Part A

Car ID Inc. is a U.S.-based distributor of auto supplies for several domestic and foreign car companies. On November 1, Year 1, Car ID sold and shipped auto parts to a customer in Switzerland for a price of 500,000 Swiss francs (CHF). Payment is to be received on January 30, Year 2. On the date of sale, Car ID also entered into a three-month forward contract to sell CHF 500,000. The forward contract is properly designated as acash flow hedge of a foreign currency receivable. Car ID's incremental borrowing rate is 12%. The present value factor for one month at an incremental borrowing rate of 12% is .99010. Relevant exchange rates are as follows:

SpotForward Rate

DateRate(to January 30, Year 2)

November 1, Year 1. . . . . . . . . . . . . .$0.500$0.495

December 31, Year 1. . . . . . . . . . . . . .0.5200.516

January 30, Year 2. . . . . . . . . . . . . . . .0.4900.490

Required: 50 Points

1.Car ID is required to formally document the hedging transaction at the time the forward contract is entered into. In general, what information is to be included in order to satisfy the hedge documentation requirements?

2.What are the necessary journal entries to account for the sale and foreign currency forward contract. Assume that Car ID Inc. closes the books and prepares financial statements on December 31, Year 1.

Where appropriate, round to 2 decimal points.

3.Based upon your work in No. 2 above, what is the impact on net income for each year, and in total, due to the foreign currency aspects of this transaction?

Note:

Submit your work in aWord document or Excel. Where appropriate, show your calculations to ensure partial credit.

This is not a group case.The work submitted must be your own.

Part B

Car ID Inc. placed an order with a company in South Africa to purchase vinyl and related upholstery materials for a total of 5,000,000 South Africa Rand (ZAR). Relevant exchange rates are as follows:

SpotForward Rate

DateRate(to April 30, Year 2)

November 1, Year 1. . . . . . . . . . . . . .$0.1200$0.1202

December 31, Year 1. . . . . . . . . . . . . . 0.13000.1301

April 30, Year 2. . . . . . . . . . . . . . . . . . 0.13500.1350

Car ID Inc. closes the books and prepares financial statements on December 31, Year 1.

Required: 40 Points

1.Assume the materials were received on November 1, Year 1 and Car ID pays the supplier on April 30, Year 2. On November 1, Car ID Inc. entered into a six-month forward contract to purchase ZAR 5,000,000. The forward contract is properly designated as afair value hedge of a foreign currency payable. The present value factor for four months at an incremental borrowing rate of 12 percent (1 percent per month) is .96098. Prepare journal entries to account for the purchase and foreign currency forward contract.Where appropriate, round to 2 decimal points.

2.Based upon your work in No. 1 above, what is the impact on net income for each year, and in total, due to the foreign currency aspects of this transaction?

Required: 10 Points

1.Independent of requirement No.1, assume that Car ID Inc.orderedthe materials on November 1, Year 1. They were received and paid for on April 30, Year 2. On November 1, Car ID Inc. entered into a six-month forward contract to purchase ZAR 5,000,000. The forward contract is properly designated as afair value hedge of a foreign currency firm commitment.Prepare journal entries to account for (a) the foreign currency forward contract, (b) the firm commitment, and (3) the payment.

Note:This type of hedge is demonstrated on pages259-260of the text. As a reference, compare these entries to those related to the Fair Value Hedge of a foreign currency payable on pages256-257. There are no new calculations that you need to make.

Pages 259- 260:

