It’s your third week on the job at Panache Inc. Last week, you made sure all investment transactions for trading, available-for-sale, held-to-maturity, and equity securities were properly recorded.
You are reviewing the financial statement reporting for the securities and have found a newspaper clipping dated December 31 that indicates the price of the stock of Omni company had dropped the day before because of the company’s severe financial difficulties. While the company is not expected to fail, the article states the earnings of the company have permanently declined due to changes in the new-homes market.
You do a quick check of the stock price on that day and find that the stock closed at $8 per share. Panache owns 10,000 shares of Omni’s stock as an available-for-sale security. The original cost of the stock was $20 per share, and the fair value at the last reporting date (September 30, 2016) was $15 per share.
You have just begun to write a memo to the president of the company, Mr. Cartwright, about this investment when he stops by your office and says, “I have a question for you.”
He says, “As you know, we use a special metal called tellurium in our cars. It takes 10 pounds for each car we build. I had a feeling last summer that tellurium prices were going to go up in October, so Mr. Brown told me he could lock the prices in by using a dirigible. Did he do that?”
“It was probably a derivative, Mr. Cartwright,” you reply. “Let me look through the files and see what I can find, and I’ll get back to you. I’ll include my findings in the memo I’m writing to you about another investment.”
You locate a file labeled tellurium futures, and inside you find several documents. The first one is a handwritten note dated August 31, 2015, that says:
Agreed to tellurium futures contract expiring December 31, 2015; agreement gives Panache the right to purchase 2,000 pounds of tellurium at a price of $500 per pound. Signed, C. Brown 8/31/2015.
The second paper is a schedule showing prices of tellurium:
The third document is an invoice for the purchase of 2,000 pounds of tellurium on October 31 at $550 per pound. There is a note on the invoice in Ms. Brown’s handwriting that says:
Settled futures contract today. C. Brown 10/31/2015.
You know that tellurium purchased in October would have been used to produce the 200 cars made in November. The cars produced in November were sold in December for $15,000 each. The total cost to produce the cars was $12,000 each.
You are required to:
- Prepare all journal entries that should have been recorded related to the futures contract, including any entries needed for the September 30, 2016, financial statements; the purchase of the tellurium; and the sale of the cars in December. Create the journal entries in an Excel spreadsheet.
- Write a 2-page memo to Mr. Cartwright that includes:
- A discussion of the investment in Omni company stock and the requirements for the accounting and reporting of this investment.
- A discussion of the tellurium futures contract that includes:
- The type of derivative it is and what it accomplished, if anything
- The way it is accounted for
- The effect of the derivative on the bottom line of Panache’s income statement
- Provide succinct but complete communication, and given the nature of the audience, avoid the use of accounting jargon in your memo.
- Cite any sources you use using the correct APA format on a separate page.