ACCT 540
Week 5
Course Project, Case 1: Applying the Authoritative Sources
This week, I will discuss my findings from the authoritative sources that relate to the case and then apply those concepts and explain how they relate to the case directly. Since the Controller of Thomas Foods is inexperienced with regards to accounting for hedging strategies, I have been asked to provide examples of different hedging strategies and explain how each example is implemented as well as how it is accounted for.
Two types of hedging strategies that the Controller should become familiar with are cash flow hedges and fair value hedges. Cash flow hedges relate to forecasted transactions where the effective portions of the hedge is initially reported in other comprehensive income and are later reclassified into earnings any portion of the hedge that is ineffective is reported currently in earnings (FASB ASC 815-30, 2010). Fair value hedges can be associated with either a recognized asset or liability, or an unrecognized commitment of the entity. The gains and losses from a fair value hedge are recognized currently in earnings. The ultimate goal of a fair value hedge is for the gains and losses to fully offset each period. However, this does not happen often and the difference is recorded as a residual credit or charge to earnings each period while the hedge is in effect (FASB ASC 815-25, 2010).
In order to apply the guidance in the FASB ASC Sections 815-20-25, 815-20-35 and 815-25-35 for how a company should evaluate hedge effectiveness, assume that Thomas Foods elected to implement a fair value hedging strategy and that the hedge fulfilled all of the criteria for hedge accounting at inception. Also assume that Thomas foods purchases on average 1,000 pounds of tomatoes from a local farmer and that two months prior to harvest, and proposes a hedging strategy in which local farmer sells a two-month futures contract to Thomas Foods for 1,000 pounds of tomatoes. Even though the futures contracts are for the tomatoes that are expected to harvest in two months, the futures contracts and hedged tomatoes have different bases since the futures contracts are based on the ripened, harvested tomatoes, while the hedged item still has two months left in its growing cycle. Therefore, Thomas Foods cannot automatically assume that the hedge will be highly successful in counterbalancing the changes in fair value.
When estimating the effectiveness of the hedge, Thomas Foods must refrain from estimating the value of the unripe tomatoes solely based on the current price. The company should also factor in the physical condition of the growing tomatoes, additional production and harvesting costs, as well as weather predictions for the next two months. This will help Thomas Foods to determine if the chosen hedging strategy is best suitable to their needs and will accomplish the goal of mitigating the risk of increased prices on the farmer’s tomatoes.
References
FASB (Financial Accounting Standards Board). (2010). ASC 815-20-25.
Retrieved August 8, 2015, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (2010). ASC 815-20-35.
Retrieved August 8, 2015, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (2010). ASC 815-25-35.
Retrieved August 8, 2015, from FASB Accounting Standards Codification database.
FASB (Financial Accounting Standards Board). (2010). ASC 815-30. Retrieved
August 8, 2015, from FASB Accounting Standards Codification database.
Self-Study Guide to Hedging with Grain and Oilseed Futures and Options.
(2014). Retrieved August 8, 2015.
Wisner, R., & Hofstrand, D. (2015, July 1). Grain Price Hedging Basics | Ag
Decision Maker. Retrieved August 8, 2015.