Result of fair value hedge of a firm commitment


On May 1, 2007, Mosby Company received an order to sell a machine to a customer in Canada at a price of 2,000,000 Mexican pesos. The machine was shipped and payment was received on March 1, 2008. On May 1, 2007, Mosby purchased a put option giving it the right to sell 2,000,000 pesos on March 1, 2008 at a price of $190,000. Mosby properly designates the option as a fair value hedge of the peso firm commitment. The option cost $3,000 and had a fair value of $3,200 on December 31, 2007. The following spot exchange rates apply:

Date Spot rate

May 1, 2007 $0.095

Dec 31, 2007 $0.094

March 1, 2008 $0.089

Mosby's incremental borrowing rate is 12 percent and the present value factor for two months at a 12 percent annual rate is .9803.

What was the net impact on Mosby's 2007 income as a result of this fair value hedge of a firm commitment?

What was the net impact on Mosby's 2008 income as a result of this fair value hedge of a firm commitment?

What was the net increase or decrease in cash flow from having purchased the foreign currency option to hedge this exposure to foreign exchange risk?

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Accounting Basics: Result of fair value hedge of a firm commitment
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