Example of Effectiveness

Item to be hedged
Accounts payable
Due January 1, 2007
For delivery of 10,000 euros
Variable is the changing value of euros
Hedge instrument
Forward contract
To accept delivery of 10,000 euros
On January 1, 2007

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 Cash Flow Hedge Example: Fuel
Utility anticipates purchasing oil for sale to its customers
next February. On Dec. 1 Utility enters a futures
contract to acquire 4,200 gallons of oil at $1.4007 per
gallon for delivery on Jan. 31. A margin of $10 is to be
paid up front.
On Dec. 31, the price for delivery of oil on Jan. 31 is
$1.4050.
On Jan. 31, the spot rate for current delivery is $1.3995.
Utility settles the contract, accepting delivery of 4,200
gallons of oil.

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 Cash Flow Hedge
In Feb. Utility sells all the oil to its customers for
$8,400 and reclassifies its OCI from the hedge as cost
of sales. Pertinent rates:
12/1 12/31 1/31
Futures rate, for 1/31 $1.4007 $1.4050 $1.3995
Cost of 4,200
Change barrelscontract
in futures $5,882.94 $5,901.00
to Dec. $5,877.90
31 = $18.06
Change in futures contract to Jan. 31 = ($23.10)
The loss on the contract is ($5.04) OCI, and this serves
to increase the cost of sales.

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 $5,901.00 - $5,882.94 $5,877.90 - $5,901.00

Hedge: Fuel - Entries

Sign 12/1 Futures contract 10.00
contract
Cash 10.00

Adjust to 12/31 Futures contract 18.06

fair value OCI 18.06
1/31 OCI 23.10
Settle Futures contract 23.10
contract;
collect 1/31 Cash 4.96
balance on Futures contract 4.96
margin.
1/31 Inventory
Purchase inventory. 5,877.90
Cash $10.00 - $5.04 ($5,877.90 - $5,882.94)
5,877.90
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 Hedge: Fuel Example (cont.)
Record Feb. Cash 8,400.00
the sale
and cost Sales 8,400.00
of sales. Feb. Cost of sales 5,877.90
Inventory 5,877.90
Feb. Cost of sales 5.04
The last entry reclassifiesOCI
the loss on the contract from5.04
OCI into Cost of sales. The effect is to increase Cost of
sales to $5,882.94. This is the cost of the oil based on the
futures contract signed on Dec. 1.

2009 Pearson Education, Inc. publishing as Prentice Hall 12-5