Kfruit Ltd, a New Zealand company, sells kiwifruit overseas. Its functional currency is the New Zealand dollar. The company has issued an invoice for US$700,000 receivable in two months’ time. The spot rate of exchange at the date of the invoice is 0.80 (that is, US$0.80 buys NZ$1.00). To hedge the currency risk, the company buys a put option, which gives it the right to sell US$ at an agreed exercise price of 0.81 (that is, US$0.81 would buy NZ$1.00 if the put is exercised). The put costs NZ$5,000.
REQUIRED:
(a) Prepare the journal entries to record the initial sale of kiwifruit and the purchase of the put option. Round figures to the nearest dollar.
(b) Assume the spot rate of exchange is 0.82 after two months (when the receivable pays). Prepare the journal entries at the time of receipt. Round figures to the nearest dollar.
(c) At expiry of the put option, use the relevant amounts in your answers for part (b) of this question to explain whether or not the company should exercise the option.