Question

A firm carries a commodity inventory at a cost of $750,000 and plans to sell it in 60 days. Its market value is currently $800,000. To hedge against a decline in value of the commodity, the company sells commodity futures for delivery in 60 days at a price of $800,000. There is no margin deposit. At the company's 2020 year-end, 30 days later, the 30-day futures price is $780,000 and the inventory value declined to $779,000. Income effects of the inventory and the futures are reported in cost of goods sold.

What is the net effect of value changes in the futures and the inventory on cost of goods sold?

a. Increase $1,000
b. Increase $21,000
c. Decrease $1,000

Answer 1

a. Increase $1,000

Step-by-step explanation:

The computation is shown below:

Decline in value of inventory is

= $800,000 - $779,000

= $21,000

Now

Gain on Future contract at year end is

= $800,000 - $780,000 = $20,000

So,

Net gain or (loss) is

= $20,000 - $21,000

= ($1,000)

As it can be seen that the cost of goods sold rise by $1,000

Hence option A is correct.