On June 1, a Company Holds an Inventory of a Commodity

Essay

On June 1, a company holds an inventory of a commodity that it expects to sell in two months. It paid $600,000 for the inventory, and the company carries it at cost. To hedge the price risk on this inventory, the company takes a short futures position in the commodity, for delivery on August 1, paying a margin deposit of $400. The company's accounting year ends December 31, and the futures qualify as a fair value hedge of the commodity inventory. The company closes its futures position on August 1 and sells the inventory on August 2 for $585,000. All income effects are reported in cost of goods sold. Spot and futures values for the commodity are:
$$\begin{array} { | l | c | c | } \hline & \text { Spot Price } & \begin{array} { c } \text { Futures Price for } \\\text { August 1 Delivery }\end{array} \\\hline \text { June 1 } & \$ 590,000 & \$ 591,000 \\\hline \text { August 1 } & 585,000 & 585,000 \\\hline\end{array}$$ Required
a. How much cash will the company receive or pay on August 1, when it closes its futures position?
b. Prepare the entries to record the above events.
c. What is the company's gross margin? What was the expected gross margin on June 1? Were the futures effective? Explain.