Ahnuld Corporation, a health juice producer, recently expanded its sales through exports to foreign markets. Earlier this year, the company negotiated the sale of several thousand cases of turnip juice to a retailer in the country of Tcheckia. The customer is unwilling to assume the risk of having to pay in US dollars. Desperate to enter the Tcheckian market, the vice president for international sales agrees to denominate the sale in tchecks, the national currency of Tcheckia. The current exchange rate for 1 tcheck is $2.00. In addition, the customer indicates that it cannot pay until it sells all of the juice. Payment is scheduled for six months from the date of sale.
Fearful that the tcheck might depreciate in value over the next six months, the head of the risk management department at Ahnuld Corporation enters into a forward contract to sell tchecks in six months at a forward rate of $1.80. The forward contract is designated as a fair value hedge of the tcheck receivable. Six months later, when Ahnuld receives payment from the Tcheckian customer, the exchange rate for the tcheck is $1.70. The corporate treasurer calls the head of the risk management department into her office.
Treasuer: I see that your decision to hedge our foreign currency position on that sale to Tcheckia was a bad one.
Department Head: What do you mean? We have a gain on that forward contract. We're $10,000 better off from having entered into that hedge.
Treasurer: That not what the books say. The accountants have recorded a net loss of $20,000 on that particular deal. I'm afraid I'm not going to be able to pay you a bonus this year. Another bad deal like this one and I'm going to have to demote you back to the interest rate swap department.
Department Head: Those bean counters have messed up again! I told those guys in international sales that selling to customers in Tcheckia was risky, but at least by hedging our exposure, we managed to receive a reasonable amount of cash on that deal. In fact, we ended up with a gain of $10,000 on the hedge. Tell the accountants to check their debits and credits again. I'm sure they just put a debit in the wrong place some accounting thing like that.
Have the accountants made a mistake? Does the company have a loss, a gain, or both from this forward contract?
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Undoubtedly, the vice president for International Sales' decision to denominate the sale in tchecks exposed Ahnuld Corporation to foreign currency exchange risk. Hence, the decision of the Head of the Risk Management Department to hedge this foreign currency exchange risk by entering into a forward contract was a prudent business decision. "[Cross-border] transactions depend upon [derivatives such as forward contracts] to ameliorate the risk of currency exchange rate fluctuations" (Bloom & Cenker, 2008, p. 54, ...
This solution discusses Ahnuld Corporation foreign currency accounting.