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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:

DateSpotFuturesDecember 1, 201474¢66¢December 31, 201465¢56¢June 1, 201547¢n/a



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QU F5I10N 3 N at changed since last amen-up: Marl-wed out «45.00 I? Flag quesfih 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 onJune 1, 201 5, 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 7’4 cents per pound. june 1, 2015, the company closes out its futures contracts by entering into an offsetting contract in which it agrees to buyjune 2015 cotton futures contracts atzlffcents a
pound. the spot rate on that date. Finally, the company sells its cotton for $0.47 per pound onJune 1. 2015. On December 31. 20141. the compa I'IYS fiscal yea r-encl. the June cotton futures price has fallen to 56 cents a poundr and the spot price has fallen to 65 cents a pound. On Following are futures and spot prices for the relevant dates: Date 5pm: Fun-es
December ‘I, 2014 7'46 66':
December 31, 2014 65': 56':
june ‘I, 20-15 47': na‘a Required Prepare the journal entries to record the following:
[If no entry is required, select "No entry required" for both the debit and credit account titles.) a. Purchase of cotton Gena-fl juurnl Dltl.‘ Deln'flfllorl Dell": Credlt 12.010014 0 0

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