Please be very detailed! NGW, a consumer gas provider, estimates a rather cold w
ID: 2518916 • Letter: P
Question
Please be very detailed!
NGW, a consumer gas provider, estimates a rather cold winter. As a result it decides to enter into a futures contract on the NYMEX for natural gas on November 2, 2016. The trading unit is 10,000 million British thermal units (MMBtu). The three-month futures contract rate is $7.00 per MMBtu, so each contract will cost NGW $70,000. In addition, the exchange requires a $5,000 deposit on each contract. NGW enters into 20 such contracts. Required: 1. Why is this futures contract likely to be considered an effective hedge and therefore qualified for hedge accounting? 2. Why would this transaction be accounted for as a cash-flow hedge? 3. Assume that the December 31, 2016, futures contract rate is $6.75 for delivery on February 2, 2017, and the spot rate on February 2, 2017, is $6.85. Assume that NGW sells all of the gas on February 3, 2017, for $8.00 per MMBtu. Prepare all the necessary journal entries from November 2, 2016, through February 3, 2017, to account for this hedge situationExplanation / Answer
02/11/2016 10000 Millions 3 Months Futures 7 One Future 70000 Deposit 5000 Total One future 75000 No of Contracts 20 Total Value 1500000 1. The futures are likely to be considered an effective hedge because the futures may increase or decrease and is likely to effect the same in NYMEX & Current prices of stock, So the profit/loss is minimised. 2. Nope it cannot be considered as cash flow hedge because there is no receivables. Hence it cannot be considered cash flow hedge 3. on December 31, 2016 if the future contract is 6.75 for delivery on February 2, 2017 then NGW should recognise loss of 2500$ (6.75-7)*10000 and again on spot at february 2, 2017 should recognise profit of 1000$(6.85-6.75)*10000, if sells for 8$ recognise profit of 11500$ (8$-6.85)*10000 31/12/2016 Loss on Futures Debit 2500 Future contract Credit 2500 02/02/2017 Future contract Debit 1000 Profit on Future Credit 1000 03/02/2017 Future contract Debit 11500 Profit on Future Credit 11500