Case 6.1 Walter Inc. (a U.S. corporation) sold inventory to a company in the Phi

Question

Case 6.1 Walter Inc. (a U.S. corporation) sold inventory to a company in the Philippines for 1,600,000 pesos on account on February 1, 2018, with payment expected in 90 days. Walter entered into a forward contract to hedge this transaction, and properly accounts for the transaction as a cash flow hedge. Walter has a March 31 fiscal year end, and uses an 8% discount rate, resulting in a 30-day present value factor of 9934. The relevant exchange rates are shown below: Forward Rate to Spot Rate May 2, 2018 0.0270 1 peso ebruary 1, 2018 March 31, 2018 May 2, 2018 0.0229-1 0.0254 1 peso 0.0280 1 peso 0.0268-1 peso 0280-1 peso Required: 1. Record the journal entries needed by Walter on February 1, March 31, and May 2. Round all entries to the nearest whole dollar (10 points) Answer the following questions: 2. a. Indicate the amount of the discount or premium that the foreign currency was originally b. What is the net impact on Walter's March 31, 2018 Stockholder equity related to this c. What is the accumulated net impact on Walters Stockholder equity related to this d. What would have been the net impact on Walter's March 31, 2018 Stockholder equity e. What would have been the accumulated net impact on Walter's Stockholder equity sold at in the foreign currency market (1 point) transaction? (1 point) transaction at May 2, 2018? (1 point) related to this transaction if Walter had not entered in the Forward Contract? (1 point) related to this transaction at May 2, 2018 if Walter had not entered in the Forward Contract? Was Walter better- or worst off with the derivative contract? (1 point)

Explanation / Answer

Q.1 Initial Journal Entry:

Feb 1st -- Philippines Company a/c Debit 16,00,000 ($36,640)

To Inventory a/c 16,00,000 ( $36,640)

Entries for Hedging the transaction:

Feb 1st --

Presuming he is entering into forward contract on Feb 1st, the entry for entering into forward contract is

Inventory receivable a/c debit (spot rate) 16,00,000 pesos ( $36,640) ( Asset a/c)

Forward Premium a/c debit $4,000 (expense a/c)

Forward Contract Payable a/c $40,640 (Liability a/c)

March 31st Forward contracts payable a/c debit $ 40,640 Liability a/c

Inventory a/c $ 40,640 (asset a/c)

To Inventory receivable a/c $40,640 (asset a/c)

To Cash a/c $40,640 (asset a/c)

May 2nd Forward Contract payable a/c debit $ 44,800

Inventory a/c debit $ 44,840

To Inventory receivable a/c $ 44,840

To Cash a/c $ 44,840

Q.2:

a) The amount of discount at which the foreign currency originally sold was $36,640.

b) net impact on 31st March was a loss of $4000

c) The accumulated net impact of the transaction on May 2nd was a loss of 8,200 pesos

d) If walter had not entered into forward contract, the net impact on 31st March would be as it was on

Feb 1st itself.

e) The net impact on May 2nd would have been that he would have to bear the net result of the risk

either loss or gain himself. That he would be better off or worse off can be decided only by the

change in the currency exchange rates. Had he not entered into this derivatives contract he would

not have hedged his risk.

P.S:

The whole solution is shown without considering the Present value factor as the information on PV value is ambiguous.

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