The Budvar Company purchases parts from a foreign customer on December 1, Year 1, with

payment of 20,000 crowns 20,000 crowns to be made on March 1, Year 2. Budvar enters into a

forward contract on December 1, Year 1, to purchase 20,000 crowns on March 1, Year 2. The

parts purchased on December 1, Year 1, become a part of the cost of goods sold on March 15,

Year 2.

Relevant exchange rates for the crown on various dates are as follows:

Date December 1, Year 1

December 31, Year

1

March 1, Year 2 Spot Rate Forward Rate

(to March 1,

Year 2) $1.00 $1.04 1.05

1.12 1.1 Budvars incremental borrowing rate is 12 percent. The present value factor for two months at an

annual interest rate of 12 percent (1 percent per month) is 0.9803. Budvar must close its books

and prepare financial statements at December 31.

Required:

a. Assuming that Budvar designates the forward contract as a cash flow hedge of a foreign

currency payable, prepare journal entries for these transactions in US dollars. What is the

impact on Year 1 net income? What is the impact on Year 2 net income? What is the

impact on net income over the two accounting periods?

b. Assuming that Budvar designates the forward contract as a fair value hedge of a foreign

currency payable, prepare journal entries for these transactions in US dollars. What is the

impact on Year 1 net income? What is the impact on Year 2 net income? What is the

impact on net income over the two accounting periods?