Question

Use of futures contracts to hedge cotton inventory—fair value hedge

On December 1, 2014, a cotton wholesaler purchases 7 million pounds of cotton inventory at an average cost of 75 cents per pound. To protect the inventory from a possible decline in cotton prices, the company sells cotton futures contracts for 7 million pounds at 66 cents a pound for delivery on June 1, 2015, to coincide with its expected physical sale of its cotton inventory. The company designates the hedge as a fair value hedge (i.e., the company is hedging changes in the inventory’s fair value, not changes in cash flows from anticipated sales). The cotton spot price on December 1 is 74 cents per pound.

On December 31, 2014, the company’s fiscal year-end, the June cotton futures price has fallen to 56 cents a pound, and the spot price has fallen to 65 cents a pound. On June 1, 2015, the company closes out its futures contracts by entering into an offsetting contract in which it agrees to buy June 2015 cotton futures contracts at 47 cents a pound, the spot rate on that date. Finally, the company sells its cotton for $0.47 per pound on June 1, 2015.

Following are futures and spot prices for the relevant dates:

Date	Spot	Futures
December 1, 2014	74¢	66¢
December 31, 2014	65¢	56¢
June 1, 2015	47¢	n/a

I need the money amounts for the following entries:

c. Adjusting entry at December 31

Loss on inventory ?

Cotton inventory ?

d. Sale of cotton on June 1

Loss on inventory ?

Cotton inventory ?

Accounts Recievable ?

Cost of goods sold ?

Cotton Sales ?

Cotton inventory ?

Answer 1

c	Adjusting Entry at December 31
	Loss on inventory	$630,000
	Cotton Inventory		$630,000
	(To adjust the carrying amount of the inventory on December 31, 2014)
	(7 million pounds x ($0.74-$0.65))
d	Loss on inventory	$1,260,000
	Cotton Inventory		$1,260,000
	(To adjust the carrying amount of the inventory on June 1, 2015)
	(7 million pounds x ($0.65-$0.47))
	Accounts Receivable	$3,290,000
	Cost of Goods sold	$3,360,000
	Cotton Sales		$3,290,000
	Cotton Inventory		$3,360,000
	Cotton Inventory cost
	Original cost (7million pounds x $0.75)	$5,250,000
	Less: 31/12/2014 adjustment	($630,000)
	Less: 1/6/2015 adjustment	($1,260,000)
	Cotton Inventory cost on June 1, 2015	$3,360,000