LEW Jewelry Co. uses gold in the manufacture of its products. LEW anticipates that it will need to purchase 500 ounces of gold in October 2020, for jewelry that will be shipped for the holiday shopping season. However, if the price of gold increases, LEW's cost to produce its jewelry will increase, which would reduce its profit margins.To hedge the risk of increased gold prices, on April 1, 2020, LEW enters into a gold futures contract and designates this futures contract as a cash flow hedge of the anticipated gold purchase. The notional amount of the contract is 500 ounces, and the terms of the contract give LEW the right and the obligation to purchase gold at a price of $300 per ounce. The price will be good until the contract expires on October 31, 2020.Assume the following data with respect to the price of the futures contract and the gold inventory purchase:Date Spot Price for October DeliveryApril 1, 2020  $300 per ounceJune 30, 2020  310 per ounceSeptember 30, 2020  315 per ounceInstructionsPrepare the journal entries for the following transactions. a. April 1, 2020—Inception of the futures contract, no premium paid. b. June 30, 2020—LEW Co. prepares financial statements. c. September 30, 2020—LEW Co. prepares financial statements. d. October 10, 2020—LEW Co. purchases 500 ounces of gold at $315 per ounce and settles the futures contract. e. December 20, 2020—LEW sells jewelry containing gold purchased in October 2020 for $350,000. The cost of the finished goods inventory is $200,000. f. Indicate the amount(s) reported on the balance sheet and income statement related to the futures contract on June 30, 2020. g. Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions on December 31, 2020.

Question
Asked Feb 3, 2020
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LEW Jewelry Co. uses gold in the manufacture of its products. LEW anticipates that it will need to purchase 500 ounces of gold in October 2020, for jewelry that will be shipped for the holiday shopping season. However, if the price of gold increases, LEW's cost to produce its jewelry will increase, which would reduce its profit margins.

To hedge the risk of increased gold prices, on April 1, 2020, LEW enters into a gold futures contract and designates this futures contract as a cash flow hedge of the anticipated gold purchase. The notional amount of the contract is 500 ounces, and the terms of the contract give LEW the right and the obligation to purchase gold at a price of $300 per ounce. The price will be good until the contract expires on October 31, 2020.

Assume the following data with respect to the price of the futures contract and the gold inventory purchase:

Date   Spot Price for October Delivery
April 1, 2020    $300 per ounce
June 30, 2020    310 per ounce
September 30, 2020    315 per ounce

Instructions

Prepare the journal entries for the following transactions.

 a. April 1, 2020—Inception of the futures contract, no premium paid.

 b. June 30, 2020—LEW Co. prepares financial statements.

 c. September 30, 2020—LEW Co. prepares financial statements.

 d. October 10, 2020—LEW Co. purchases 500 ounces of gold at $315 per ounce and settles the futures contract.

 e. December 20, 2020—LEW sells jewelry containing gold purchased in October 2020 for $350,000. The cost of the finished goods inventory is $200,000.

 f. Indicate the amount(s) reported on the balance sheet and income statement related to the futures contract on June 30, 2020.

 g. Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions on December 31, 2020.

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Expert Answer

Step 1

Note: Since we are entitled to answer up to 3 sub-parts, we’ll answer the first 3. Please resubmit the question and specify the other subparts (up to 3) you’d like to get answered.

A future contract is a legitimate consent to purchase or sell a specific commodity, or security at a cost that is predetermined and at a predefined time in the future.

Step 2

a. 1st April 2020- A memo entry will be passed for the inception of future contracts:

  • A memo entry is a short note that goes into the journal and furthermore goes into a general ledger account. This entry is not a complete journal entry as it does not include debit and credit amounts.

 

Step 3

b. To record journal entry when L prepares financial statements on 30th June 2020:

Accounting homework question answer, step 3, image 1

Working note:

Unrealized loss or gain= (($310 – $300) × 500 ounces) = $5,000

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