Question

Please help complete this problem. This is the second time I request help with this problem as the first time was answered all wrong.

Based on past experience, Leickner Company expects to purchase raw materials from a foreign supplier at a cost of 1,000,000 marks on March 15, 2018. To hedge this forecasted transaction, the company acquires a three-month call option to purchase 1,000,000 marks on December 15, 2017 Leickner selects a strike price of $0.59 per mark, paying a premium of $0.001 per unit, when the spot rate is $0.59. The spot rate increases to $0.598 at December 31, 2017, causing the fair value of the option to increase to $8,500. By March 15, 2018, when the raw materials are purchased, the spot rate has climbed to $0.60, resulting in a fair value for the option of $10,000. 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 A Req B 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.) Date Debit Credit General Journal No Transaction Recorded 12/15/2017 No Transaction Recorded 12/31/2017 No Transaction Recorded 12/31/2017 No Transaction Recorded 51 03/15/2018 No Transaction Recorded 61 03/15/2018 No Transaction Recorded 7 03/15/2018 No Transaction Recorded 8 03/15/2018 No Transaction Recorded 03/15/2018 No Transaction Recorded

Answer 1

Solution

No.	Date	General Journal	Debit($)	Credit($)
1	12/15/2017	Foreign Currency Option	1000
		Cash (1,000,000 x $0.001)		1000
		( Being call option purchased)
2	12/15/2017	No journal entry required
3	12/31/2017	Foreign Currency Option ($8,500 - $1,000)	7500
		Accumulated other comprehensive Income		7500
		(Being fair value of option increased to $ 8500)
4	12/31/2017	Option Expense	500
		Accumulated other comprehensive income		500
		( see workings)
5	03/15/2018	Foreign Currency Option [10,000 - (1000+7500) ]	1500
		Accumulated other comprehensive Income		1500
		(Being fair value of option increased to $10,000)
6	03/15/2018	Option Expense	500
		Accumulated other comprehensive income		500
		(see workings)
7	03/15/2018	Foreign Currency ( marks) (1,000,000 x $ 0.6)	600,000
		Cash (1,000,000 x $0.59)		590,000
		Foreign currency option		10,000
8	03/15/2018	Inventory	600,000
		Foreign currency (marks)		600,000
9	03/15/2018	Accumulated Other comprehensive Income	10,000
		Adjustment to Net Income		10,000
		( Being balance of other comprehensive income transferred to net income)

Calculation of option expense:

On 12/31/2017 :

Gain due to increase in spot rate = ($ 0.598 - $ 0.59) x 1,000,000

= $ 0.008 x 1,000,000

= $ 8,000

Actual increase in Fair value = $ 8,500 - $1,000

= $ 7,500

So, Balance amount is option Expense = $8,000 - $ 7,500

= $500

On 3/15/ 2018:

Gain due to increase in spot rate = ($ 0.60 - $ 0.598) x 1,000,000

= $ 0.002 x 1,000,000

= $ 2,000

Actual increase in Fair value = $ 10,000 - $8,500

= $ 1,500

So, Balance amount is option Expense = $2,000 - $ 1,500

= $500

(B) Impact on net Income:

	2017	2018
Option Expense	(500)	(500)
Cost of goods sold		(600,000)
Adjustment to net income		10,000
Impact on net Income	(500)	(590,500)

(C) Net Cash Outflow :

Purchase of option + Purchase of raw materials (see journal entry no.7)

1,000 + 590,000

= $ 591,000