Critical Thinking Assignment Option 2 Journal

Informationact506critical Thinking Assignment Option 2journal Entries

Include the core assignment question or prompt: Analyze and prepare journal entries related to hedging a forecasted foreign currency transaction, specifically focusing on a foreign currency cash value hedge involving a U.S. company (Push Corp) purchasing inventory from a German supplier, with forward exchange contracts and the related accounting entries over multiple periods.

Paper For Above instruction

Hedging foreign currency transactions is a crucial aspect of international business accounting, particularly when a company seeks to mitigate foreign exchange risk associated with forecasted or committed foreign currency payments. Push Corp, a U.S.-based company operating with the Euro as its transactional currency, provides an illustrative case for examining how hedging strategies, specifically cash flow hedges involving forward exchange contracts, are recorded and accounted for under U.S. GAAP standards, notably ASC 815 (Derivatives and Hedging).

In this scenario, Push Corp intends to acquire inventory from a German supplier, with the transaction scheduled for November 1, 20x7. Although the purchase is forecasted, it is not yet a binding obligation when hedging is initiated. Recognizing the inherent foreign exchange risk, Push Corp enters into a forward exchange contract on October 1, 20x7, to receive €5,000 in 210 days, aligning with the anticipated inventory purchase. This section will analyze the accounting treatment, including the initial recognition of the hedge, subsequent adjustments at reporting dates, and the recognition of exchange gains or losses, following the principles under ASC 815.

Initial Recognition of the Hedge

On October 1, 20x7, when Push Corp enters into the forward contract, it recognizes a foreign currency receivable and a corresponding payable (liability) to the exchange broker. The entry includes recording the commitment at the agreed-upon forward rate, with the purpose of offsetting the forecasted euro payable. The journal entry might be:

Debit: Foreign Currency Receivable from Exchange Broker


Credit: Dollars Payable to Exchange Broker

This initial recognition establishes the hedge's fair value at inception, with the amount recorded based on the contract rate, which corresponds to the forward exchange rate for delivery after 210 days.

Subsequent Adjustments and Recognitions

As the reporting dates approach, the fair value of the forward contract must be adjusted to reflect market movements. On November 1, 20x7, when the inventory delivery occurs, the company assesses the contract's fair value. The journal entries depend on whether the fair value has increased or decreased. If it has increased, a gain is recognized; if decreased, a loss is acknowledged. The entries may look like:

Debit: Foreign Currency Receivable (EURO)


Debit or Credit: Other Comprehensive Income (for the fair value adjustment of the hedge)


Credit: Foreign Currency Gain or Debit: Foreign Currency Loss (depending on the change)

This adjustment ensures that the hedge is marked-to-market, aligning the recorded value with current market conditions. The accumulated gains or losses in other comprehensive income will be reclassified into earnings when the inventory is recognized or the hedge effect is realized.

Recognizing the Purchase and Hedge Effect

Upon acquiring the inventory on November 1, 20x7, the journal entries reflect the recognition of inventory at the euro amount and the settlement of the forward contract. The entries include:

Debit: Inventory (Euro equivalent)


Credit: Accounts Payable (Euro)

Simultaneously, the foreign currency gain or loss accumulated in OCI is reclassified. For instance, if the forward contract had appreciated, the loss recognized earlier is offset; if it depreciated, the gain is similarly adjusted. At year-end or settlement, any remaining unrealized gains or losses are finalized, such as:

Debit: Foreign Currency Loss or Credit: Foreign Currency Gain


Debit or Credit: Accounts Payable


Credit: Foreign Currency Receivable (EURO)

Closing entries adjust the accounts for actual settlement, reflecting the differences between the hedge's fair value and the spot rate at settlement, ensuring accurate financial reporting.

Final Settlement and Reporting

On April 28, 20x8, when the euro payable is settled, Push Corp recognizes the final foreign currency exchange difference between the hedge and the actual spot rate at settlement, recording the related foreign currency gain or loss. The final entries will involve settling the accounts payable in dollars, recognizing the exchange rate impact, and removing the hedge instruments from the books:

Debit: Accounts Payable (Euro)


Credit: Foreign Currency Receivable


Debit/Credit: Foreign Currency Loss or Gain


Credit: Cash (Dollars Paid)

Throughout the process, the hedge accounting ensures that the impact of currency fluctuations on forecasted transactions is appropriately captured in OCI until the forecasted transaction affects earnings, aligning with U.S. GAAP's hedge accounting principles.

Conclusion

Effective foreign currency risk management through hedging requires precise accounting entries to reflect fair values, gains, and losses. Utilizing forward exchange contracts as cash flow hedges, Push Corp demonstrates compliance with ASC 815, ensuring that foreign currency exposures related to forecasted transactions are transparently and accurately reported. Proper recognition and subsequent adjustments facilitate the mitigation of earnings volatility caused by exchange rate fluctuations, optimizing financial statement reliability for stakeholders.

References

  • FASB. (2021). Accounting Standards Codification (ASC) 815 - Derivatives and Hedging.
  • Ernst & Young. (2020). IFRS and US GAAP: A Comparative Analysis of Hedge Accounting.
  • Hampton, J. J. (2020). Financial Decision Making: Financial Accounting, 10th Edition. Cengage Learning.
  • Smith, J. E. (2019). International Financial Management, 14th Edition. Cengage Learning.
  • Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2020). Intermediate Accounting, 16th Edition. Wiley.
  • Chen, S. & Wang, H. (2018). Hedge Accounting and Foreign Exchange Risk Management. Journal of International Financial Management & Accounting.
  • Kothari, S. P. (2019). Capital Markets and Institutions. McGraw-Hill Education.
  • PricewaterhouseCoopers. (2020). Guide to Hedge Accounting under US GAAP and IFRS.
  • Goh, B. (2017). International Financial Reporting: A Practical Guide. John Wiley & Sons.
  • Wahlen, J. M., Baginski, S. P., & Bradshaw, M. (2021). Financial Reporting, Financial Statement Analysis, and Valuation. Cengage Learning.

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