Hedge of an anticipated purchase
On December 1, 2008, Jolly Rice Company enters into a 90-day forward contract with a rice speculator to purchase 500 tons of rice at $1,000 per ton. Jolly Rice enters into this contract in order to hedge an anticipated rice purchase. The contract is to be settled net. The spot price of rice at December 1, 2008, is $950. On December 31, 2008, the forward rate is $980 per ton. The contract is settled and rice is purchased on February 28, 2009. The spot and forward rates when the contract is settled are $1,005. Assume that Jolly purchases 500 tons of rice on the date of the forward contract's expiration. Assume that this contract has been documented to be an effective hedge. Also assume an appropriate interest rate is 6%.
1. Prepare the required journal entries to account for this hedge situation and the subsequent rice purchase on:
a. December 1, 2008
b. December 31, 2008
c. The settlement date
2. Assume that the rice is subsequently sold by Jolly on June 1, 2009, for $1,200 per ton. What journal entries will Jolly make on that date?
Cash flow hedge, futures contract
3Northwest Gas Works, a consumer gas provider, estimates a rather cold winter. As a result it decides to enter into a futures contract on the NYMEX for natural gas on November 2, 2008. The trading unit is 10,000 million British thermal units (MMBtu). The three-month futures contract rate is $7.00 per MMBtu, so each contract will cost Northwest Gas Works $70,000. In addition, the exchange requires a $5,000 deposit on each contract. Northwest enters into 20 such contracts.
REQUIRED with calculation:
1. Why is this futures contract likely to be considered an effective hedge and therefore qualified for hedge accounting?
2. Why would this transaction be accounted for as a cash flow hedge?
3. Assume that the December 31, 2008, futures contract rate is $6.75 for delivery on February 2, 2009, and the spot rate on February 2, 2009, is $6.85. Assume that Northwest Gas Works sells all of the gas on February 3, 2009, for $8.00 per MMBtu. Prepare all the necessary journal entries from November 2, 2008, through February 3, 2009, to account for this hedge situation.