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Apply Spot Exchange Rates

On November 1, 2011, Dos Santos Company forescasts the purchase of raw materials from a Brazilian supplier on February 1, 2012, at a price of 200,000 Brazilian reals. On November 1, 2011, Dos Santos pays 1,500 for a three month call option on 200,000 reals with a strike price of .40 per real. Dos Santos property designates the option as a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of 1,100. The following spot exchange rates apply.

Date U.S. Dollar per Brazillian Real
Noverber 1, 2011 .40
December 31, 2011 .38
February 1, 2012 .41

What is the net impact on Dos Santos Company's 2012 net income as a result of this hedge of a forecasted foreign currency trasaction? Assume that the raw materials are consumed and become a part of the cost of goods sold in 2012.

A 80,000 decrease in net income
B 80,600 decrease in net income
C 81,100 decrease in net income
D 83,100 decrease in net income

Solution Preview

ANSWER: B 80,600 decrease in net income

November 1, 2011
DR: Foreign currency option 1,500
CR: Cash 1,500

December 31, 2011
DR: Loss on foreign currency ...

Solution Summary

The expert applies spot exchange rates. A spot exchange for rates applied are determined.

$2.19