On 6/1/X2, an American firm purchased a inventory costing 100,000 Canadian Dollars from a Canadian firm to be paid for on 8/1/X2. Also on 6/1/X2, the American firm entered into a forward contract to purchase 100,000 Canadian dollars for delivery on 8/1/X2. The exchange rates were as follows: The American firm's fiscal year end is 6/30/X2. The changes in the value of the forward contract should be discounted at 8%. The transaction qualifies as for accounting as a cash flow hedge. What is the total amount that will be recognized in other comprehensive income in the year ended 6/30/X2?

Question

On 6/1/X2, an American firm purchased a inventory costing 100,000 Canadian Dollars from a Canadian firm to be paid for on 8/1/X2. Also on 6/1/X2, the American firm entered into a forward contract to purchase 100,000 Canadian dollars for delivery on 8/1/X2. The exchange rates were as follows:  The American firm's fiscal year end is 6/30/X2. The changes in the value of the forward contract should be discounted at 8%. The transaction qualifies as for accounting as a cash flow hedge. What is the total amount that will be recognized in other comprehensive income in the year ended 6/30/X2?

Quizplus · Accepted Answer

Since this is a cash flow hedge, the gain or loss on the forward contract will be recognized in other comprehensive income. The Canadian dollar weakened from 1.20 USD/CAD to 1.25 USD/CAD, causing a loss on the forward contract. The loss on the forward contract would be ($100,000 x (1.25-1.20)) = $5,000. Since the contract is to be settled in two months, we need to discount the loss at 8% for two months: $5,000 x (2/12) x 0.08 = $66.67. Therefore, the total amount recognized in other comprehensive income would be the loss on the forward contract ($5,000) minus the discount ($66.67), which equals $4,933.33 or $320 credit after tax (assuming a tax rate of 35%).

On 6/1/X2, an American Firm Purchased a Inventory Costing 100,000