On October 1, 20x1, Almira, Inc., a U.S. based company, had its first foreign purchase when they
Question:
On October 1, 20x1, Almira, Inc., a U.S. based company, had its first foreign purchase when they acquired inventory from a non-U.S. company.
In conjunction with their foreign purchase, and to facilitate expanding their supply chain into the foreign market, rather than paying in U.S. dollars, Almira, Inc. agreed to pay for the inventory in the seller’s currency, which is designated as local currency units or “LCUs.”
With respect to the foreign purchase, Almira, Inc. has to pay 100,000 local currency units (LCU) in full payment for the inventory purchase. Payment is due no later than February 1, 20x2.
On October 1, 20x1, Almira also entered into a forward foreign currency exchange contract wherein they would receive LCU100,000 from a broker on February 1, 20x2. The four-month forward exchange rate on October 1, 20x1 was 1 LCU = $0.78. Any contract discount or premium is amortized using the straight-line method.
The spot rates and applicable forward rates, i.e., for a February 1, 20x2 delivery, on various dates were as follows:
Date | Spot Rate | Forward Rate |
October 1, 20x1 | $.0.83 for 1 LCU | $0.78 for 1 LCU |
December 31, 20x1 | $0.85 for 1LCU | $0.80 for 1LCU |
February 1, 20x2 | $0.86 for 1LCU | $0.86 for 1LCU |
The company's borrowing rate is 12%. The present value factor for one month is .9901. Almira prepares its annual report and financial statements as of December 31, 20x1.
Required
Assuming Almira makes their payment on February 1, 20x2, as agreed, and Almira designated the forward exchange contract as a cash flow hedge of the foreign purchase:
- a. Prepare Almira’s journal entries relating to the inventory purchase transaction and the forward exchange contract hedge transaction, at October 1, 20x1, at December 31, 20x1, and February 1, 20x2.
- b. Prepare a schedule showing the total effect of the sale and the forward contract hedge on 20x1 net income. (Please show your work)
- c. Prepare a schedule showing the effect of the sale and the forward exchange contract on 20x2 net income. (Please show your work)
- d. If Almira, Inc. had designated the forward exchange contract as a fair value hedge, briefly explain how the accounting would have differed from your answer in part A. (Journal entries are permitted but not required).
Canadian Income Taxation planning and decision making
ISBN: 9781259094330
17th edition 2014-2015 version
Authors: Joan Kitunen, William Buckwold