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2. Use of Futures Contracts to Hedge a Forecasted Transaction - Cash Flow Hedge (10 points) Assume that, as of July 1, Tommy's T-Shirts, Inc.

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2. Use of Futures Contracts to Hedge a Forecasted Transaction - Cash Flow Hedge (10 points) Assume that, as of July 1, Tommy's T-Shirts, Inc. plans to purchase 400,000 lbs. of cotton on October 1 at the prevailing spot rate. To hedge this forecasted transaction, Tommy purchases October futures contracts in July for 400,000 lbs. of cotton at the futures price of $1.10/lb. On October 1, Tommy closes out his futures contracts by entering into an offsetting contract in which he agrees to buy 400,000 lbs. of October cotton futures contracts at $1.30/b., the spot rate on that date. Tommy also purchases 400.000 lbs. of cotton at $1.30/lb. on that date for use in making t-shirts. Tommy operates on a calendar year and issues financial statements quarterly. Following are futures and spot prices for the relevant dates: Date July September 30 October 1 Spot $1.00 $1.15 $1.30 Futures $1.10 $1.15 na Required: Prepare the journal entries to record the following: a. Purchase of cotton futures contract in July b. Adjusting entry at September 30 c. Purchase of cotton on October 1 d. At what dollar amount will the cotton be reflected in COGS

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