Based on past experience, Leickner Company expects to purchase raw materials fro

Question

Based on past experience, Leickner Company expects to purchase raw materials from a foreign supplier at a cost of 1,700,000 marks on March 15, 2018. To hedge this forecasted transaction, the company acquires a three-month call option to purchase 1,700,000 marks on December 15, 2017. Leickner selects a strike price of $0.65 per mark, paying a premium of $0.002 per unit, when the spot rate is $0.65. The spot rate increases to $0.653 at December 31, 2017, causing the fair value of the option to increase to $7,000. By March 15, 2018, when the raw materials are purchased, the spot rate has climbed to $0.67, resulting in a fair value for the option of $34,000.

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?

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.) View transaction list Journal entry worksheet 4. 6 Record purchase of foreign currency option as an asset. Note: Enter debits before credits. Date General Journal Debit Credit 12/15/2017 Record entry Clear entry View general journal K Req A Req B and C >

Explanation / Answer

Solution a:

Solution b:

Impact on net income in 2017 = $5,100 - $1,500 = $3,600

Impact on net income in 2018 = $28,900 - $1,900 = $27,000

Solution c:

Net cash outflow to acquire the raw materials = $1,139,000 - $30,600 = $1,108,400

Journal Entries - Leickner S. No Date Particulars Debit Credit 1 15-Dec-17 Foreign Currency Option Dr (1,700,000*0.002) $3,400.00              To Cash $3,400.00 (Being call option purchased to acquire 1700000 marks at $0.002 per mark) 2 15-Dec-17 No Journal Entry Required 3 31-Dec-17 Foreign Currency Option Dr [(0.653 - 0.65)*1700000] $5,100.00              To Accumulated - Other Comrehensive Income $5,100.00 (Being adjustment of increase in fair value of option) 4 31-Dec-17 Option Expense (AOCI) Dr ($5,100 + $3,400 - $7,000) $1,500.00              To Foreign currency option $1,500.00 (Being time value reduction of foreign currency option) 5 15-Mar-18 Foreign Currency Option Dr [(0.67 - 0.653)*1700000] $28,900.00              To Accumulated - Other Comrehensive Income $28,900.00 (Being adjustment of increase in fair value of option) 6 15-Mar-18 Option Expense (AOCI) Dr ($3,400 - $1,500) $1,900.00              To Foreign currency option $1,900.00 (Being time value reduction of foreign currency option) 7 15-Mar-18 Cash A/c Dr $34,000.00              To Foreign currency option $34,000.00 (Being sale of foreign currency option) 8 15-Mar-18 Raw material inventory Dr $1,139,000.00              To Cash (1700000*0.67) $1,139,000.00 (To record purchase of raw material) 9 15-Mar-18 Accumulated - Other Comprehensive Income Dr $30,600.00              To Gain on sale of Option (Income statement) $30,600.00 (Being gain on option realzied and transferred to statement of comprehensive income)

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