Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

The purpose of this example is to provide an example of the concepts covered in Chapters 7 and 8: Foreign currency transactions and translation of

The purpose of this example is to provide an example of the concepts covered in Chapters 7 and 8: Foreign currency transactions and translation of foreign subsidiary financial statements. Part 2 extends Part 1 by introducing the concept of hedging.

PART 1.

US International (USI) is a large US based corporation headquartered in Chicago, IL. Kanga Company (Kanga) is an Australian distributor based in Sydney, Australia. USI has granted Kanga a 5-year exclusive distribution contract (expires December 31, 2022 and this contract is subject to renewal rights) for USI products in the Australian state of New South Wales.

Kanga places orders twice a month for delivery at the start of the month (2nd) and mid-month (16th) and these orders are priced in Australian dollars ($AUD). USI recognizes revenue on the date of delivery. Kanga pays for the deliveries on credit terms. The balance outstanding on the 10th of each month is paid on the last day of the same month. As selling prices are set in $AUD, USI bears the risk of exchange rate changes between the $AUD and $US. USI expenses are primarily in $US so fluctuations in exchange rates impacts profit margins. As a general rule, USI reviews Australian prices each quarter. Based on exchange rates in early February 2020 and desired profit margins, USI advised Kanga that prices will increase 3% for the second quarter of 2020, effective April 1, 2020.

In accordance with US GAAP, sales revenue and the associated accounts receivable are recorded using the spot exchange rate on the date of the sale. USI adjusts the accounts receivable to the spot rate at the end of each month and recognizes a foreign exchange gain or loss due to exchange rate movements for the month. This is consistent with the requirement that foreign currency denominated assets and liabilities be remeasured to the spot rate on the date of the balance sheet.

Sales, payment and exchange rate data for the first quarter of 2020 (and first quarter 2019) are reported in the attached excel spreadsheet. Due to shutdowns associated with the coronavirus outbreak, sales dropped during the first quarter. Kanga also advised that they would not be placing an order for delivery on April 2, 2020. Also due to the strengthening of the $US the value of the $AUD declined further reducing sales measured in $US.

image text in transcribed

PART 2.

See the information provided in Part 1. US International (USI) is considering using derivatives to hedge their $AUD exposure. As at January 2, 2020 the following information is known:

Cash to be collected on January 31, 2020 $AUD230,000

Estimated cash February 28, 2020 $AUD240,000

Estimated cash March 31, 2020 $AUD240,000

Spot rate 0.70149

January 31, 2020 forward rate 0.7016

February 28, 2020 forward rate 0.7017

March 31, 2020 forward rate 0.7018

Call option premium: (per $AUD1.00) 0.0115

(3/31/2020 expiration, XP 0.7015)

At January 31, 2020:

Cash to be collected on February 28, 2020 $AUD240,000

Estimated cash March 31, 2020 $AUD200,000

Spot rate 0.67241

February 28, 2020 forward rate 0.6725

March 31, 2020 forward rate 0.6726

Call option premium: (per $AUD1.00) 0.0371

(3/31/2020 expiration, XP 0.7015)

At February 28, 2020:

Cash to be collected on March 31, 2020 $AUD140,000

Spot rate 0.65691

March 31, 2020 forward rate 0.65702

Call option premium: (per $AUD1.00) 0.0486

(3/31/2020 expiration, XP 0.7015)

question :

  1. Assume USI prepares monthly income statements. On January 2, 2020 USI enters into three forward contracts: $AUD230,000 for January 31, 2020; $AUD 240,000 for February 28, 2020; and $AUD240,000 for March 31, 2020. Prepare the journal entries for January, February and March for these forward contracts. What problems do you see with the March 31, 2020 forward contract and how should these problems be resolved?

