Question: The Budvar Company sells parts to a foreign customer on December 1, Year 1, with payment of 20,000 crowns to be received on March 1, Year 2. Budvar enters into a forward contract on December 1, Year 1, to sell 20,000 crowns on March 1, Year 2. Relevant exchange rates for the crown on various dates are as follows:
Forward Rate
Date Spot Rate (to March 1, Year 2)
December 1, Year 1 $1.00 $1.04
December 31, Year 1 1.05 1.10
March 1, Year 2 1.12
Budvar's incremental borrowing rate is 12 percent. The present value factor for two months at an annual interest rate of 12 percent (1 percent per month) is 0.9803. Budvar must close its books and prepare financial statements at December 31.
Required: a. Assuming that Budvar designates the forward contract as a cash flow hedge of a foreign currency receivable, prepare journal entries for these transactions in U.S. dollars. What is the impact on Year 1 net income? What is the impact on Year 2 net income? What is the impact on net income over the two accounting periods?
b. Assuming that Budvar designates the forward contract as a fair value hedge of a foreign currency receivable, prepare journal entries for these transactions in U.S. dollars. What is the impact on Year 1 net income? What is the impact on Year 2 net income? What is the impact on net income over the two accounting periods?