Question

chanics of Futures Markets: 1. A Silver futures contract covers 5,000 ounces of silver and is quoted in dollars per ounce. In October 2013 a company goes long and buys 4 May 2015 Silver futures contracts for $22.437. Year-end December, 2013, the futures price is $21.668; year-end December, 2014, the futures price is $19.987. In February, 2015, the futures price is $19.114 at which time the company decides to close out its position entirely. The company operationally works on a calendar year basis with December serving as its year end. What is the actual gain or loss on the 4 Silver contracts for the company? Explain how the gain or loss is realized? Explain how the accounting & tax treatments differs between that of a speculator and that of a hedger.

Answer 1

Solution:

(1) Computation of actual gain/loss on the 4 Silver Contracts for the company:

Here, the company entered into buy 4 futures contracts of 5000 ounces of silver at $22.437 per ounce. But later, the company closed its position at $19.114 per ounce. Hence total actual loss will be

Actual Loss = 5000 ounces x 4 Contracts x ($22.437 - $19.114)

Actual Loss = $66,460.

(2) In this question, Company entered into 4 futures contract to buy silver ounces $22.437 but the price of silver ounces continuously declining, hence here is a loss for the company and when we are talking about realizations of loss/profit then it will only happen when company closes its position i.e. take a reverse position.

(3) Accounting Treatment:

In case of a speculator:

When we are doing accounting treatment of future contracts for a speculator then as per accounting provisions we have to realise mark-to-market profit/loss on each year ends. Hence in this question, we will enter journal entry of profit/loss on every year-end until the contract closes.

            (I) 01/10/2013, when the company entered into future contracts

                                                            No Journal Entry

            (II) 31/12/2013, On the year-end for realising the loss

                        Loss on Future Contract A/C Dr.                           $ 15,380

                                    To amount payable to broker a/c                           $ 15,380

                        (Being MTM loss realised i.e. 4x5000x($22.437-$21.668))

            (III) 31/12/2013, on transferring loss to Profit & Loss A/c

                        Profit & Loss A/c Dr. $ 15,380

                                    Loss on Future Contract a/c          $ 15,380

                        (Being MTM loss transferred to P&L A/c)

(IV) 31/12/2014, On the year-end for realising the loss

                        Loss on Future Contract A/C Dr.                           $ 33,620

                                    To amount payable to broker a/c                           $ 33,620

                        (Being MTM loss realised i.e. 4x5000x($21.668-$19.987))

            (V) 31/12/2014, on transferring loss to Profit & Loss A/c

                        Profit & Loss A/c Dr. $ 33,620

                                    Loss on Future Contract a/c          $ 33,620

                        (Being MTM loss transferred to P&L A/c)

(VI) 28/02/2015, On the year-end for realising the loss

                        Loss on Future Contract A/C Dr.                           $ 17,460

                                    To amount payable to broker a/c                           $ 17,460

                        (Being MTM loss realised i.e. 4x5000x($19.987-$19.114))

            (VII) 28/02/2015, on transferring loss to Profit & Loss A/c

                        Profit & Loss A/c Dr. $ 15,380

                                    Loss on Future Contract a/c          $ 15,380

                        (Being MTM loss transferred to P&L A/c)

            (VIII) 28/02/2015, On settlement with the broker

                        Amount payable to broker A/c Dr.             $ 66,460

                                    To Bank A/c                                                 $ 66,460

                        (Being amount paid to broker)

In case of a Hedger:

When we are doing accounting treatment of future contracts for a hedger then as per accounting provisions we don’t have to realise mark-to-market profit/loss on each year ends. Here we will realise the loss when we did full and final settlement with a broker for future contract i.e. on closure. Hence in this question, we will book journal entry of profit/loss only on the settlement with broker i.e. on 28/02/2015.

            (I) 01/10/2013, when the company entered into future contracts

                                                            No Journal Entry

            (II) 28/02/2015, on the settlement with the broker

                        Loss on Future Contract A/C Dr.                           $ 66,460

                                    To Bank A/c                                                              $ 66,460

(Being settlement with the broker has been made)

            (III) 28/02/2015, on transferring loss to Profit & Loss A/c

                        Profit & Loss A/c Dr. $ 66,460

                                    Loss on Future Contract a/c          $ 66,460

(Being total actual loss transferred to P&L A/c i.e. 4X5000X($22.437-$19.114))

(4) Tax Treatment:

As per Tax provisions, Future & Options deals are almost always treated as business income. This treatment is irrespective of the frequency or volume or purpose of your transaction. Hence, both in case of hedger and speculator; loss on future contract treated as a business loss and allowed to set-off, set-off and carry forward.