Case 6.2 Cocoa Corporation is a U.S. corporation that purchased 50,000 chocolate

Question

Case 6.2 Cocoa Corporation is a U.S. corporation that purchased 50,000 chocolate bars from a foreign manufacturer on 6/1/2018 for 80,000 foreign currency units, to be paid on 9/1/2018. On 6/1/2018 Cocoa also entered into an option contract to purchase 80,000 foreign currency units on 9/1/2018. Cocoa has a July 31 year end. Cocoa properly account for the transaction as Fair Value Hedge. Exchange rates are as follows Date 6/1/2018 7/31/2018 9/1/2018 t Rate $0.64 $0.66 $0.69 tion Price $800 $1,500 3,600 The option strike price was $0.645 Required 1. Record the journal entries needed by Cocoa on June 1, July 31, and September 1. Round all entries to the nearest whole dollar (10 points) Answer the following questions 2. a. What is the net impact on Cocoa's July 31, 2018 Stockholder equity related to this b. What is the accumulated net impact on Cocoa's Stockholder equity related to this C. What would have been the net impact on Cocoa's July, 31 2018 Stockholder equity d. What would have been the accumulated net impact on Cocoa's Stockholder equity transaction? (1 point) transaction at September 1, 2018? (1 point) related to this transaction if Cocoa had not entered in the Option Contract? (1 point) related to this transaction at September 1, 2018 if Cocoa had not entered in the Option Contract? (1 point) Was the company better- or worst off with the derivative contract? (1 point) e.

Explanation / Answer

1. jOURNAL ENTRIES

6/1/2018 Company purchased chocolates worth foreign currency 80,000 converted @0.64 = $51200

so journal entry is

purchase dr 51200

account payable cr 51200

7/31/2018

closing entry for exchange fluctuation

year end raet $.66 earlier rate $0.64 difference 0.02 for 80000 converted to $ it is $1600 so journal entry for exchange loss is

Foreign exchange difference dr 1600

account payable cr 1600

entry for option contract will be difference between premium price i.e 1500-800there is a gain of $700

forward contract dr 700

foreign echange difference cr 700

9/1/2018 entryon settlement date for rate difference

0.69 - closing rate 0.66 =0.03 for 80000 loss is equal to $2400

so journal entry for exchange loss & account payable settlement is

account payable dr 52800 ( 51200+1600)

foreign exchange difference dr 2400

cash cr 55200

entry for option contract will be difference between premium price i.e 13600-1500 is a gain of $2100

forward contract dr 2100

foreign echange difference cr 2100

2a on 31 st july there is an exchange loss on purchase for 1600 & gain on option for 700 so there is a net loss of $900

2b on 1st sep there is a loss on payable for $1600 + $2400 = $ 4000

& on option there is a gain of $700 +$2100 = $ 2800 so there is a net loss of $4000-$2800 = $1200

2c. on 31st july as per point no. 2a there is a loss of $900 if there is no forward contract loss would have been $ 1600 so there is net gain of $ 700 as on that date

2d on 1st sep there is a net loss of $1200 as per 2b above with forward contract if there is no forward contract loss would have been $4000 so net impact is gain of $2800

2e company is better off with forward contract since co. has reduced loss of $4000 to $1200 by forward contract

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