  1. (Ignore part 3 when answering this part) Assume USI prepares monthly income statements. On January 2, 2020 USI purchases a three-month call option on $AUD 240,000 with an exercise price of 0.7015 and an expiration date of March 31, 2020. Prepare the journal entries for January, February and March for this option. Assume that the time value of the option is included in the measure of hedge effectiveness. How would the accounting differ if the time value was treated as an excluded component in measuring hedge effectiveness?
Cash Cash FX gain (loss) $80,000.00 $160,000.00 $56,119.20 $110,353.60 (9,141.40) 1 Quarter 1 2020 Date Sales 12/31/2019 1/2/2020 1/16/2020 1/31/2020 2/2/2020 2/16/2020 2/28/2020 3/2/2020 3/16/2020 3/31/2020 TOTAL Quarter 1 Australian dollars Accounts Receivable Balance $150,000.00 $230,000.00 $390,000.00 $230,000.00 $160,000.00 $240,000.00 $350,000.00 $240,000.00 $110,000.00 $140,000.00 $170,000.00 $140,000.00 $30,000.00 US dollars Accounts Receivable Balance $104,908.50 $161,342.70 $268,986.90 $154,654.30 $107,585.60 $160,312.80 $234,892.00 $157,658.40 $72,260.10 $91,026.60 $105,104.20 $83,827.80 $17,963.10 Exchange rate* Sales 0.69939 0.70149 0.68971 0.67241 0.66797 0.67112 0.65691 0.65019 0.61826 0.59877 $80,000.00 $110,000.00 $53,437.60 $73,823.20 (4,927.90) $30,000.00 $30,000.00 $19,505.70 $18,547.80 (8,522.70) (22,592.00) $490,000.00 $331,787.10 Weighted Average rate for QTR 1 0.67712 $331,787.10 (30.96) Percentage change in sales - 2020 vs 2019 * Exchange rates from www.oanda.com Marrch 31, 2020 rate actually 3/27/2020 Constant currency sales Change due to exchange rate change $349,356.97 -$17,569.87 (27.30) Percentage change in sales - 2020 vs 2019 (3.66) Percentage change in sales - 2020 vs 2019 Cash Cash FX gain (loss) $80,000.00 $160,000.00 $56,119.20 $110,353.60 (9,141.40) 1 Quarter 1 2020 Date Sales 12/31/2019 1/2/2020 1/16/2020 1/31/2020 2/2/2020 2/16/2020 2/28/2020 3/2/2020 3/16/2020 3/31/2020 TOTAL Quarter 1 Australian dollars Accounts Receivable Balance $150,000.00 $230,000.00 $390,000.00 $230,000.00 $160,000.00 $240,000.00 $350,000.00 $240,000.00 $110,000.00 $140,000.00 $170,000.00 $140,000.00 $30,000.00 US dollars Accounts Receivable Balance $104,908.50 $161,342.70 $268,986.90 $154,654.30 $107,585.60 $160,312.80 $234,892.00 $157,658.40 $72,260.10 $91,026.60 $105,104.20 $83,827.80 $17,963.10 Exchange rate* Sales 0.69939 0.70149 0.68971 0.67241 0.66797 0.67112 0.65691 0.65019 0.61826 0.59877 $80,000.00 $110,000.00 $53,437.60 $73,823.20 (4,927.90) $30,000.00 $30,000.00 $19,505.70 $18,547.80 (8,522.70) (22,592.00) $490,000.00 $331,787.10 Weighted Average rate for QTR 1 0.67712 $331,787.10 (30.96) Percentage change in sales - 2020 vs 2019 * Exchange rates from www.oanda.com Marrch 31, 2020 rate actually 3/27/2020 Constant currency sales Change due to exchange rate change $349,356.97 -$17,569.87 (27.30) Percentage change in sales - 2020 vs 2019 (3.66) Percentage change in sales - 2020 vs 2019

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Financial Accounting For Decision Makers

Authors: Peter Atrill, Eddie McLaney

10th Edition

1292409185, 9781292409184

More Books

Students also viewed these Accounting questions

Question

Describe Hartleys seven varieties of pleasure.

Answered: 1 week ago

Question

What is meant by planning or define planning?

Answered: 1 week ago

Question

Define span of management or define span of control ?

Answered: 1 week ago

Question

What is meant by formal organisation ?

Answered: 1 week ago

Question

What is meant by staff authority ?

Answered: 1 week ago

Question

What can PMT do to improve its safety practices and policies?

Answered: 1 week ago