Question

As part of its risk management strategy, Copper Monkey Mining sells futures contracts to hedge changes in fair value of its inventory. On March 12, the commodity exchange spot price was $0.81/lb., and the futures price for mid-June was $0.83/lb. On that date, Copper Monkey, which has a March 31 fiscal year end, sold 200 futures contracts on the commodity exchange at $0.83/lb. for delivery in June. Each contract was for 25,000 lb. Copper Monkey designated these contracts as a fair value hedge of 5 million lb. of current inventory for which a mid-June sale is expected. The average cost of this inventory was $0.58/lb. The hedge was expected to be highly effective. On March 31, the mid-June commodity exchange futures price was $0.85/lb.
In the March 31 statement of financial position, the company should record the futures contracts as a?

Answer 1

Answer:

In the March 31 statement of financial position, the company should record the futures contracts as a  loss and liability of $100,000

Explanation:

GAAP specifies that all derivatives instrument and hedging activities recorded  in the balance sheet are assets and liabilities and measured at fair value.

At the starting of the futures contracts, the fair value is $0 since the prices of the future contract was entered at that date.

Given that 200 futures contracts was sold at the commodity exchange foo $$0.83/lb and each contract was for 25,000 lb. Therefore a fair value hedge of 5 million lb. (25,000 lb. × 200 contracts) of copper at $0.83/lb is expected to be delivered.

The price had risen to $0.85/lb at the date of the financial statements, Copper Monkey should record a loss and liability = (5 million lb) × ($0.83 – $0.85) = 5000000 × 0.02 = 100000

Copper Monkey should record a loss and liability of $100,000