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Homework answers / question archive / Mack Ltd

Mack Ltd

Accounting

Mack Ltd. is a Canadian company that reports using IFRS. Mack sells equipment to industrial firms and is involved in foreign-currency transactions both as a purchaser and as a seller. The company had two international transactions in 20x6: it sold equipment to a customer in Thailand and it purchased a specialized piece of equipment from a retailer in Britain. Details of these transactions follow. Mack has a May 31 year end. a) Thai sale On April 30, 20X6 (20x6 fiscal year), Mack reached an agreement to sell equipment to a customer in Thailand and agreed to take payment in Thai baht (B). The equipment was scheduled to be delivered on June 12, 20X6 (20X7 fiscal year), at which time the customer would pay in full. Given Mack's uncertainty about dealing in this unfamiliar currency, on the date the sale was negotiated, the company also arranged with its bank to hedge the transaction. This was the first time that Mack has entered into a formal hedging arrangement for one of its foreign-currency transactions. The sale price of the equipment was B2,500,000 and the cost to manufacture the equipment was C$65,000. Selected information regarding the spot rates and forward rates between the Thai baht and the Canadian dollar was as follows: Forward rate for Date Spot rate delivery June 12, 20X6 April 30, 20X6 B1 = C$0.03200 B1 = C$0.03336 May 31, 20X6 B1 = C$0.03334 B1 = C$0.03385 June 12, 20X6 B1 = C$0.03475 B1 = C$0.03475 The goods were delivered on June 12, 20X6, as per the sales agreement, and the customer paid on the same day. The forward contract was settled on June 12, 20X6, as well. Hedge accounting was not used. Required: Prepare journal entries to record the forward contract and the sale of equipment, including the adjusting entries required at year end and the settlement date. Support the journal entries with a brief explanation as to their nature. Include supporting calculations in the journal entries or reference their location elsewhere on the worksheet. 

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Please note that the answer to this question may confuse you because to answer this question we need knowledge of Derivatives and Forex also, I assume that you know the Basics of how derivative and forex work, if you know the basics it will do the work, otherwise please don't dislike question if you don't understand it, because the answer is correct only, though you can ask doubts in comments.

Please note that this question is about the hedging transaction. Here we will account for it as an embedded derivative according to IFRS 9 Financial Instrument. We can see that here a forward sale agreement is entered by a Canadian company with a company in Thailand to Sale equipment and receive Thai Baht. Hence this contract is comprised of two transactions:

1) A host contract to Receive C$83400 (2500000*0.03336) from the sale of Equipment.

2) And a reverse hedge contract to pay C$ and Receive Thai Baht at 1Baht = C$0.03336.

Please note that both of the above transactions are notional transactions for accounting purposes based on the notional amount and we will be recording only net gain or loss entries, as real transactions are the sale of equipment and receipt of Thai Baht which will be performed on June 12 only.

So here host contract will not be accounted for till the sale of Equipment, however, we will record gain or loss in the derivative transactions and will create corresponding Derivative assets or liability. This gain or loss will be recorded in the profit or loss account.

On delivery date sales will be recorded at the amount of host contract i.e C$83400, after this derivative asset or liability will become part of FInancial asset(Debtors) that arise on delivery.

So Journal Entries and all the calculations will be as follows.

please see the attached file for the complete solution.

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