On September 3, 2017, Robin Franchises, a U.S. company, sold merchandise to a fr

Question

On September 3, 2017, Robin Franchises, a U.S. company, sold merchandise to a franchisee in the U.K., at a price of £8,000,000, payable in three months in pounds. To hedge its exposed asset position, on September 3, 2017, Robin entered a forward contract for delivery of £8,000,000 to the broker on December 3, 2017. On December 3, 2017, Robin received payment from the franchisee, and delivered the pounds to the broker to close the forward contract. Robin’s accounting year ends December 31. Exchange rates ($/£) are as follows:

Required

a. Prepare the journal entries Robin Franchises made on September 3, 2017 and December 3, 2017.

b. Calculate the cash gain or loss realized by Robin Franchises by hedging compared with not hedging.

Spot rate Forward rate for delivery December 3, 2017 September 3, 2017 $1.6168 $1.6155 December 3, 2017 1.6150 ----

Explanation / Answer

Journal Entries 3-Sep Foreign exchange $10,400 Forward Contract $10,400 (To record exchange difference in spot and forward rate) 3-Dec Cash    12,920,000 Foreign exchange              4,000 Forward Contract            10,400 Accounts receivable    12,934,400 (To record settlement of transaction) b. Cash gain or loss realized without hedging Exchange rate on the date of transaction=1.6168 Exchange rate on the date of settlement=1.6150 Exchange difference=0.0018 loss=8000000*0.0018          = $14,400 Cash gain or loss with hedging Exchange rate on the date oof transaction=1.6168 Exchange rate on the date of settlement=1.6150 Exchange rate of forward contract=1.6155 Exchange difference=0.0005 (1.6155-1.6150) Gain=8000000*0.0005          = $4000

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