3-1 CASE 3 - Firm Commitment Hedged with Forward Contract On 9/30/2001, GlobalTechCo, a U.S. company issues a purchase order to a foreign supplier for.

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Presentation transcript:

3-1 CASE 3 - Firm Commitment Hedged with Forward Contract On 9/30/2001, GlobalTechCo, a U.S. company issues a purchase order to a foreign supplier for equipment to be delivered and paid for at 3/31/2002. The terms of the agreement meet the criteria for a firm commitment. The price is denominated in the foreign currency FC10,000,000. The company simultaneously enters into a forward- exchange contract, which matures 3/31/2002, in order to receive FC10,000,000 and pay U.S. $6,600,000.

3-2 Forward Rates Spot Ratesfor 3/31/2002 9/30/2001FC1 = $0.65FC1 = $ /31/2001 FC1 = $0.67FC1 = $0.69 3/31/2002FC1 = $0.69FC1 = $0.69 CASE 3 - Firm Commitment Hedged with Forward Contract

3-3 CASE 3 - Firm Commitment Hedged with Forward Contract The entity documents the following: – Effectiveness will be measured by (a) comparing the change in the fair value of the forward contract attributable to changes in spot rates with (b) the changes in the fair value of the firm commitment attributable to changes in the spot rates – The spot-forward difference will be excluded from the assessment of effectiveness and recorded through earnings

3-4 CASE 3 - Firm Commitment Hedged with Forward Contract The following demonstrates the journal entries to record this hedge under Statement 133: At 9/30/2001, no entry is recorded under Statement 133 because a cash payment is not made and the contract has a zero value.

3-5 Entries recorded at 12/31/2001 Forward contract295,567 Earnings 295,567 To record the forward contract fair value (present value at a 6% discount rate of ((.69 –.66) x FC10 million); includes both effective portion of hedge and ineffectiveness due to changes in the forward rate. Earnings 197,044 Firm commitment 197,044 To record the change in the fair value of the foreign-currency component of the firm commitment attributable to the change in spot rates ((.65 –.67) x FC10 million), discounted at 6%. CASE 3 - Firm Commitment Hedged with Forward Contract

3-6 Entries recorded at 3/31/2002 Forward contract4,433 Earnings 4,433 To record time value change as there was no change in the forward rate (assumption for illustrative purposes only). Earnings202,956 Firm commitment 202,956 To record the change in the fair value of the foreign-currency component of the firm commitment attributable to the change in spot rates ((.65 –.69) x FC10 million) – 197,044 CASE 3 - Firm Commitment Hedged with Forward Contract

3-7 3/31/2002 (continued) Cash 300,000 Forward contract 300,000 To record cash receipt upon maturity of forward contract Equipment6,500,000 Firm commitment 400,000 Cash6,900,000 To record purchase of equipment CASE 3 - Firm Commitment Hedged with Forward Contract

3-8 CASE 4 – Example 7 from Appendix B of FASB Statement 133 Designation and Discontinuance of a Cash Flow of the Forecasted Purchase of Inventory