On November 1, 2011, Cahoon Company sold some limited edition art prints to Sitake Company for ¥47,850,000 to be paid on January 1, 2012. The current exchange rate on November 1, 2011, was ¥110=$1, so the total payment at the current exchange rate would be equal to $435,000. Cahoon entered into a forward contract with a large bank to guarantee the number of dollars to be received. According to the terms of the contract, if ¥47,850,000 is worth less than $435,000, the bank will pay Cahoon the difference in cash. Likewise, if ¥47,850,000 is worth more than $435,000, Cahoon must pay the bank the difference in cash. Assuming the exchange rate on December 31, 2011 is ¥115=$1, what amount will Cahoon disclose as the fair value of the forward contract on December 31, 2011 (answers rounded to the nearest dollar)?

Question

Quizplus · Accepted Answer

As of November 1, 2011, the forward contract had no fair value because the exchange rate on that date was the same as the contract rate.

On December 31, 2011, the exchange rate had changed to ¥115=$1. Therefore, the yen amount of the contract, ¥47,850,000, is worth $416,086.96 ($47,850,000 ÷ 115).

Since the spot rate on December 31, 2011, is greater than the contract rate, the contract is now in a liability position for Cahoon. The liability amount will be equal to the difference between the current spot rate and the contract rate multiplied by the contract amount in yen. That is, ($1/¥115 − $1/¥110) × ¥ 47,850,000 = ¥18,300, and when converted to dollars using the current spot rate, the result is $18,912.69 rounded to $18,913.

Therefore, Cahoon would disclose a liability of $18,913 for the forward contract on December 31, 2011.

On November 1, 2011, Cahoon Company Sold Some Limited Edition