On December 1, 2013, a US firm, manufacturing equipment, plans to sell a piece of equipment [with asking price of 200,000 units of foreign currency (FC)] during January of 2014. The transaction is probable. The company enters into a forward contract on December 1, 2013 to sell 200,000 FC on February 1, 2014 for $1.02.
Spot rates and forward rates were as follows (dollars per FC unit):
December 1, 2013: spot rate = $1.04; Forward Rate 2/1/14 = $1.02
Balance Sheet Date 12/31/13: spot rate = $1.01; Forward Rate 2/1/14 = $1.00
January 31 and February 1, 2014: spot rate = $0.99, Forward Rate = N/A
On January 31, 2014, the equipment was sold for 200,000 FC. The cost of the equipment is $170,000. (Hint: the equipment is inventory for the US firm).
The US company has an incremental borrowing rate of 12% per year.
Required:
Record the journal entries needed on December 1 and December 31, 2013; January 31 and February 1, 2014. Round all entries to the nearest whole dollar.
Answer the following questions:
a. Indicate the amount of the discount or premium at which the foreign currency was original sold in the foreign currency market.
b. What is the net impact on December 31, 2013 Stockholder equity related to this transaction?
c. What is the accumulated net impact at February 1, 2014 on Stockholder equity related to this transaction?
d. What would have been the net impact on December, 31 2013 Stockholder equity related to this transaction if the US company had not entered in the Forward Contract?
e. What would have been the accumulated net impact on the US Company’s Stockholder equity related to this transaction at February 1, 2014 if the US Company had not entered in the Forward Contract? Was the US company better off or worse off with the derivative contract?