PROBLEM H Bulldog Enterprise, a U.S. firm, agreed on November 1, 2016, to buy ge

Question

PROBLEM H Bulldog Enterprise, a U.S. firm, agreed on November 1, 2016, to buy gears from a Mexican firm for 75,000 pesos Delivery and payment are scheduled for February1, 2017. On November 1, 2016, Buldog also acquired a forvard contract to buy 75.000 pesos on February 1, 2016. (The gears represent inventory to the U.S. firm.) The following exchange rates existed: Date Spot Rate 1 peso so.223 1 peso s0.228 1 peso = $0.226 Forward Rate peso s0.227 1 peso s0.230 1 peso-S0226 November 1, 2016 December 31, 2016 February 1, 2017 Discount rate-15% Required a) Prepare the joumal entries needed to properly reflect the purchase transaction and the forward exchange contract. The forward contract meets the conditions necessary to be classified as a hedge on an identifiable foreign currency commitment b) Show how the transactions will be reflected in the 12/31/16 balance sheet.

Explanation / Answer

a) Calculation of profit or loss to be recognized in the books of Bulldog enterprise $ Forward Contract rate            0.226 Less : Spot rate          (0.227) Premium on Contract          (0.001) Forward Contract Amount          75,000 Total premium on entering into forward contract (peso75000*$0.001)                 75 b) As per Accounting Standard 11 on 'The effects of changes in Foreign Exchange Rates' , all foreign currency transactions should be recorded by applying the exchange rate on the date of transactions. Thus, Gears purchased on 01.11.2016 and curresponding creditor would be recorded at $ 16725(i.e. 75000pes*$0.223) According to the Standard, at the balance sheet date all monetary transactions should be reported using the closing rate. Thus, creditor of pesos 75000 on 31.12.2016 will be reported at $17100(i.e. 75000pes* $0.228) and exchange loss of $375(i.e. 17100-16725) should be debited to Profit and Loss Account On 01.02.2017, creditor of pesos 75000 is paid at the rate of $0.226. As per AS 11, exchange difference on settlement of the account should also be transferred to Profit and Loss account. Therefore, $150(17100-16950) will be credited to Profit and Loss Account.

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