4. Accounting for Derivative Securities- Cash Flow Hedge (13 points) On November

Question

4. Accounting for Derivative Securities- Cash Flow Hedge (13 points) On November 1, 2017 Husky owned 1,000,000 barrels of oil that it wants to sell in March 2018 for $72 per barrel. Husky acquired the oil for $65 per barrel in September from a local competitor that was going out of business. Husky management would like to hedge against a change in the price of oil so they can remove the risk that future cash flows will be different from the $72,000,000 expected amount. On November 1, 2017 the company enters into a forward contract to sell 1,000,000 barrels of oil in March 2018 for a price of $72 per barrel (the right and obligation to deliver). Assume the forward contract has no value at inception. The company's managers designate this as a cash flow hedge, and it is expected to be highly effective. (a) Assume that on December 31, 2017 the forward price for March 2018 delivery of oil has increased to $73.50 per barrel. Since Husky is a calendar year-end firm, how would Husky refl the change in value of the forward contract in their financial statements? (2 pts)

Explanation / Answer

Solution:-

(a).

Forward price increased = $73.50

Derivative assets of oil inventory = (72 - 73.50)* 1,000,000

= 1.50 * 1,000,000

= $1,500,000

Derivative assets of oil inventory= $1,500,000

(b).Journal entries to record the settlement transactions:-

= 70 * 1,000 ,000

= $70,000,000

= 1,000,000 * 72

= $72,000,000

= 72,000,000 - 70,000,000

= $200,000

Cash

= 70 * 1,000 ,000

= $70,000,000

Revenue

= 1,000,000 * 72

= $72,000,000

Derivative expenses

= 72,000,000 - 70,000,000

= $200,000

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