Question

Question: (Cash Flow Hedge) LEW Jewelry Co. uses gold in the manufacture of its products. LEW anticipates that it will

need to purchase 500 ounces of gold in October 2017, for jewelry that will be shipped for the holiday shopping season. However,

if the price of gold increases, LEW’s cost to produce its jewelry will increase, which would reduce its profit margins.

To hedge the risk of increased gold prices, on April 1, 2017, LEW enters into a gold futures contract and designates this

futures contract as a cash flow hedge of the anticipated gold purchase. The notional amount of the contract is 500 ounces, and

the terms of the contract give LEW the right and the obligation to purchase gold at a price of \(300 per ounce. The price will be

good until the contract expires on October 31, 2017.

Assume the following data with respect to the price of the futures contract and the gold inventory purchase:

Date Spot Price for October Delivery

April 1, 2017 \)300 per ounce

June 30, 2017 310 per ounce

September 30, 2017 315 per ounce

Instructions

Prepare the journal entries for the following transactions.

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

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

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

(d) October 10, 2017—LEW Co. purchases 500 ounces of gold at \(315 per ounce and settles the futures contract.

(e) December 20, 2017—LEW sells jewelry containing gold purchased in October 2017 for \)350,000. The cost of the finished

goods inventory is $200,000.

(f) Indicate the amount(s) reported on the balance sheet and income statement related to the futures contract on June 30, 2017.

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

on December 31, 2017.-

Short answer

Answer:

Gross profit is $150,000. Future contract debited by $5,000 and unrealized holding gain or loss equity credited by $5,000. Futures Contract debited by $2,500 and Unrealized Holding Gain or Loss- Equity credited by $2,500

Step-by-step solution

Entry for the inception of future contract

No Entry will be passed.

Entry for the unrealized holding gain or loss

Date	Particulars	Debit	Credit
June 30, 2017	Futures Contract	$5,000
	Unrealized Holding Gain or Loss- Equity		$5,000
	(Being entry for the unrealized holding gain or loss)

Entry for the recording of unrealized holding gain or loss

Date	Particulars	Debit	Credit
September 30, 2017	Futures Contract	$2,500
	Unrealized Holding Gain or Loss- Equity		$2,500
	(Being entry for the unrealized holding gain or loss)

Entry for recording purchase of the futures contract

Date	Particulars	Debit	Credit
June 30, 2017	Inventory	$157,500
	Cash		$157,500
	(Being entry for the purchase of future contract)
June 30, 2017	Cash	$7,500
	Future Contract		$7,500
	(Being entry for the settlement of contract)

Entry for the recording of sales

Date	Particulars	Debit	Credit
December 20, 2017	Cash	$350,000
	Sales Revenue		$350,000
	(Being of the sale of gold)
December 20, 2017	Cost of goods sold	$200,000
	Inventory		$200,000
	(Being entry of the cost of goods sold)
December 20, 2017	Unrealized holding Gain or Loss	$7,500
	Cost of goods sold		$7,500
	(Being entry for the unrealized gain or loss)

Preparation of balance sheet

Partial Balance Sheet
LEW Jewelry Co.
June 30, 2017
Current Assets:
Future Contract	$5,000
Stockholder’s Equity:
Accumulated other comprehensive income	$5,000

Preparation of income statement

LEW Jewelry Co.
Income Statement
December 31, 2017
Sale Revenue	$350,000
Cost of goods sold	$200,000
Gross Profit	$150,000