3. Sold k r l,000,000 forward in anticipation of a fall in the spot rate — Accounting for Contracts Hedging and Speculation Futura Corporation calendar-year active trader foreign

Accounting for Forward Contracts—Hedging and Speculation Futura Corporation, a calendar-year corporation, is an active trader in foreign exchange, to hedge its international activities and for outright speculation. In particular, it is active in the forward market for krone (kr), the currency of Den-mark. On November 1, 2012, Futura entered into the following forward contracts. The contracts were settled on January 29, 2013.

1. Sold kr 2,000,000 forward to hedge a forthcoming kr 2,000,000 sale to a Danish firm; the sale price and January 29,2013 delivery date have been negotiated and the customer will pay upon delivery.

2. Purchased kr 3,000,000 forward to hedge a forecasted purchase from a Danish supplier. Delivery and payment on the forecasted purchase takes place on January 29, 2013.

3. Sold k r l,000,000 forward in anticipation of a fall in the spot rate.

Relevant exchange rates ($/kr) are as follows:

Required

a. Prepare the journal entries made by Futura on December 31, 2012, and January 29, 2013, regarding the above transactions.

b. Indicate how the above transactions would be disclosed on Futura's December 31, 2012, balance sheet and income statement.

c. Comment on the specific use of the forward market by Futura.

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SOLUTION

December 31, 2012	December 31, 2012	December 31, 2012	December 31, 2012
Exchange loss	Exchange loss			120,000
		Investment in forward
		Contract			120,000
To record decline in value of forward sale contract #1;	To record decline in value of forward sale contract #1;	To record decline in value of forward sale contract #1;	To record decline in value of forward sale contract #1;
$120,000 = ($.165 - $.105) x 2,000,000.	$120,000 = ($.165 - $.105) x 2,000,000.	$120,000 = ($.165 - $.105) x 2,000,000.	$120,000 = ($.165 - $.105) x 2,000,000.
Firm commitment	Firm commitment			120,000
		Exchange gain			120,000
To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.
Investment in forward contract				180,000
		Other comprehensive income			180,000
To record increase in value of forward purchase contract #2;	To record increase in value of forward purchase contract #2;	To record increase in value of forward purchase contract #2;	To record increase in value of forward purchase contract #2;
$60,000 = ($.165 - $.105) x 3,000,000.	$60,000 = ($.165 - $.105) x 3,000,000.	$60,000 = ($.165 - $.105) x 3,000,000.	$60,000 = ($.165 - $.105) x 3,000,000.
Exchange loss	Exchange loss			60,000
		Investment in forward
		contract			60,000
To record loss on speculative contract #3; $60,000 = ($.165 - $.105) x 1,000,000.	To record loss on speculative contract #3; $60,000 = ($.165 - $.105) x 1,000,000.	To record loss on speculative contract #3; $60,000 = ($.165 - $.105) x 1,000,000.	To record loss on speculative contract #3; $60,000 = ($.165 - $.105) x 1,000,000.	To record loss on speculative contract #3; $60,000 = ($.165 - $.105) x 1,000,000.	To record loss on speculative contract #3; $60,000 = ($.165 - $.105) x 1,000,000.
January 29, 2013	January 29, 2013	January 29, 2013	January 29, 2013
Exchange loss	Exchange loss			54,000
		Investment in forward
		contract			54,000
To record decline in value of forward sale contract #1 since December 31; $54,000	To record decline in value of forward sale contract #1 since December 31; $54,000	To record decline in value of forward sale contract #1 since December 31; $54,000	To record decline in value of forward sale contract #1 since December 31; $54,000	To record decline in value of forward sale contract #1 since December 31; $54,000	To record decline in value of forward sale contract #1 since December 31; $54,000
= ($.192 - $.165) x 2,000,000.	= ($.192 - $.165) x 2,000,000.	= ($.192 - $.165) x 2,000,000.	= ($.192 - $.165) x 2,000,000.
Firm commitment	Firm commitment			54,000
		Exchange gain			54,000
To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.	To record increase in sales value of firm commitment related to contract #1.
Foreign currency	Foreign currency			384,000
		Sales revenue			384,000
To record sale to Danish customer; $384,000 = $.192 x 2,000,000.	To record sale to Danish customer; $384,000 = $.192 x 2,000,000.	To record sale to Danish customer; $384,000 = $.192 x 2,000,000.	To record sale to Danish customer; $384,000 = $.192 x 2,000,000.
Sales revenue	Sales revenue			174,000
		Firm commitment			174,000

To adjust sales revenue for the accumulated balance in the firm commitment account.

Cash		210,000	210,000
Investment in forward contract		174,000	174,000
	Foreign currency				384,000
To record the settlement of forward sale contract #1.	To record the settlement of forward sale contract #1.
Investment in forward contract		81,000	81,000
	Other comprehensive
	income				81,000
To record increase in value of forward purchase contract #2;	To record increase in value of forward purchase contract #2;
$81,000 = ($.192 - $.165) x 3,000,000.	$81,000 = ($.192 - $.165) x 3,000,000.
Foreign currency		576,000	576,000
	Investment in forward
	contract				261,000
	Cash				315,000
To record settlement of forward purchase contract #2.	To record settlement of forward purchase contract #2.
Inventory		576,000	576,000
	Foreign currency				576,000
To record purchase #2 at the current spot rate of $.192.	To record purchase #2 at the current spot rate of $.192.
Exchange loss		27,000
	Investment in forward
	contract		27,000	27,000	27,000
To record loss on forward sale contract #3; $27,000 = ($.192 - $.165) x 1,000,000.
Foreign currency		192,000
	Cash			192,000	192,000
To record purchase of krone in the spot market, in anticipation of settlement of
forward sale contract #3.	forward sale contract #3.
Cash		105,000
Investment in forward contract		87,000
	Foreign currency			192,000	192,000
To record settlement of forward sale contract #3.	To record settlement of forward sale contract #3.
b.	December 31, 2012 Balance Sheet:

Investment in forward contracts has a net balance of zero.

Firm commitment has a net debit balance of $120,000 (currentasset).

Other comprehensive income is increased by $180,000 (stockholders= equity).

2012 Income Statement:

Net exchange loss on speculative activity is $60,000.

c. Observe that the forward contracts entered into by Futura represented a perfect hedge. That is, forward sale contracts #1 and #3 were hedged by forward purchase contract #2. One could argue that these forward exchange contracts were unnecessary, and whatever transaction costs were incurred by Futura in connection with the contracts represent an unnecessary loss to the firm.