Problem 9

Entity A has the peso as its functional currency. It expects to purchase a machine for $10,000 on October 31, 2020. Accordingly, it is exposed to the risk of increases in the dollar rate. If the dollar rate increases before the purchase takes place, the entity will have to pay more pesos to obtain the $10,000 that it will have to pay for the machine. To offset the risk of increases in the dollar rate, the entity enters into a forward contract on April 30, 2020, to purchase $10,000 in six-months for a fixed amount of P500,000. Entity A designates the forward contract as a hedging instrument in a cash flow hedge of its exposure to increases in the dollar rate.

On July 31, 2020, the dollar has appreciated such that $10,000 for delivery on October 31, 2020 costs P550,000 on the market. Therefore, the forward contract has increased in fair value by P50,000; i.e., the difference between the committed price of P500,000 and the current price of P550,000. (Ignoring for simplicity, the effect of differences in interest rates between the two currencies) Entity A still expects to purchase the machine for $10,000, so it concludes the hedge is 100% effective. Because the hedge is fully effective, the entire change in the fair value of the hedging instrument is recognized directly in equity.

On October 31, 2020, the dollar rate has further increased, such that $10,000 cost 560,000 in the spot market. Therefore, the fair value of the forward contract has increased by P60,000; the difference between the committed price of P500,000 and the spot price of P560,000. It still expects to purchase machine for $10,000.

Required: Prepare all the journal entries for the given information.