Homework Chapter 7: Dfll Company Is A US Manufacturer And Se ✓ Solved

Homework Chapter 7 Dfll Company Is A Us Manufacturer And Seller Of

Record the sale journal entry (ignore the cost of goods entry) for DFLL Company on Nov 20, 2017. Provide the adjusting entry (if necessary) about the Nov 20 sale on Dec 31, 2017. Provide the journal entry for DFLL Company for the cash collection on Feb 1, 2018, assuming the euros are exchanged immediately after collection. Analyze the trend of the USD-EUR exchange rate during this period. Consider whether DFLL Company should enter into a forward contract on Nov 20, 2017, at 1 USD = 0.851 EUR. Evaluate if the company should consider purchasing a put option on Nov 20, 2017, to sell €500,000 at the same rate, and provide rational commentary.

Sample Paper For Above instruction

The financial management of multinational companies often hinges critically on currency exchange rates and associated risk management strategies. In this scenario, DFLL Company, a U.S.-based manufacturer and seller of personal electronic devices, engaged in a significant cross-border transaction involving the sale of 1,000 laptops to a German wholesaler, payable in euros. This case underscores the importance of understanding journal entries for sales, the effects of exchange rate fluctuations on financial statements, and the strategic decisions regarding hedging instruments such as forward contracts and options.

Initially, on November 20, 2017, DFLL Company recorded the sale. Although the sale was completed, payment was not received in cash until February 1, 2018. The journal entry on November 20, 2017, is made to recognize the sale and accounts receivable, excluding the cost of goods sold for simplicity, as per instructions. The entry involves debiting accounts receivable and crediting sales revenue. Since the payment is to be received in euros, and considering the transaction date, the initial journal entry would be based on the spot exchange rate, which was 1 USD = 0.852 EUR.

Moving to December 31, 2017, an adjustment might be necessary if the company applies accounting standards that require recognition of unrealized currency translation gains or losses at period-end. If the exchange rate changed substantially from the initial recording, an adjusting entry would adjust accounts receivable to reflect the fair value based on the current exchange rate—here, 1 USD = 0.833 EUR. This adjustment affects the company's income statement and reflects the hedging or directional risk from currency movements.

Upon collection of the euro receivable on February 1, 2018, the company records the receipt in USD based on the prevailing exchange rate at that date, 1 USD = 0.799 EUR. The journal entry includes debiting cash in USD and crediting accounts receivable, with foreign exchange gains or losses recorded as applicable. This transaction effectively realizes the foreign currency translation, translating the receivable amount into USD at the exchange rate prevailing on collection date.

Examining the trend of the USD-EUR rate over the period reveals a depreciation of the euro relative to the USD. Starting at 1 USD = 0.852 EUR in November, then fluctuating, but ending at 1 USD = 0.799 EUR in February, indicates a consistent trend where the euro weakens against the dollar. Such percentage-based depreciation influences the company’s foreign currency exposure and risk management strategies.

Regarding hedging decisions, a forward contract at 1 USD = 0.851 EUR locking in the rate for February 1, 2018, could mitigate the risk of unfavorable currency movements. Given that the euro depreciated further to 0.799 EUR, the forward contract would have protected DFLL from adverse exchange rate shifts, suggesting a beneficial hedge historically. However, if the euro had appreciated, the company might have missed out on potential gains. Thus, the decision to hedge depends on risk appetite, cost of hedging, and market expectations.

Alternatively, the company may consider purchasing a put option at a premium to hedge against adverse currency movements while retaining some upside potential if the euro appreciates. A put option with a strike rate of 1 USD = 0.851 EUR provides the right, but not obligation, to sell euros at that rate, providing insurance against a further decline in the euro’s value relative to USD. Rationally, if the company anticipates continued euro depreciation and wants to preserve flexibility, buying the put option is prudent, especially if the premium cost is justified by potential gains from currency movements.

In conclusion, managing foreign currency risk is vital for companies engaged in international transactions. The decision to hedge via forward contracts or options must be aligned with the company’s risk management policy, market outlook, and financial capacity. DFLL’s case exemplifies the importance of understanding exchange rate trends, accounting implications of currency fluctuations, and strategic hedging choices to optimize financial performance amidst currency volatility. Each instrument—forward contracts and options—offers distinct advantages and disadvantages, requiring careful analysis to determine suitability based on company objectives and market conditions.

References

  1. Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management (15th ed.). Cengage Learning.
  2. Madura, J. (2018). International Financial Management (13th ed.). Cengage Learning.
  3. Shapiro, A. C. (2020). Multinational Financial Management (11th ed.). Wiley.
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  5. United States Department of the Treasury. (2017). Currency Exchange Rate Data. Retrieved from https://treasury.gov
  6. Investopedia. (2017). Forward contracts. https://www.investopedia.com/terms/f/forwardcontract.asp
  7. Investopedia. (2018). Currency options. https://www.investopedia.com/terms/c/currencyoption.asp
  8. International Monetary Fund. (2017). Exchange Rate Arrangements. IMF Publication.
  9. Bloomenthal, A. (2020). Foreign Currency Hedge. Investopedia. https://www.investopedia.com/terms/f/foreigncurrencyhedge.asp
  10. CFA Institute. (2016). Asset Risk Management in International Contexts. CFA Publications.

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