Cash-flow hedge, futures contract
NGW, a consumer gas provider, estimates a rather cold winter. As a result it decides to enter into a fu- tures 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.