Question

Arlington Steel Company is a producer of raw steel and steel-related products. On January 3, 2022, Arlington enters into a firm commitment to purchase 10,000 tons of iron ore pellets from a supplier to satisfy spring production demands. The purchase is to be at a fixed price of $63 per ton on April 30, 2022. To protect against the risk of changes in the fair value of the commitment contract, Arlington enters into a futures contract to sell 10,000 tons of iron ore on April 30 for $63/ton (the current price). The contract calls for net cash settlement, and the company must report changes in the fair values of its hedging instruments each quarter. Required: On March 31, the price of iron ore fell to $61/ton, and then to $60/ton on April 30. 1. Calculate the net cash settlement at April 30, 2022. 2. Prepare the journal entries for the period January 3 to April 30, 2022, to record the firm commitment, necessary adjustments for changes in fair value, and settlement of the futures contract.

Answer 1

Answer:-

Requirement 1
Particulars	Jan-03	Mar-31	Apr-30
Fair value of futures contract	$0	$20,000	$30,000
Fair value of firm commitment	0	20,000	30,000
Receipts—futures contract			6,30,000
Payment at spot rate			6,00,000
Net cash receipts (payments)			30,000

Requirement 2

January 3

Document the firm commitment and the futures contract, but no formal entry. Futures contract is issued at the current/spot price.

March 31

1. Futures contract [($63 – $61) × 10,000] A/c Dr 20,000

To Cost of goods sold A/c 20,000

Being record the change in fair value of the futures contract.

2.Cost of goods sold A/c Dr   20,000

To Firm commitment A/c   20,000

Being record the change in fair value of the firm commitment.

April 30

1. Futures contract [($51 – $50) × 10,000] A/c Dr 10,000

To Cost of goods sold A/c 10,000

Being record the change in fair value of the futures contract.

2. Cost of goods sold A/c Dr 10,000

To Firm commitment A/c 10,000

Being record the change in fair value of the firm commitment.

3. Cash A/c Dr 30,000

To Futures contract A/c 30,000

Being record the net settlement of the futures contract.

4. Inventory A/c Dr 500,000

Firm commitment A/c Dr 30,000   

To Cash A/c 530,000

Being record the purchase of inventory