Problem:
A Gunsmith company has an inventory of 100,000 ounces of gold originally purchased for $4.00 per ounce. On September 30, 2003, gold is selling for $5.00 per ounce in the spot market, and the company decides to hedge its gold inventory by going short in exchange-traded March 2004 gold futures at a price of $5.15. The exchange requires that a margin deposit of $825.00 be maintained for each 5,000 ounce futures contract. At December 1, 2003, the spot price of gold is $4.70, and March 2004gold futures are $4.80. By March 31, 2004 gold has dropped to $4.20 in the spot market.
Requirement:
Question 1: Describe the documentation that the company must prepare to account for the silver futures as a fair value hedge.
Question 2: Evaluate hedge effectiveness at (1) December 1, 2003, and (2) March 31, 2004. Use Futures Price
Question 3: Prepare the journal entries required at (1) September 30, 2003, (2) December 1, 2003, and (3) March 31, 2004.
Question 4: How would the accounting be affected if the original costs of the silver were $5.00, considering the lower-of-cost or market rule for inventory?
Note: Show supporting computations in good form.