Accounting for Foreign Currency Forward Contracts
Avanti Corporation is a small Midwestern company that manufactures wooden furniture. Tim Martin, Avanti’s president, has decided to expand operations significantly and has entered into a contract with a German company to purchase specialty equipment for the expansion in manufacturing capacity. The contract fixes the price of the equipment at 4.5 million euros, and the equipment will be delivered in five months with payment due 30 days after delivery.
Tim is concerned that the value of the euro versus the U.S. dollar could increase during the six months between the date of the contract and the date of payment, thus increasing the effective price of the equipment to Avanti. Lindsay Williams, Avanti’s treasurer, has suggested that the company enter into a forward contract to purchase 4.5 million euros in six months, thereby locking in an exchange rate for euros. Tim likes the idea of eliminating the uncertainty over the exchange rate for euros but is concerned about the effects of the forward contract on Avanti’s financial statements. Because Avanti has not had previous experience with foreign currency transactions, Lindsay is unsure of what the financial statement effects are.
Required
Obtain the most current accounting standards on accounting for foreign currency forward contracts. You can obtain access to accounting standards through the FASB codification. Lindsay has asked you, as her assistant, to research the accounting for a foreign currency forward contract. Write a memo to her reporting on the results of your research. Support your recommendations with citations and quotations from the authoritative financial reporting standards.
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