Question

(Cash Flow Hedge) Hart Golf Co. uses titanium to produce specialty drivers. Hart anticipates that

it will need to purchase 200 ounces of titanium in November 2017 for clubs sold in advance of the spring and

summer of 2018. However, if the price of titanium increases, this will increase the cost to produce the clubs, resulting in

lower profit margins.

To hedge the risk of increased titanium prices, on May 1, 2017, Hart entered into a titanium futures contract and designates

this futures contract as a cash flow hedge of the anticipated titanium purchase. The notional amount of the contract is 200

ounces and the contract terms give Hart the option to purchase titanium for $500 per ounce. The price will be

good until the contract expired on November 30, 2017.

Assume the following data concerning the price of the call options and the titanium inventory purchase.

Spot Price for

Date November Delivery

May 1, 2017, $500 per ounce

June 30, 2017, 520 per ounce

September 30, 2017, 525 per ounce

Instructions

Present the journal entries for the following dates/transactions.

(a) May 1, 2017—Inception of the futures contract, no premium paid.

(b) June 30, 2017—Hart prepares financial statements.

(c) September 30, 2017—Hart prepares financial statements.

(d) October 5, 2017—Hart purchases 200 ounces of titanium at $525 per ounce and settles the futures contract.

(e) December 15, 2017—Hart sells clubs containing titanium purchased in October 2017 for $250,000. The cost of the finished

goods inventory is $140,000.

(f) Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions

on December 31, 2017.

Answer 1

 

Step-by-Step Solution

Step 1: Definition of cash flow hedge

It is the type of derivative instrument that fixed the amount of sale or purchase of assets according to the market situation.

Step 2: Entry for the inception

In this, no entry is passed

Step 3: Entry for financial statement

Date	Particulars	Debit	Credit
September 30, 2017	Future contract	$4,000
	Unrealized holding Gain or loss- Equity		$4,000
	(To record future contract)

 

Step 4: Entry for financial statement

Date	Particulars	Debit	Credit
September 30, 2017	Future contract	$1,000
	Unrealized holding Gain or loss- Equity		$1,000
	(To record future contract)

 

Step 5: Entry for the purchase of Titanium

Date	Particulars	Debit	Credit
October 5, 2017	Titanium Inventory	$105,000
	Cash		$105,000
	(To record purchase)
October 5, 2017	Cash	$5,000
	Future Contract		$5,000
	(To record the settlement of futures contract)

 

Step 6: Entry of the sale of Titanium

Date	Particulars	Debit	Credit
December 15, 2017	Cash	$250,000
	Sales Revenue		$250,000
	Cost of goods sold	$140,000
	Inventory		$140,000
	(Being entry for the sale of titanium)

 

 

Step 7: Recording of the sale in the income statement

                                                   Sweet Co.

                                            Income Statement

Particulars	Amount
Sales Revenue	$250,000
Less: Cost of goods sold	($140,000)
Gross Profit	$110,000

 

 

 

The gross profit on the sale is $110,000