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Accounting for fair value hedge of inventory (ineffectiveness in the hedge) Our company reports commodities inventory...

Accounting for fair value hedge of inventory (ineffectiveness in the hedge)
Our company reports commodities inventory on our balance sheet at $1 million. The inventory has a fair value of $1.1 million and we are concerned about a forecasted decline in the commodity price. We a financial derivative in order to mitigate this risk. On the last day of the period, the fair value of the inventory has declined by $25,000 whereas, the fair value of the derivative has increased by $22,500. All of the inventory is sold at its fair value and the derivative is settled on the last day of the period. Complete the following table of the required journal entries during the period:

Use a negative sign with your answers to indicate a credit entry.

	Debit (Credit)
	Cash	Derivative	Inventory	Earnings
Recognize the change in the fair value of the derivative	$Answer	$Answer	$Answer	$Answer
Recognize the change in the fair value of the inventory	Answer	Answer	Answer	Answer
Recognize revenue from the sale	Answer	Answer	Answer	Answer
Recognize cost of goods sold relating to the sale	Answer	Answer	Answer	Answer
Recognize settlement of the derivative	Answer	Answer	Answer	Answer

Expert Solution

Fair value hedge is made to cover the risk of changes in fair value of an asset or liability. To cover changes in fair value of of asset/liability i.e. hedged instrument, a derivative instrument i.e. hedging instrument is taken in opposite direction of expected change. As a result, net impact on balance sheet and / or profit and loss remains the same.

Debit(Credit)

Cash

Derivative

Inventory

Earnings

Explaination

Recognize the change in the fair value of the derivative

22500

-22500

Recognition of increase in the value of the derivative

Recognize the change in the fair value of the inventory

-25000

25000

Recognition of loss due to decline in value of inventory

Recognize revenue from the sale

1100000

-1100000

Sale resulted in increase of earnings

Recognize cost of goods sold relating to the sale

-1075000

1075000

Cost of inventory less already adjusted decline in the value of inventory

Recognize settlement of the derivative

22500

-22500

Receipt of cash due to settlement on the final day.

ekkarill92 answered 2 years ago

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