I have already explained in previous lecture about forward contracts. Here before explaining its journal entries, I will explain again. Forward contract is the contract between two private parties in which one party buys and other sells at current price but asset's payment and delivery will be in future specified date.
It provides the hedge against the fluctuation in the price in future date. Seller secures the sale of products and buyer secures the risk due to inflation in the prices.
Features of Forward Contract
There are three features of forward contract.
a) Spot Price
This is today market rate. For example, I went to market of labors and today labor one day cost is Rs. 300.
b) Forward Price
Forward price is the future price of any product or service. For example, it is the chance of shortage of labor after one year. So, factory owner has forward contracted today for supply of labor at the end of year with forward price Rs. 400 per day labor cost.
c) Forward Asset Exchanged
Now, at the end of year, laborers will provide service at Rs. 400 whether labor cost will more or less than Rs. 400 because they have gained at current time. Factory owner has hedged of any loss due to shortage of laborers.
Following journal entries for forward contracts will be passed.
1. In the Books of Buyer of Assets
(A) on the Forward Contract Date
Asset Receivable Account Debit ( At Spot Price )
Premium on Forward Contact Account Debit ( Difference between forward price and spot price)
Creditor ( for Forward Contract) Account Credit
Logic behind the journal entry : -
a) Asset has come in the books if owner will cheat us on the maturity date, we can get same asset from court. So, this asset account will debit by writing asset receivable account.
b) Buyer will surely face loss current time but it will surely gain in future. So, premium on forward contract will debit because loss will always be debit.
c) Creditor account for forward contract is our liability which we have to pay in future date. So, liability account will credit.
(B) On the Maturity of Forward Contract Date
Asset (Purchase) Account Debit
Creditor Account Debit
Loss on Forward Contract Account Debit
Asset Receivable Account Credit
Gain on Forward Contract Account Credit
Premium on Forward Contract Credit
Cash/ Bank Account Credit
Logic of this journal entry :
a) We have received asset in physical form.
b) We have paid our creditors which has decreased our liabilities. So, creditor account will debit
c) If we have loss in this contract, it will debit
d) If we have gain in this contract, it will credit.
e) Account receivable account will credit because we are closing this account
f) Premium on forward contract will credit because we are closing this account.
g) We have paid the money. With this, our cash balance has been decreased. So, it will credit as decrease in asset will credit always.
2. In the Books of Seller of Assets
(A) on the Forward Contract Date
Debtor Account Debit
Asset Obligations Account Credit
Premium on Forward Contract Credit
(B) On the Maturity of Forward Contract Date
Asset Obligation Account Debit
Loss on Forward Contract Account Debit
Premium on Forward Contract Debit
Debtor Account Credit
Gain on Forward Contract Account Credit
Asset Account (Sale) Credit
Example
Mr. A seller of seeds. On 26th Aug. 2015, its one kg. price is Rs. 100. Mr. B is the buyer. He want to buy 100 kgs of same seed in 31st Dec. 2015 but he does not want to get loss of increasing its price. So, he did forward contract of 100 kgs buying in 31st dec. 2015 at the forward price of Rs. 120 today. Mr. A is gaining Rs. 20 per kg sale today on 26th aug. 2015. Pass the journal entries
In the books of Mr. B buyer
(A) on the Forward Contract Date
Asset Receivable Account Debit ( At Spot Price ) 10000
Premium on Forward Contact Account Debit ( Difference between forward price and spot price) 2000
Mr. A Creditor ( for Forward Contract) Account Credit 12000
(B) On the Maturity of Forward Contract Date
Asset (Purchase) Account Debit 13000
Mr. A Creditor Account Debit 12000
Asset Receivable Account Credit 10,000
Premium on Forward Contract Credit 2000
Cash/ Bank Account Credit 12,000
Gain on forward contract { ( 130-120 ) * 1000}Credit 1000
2. In the Books of Seller of Assets
(A) on the Forward Contract Date
Debtor Account Debit 12000
Asset Obligations Account Credit 10000
Premium on Forward Contract Credit 2000
(B) On the Maturity of Forward Contract Date
Asset Obligation Account Debit 10000
Loss on Forward Contract Account Debit 1000
Premium on Forward Contract Debit 2000
Debtor Account Credit 12000
Asset Account (Sale) Credit 13000
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It provides the hedge against the fluctuation in the price in future date. Seller secures the sale of products and buyer secures the risk due to inflation in the prices.
