Question

On April 1, Quality Corporation, a U.S. company, expects to sell merchandise to a French customer in three months, denominating the transaction in euros. On April 1, the spot rate is $1.41 per euro, and Quality enters into a three-month forward contract cash flow hedge to sell 400,000 euros at a rate of $1.36. At the end of three months, the spot rate is $1.37 per euro, and Quality delivers the merchandise, collecting 400,000 euros. What are the effects on net income from these transactions?

A) $20,000 Discount Expense plus a $12,000 positive Adjustment to Net Income when the merchandise is delivered.

B) $20,000 Discount Expense plus a $12,000 negative Adjustment to Net Income when the merchandise is delivered.

C) $20,000 Discount Expense plus a $20,000 negative Adjustment to Net Income when the merchandise is delivered.

D) $20,000 Discount Expense plus a $16,000 positive Adjustment to Net Income when the merchandise is delivered.

E) $20,000 Discount Expense plus a $20,000 positive Adjustment to Net Income when the merchandise is delivered.

Answer: D Please explain why. why is it a positive Adjustment ???

Answer 1

(Q) On April 1, Quality Corporation, a U.S. company, expects to sell merchandise to a French customer in three months, denominating the transaction in euros. On April 1, the spot rate is $1.41 per euro, and Quality enters into a three-month forward contract cash flow hedge to sell 400,000 euros at a rate of $1.36. At the end of three months, the spot rate is $1.37 per euro, and Quality delivers the merchandise, collecting 400,000 euros. What are the effects on net income from these transactions?

(Ans) The correct answer is = $16,000 Discount Expense plus a $20,000 positive Adjustment to Net Income when the merchandise is delivered.

• Explanation :- $1.41 - $1.37 = $.04 × 400,000 euro = $16,000 Discount expense

$1.41 - $1.36 = $.05 × 400,000 euro = $20,000 Adjustment at Delivery (positive)

note* - there is a mistake in the option (D) , the correct form is "$16,000 Discount Expense plus a $20,000 positive Adjustment to Net Income when the merchandise is delivered".  hope you will correct it.