Icebreaker Company (a U.S.-based company) purchases materials from a foreign supplier on December 1,...

Question

Icebreaker Company (a U.S.-based company) purchases materials from a foreign supplier on December 1, 2020, with payment of 16,000 dinars to be made on March 1, 2021. The materials are consumed immediately and recognized as cost of goods sold at the date of purchase. On December 1, 2020, Icebreaker enters into a forward contract to purchase 16,000 dinars on March 1, 2021.
Relevant exchange rates for the dinar on various dates are as follows:

Date
Spot Rate
Forward Rate(to March 1, 2021)

December 1, 2020
$2.70
$2.775

December 31, 2020
2.80
2.900

March 1, 2021
2.95
N/A

A. Assuming that Icebreaker designates the forward contract as a cash flow hedge of a foreign currency payable, prepare journal entries for the import purchase and foreign currency forward contract in U.S. dollars.

Uroosa · Accepted Answer

Solution: 
As on 1st December 2020, forward rate is higher than the spot rate. This means the dinar is selling at a premium in the forward market. The forward contract includes a premium of $1,200 [16,000 dinars x ($2.775 − $2.70)]. This premium will be amortized over the life of the forward contract by $400 per month [$1,200 / 3 months]. 
The Icebreaker company will record the following journal entries:
	Icebreaker Company
	General Journal Entries
	Date
	Account Title
	Debit ($)
	Credit ($)
	December 1, 2020
	Cost of goods Sold
	            43,200 
	 
	 
	Accounts Payable
	 
	          43,200 
	 
	(To record the purchase of materials immediately as cost of goods sold and record a foreign currency Accounts payable)
	 
	 
	 
	(16000*$2.70)
	 
	 
	 
	         
	 
	 
	December 1, 2020
	No entry for forward contract
	 
	 
	 
	
	 
	 
	December 31, 2020
	Foreign Exchange Gain/Loss
	              1,600 
	 
	 
	Accounts Payable
	 
	            1,

Icebreaker Company (a U.S.-based company) purchases materials from a foreign supplier on December 1, 2020, with payment of 16,000 dinars to be made on March 1, 2021. The materials are consumed...

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Date	Spot Rate	Forward Rate (to March 1, 2021)
December 1, 2020	$2.70	$2.775
December 31, 2020	2.80	2.900
March 1, 2021	2.95	N/A