Comprehensive Problem: Four Uses of Forward Exchange Contracts without and with Time Value of Money Considerations
On December 1, 20X1, Micro World, Inc., entered into a 120-day forward contract to purchase 100,000 Australian dollars (A$). Micro World’s fiscal year ends on December 31. The direct exchange rates follow:
Date | Spot Rate | Forward Rate for March 31, 20×2 |
December 1, 20×1 | $0.600 | $0.609 |
December 31, 20×1 | 0.610 | 0.612 |
January 30, 20×2 | 0.608 | 0.605 |
March 31, 20×2 | 0.602 |
|
Required
Prepare all journal entries for Micro World, Inc., for the following independent situations:
a. The forward contract was to manage the foreign currency risks from the purchase of furniture for 100,000 Australian dollars on December 1, 20X1, with payment due on March 31, 20X2. The forward contract is not designated as a hedge.
b. The forward contract was to hedge a firm commitment agreement made on December 1, 20X1, to purchase furniture on January 30, with payment due on March 31, 20X2. The derivative is designated as a fair value hedge.
c. The forward contract was to hedge an anticipated purchase of furniture on January 30. The purchase took place on January 30, with payment due on March 31, 20X2. The derivative is designated as a cash flow hedge. The company uses the forward exchange rate to measure hedge effectiveness.
d. The forward contract was for speculative purposes only.
Note: Requirement (e) uses the material in Appendix 11A.
e. Assume that interest is significant and the time value of money is considered in valuing the forward contract. Use a 12 percent annual interest rate. Prepare all journal entries required if, as in requirement (a), the forward contract was to manage the foreign currency-denominated payable from the purchase of furniture for 100,000 Australian dollars on December 1, 20X1, with payment due on March 31, 20X2.
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