CASE 3 Firm Commitment Hedged with Forward Contract

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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
  currencyFC10,000,000.
• 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.

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CASE 3 - Firm Commitment Hedged with Forward
Contract
Forward Rates Spot Rates for
3/31/2002 9/30/2001 FC1 0.65 FC1
0.66 12/31/2001 FC1 0.67 FC1
0.69 3/31/2002 FC1 0.69 FC1 0.69
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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

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.

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CASE 3 - Firm Commitment Hedged with Forward
Contract

• Entries recorded at 12/31/2001
• Forward contract 295,567
• 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.

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CASE 3 - Firm Commitment Hedged with Forward
Contract

• Entries recorded at 3/31/2002
• Forward contract 4,433
• Earnings 4,433
• To record time value change as there was no
  change in the forward rate (assumption for
  illustrative purposes only).
• Earnings 202,956
• 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

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CASE 3 - Firm Commitment Hedged with Forward
Contract

• 3/31/2002 (continued)
• Cash 300,000
• Forward contract 300,000
• To record cash receipt upon maturity of forward
  contract
• Equipment 6,500,000
• Firm commitment 400,000
• Cash 6,900,000
• To record purchase of equipment

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CASE 4 Example 7 from Appendix B of FASB
Statement 133

• Designation and Discontinuance of a Cash Flow of
  the Forecasted Purchase of Inventory