Machinery International (B) Case Solution & Answer

Machinery International (B) Case Solution 

1.     Is Taylor’s assessment that the forward exchange contract qualified for cash-flow-hedge accounting correct?

Yes the Taylor’s assessment is correct that the overall situation is qualified for a cash flow hedge accounting in the sense that this type of hedging is done in order to reduce the risk which arises due to the variability in exchange rate, it can be seen that the company is currently exposed to the currency risk due to its multinational nature of the organization. Also in the given case it can be seen from the illustrative example that a British subsidiary is required to pay royalty to its parent company which is located in United States.

The locations of the two are entirely different which conveys the issue of different currencies. By considering the overall situation, it can be seen that the cash flow hedging could provide benefit to the company in terms of hedging against the loss in the future cash flows of the firm. The situation given in the case depicts that the company estimates its future in the beginning of the year which is remitted four months later which could create its value down because of the time value of money concept.

The accounting for cash flow hedging is done in a way that until the value is exercised by the company, it would be recorded in the accumulative other comprehensive income and when the hedging is exercised then the losses or gains would be recorded under the retained earnings portion of the company.

2.     What are the journal entries in the parent’s books (all amounts in U.S. $) on January 1, March 31 and April 30, 2001 associated with the illustrative example described in Exhibit 1?

The journal entries regarding the different dates are given as below:

Journal Entries
Date Particulars Debit Credit
1/1/2001 Cash 1,000,000  
31-Mar-01 Forward Contract Receivable (1000000-127000) 873,000  
  Other Comprehensive Income   127000
30-Apr-01 Forward Contract Receivable (1000000-196079) 803,921  
  Other Comprehensive Income   196079
  Cash    1,666,666.67  
  Royalty Income      1,000,000.00
  Forward Contract Receivable    1,666,666.67  
  Other Comprehensive Income          666,666.67

 Accounting Treatment of Hedging in US GAAP and IFRS

In relation to the fair values hedges as well as cash flow hedges, the accounting treatment for U.S. GAAP and IFRS do not have any difference.

In the case of fair value hedges, the standards says that company should re-measure hedged items as well as it derivative each period and whatever the gains or losses occur in the change in value is required to be recorded in the net income. In the circumstances of effective hedging, the gains or losses on derivatives are absolutely offset by gains or losses on the hedged and the net effect is then zero whereas if hedge is not effective then the offsetting is incomplete. However, in both the cases the changes in fair value are recognized in the earnings.

In the cash flow hedging, the changes in the fair value are recorded in other comprehensive income in the period which it occurs. In addition to this, the firms are required to close this amount to the accumulated other comprehensive income. This amount is appeared in net income over the life of hedging instrument. In the cash flow hedge, value of derivative instrument appears in the balance sheet.

What are the possible alternatives with the Machinery International for the hedging?

The company in order to mitigate its risk related to the exposure of currency risk can use any of the three alternatives which are given as below:

  1. Company can go for hedging using the forward contract on January 1, 2001.
  2. Company can go for hedging using the forward contract on March 31, 2001.
  3. Company should not enter into forward contract and accept the spot rate of April 30, 2001……………………                                                                                                                                                                                                                                                This is just a sample partial work. Please place the order on the website to get your own originally done case solution
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