Case 6.3 Eagle Corp., a U.S. corporation, received an order on November 1, 2013,

Question

Case 6.3 Eagle Corp., a U.S. corporation, received an order on November 1, 2013, to sell two machines to Crown Company, for 95,000 foreign currency units (FCU). The machines were to be delivered and the amount collected on March 1, 2014. In order to hedge its commitment, Eagle entered into a forward contract for 95,000 FCU with delivery on March 1, 2014. The forward contract met all conditions for hedging. Eagle Corp. has an incremental borrowing rate of 12% per year Selected exchange rates for FCU at various dates were as follows: $1.3076 1.2980 1.3060 1.3150 1.2972 November 1, 2013-Spot rate Forward rate for delivery on March 1, 2014 December 31, 2013-Spot rate Forward rate for delivery on March 1, 2014 March 1, 2014- Spot rate Required 1. Record the journal entries needed by Eagle on November 1 and December 31, 2013, and March 1, 2014. Round all entries to the nearest whole dollar (10 points) 2. Answer the following questions Indicate the amount of the discount or premium that the foreign currency was originally sold at in the foreign currency market (1 point) What is the net impact on Eagle's December 31, 2013 Stockholder equity related to this transaction? (1 point) What is the accumulated net impact at March 1, 2014 on Eagle's Stockholder equity related to this transaction? (1 point) What would have been the net impact on Eagle's December, 31 2013 Stockholder equity related to this transaction if Eagle had not entered in the Forward Contract? (1 point) What would have been the accumulated net impact on Eagle's Stockholder equity related to this transaction at March 1, 2014 if Eagle had not entered in the Forward Contract? Was Eagle better- or worst off with the derivative contract? (1 point) a. b. c. d. e.

Explanation / Answer

Transactions involving foreign currency is recorded at three stages which are described as follows:-

1. At the the time if sale

2. On balancesheet date

3. At the time of settlement.

Now initially at the time of sale, transaction will be recorded at the then spot rate i.e. spot rate at the time of sale in the present case spot rate as on 1 Nov. 2013 which is $1.3076, thus AMT. To be recorded will be 95000x1.3076=$124,222. On balancesheet date value to be recorded will be spot rate aa on balance sheet date in the present case value aa on 31 Dec. 2013 i e. $1.3060. The entry at the time of sale and on balance sheet satr will be

Accounts receivable. Dr

To Sales

124,222

124,222

Foreign exchange loss. Dr

To Accounts receivable

152

152

Foreign exchange loss. Dr

To Forward contract

Difference between forward rate as on sale date and as on balance sheet date

1615

1615

On settlement again two entries will be made. In the present case first of all amt. Will be realised at the spot rate on settlement date i.e. with 1.2972 and than for settlement of forward contract. It is to be noted that every time for forward contract entry will be made only for differences in rate and not for principal value.

cash (1.2972x95000 dr

Foreign exchange loss(1.3060-1.2972)x95000

To Accounts receivable

123,234

836

124,070

Forward contract . Dr

To Foreign exchange gain (1.3150-1.2972)x95000

1691

1691

a) since spot rate of fc is more than its forward rate it means fc is at discount rate of discount will be

1.3076-1.2980/1.3076x100=0.74

b) first of all as on balance sheet date total loss on foreign currency transaction will be 152+1615=1767. This loss will reduce the stockholder equity with the same AMT.

C) Now as on settlement date there is a loss of 836 and gain of 1691 as we can see both in journal entries thus the net effect is gain of 855 which will increase the stockholder equity with the same AMT I.e. with 855. This overall combine effect of both the transaction is loss of $912 which will reduce stockholder equity by that AMT.

D) The effect as on balance sheet date if it has not entered into any forward contract would have been only of difference between spot rate as on balance date and spot rate as on sale date i.e. (1.3076-1.3060)x95000=$152 loss i.e. reduction of stockholder equity by $152 as on balance sheet date

E) Now again on settlement date we would have recognised the difference between spot rate as on settlement date and spot rate as on balance sheet satr i.e. (1.3060.12972)x95000=$836. Thus cumulative impact of both transactions would be of $152+$836=$988.

Thus wewean see if we would have gone with forward contract loss would have been for $912 and if no forward cover loss would have been for $988. Thus, the position would have been worst off with an AMT. Of $988-$912=$76.

1 November 2013

Accounts receivable. Dr

To Sales

124,222

124,222

31 December 2013

Foreign exchange loss. Dr

To Accounts receivable

152

152

31 De ember 2013

Foreign exchange loss. Dr

To Forward contract

Difference between forward rate as on sale date and as on balance sheet date

1615

1615

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