Foreign Currency 11,000 Option To record exercise of the foreign currency option: record payment of $80,000 in exchange for Mex$1,000,000, record the receipt of Mex$1,000,000 as an asset at the spot rate of $0.091, and remove the option from the accounts.\fcredit) $85,200 Parts Inventory $80,000 Retained Earnings, 9/30 1,700 Foreign Exchange Loss 5 ,000 Gain on Foreign Currency Option 5,000 Option Expense 3,500 _ $90,200 $90,200 4. Forward Contract Fair Value Hedge of a Foreign Currency Firm Commitment On August 1, Telectro orders parts from its Mexican supplier at a price of Mex$1,000,000. The parts are received and paid for on October 31. On August 1, Telectro enters into a forward contract to purchase Mex$ 1,000,000 on October 3 1. The forward contract is designated as a fair value hedge of the Mexican peso firm commitment. The fair value of the firm commitment is determined through reference to changes in the forward exchange rate. Journal Entries and Impact on the September 30 and October 31 Trial Balances There is no formal entry for the forward contract or the purchase order. A memorandum would 8/1 be prepared designating the forward contract as a fair value hedge of the foreign currency firm commitment. 9/30 Forward Contract $2,970Gain on Forward Contract $2,970 To record the forward contract as an asset at its fair value of $2,970 and record a forward contract gain for the change in the fair value of the forward contract since August 1. Loss on Firm Commitment $2,970 Firm Commitment $2,970 To record the firm commitment as aliability at its fair value of $2,970 based on changes in the forward rate and record a firm commitment loss for the change in fair value since August 1. page 260 Trial Balance-September 30 Debit Credit Forward Contract (asset) $2,970 Firm Commitment (liability) $2,970 Gain on Forward Contract 2,970 Loss on Firm Commitment 2,970$5,940 $5,940 10/31 Forward Contract $3,030 Gain on Forward $3,030 Contract To adjust the carrying value of the forward contract to its - current fair value of $6,000 and record a forward contract gain for the change in fair value since September 30.Loss on Firm Commitment $3,030 Firm Commitment $3,030 To adjust the value of the firm commitment to $6,000 based on changes in the forward rate and record a firm commitment loss for the change in fair value since September 30.Foreign Currency (pesos) $91,000 Cash $85,000 Forward Contract 6,000 To record settlement of the forward contract: record payment of $85,000 in exchange for Mex$1,000,000, record the receipt of Mex$1,000,000 as an asset at the spot rate of$0.091, and remove the forward contract from the accounts. Parts Inventory $91,000 Foreign Currency $91,000 (Mex$) To record the purchase of parts through the payment of Mex$ 1,000,000 to the Mexican supplier. Firm Commitment $6,000spot rate of $0.080. Foreign Currency Option $5,200 Cash $5,200 To record the purchase of a foreign currency option as an asset. 9/30 Foreign Exchange Loss $6,000 Accounts Payable (Mex$) $6,000 To adjust the value of the peso payable to theAdjustment to Net $6,000 Income To close the firm commitment account as an adjustment to net income. Note that the final entry to close the Firm Commitment as an Adjustment to Net Income will be made only in the period in which the Parts Inventory affects net income through Cost of Goods Sold. The Firm Commitment remains on the books as a liability until that time. Trial Balance-October 31 Debit Creditnew spot rate of $0.086 and record a foreign exchange loss resulting from the appreciation of the peso since August 1. Foreign Currency Option $4,300 Accumulated Other Comprehensive $4,300 Income (AOCI) To adjust the fair value of the option from $5,200 to $9,500 witha corresponding credit to AOCI. Accumulated Other Comprehensive $6,000 Income (AOCI) Gain on Foreign Currency $6,000 Option To record a gain on foreign currency option to offset the foreign exchange loss on account payable with a corresponding debit to AOCI.Option Expense $1,700 Accumulated Other Comprehensive $1,700 Income (AOCI) To recognize the change in the time value of the foreign currency option as an expense with a corresponding credit to AOCI. Trial Balance-September 30 Debit Credit Parts Inventory $80,000Accounts Payable (Mex$) $86,000 Foreign Currency Option (asset) 9,500 Cash 5,200 Foreign Exchange Loss 6,000 Gain on Foreign Currency Option 6,000 Option Expense 1,700 $97,200 $97,200 10/31 Foreign Exchange Loss $5,000 Accounts Payable (Mex$) $5,000 To adjust the value of the peso payable to the new spot rate of$0.091 and record a foreign exchange loss resulting from the appreciation of the peso since September 30. Foreign Currency Option $1,500 Accumulated Other Comprehensive $1,500 Income (AOCI) To adjust the carrying value of the foreign currency option to its current fairvalue of $11,000 with a corresponding credit to AOCI. Accumulated Other Comprehensive $5,000 Income (AOCI) Gain on Foreign Currency $5,000 Option To record a gain on foreign currency option to offset the foreign exchange loss on account payable with acorresponding debit to AOCI. Option Expense $3,500 Accumulated Other Comprehensive $3,500 Income (AOCI) To recognize the change in the time value of the foreign currency option as an expense with a corresponding credit to AOCI. Foreign Currency (Mex$) $91,000 Cash $80,000