 20x7 E1 $1.59 E11.62 1 1.60 Date Spot Rate E1 $1.61 November 1, 20x6 December 31, 20X6 1165 January 30, 20x7 March 1, 20x7 1 1.59 1.585