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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, 2011. The trading unit is 10,000...

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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, 2011. 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, 2011, futures contract rate is $6.75 for delivery on February 2, 2012, and the spot rate on February 2, 2012, is $6.85. Assume that NGW sells all of the gas on February 3, 2012, for $8.00 per MMBtu. Prepare all the necessary journal entries from November 2, 2011, through February 3, 2012, to account for this hedge situation.

Answered Same DayDec 31, 2021

Solution

David answered on Dec 31 2021
61 Votes
Hedge Accounting
1) Considering the terms of the hedge and the facts present under the cu
ent situation, it seem
that the hedge would be effective and therefore complying to the requirement of Hedge
Accounting. The reason for the same being that the value of the asset at which the consideration
for the hedge is planned to be received and the value of the underlying asset is ideally the same
and there is one to one co
elation of the asset value and the hedge amount and hence the actual
consideration or the actual value is unlikely to be the different. This would therefore call for the...
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