Question

Based on past experience, Leickner Company expects to purchase raw materials from a foreign supplier at a cost of 1,200,000 marks on March 15, 2018. To hedge this forecasted transaction, the company acquires a three-month call option to purchase 1,200,000 marks on December 15, 2017. Leickner selects a strike price of $0.82 per mark, paying a premium of $0.001 per unit, when the spot rate is $0.82. The spot rate increases to $0.827 at December 31, 2017, causing the fair value of the option to increase to $9,000. By March 15, 2018, when the raw materials are purchased, the spot rate has climbed to $0.84, resulting in a fair value for the option of $24,000 a. Prepare all journal entries for the option hedge of a forecasted transaction and for the purchase of raw materials, assuming that December 31 is Leickner's year-end and that the raw materials are included in the cost of goods sold in 2018. b. What is the overall impact on net income over the two accounting periods? c. What is the net cash outflow to acquire the raw materials? Complete this question by entering your answers in the tabs below Req AReq 8 and C Prepare all journal entries for the option hedge of a forecasted transaction and for the purchase of raw materials, assuming that December 31 is Leickner's year-end and that the raw materials are included in the cost of goods sold in 2018. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.) View transaction list Journal entry worksheet Record purchase of foreign currency option as an asset. Note: Enter debits before credits

Answer 1

Solution a:

Journal Entries - Leickner
S. No	Date	Particulars	Debit	Credit
1	15-Dec-17	Foreign Currency Option Dr (1,200,000*0.001)	$1,200.00
		To Cash		$1,200.00
		(Being call option purchased to acquire 1200000 marks at $0.001 per mark)
2	15-Dec-17	No Journal Entry Required
3	31-Dec-17	Foreign Currency Option Dr [(0.827 - 0.82)*1200000]	$8,400.00
		To Accumulated - Other Comrehensive Income		$8,400.00
		(Being adjustment of increase in fair value of option)
4	31-Dec-17	Option Expense (AOCI) Dr ($8,400 + $1,200 - $9,000)	$600.00
		To Foreign currency option		$600.00
		(Being time value reduction of foreign currency option)
5	15-Mar-18	Foreign Currency Option Dr [(0.84 - 0.827)*1200000]	$15,600.00
		To Accumulated - Other Comrehensive Income		$15,600.00
		(Being adjustment of increase in fair value of option)
6	15-Mar-18	Option Expense (AOCI) Dr ($9,000 + $15,600 - $24,000)	$600.00
		To Foreign currency option		$600.00
		(Being time value reduction of foreign currency option)
7	15-Mar-18	Cash A/c Dr	$24,000.00
		To Foreign currency option		$24,000.00
		(Being sale of foreign currency option)
8	15-Mar-18	Raw material inventory Dr	$1,008,000.00
		To Cash (1200000*0.84)		$1,008,000.00
		(To record purchase of raw material)
9	15-Mar-18	Accumulated - Other Comprehensive Income Dr	$22,800.00
		To Gain on sale of Option (Income statement)		$22,800.00
		(Being gain on option realzied and transferred to statement of comprehensive income)

Solution b:

Impact on net income in 2017 = $8,400 - $600 = $7,800

Impact on net income in 2018 = $15,600 - $600 = $15,000

Solution c:

Net cash outflow = $1,008,000 - $22,800 = $985,200

Answer 2

Prepare journal entry for option hedge of a forecasted transaction, raw material purchase in the manner given below: Date Account title and explanation Debit | Credit No entry to record the forecasted transaction. 15-Dec $1,200 Foreign currency option (1,200,000x0.001) Cash (To record purchase of foreign currency option) $1.200 $7,800 Foreign curreny option 31-Decla ($9,000-$1,200) AOCI (To record the increase in foreign currency options) $7.800 31-De $600) Option expense [(0.827-0.82)x1,200,000)-S7,800 AOCI (To record the decrease in time value of option as an expense) $600 $15.000 Foreign currency option 15-Mar (S24,000-$9,000) AOCI (To record the increase in foreign currency option) $15,000

15-Mar Option expense [CO.84-0.827)x1,200,000]-$15,000 $6001 $600 AOCI (To record the decrease in time value of option as an expense) $1,008,000 $984,000 $24,000 Foreign currency 15-Mar (1,200,000 $0.84) Cash (1,200,000x0.82) Foreign currency option (To record exercise of foreign currency option at the strike price of 0.82 and close out the foreign currency option account) $1,008,000 $1,008,000 15-Mar Parts inventory Foreign currency (To record the purchase and payment of 1,200,000 marks to the supplier) $24,000 $24,000 15-Mar AOCI Adjustment to net income (To reord the transfer of AOCI amount to adjustment to net income in the period when the forecasted transaction occurs)

Compute the overall impact on net income over two accounting periods in the manner given below: Amount ($600) (S600) Particulars 2017 Option expense Impact on net income (A) 2018 Cost of goods sold Option expense Adjustment to net income Impact on net income (B) Impact on net income (A+B) ($1,008,000) ($600) $24.000 ($984,600) ($985,200) Calculate net cash outflow to acquire the raw materials in the manner given below: Foreign currency option on December 31 Add: Foreign currency option on March 15th Net cash outflow $984,000 $6,000 $990,000