@Determined CPA – The fun of derivatives and hedging. In this problem, Imp Co. entered into a firm commitment to purchase equipment. A firm commitment is basically a contract where both the price and the quantity are agreed upon prior to delivery. Imp is exposed to foreign currency risk because they have agreed to purchase the equipment for a fixed price in a different currency (francs in this case). In order to mitigate this risk, Imp entered into a forward contract to lock in its costs at $90,000 (100,000 francs * $.90). At the inception of there is no journal entry required for both the firm commitment and the forward contract. The forward contract has no value at inception, and the purchase order would not be recorded for financial statement purposes. At the fiscal year end, both the forward contract and the firm commitment would be marked to market, with gains/losses recognized on the income statement. On 12/31/20X1, Imp’s forward contract has increased in value by $3,000 because, while they locked in $.90/franc, a contract with the same delivery date, purchased 12/31/20X1, would cost $.93/franc. At the same time however, Imps firm commitment (a liability) has increased because they have agreed to purchase this equipment for 100,000 francs. When they agreed to the firm commitment, the machine was projected to cost them $90,000. However, when marked to market on 12/31/20X1, the machine would now cost $93,000, a $3,000 loss simply from changes to the exchange rate. The 3,000 gain on the forward contract and the 3,000 loss on the firm commitment will offset each other on the income statement, for a net gain/loss of $0. Journal entries would be:
12/12/20X1 – No entry required
12/31/20X1 – To record the gain in fair value on the forward contract
Dr. Investment in forward contract………………………..3,000 ($.93-$.90) X 100,000
Cr. Exchange gain………………………………………………3,000
12/31/20X1 – To record the loss on the firm commitment
Dr. Exchange loss………………………………………….3,000
Cr. Firm commitment……………………………………………3,000
I hope this helps more than confuses you. And good luck later today!
Also, something that helped me with preferred dividends and EPS was realizing it's reported on the Income Statement, which is for one fiscal year only. Therefore, only the current years portion of preferred cumulative dividends, noncumulative preferred dividends declared are subtracted to get net income available to common stock holders. Dividends in arrears are ignored for EPS.
FAR - 91
AUD - 88
BEC - 86
REG - 79
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