Reference no: EM131119243
Refer to Examples 19 and 23 in the chapter. Firm D holds 10,000 gallons of whiskey in inventory on October 31, 2010, that costs $225 per gallon. Firm D contemplates selling the whiskey on March 31, 2011, when it completes the aging process. Uncertainty about the selling price of whiskey on March 31, 2011, leads Firm D to acquire a forward contract on whiskey. The forward contract does not require an initial investment of funds. Firm D designates the forward commodity contract as a cash flow hedge of an anticipated transaction. The forward price on October 31, 2010, for delivery on March 31, 2011, is $320 per gallon.
Required
a. Using the financial statement effects template, show the financial statement effects, if any, that Firm D would have on October 31, 2010, when it acquires the forward commodity price contract.
b. On December 31, 2010, the end of the accounting period for Firm D, the forward price of whiskey for March 31, 2011, delivery is $310 per gallon. Show the financial statement effects of recording the change in the value of the forward commodity price contract. Ignore the discounting of cash flows in this part and in the remainder of the problem.
c. Show the financial statement effects of the December 31, 2010, decline in value of the whiskey inventory.
d. On March 31, 2011, the price of whiskey declines to $270 per gallon. Show the financial statement effects of revaluing the forward contract.
e. Show the financial statement effects on March 31, 2011, to reflect the decline in value of the inventory.
f. Show the financial statement effects on March 31, 2011, to settle the forward contract.
g. Assume that Firm D sells the whiskey on March 31, 2011, for $270 a gallon. Show the financial statement effects of recording the sale and recognizing the cost of goods sold.
h. How would the effects in Parts b-g differ if Firm D had chosen to designate the forward commodity price contract as a fair value hedge instead of a cash flow hedge?
i. Suggest a scenario that would justify treating the forward commodity price contract as a fair value hedge and a scenario that would justify treating it as a cash flow hedge.
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