Question

NGW, a consumer gas provider, estimates a rather cold winter. As a result it decides to enter into a futures contract on the NYMEX for natural gas on November 2, 2016. The trading unit is 10,000 millioin British thermal units (MMBtu). The three month futures contract rate is $7.00 per MMBtu, so each contract will cost NGW $70,000. In addition, the exchange requires a $5,000 deposit on each contract. NGW enters into 20 such contracts.

1. Why is the futures contract likely to be considered an effective hedge and therefore qualified for hedge accounting?
2. Why would this transaction be accounted for as a cash flow hedge?
3. Assume the Dec 31, 2016, futures contract is $6.75 for delivery on Feb 2, 2017, and the spot rate on Feb 2, 2017, is $6.85. Assume that NGW sells all of the gas on Feb 3, 2017, for $8.00 per MMBtu. Prepare all the necessary journal entries from Nov 2, 2016, through Feb 3, 2017, to account for this hedge situation.

Answer 1

02/11/2016	10000	Millions
3 Months Futures	7
One Future	70000
Deposit	5000
Total One future	75000
No of Contracts	20
Total Value	1500000

1. The futures are likely to be considered an effective hedge because the futures may increase or decrease and is likely to effect the same in NYMEX & Current prices of stock, So the profit/loss is minimised.

2. Nope it cannot be considered as cash flow hedge because there is no receivables. Hence it cannot be considered cash flow hedge

3. on December 31, 2016 if the future contract is 6.75 for delivery on February 2, 2017 then NGW should recognise loss of 2500$ (6.75-7)*10000 and

again on spot at february 2, 2017 should recognise profit of 1000$(6.85-6.75)*10000, if sells for 8$ recognise profit of 11500$ (8$-6.85)*10000

31/12/2016	Loss on Futures Debit	2500
	Future contract Credit	2500
02/02/2017	Future contract Debit	1000
	Profit on Future Credit	1000
03/02/2017	Future contract Debit	11500
	Profit on Future Credit	11500