MSH Corporation uses gold to manufacture jewelry. MSH anticipates the need for gold on June 30th for goods that will be sold on September 30th. Concerned that the price of gold will increase, MSH purchases a futures contract and designates the contract as a cash flow hedge. As it turns out, the spot price of gold was lower at the end of June when the contract was settled. When should MSH recognize the loss on the futures contract in the income statement and should the loss be included in income from continuing operations (IFCO)? why is the loss recognized on sept 30 and not June 30?
Futures contracts settle each day and a mark-to-market cash flow takes place ( typically into or out of a margin account ) , hence the term cash-flow-hedge. Just because it settles on June 30th doesn’t mean it won’t settle again on Jul 1st or Jul 2nd or Jul 3rd and so on all the way to sep 30th when the need for delivery arises and the hedge can be wound down. But since MSH hedged the exact quantity it needs of gold on June 30th , asset and hedge would move together from that point on , and the loss is locked in , all the way until Sep 30th when the hedge ( futures) and the original need for gold both expire. Since the actual cash flow on the sale takes place on 30th Sep , that’s when everything is recognized in the income statement . Otherwise if we try and recognze one leg on June 30th and another on Sep 30th , it would look like separate ( unitended ) transactions and not one intended flow. I suppose on June 30th ( being a 10-Q filing date ) we could put the loss into “Accumulated comp income in the balance sheet” and the footnotes would explain that it is on account of the large gold deal that was due to deliver on Sep 30th and the hedge has suffered an initial loss . The analysts would be happy with that. FASB 133 deals with things like this
doesn’t make sense…the need for gold is on June 30 so why wouldn’t the hedge wind down then? doesn’t make sense that MSH would need the settlement to occur after the gold input is needed.
Read carefully , they “realized the need for gold on June30th for delivery on Seo 30th”. They anticipated the need and created a hedge . The actual cash flows ( final settlement ) would only take place on Sep 30th . They initiate the futures contract on June 30th and wind it down on Sep 30th.
gazhoo Wrote: ------------------------------------------------------- > MSH Corporation uses gold to manufacture jewelry. > MSH anticipates the need for gold on June 30th for > goods that will be sold on September 30th. > Concerned that the price of gold will increase, > MSH purchases a futures contract and designates > the contract as a cash flow hedge. As it turns > out, the spot price of gold was lower at the end > of June when the contract was settled. When should > MSH recognize the loss on the futures contract in > the income statement and should the loss be > included in income from continuing operations > (IFCO)? > > why is the loss recognized on sept 30 and not June > 30? heres the way cash flow hedges work -because its a “cash flow hedge” they are hedging a future or anticipated transaction, which would be the sale of goods on 9/30. Up until that transaction occurs, changes in the value of the future contract are reported in “other comprehensive income” (similar to f/x translation adjustments, changes in pension plan funded status, or available for sale securities). Once the underlying cash flows that you were hedging are realized, that is when you would recognize the gain or loss through the income statement. The reason why cash flow hedges exist is to eliminate volatility in the income statement. Once the company satisfies the cash flow hedge" criteria, it can record the gains or losses on the derivative through OCI, up until the underlying transaction occurs. In this manner, the company recognizes both the sale and the changes in value of the derivative in the same period.
ok got it thanks