Question

On December 1, 2021, King Co. sold inventory to a customer in a foreign country. King agreed to accept 96,000 local currency units (LCU) in full payment for this inventory. Payment was to be made on February 1, 2022. On the date of sale, King entered into a forward exchange contract wherein 96,000 LCU would be delivered to a currency broker in two months. The two-month forward exchange rate on that date was 1 LCU = $0.30. Any contract discount or premium is amortized using the straight-line method. The spot rates and forward rates on various dates were as follows:

Date Rate Description Exchange Rate

December 1, 2024 Spot Rate $0.32 = 1 LCU
2 - Month Forward Rate $0.30 = 1 LCU
December 31, 2024 Spot Rate $0.29 = 1 LCU
1 - Month Forward Rate $0.28 = 1 LCU
February 1, 2025 Spot Rate $0.27 = 1 LCU

Assume this hedge is designated as a cash flow hedge. Prepare the journal entries relating to the transaction and the forward contract.

Prepare the journal entries relating to the transaction and the forward contract.

Answer 1

To prepare the journal entries relating to the transaction and the forward contract, we need to consider the different exchange rates on various dates. On December 1, 2021...

To prepare the journal entries relating to the transaction and the forward contract, we need to consider the different exchange rates on various dates.

First, on December 1, 2021, King Co. sold inventory to a customer and agreed to accept 96,000 local currency units (LCU) in full payment.

The two-month forward exchange rate was 1 LCU = $0.30.

Therefore, the journal entry on this date would be:

Accounts Receivable (LCU) 96,000

Sales Revenue 96,000

Then, on February 1, 2022, when the payment is made, we need to adjust for the exchange rate on that date.

The spot rate was $0.27 = 1 LCU.

Therefore, the journal entry would be:

Cash 25,920

Gain on Foreign Exchange 960

Accounts Receivable (LCU) 96,000

Forward Exchange Contract Liability 125,880

To amortize the contract discount or premium, we can use the straight-line method.

This means that the gain or loss on the forward exchange contract would be amortized over the two-month period.