Features of Forward Contract
There are three features of forward contract.
a) Spot Price
This is today market rate. For example, I went to market of labors and today labor one day cost is Rs. 300.
b) Forward Price
Forward price is the future price of any product or service. For example, it is the chance of shortage of labor after one year. So, factory owner has forward contracted today for supply of labor at the end of year with forward price Rs. 400 per day labor cost.
c) Forward Asset Exchanged
Now, at the end of year, laborers will provide service at Rs. 400 whether labor cost will more or less than Rs. 400 because they have gained at current time. Factory owner has hedged of any loss due to shortage of laborers.
Following journal entries for forward contracts will be passed.
1. In the Books of Buyer of Assets
(A) on the Forward Contract Date
Asset Receivable Account Debit ( At Spot Price )
Premium on Forward Contact Account Debit ( Difference between forward price and spot price)
Creditor ( for Forward Contract) Account Credit
Logic behind the journal entry : -
a) Asset has come in the books if owner will cheat us on the maturity date, we can get same asset from court. So, this asset account will debit by writing asset receivable account.
b) Buyer will surely face loss current time but it will surely gain in future. So, premium on forward contract will debit because loss will always be debit.
c) Creditor account for forward contract is our liability which we have to pay in future date. So, liability account will credit.
(B) On the Maturity of Forward Contract Date
On the maturity date, current market price will be calculated. It will compare with future price. Difference will either loss or gain on forward contract.
Creditor Account Debit
Loss on Forward Contract Account Debit
Asset Receivable Account Credit
Gain on Forward Contract Account Credit
Premium on Forward Contract Credit
Cash/ Bank Account Credit
Logic of this journal entry :
a) We have received asset in physical form.
b) We have paid our creditors which has decreased our liabilities. So, creditor account will debit
c) If we have loss in this contract, it will debit
d) If we have gain in this contract, it will credit.
e) Account receivable account will credit because we are closing this account
f) Premium on forward contract will credit because we are closing this account.
g) We have paid the money. With this, our cash balance has been decreased. So, it will credit as decrease in asset will credit always.
2. In the Books of Seller of Assets
(A) on the Forward Contract Date
Debtor Account Debit
Asset Obligations Account Credit
Premium on Forward Contract Credit
(B) On the Maturity of Forward Contract Date
On the maturity date, current market price will be calculated. It will compare with future price. Difference will either loss or gain on forward contract.
Cash/ Bank Account Debit
Asset Obligation Account Debit
Loss on Forward Contract Account Debit
Premium on Forward Contract Debit
Debtor Account Credit
Gain on Forward Contract Account Credit
Asset Account (Sale) Credit
Example
Mr. A seller of seeds. On 26th Aug. 2015, its one kg. price is Rs. 100. Mr. B is the buyer. He want to buy 100 kgs of same seed in 31st Dec. 2015 but he does not want to get loss of increasing its price. So, he did forward contract of 100 kgs buying in 31st dec. 2015 at the forward price of Rs. 120 today. Mr. A is gaining Rs. 20 per kg sale today on 26th aug. 2015. Pass the journal entries
In the books of Mr. B buyer
(A) on the Forward Contract Date
Asset Receivable Account Debit ( At Spot Price ) 10000
Premium on Forward Contact Account Debit ( Difference between forward price and spot price) 2000
Mr. A Creditor ( for Forward Contract) Account Credit 12000
(B) On the Maturity of Forward Contract Date
On the maturity date 31st dec. 2015, current market price is Rs. 130 per kg seed . It will compare with future price. Difference will either loss or gain on forward contract.
Mr. A Creditor Account Debit 12000
Asset Receivable Account Credit 10,000
Premium on Forward Contract Credit 2000
Cash/ Bank Account Credit 12,000
Gain on forward contract { ( 130-120 ) * 1000}Credit 1000
2. In the Books of Seller of Assets
(A) on the Forward Contract Date
Debtor Account Debit 12000
Asset Obligations Account Credit 10000
Premium on Forward Contract Credit 2000
(B) On the Maturity of Forward Contract Date
On the maturity date, current market price will be calculated. It will compare with future price. Difference will either loss or gain on forward contract.
Cash/ Bank Account Debit 12000
Asset Obligation Account Debit 10000
Loss on Forward Contract Account Debit 1000
Premium on Forward Contract Debit 2000
Debtor Account Credit 12000
Asset Account (Sale) Credit 13000
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Reference of Book for Reading
Could you also let us know the accounting entry for mark to market during period close?
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