Question

On October 15, 2018, Sage Ltd. signed a contract to sell fishing rods to Bay Ltd., which is located in France whose currency is the Euro. The selling price of the fishing rods was €200,000 and the terms of the sale called for delivery to be made on January 15, 2019 and with payment in full on January 31, 2019.

Having signed the sales order, Sage immediately entered into a forward contract with its bank to sell €200,000 on January 31, 2019, at the forward rate of € = $1.220. The spot rate on October 15 was € = $1.210. At the company’s year-end, December 31, 2018, the spot rate was € = $1.217 and the 30-day forward rate was € = $1.225. On January 15 Sage delivered the fishing rods (and recorded the sale) when the spot rate was € = $1.227 and the forward rate was € = $1.231. Sage received €200,000 from Bay Ltd. on January 31, 2019 and settled the forward contract with the bank when the spot rate was € = $1.24. Exchange rates are summarized as follows:

Spot Rate          Forward Rate ¹

October 15, 2018                        $1.210               $1.220

December 31, 2018                     $1.217              $1.225

January 15, 2019                        $1.227               $1.231

January 31, 2019                       $1.240               n/a

¹ For contracts expiring on January 31, 2019

Required:

Prepare the journal entries required in 2018 and 2019 for Sage Ltd. assuming that the forward contract is designated as a cash flow hedge. (Please use the gross method to record the forward contract)

Answer 1

Journal Entries for the year 2018 :

On the date of Entering Contract :

1) Bay Ltd A/C Dr $2,42,000

To Sales A/C $2,42,000

(Being sales recognized because of seller and buyer entering into contract and seller recognized the sales at 1€=$1.210@forward rate)

At the end of the year :

1) Bay Ltd A/C Dr $1400

To provision for Exchange Gain A/C $1400

(Being the Receivable recognised at closing forward rate@$1.217)

2)provision for Foreign Exchange Gain A/C Dr $1400

To profit &Loss A/C. $1400

(Being Gain on exchange of currency is transfer to P&L a/c)

At the time of Payment :

1) .Bank A/C. Dr. $2,48,000

To Bay Ltd A/C. $2,43,400

To Foreign Exchange Gain A/C $4600

(Being the amount received and Gain on exchange transfer to profit&loss A/C and transfer price @$1.24)