Problem 10-5 (LO 6) Cash flow hedges of a commitment, a forecasted transaction and a recognized liability. On March 1, a company committed to acquire 10,000 units of inventory to be delivered on May 31. The purchase price is to be paid in foreign currency (FC) in the amount of 200,000 FC. Assume that the commitment?s negative values are $7,960 and $14,000 as of March 31 and May 31, respectively. Also assume that the inventory will be processed further during the month of June at a cost of $12.50 per unit and will be sold on July 10 to a customer for $90 per unit. On March 1, the company also forecasted the purchase of a piece of equipment to be delivered on May 31 with a cost of 200,000 FC. The equipment was placed into service at the beginning of July and has a useful life of 10 years and a salvage value of $74,000. On March 1, the company borrowed 200,000 FC from a foreign bank at an interest rate of 6.0% with interest and principal to be repaid on May 31.

Assume that on March 1 the company acquired three identical options to buy FC on May 31 with each option to be designated as a hedge for each of the three situations described above. Information relating to each option is as follows:

For Each Option Mar 1 Mar 31 May 31

Notional Amt 200,000 200,000 200,000

Strike Price $2.52 $2.52 $2.52

Spot Price $2.50 $2.54 $2.57

Value of option $1,300 $5,000 $10,000

For each of the three hedged situations, prepare a schedule to show the impact on earnings for each of the first three calendar quarters of the year noting that all hedges are to be considered cash flow hedges.

The attached spreadsheet was given to us. Problem 10-5 is on a separate tab

Problem 10-2 Balance Sheet Accounts Debit (Credit) Inventory of medical equipment Firm commitment Accounts Receivable Forward contract receivable 2nd Quarter 3rd Quarter Income Statement Accounts Debit (Credit) (Gain) loss on firm commitment (Gain) loss on forward contract (See calculations below) Sales Revenue: Adjusted for firm commitment Adjusted sales revenue Cost of sales Exchange (gain) loss on receivable Use the rows below for your calculations 1-Jun Number of FC Spot rate - 1 FC Forward rate remaining time - 1 FC Fair value of forward contract: Original forward rate Current forward rate Change-gain (loss) in forward rate Present value of change: n=3.5, I = .50% n=2.0, I = .50% n=0.5, I = .50% Change in value from prior period: Current present value Prior present value 30-Jun Change in present value The cost of the equipment is given in the problem with a date of June 15, which is in the second quarter. See page 570 for firm commitment. Present Value of change - n= 3.5, I =.50, complete calculations below 800,000 FC x September 30 spot rate. (3rd Quarter since it is for October 15) For second quarter current PV at June 30 and for third quarter PV at September 30. Use the space for you Pages 570 and 580-583 are helpful when completing this problem. Change in PV for June 30 and August 15, in the respective quarters Second quarter change in PV; Third quarter is the total of the August 15 gain and the Sept 30 gain. 800,000 FC x August 15 spot rate PV of change at August 15, n=2, I = .50% Sales revenue + Adjustment for firm commitment. Cost of the equipment 800,000 FC x (September 30 spot rate - August 15 spot rate) 15-Aug 30-Sep hich is in the second quarter. , complete calculations below. mber 30. Use the space for your calculations below. n and the Sept 30 gain. Problem 10-5 PROBLEM 10-5 For each option March 1 March 31 Notional amount Strike price Spot rate Value of option... Intrinsic value Time value 1st Quarter 2nd Quarter Related to the commitment: Gain (loss) on commitment Gain (loss) on option transferred from OCI to offset gain or loss on commitment Gain (loss) in time value Sales revenue Cost of Sales: Original cost Adjustment for change in value of commitment Additional processing costs Total impact on earnings Related to the purchase of equipment: Gain (loss) in time value Depreciation expense: Total impact on earnings....................................................... Related to the note payable: Total impact on earnings....................................................... Refer to exercise 10-3. May 31 Copy rows 5-8 directly from the problem. 3rd Quarter Total Refer to the problem: Assume the negative values are....., fill these numbers in here 10,000 units @ $90 per unit FC x May 31 spot rate (May is 3rd quarter) Negative value of 14,000 as of May 31. 10,000 units x processing fee. Same as above Use the salvage value and the useful life to determine the depreciation. Total each column ....., fill these numbers in here. May 31 gives you the total, so you can calculate the 2nd Quarter by subtracting the 1s the depreciation. d Quarter by subtracting the 1st quarter from the total