Question

On March 1, Derby Corporation (a U.S.-based company) expects to order merchandise from a supplier in Norway in three months. On March 1, when the spot rate is $0.22 per Norwegian krone, Derby enters into a forward contract to purchase 575,000 Norwegian kroner at a three-month forward rate of $0.240. Forward points are excluded in assessing the forward contract's effectiveness as a hedge, and are amortized to net income on a straight-line basis. At the end of three months, when the spot rate is $0.232 per Norwegian krone, Derby orders and receives the merchandise, paying 575,000 kroner. The merchandise is sold within 30 days. What amount(s) does Derby report in net income as a result of this cash flow hedge of a forecasted transaction and the related purchase and sale of merchandise?

Multiple Choice

- Cost of goods sold of $133,400 plus foreign exchange loss of $4,600
- Cost of goods sold of $138,000 less foreign exchange gain of $11,500
- Cost of goods sold of $138,000
- Cost of goods sold of $126,500 plus foreign exchange loss of $11,500

Answer 1

Derby Corporation reports a net income impact of $138,000 less a foreign exchange gain of $4,600 due to its cash flow hedge and subsequent purchase and sale of merchandise. The answer is B.

To calculate the impact on net income due to the cash flow hedge and subsequent purchase and sale of merchandise, we need to go through the following steps:

1. Calculate the cost of goods sold (COGS) in U.S. dollars based on the forward contract rate:

COGS = Amount in Kroner × Forward Rate

COGS = 575,000 krone × $0.240 {krone

2. Calculate the foreign exchange gain or loss:

`\text{Foreign Exchange Gain or Loss} = (\text{Spot Rate at Sale} - \text{Forward Rate}) * \text{Amount in Kroner} \\ \text{Foreign Exchange Gain or Loss} = ($0.232 - $0.240) * 575,000 \text{ krone}`

Now, let's perform the calculations:

`\text{COGS} = 575,000 * $0.240 = $138,000 \\ \text{Foreign Exchange Gain or Loss} = ($0.232 - $0.240) * 575,000 = -$4,600`

Now, let's determine the net impact on net income:

`\[ \text{Net Income Impact} = \text{COGS} + \text{Foreign Exchange Gain or Loss} \]\[ \text{Net Income Impact} = $138,000 - $4,600 \]`

Therefore, the correct answer is:

B - Cost of goods sold of $138,000 less foreign exchange gain of $4,600