On August 1, Pure Joy Corporation (a U.S.-based importer) placed an order to purchase merchandise from a foreign supplier at a price of 400,000 pounds. Pure Joy will receive and make payment for the merchandise in three months on October 31. On August 1, Pure Joy entered into a forward contract to purchase 400,000 pounds in three months at a forward rate of $0.60 per pound. The company properly designates the forward contract as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the forward rate, and, therefore, forward points are included in assessing hedge effectiveness. Relevant U.S. dollar exchange rates for the pound are as follows:

Pure Joy must close its books and prepare its third-quarter financial statements on September 30. The merchandise is received and paid for on October 31 and sold to local customers in November. Discounting to present value can be ignored.

a. Prepare journal entries for the foreign currency forward contract, foreign currency firm commitment, and import purchase.

b. What is the impact on net income over the two accounting periods?

c. What is the amount of net cash outflow resulting from the purchase of merchandise from the foreign supplier?

Transcribed Image Text:

Forward Rate Date Spot Rate (to October 31) $0.60 $0.60 August 1 September 30 October 31 0.63 0.66 0.68 N/A