Superb Professors

The Budvar Company purchases parts from a foreign customer on December 1, Year 1, withpayment of 20,000 crowns 20,000 crowns to be made on March 1, Year 2. Budvar enters into aforward contract on December 1, Year 1, to purchase 20,000 crowns on March 1, Year 2. Theparts purchased on December 1, Year 1, become a part of the cost of goods sold on March 15,Year 2.Relevant exchange rates for the crown on various dates are as follows:Date December 1, Year 1December 31, Year1March 1, Year 2 Spot Rate Forward Rate(to March 1,Year 2) $1.00 $1.04 1.051.12 1.1 Budvar’s incremental borrowing rate is 12 percent. The present value factor for two months at anannual interest rate of 12 percent (1 percent per month) is 0.9803. Budvar must close its booksand prepare financial statements at December 31.Required:a. Assuming that Budvar designates the forward contract as a cash flow hedge of a foreigncurrency payable, prepare journal entries for these transactions in US dollars. What is theimpact on Year 1 net income? What is the impact on Year 2 net income? What is theimpact on net income over the two accounting periods?b. Assuming that Budvar designates the forward contract as a fair value hedge of a foreigncurrency payable, prepare journal entries for these transactions in US dollars. What is theimpact on Year 1 net income? What is the impact on Year 2 net income? What is theimpact on net income over the two accounting periods?

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