P9.12 Hedge Accounting Versus Normal Accounting for Fair Value Hedge with Options: Financial Statement Impacts

On November 1, 2020, Monarch Foods, a U.S. company, issued a purchase order to Singapore supplier for S$1,000,000 in food products, to be delivered in 6 months. On that date, the spot rate was $0.73/S$ an the 6-month forward rate was $0.732/S$. Monarch locks in the maximum U.S. dollar cost of this purchase by investing in call options on S$1,000,000 at a strike price of $0.73, costing $0.007/S$, and the options sell for $0.009/S$. On May 1, 2021, the spot rate is $0.741. Monarch takes delivery of the food products, sells the options at their intrinsic value og $0.011/S$, and pays Singapore supplier by buying S$1,000,000 in the spot market. The food products are sold later in 2021.

Required

The total cash outflow related to the food products and the options is $737,000 (=$7,000 - $11,000+$741,000). Monarch can use hedge accounting to account for the options, designating the intrinsic value of the calls as a fair value hedge of a firm commitment, or it can elect to use normal accounting.

a. At what amount does Monarch report cost of goods sold for the food products when they are sold, if Monarch uses hedge accounting versus if it uses normal accounting?

b. Calculate the income effects in 2020 and 2021 if Monarch uses hedge accounting versus if it uses normal accounting.