On June 1, Cairns Corporation purchased goods from a foreign supplier at a price of 1,300,000 francs and will make payment in three months on September 1. On June 1, Cairns acquired an option to purchase 1,300,000 francs in three months at a strike price of $0.824. Relevant exchange rates and option premiums for the franc are as follows:
Date Spot Rate Call Option Premium
for September 1
(strike price $0.824)
June 1 $ 0.824 $ 0.004
June 30 0.832 0.009
September 1 0.854 N/A
Cairns must close its books and prepare its second-quarter financial statements on June 30.
a-1. Assuming that Cairns designates the foreign currency option as a cash flow hedge of a foreign currency payable, prepare journal entries for these transactions in U.S. dollars.
a-2. What is the impact on net income over the two accounting periods?
b-1. Assuming that Cairns designates the foreign currency option as a fair value hedge of a foreign currency payable, prepare journal entries for these transactions in U.S. dollars.
b-2. What is the impact on net income over the two accounting periods?