Accounting Problem 6-1, 6-3 Solution

Jarvis Corporation transacts business with a number of foreign vendors and customers. These transactions are denominated in FC, and the company uses a number of hedging strategies to reduce the exposure to exchange rate risk. Several such transactions are as follows:
Transaction A: On November 30, the company purchased inventory from a vendor in the amount of 100,000 FC with payment due in 60 days. Also on November 30, the company purchased a forward contract to buy FC in 60 days. Changes in the value of the commitment are based on changes in forward rates.

Transaction B: On November 1, the company committed to provide services to a foreign customer in the amount of 100,000 FC. The services will be provided in 30 days. On November
1, the company also purchased a forward contract to sell 100,000 FC in 30 days.

Transaction C: On November 1, the company forecasted a purchase of equipment in 30 days. The forecasted cost is 100,000 FC, and the equipment is to be depreciated over five years using the straight-line method of depreciation. On November 1, the company acquired a forwardcontract to buy 100,000 FC in 30 days.

Transaction D: On November 30, the company purchased an option to sell 100,000 FC in 60 days to hedge a forecasted sale to a customer in 60 days. The option sold for a premium of $1,200 and had a strike price of $1.155. The value of the option on December 31 was $2,000.
The time value of all hedging instruments is excluded from the assessment of hedge effectiveness. Relevant spot and forward rates are as follows:

Spot Rate Forward Rate for 30
Daysfrom November 1 Forward Rate for 60
Daysfrom November 30
ovember 1 .. . . . . ... .. .. .. 1 FC ¼ $1.12 1FC ¼ $1.132
November 15 . . . . . ... .. .. .. 1 FC ¼ $1.13
November 30 . . . . . ... .. .. .. 1 FC ¼ $1.15 1 FC ¼$1.146
December 31.. . . . . ... .. .. .. 1 FC ¼ $1.14 1 FC ¼$1.138
Assuming that the company’s year-end is December 31, for each of the above transactions determine the current-year effect on earnings. All necessary discounting should be determined by using a 6% discount rate. For transactions C and D, the time value of the hedging instrument is excluded from hedge effectiveness and is to be separately accounted

Income statement effect of transactions, commitments,& hedging. Clayton industries sells medical equipment worldwide. On Mar 1 of the current year, the company sold equipment, with a cost of $160,000 to a foreign customer for 200,000 euros payable in 60 days. At the same time, the company purchased a forward contract to sell 200,000 euros in 60 days. In another transaction, the company committed, on Mar 15, to deliver equipment in May to a foreign customer in exchange for 300,000 euros payble in June. This equipment is anticipated to have a completed cost of $210,000. On Mar 15, the company hedged the commitment by acquiring a forward contract to sell 300,000 in 90 days. Changes in the value of the commitment are based on changes in forward rates & all discounting is based on a 6% discount rate.
Various spot and forward rates for the euro are as follows:
Spot rate Forward rate fo 60 days from Mar 1 Forward rate for 90 days from Mar 15
Mar 1 $1.180 $1.181
Mar 15 1.181 1.180 $ 1.179
Mar 31 1.179 1.178 1.177
Apr 30 1.175 1.174
For individual months of Mar & Apr calculate the income statement effects of:
1. the foreign currency transaction
2. the hedge on the foreign currency transaction.
3. the foreign currency commitment.
4. the hedge on the foregin currency commitment.