Vino Veritas Company, a U. S.–based importer of wines and spirits, placed an order with a French supplier for 1,400 cases of wine at a price of 250 euros per case. The total purchase price is 350,000 euros. Relevant exchange rates for the euro are as follows: DateSpot RateForward Rate to
October 31, 2015Call Option Premium
for October 31, 2015
(strike price $1.25)
September 15, 2015$1.25 $1.31 $0.060
September 30, 2013 1.30 1.34 0.095
October 31, 2015 1.35 1.35 0.100
Vino Veritas Company has an incremental borrowing rate of 12 percent (1 percent per month) and closes the books and prepares financial statements at September 30.
a. Assume that the beer arrived on August 15, and the company made payment on October 15. There was no attempt to hedge the exposure to foreign exchange risk. Prepare journal entries to account for this import purchase.
b. Assume that the beer arrived on August 15, and the company made payment on October 15. On August 15, the company entered into a two-month forward contract to purchase 350,000 euros. The company designated the forward contract as a cash flow hedge of a foreign currency payable. Forward points are excluded in assessing hedge effectiveness and amortized to net income using a straight-line method on a monthly basis. Prepare journal entries to account for the import purchase and foreign currency forward contract.
c. Assume that the company ordered the beer on August 15. The beer arrived and the company paid for it on October 15. On August 15, the company entered into a two-month forward contract to purchase 390,000 euros. The company designated the forward contract as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the forward rate. Forward points are not excluded in assessing hedge effectiveness. Prepare journal entries to account for the foreign currency forward contract, foreign currency firm commitment, and import purchase.
d. Assume that the company ordered the beer on August 15. The beer arrived and the company paid for it on October 15. On August 15, the company purchased a two-month call option on 390,000 euros. The company designated the option as a fair value hedge of a foreign currency firm commitment. The fair value of the firm commitment is measured by referring to changes in the spot rate. The time value of the option is excluded from the assessment of hedge effectiveness, and the change in time value is recognized in net income over the life of the option. Prepare journal entries to account for the foreign currency option, foreign currency firm commitment, and import purchase.
e. Assume that, on August 15, the company forecasted the purchase of beer on October 15. On August 15, the company acquired a two-month call option on 390,000 euros. The company designated the option as a cash value hedge of a forecasted foreign currency transaction. The time value of the option is excluded from the assessment of hedge effectiveness, and the change in time value is recognized in net income over the life of the option. Prepare journal entries to account for the foreign currency option and import purchase.