Main Scenario: The Gannonsan Micro-Brewery (GMB), a Japanese company, is experimenting with a new brew Gannon Stoutas a local competitor to the famous Guinness. GMB's investigations have led to the determination that new equipment, including a stainless steel brewkettle, lauter tune, whirlpool, 6 fermenting and storage tanks, and a hot water tank, all of the highest quality, is needed. Such equipment has been located; it is produced by the German company Bierhaus GMBH, and is available through a distributor in Hong Kong. On November 1, 19X1, GMB signed a contract to purchase the equipment on March 31, 19X2, at a cost of 470,100 Hong Kong dollars (HK$), payable in HK$. GMB is concerned about foreign currency exchange rate movements over the contract period, and wishes to x the price in yen, its functional currency. Therefore, the company enters into a forward to purchase HK$470,100 for ¥ = 7,356,783, when the exchange rate for settlement on March 31, 19X2, is ¥ = 15.6494 per HK$. 

When the contract is signed, and the forward entered into, there are no journal entries. At that time, the forward contract has a value of zero, as does the rm commitment. 

1. On December 31, 19X1, the ¥:HK$ forward exchange rate for settlement on March 31, 19X2, has changed to ¥ = 17.0877 per HK$. Prepare required journal entries, and summary financial statements, showing the results of the change in exchange rates. Assume that GMB has determined that, in the long run, transparent financial statements will be beneficial, so will prepare statements in conformity with U.S. GAAP. (Ignore present value considerations in this case, both in the main scenario and the alternative scenarios.) 

2. On March 31, 19X2, the spot exchange rate is ¥ = 16.8333 per HK$. Make the required journal entries to (1) record the fair values of the firm commitment and forward; (2) reflect the settlement of the forward; and (3) record the purchase of the new equipment. Also, prepare summary financial statements reflecting the results of these transactions.

Click Here to View the Answer for the Initial Case.

Alternative Scenarios: 

Scenario A: 
Assume GMB has not entered into a firm commitment to purchase the equipment, but only forecasts the purchase of the equipment. Repeat requirements 1 and 2 above, assuming GMB enters into the ¥:HK$ hedge. In addition, prepare adjusting entries needed at 12/31/X2 to record depreciation and related items, assuming a ten-year useful life, no salvage, straight-line depreciation, and use of the half-year convention.   Click Here to View the Answer for Scenario A.

Scenario B: 
Assume again GMB has entered into a firm commitment, but will instead enter into a ¥-US$ forward in the amount of US$60,780 to hedge the HK$ firm commitment. Repeat requirements 1 and 2 above, assuming that in addition to the ¥:HK$ rates given above the ¥-US$ rates on November 1, December 31, and March 31 are 121.03954, 132.37000, and 130.45000. (Do not calculate depreciation expense.)  Click Here to View the Answer for Scenario B.

Scenario C:
Assume GMB has not entered into a firm commitment to purchase the equipment, but only forecasts the purchase of the equipment. Repeat requirements 1 and 2 above, assuming that in addition to the ¥:HK$ rates given above the ¥-US$ rates on November 1, December 31, and March 31 are 121.03954, 132.37000, and 130.45000. (Do not calculate depreciation expense.)  Click Here to View the Answer for Scenario C.

Hedging a Firm Commitment HK$ Purchase with a
¥:US$ Forward--Alternative Scenario B

Preliminary Calculations

Total Ineffectiveness =  $12,521 + $2,896 = $15,417

Hedging a Forecasted HK$ Purchase with a
¥:US$ Forward--Alternative Scenario C