On November 10, 2011, King Co. sold inventory to a customer in a foreign country. King agreed to accept 96,000 local currency units (LCU) in full payment for this inventory. Payment was to be made on February 1, 2012. On December 1, 2011, King entered into a forward exchange contract wherein 96,000 LCU would be delivered to a currency broker in two months. The two month forward exchange rate on that date was 1 LCU = $.30. Any contract discount or premium is amortized using the straight-line method. The spot rates and forward rates on various dates were as follows:
November 10, 2011 - spot rate - $.35 = 1 LCU
December 1, 2011 - spot rate - $.32 = 1 LCE
December 1, 2011 - 2 month foward rate - $.30 = 1 LCU
December 31, 2011 - spot rate - $.29 = 1 LCU
December 31, 2011 - 1 month foward rate - $.28 = 1 LCU
February 1, 2012 - spot rate - $.27 = 1 LCU
The company's borrowing rate is 12%. The present value factor for one month is .9901.
1. (A.) Assume this hedge is designated as a cash flow hedge. Prepare the journal entries relating to the transaction and the forward contract.
(B.) Compute the effect on 2011 net income.
(C.) Compute the effect on 2012 net income
2. (A.) Assume this hedge is designated as a fair value hedge. Prepare the journal entries relating to the transaction and the forward contract.
(B.) Compute the effect on 2011 net income.
(C.) Compute the effect on 2012 net income.