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5. Accounting for Derivative Securities - Fair Value Hedge (20 points) On 1 October 20X6 Smiths Company, which produces aluminum, had 1,000 tons of aluminum that cost Smiths $1,000,000 to produce. Management chooses to hedge the aluminum position against a decline in aluminum prices (a fair value hedge) by selling aluminum futures contracts to sell 1,000 tons of aluminum at $1,600 per ton. The futures contracts mature in March 20X7 which coincides with the date management expects to sell the aluminum in their local market Assume that Smiths made a margin deposit with the commodities broker of $50,000 on 1 October 20X6 related to the futures contract A summary of the aluminum spot and futures prices on relevant dates is as follows: Aluminum Prices per ton in $US Futures prices for delivery on 3/20/X5 $1,600 $1,540 $1,565 Spot Price $1,590 $1,535 $1,565 Date | 10/1/X6 12/31/X6 3/20/X7 The contract has no value at inception Assume that Smiths' management designates the derivative as a fair value hedge. Hint: you can use an account labeled Amount due to/from Broker to reflect the position Smiths has on the derivative. Please record required transactions on the following dates: a) Deposit with broker on 10/1/X6. (2 pts) b) Adjusting journal entries on 12/31/X6. (4 pts) c) Adjusting jourmal entries on 3/20/X7 to update accounts. (6 pts) d) Net settlement of the futures contracts on 3/20/X7. (3 pts) e) Sale of the aluminum on 3/20/X7. (5 pts) 5. Accounting for Derivative Securities - Fair Value Hedge (20 points) On 1 October 20X6 Smiths Company, which produces aluminum, had 1,000 tons of aluminum that cost Smiths $1,000,000 to produce. Management chooses to hedge the aluminum position against a decline in aluminum prices (a fair value hedge) by selling aluminum futures contracts to sell 1,000 tons of aluminum at $1,600 per ton. The futures contracts mature in March 20X7 which coincides with the date management expects to sell the aluminum in their local market Assume that Smiths made a margin deposit with the commodities broker of $50,000 on 1 October 20X6 related to the futures contract A summary of the aluminum spot and futures prices on relevant dates is as follows: Aluminum Prices per ton in $US Futures prices for delivery on 3/20/X5 $1,600 $1,540 $1,565 Spot Price $1,590 $1,535 $1,565 Date | 10/1/X6 12/31/X6 3/20/X7 The contract has no value at inception Assume that Smiths' management designates the derivative as a fair value hedge. Hint: you can use an account labeled Amount due to/from Broker to reflect the position Smiths has on the derivative. Please record required transactions on the following dates: a) Deposit with broker on 10/1/X6. (2 pts) b) Adjusting journal entries on 12/31/X6. (4 pts) c) Adjusting jourmal entries on 3/20/X7 to update accounts. (6 pts) d) Net settlement of the futures contracts on 3/20/X7. (3 pts) e) Sale of the aluminum on 3/20/X7. (5 pts)

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