A U.S. company issues a purchase order for £1,000,000 in merchandise, to be delivered in 60 days and paid for in 90 days. The current spot rate is $1.32/£ and the 90-day forward rate is $1.33/£. The company purchases 90-day call options on £1,000,000 with a strike price of $1.32/£, paying $0.02/£ for the call options. The options qualify as a fair value hedge of the firm commitment to buy currency. After 60 days, the spot rate is $1.34, the 30-day forward rate is $1.342, and the calls are worth $0.033. The company takes delivery of the merchandise. Thirty days later, the spot rate is $1.36, and the calls are worth their intrinsic value of $0.04. The company uses the options to pay for the merchandise. All income effects of these transactions are reported in cost of goods sold.
Required
Prepare the journal entries to record the above events.

Question

Quizplus · Accepted Answer

The Answer of A U.S. company issues a purchase order for £1,000,000 in merchandise, to be delivered in 60 days and paid for in 90 days. The current spot rate is $1.32/£ and the 90-day forward rate is $1.33/£. The company purchases 90-day call options on £1,000,000 with a strike price of $1.32/£, paying $0.02/£ for the call options. The options qualify as a fair value hedge of the firm commitment to buy currency. After 60 days, the spot rate is $1.34, the 30-day forward rate is $1.342, and the calls are worth $0.033. The company takes delivery of the merchandise. Thirty days later, the spot rate is $1.36, and the calls are worth their intrinsic value of $0.04. The company uses the options to pay for the merchandise. All income effects of these transactions are reported in cost of goods sold.
Required
Prepare the journal entries to record the above events.

A US Company Issues a Purchase Order for £1,000,000 in Merchandise