Eddie's Burgers uses 1000 pounds of soybean oil per month in its deep fryers.Eddie's typically purchases soybean oil on the local spot market on a just-in-time basis, and the company has not entered into any forward purchase contracts for its supply of oil.Eddie's management team has prepared a business plan for the year which assumes $30.00 per pound soybean oil prices.Margins in the fast food business are fairly slim, though, so management is concerned that a significant increase in the price of oil could cause the company to miss its earnings projections. Spot soybean oil prices have been acceptable over the first six months of the year, but management is now concerned about December oil prices. On July 1, management decides it wants to use soybean oil futures contracts to manage its price risk for purchases of soybean oil in December.

Assume that Eddie's management has properly documented a cash flow hedge accounting program associated with this contract, and based on a valid assessment, management believes that the December CME soybean oil futures contract will be a highly effective hedge against its December soybean oil prices.

The following chart provides information about soybean oil prices:

Expected local cash price for December soybean oil delivery/lb.

CME

December Soybean oil Futures price/lb.

July 1

$30.75

$32.00

September 30

31.35

33.50

December 31

35.90

36.00

1.What futures transaction should Eddie's make?

July (Basis)

(1.25) = 30.75 - 32

December (Basis)

(0.1)=35.9 - 36

1.15 (basis strengthened)

Quantity (pounds)

1,000

1,150

Sell the 1,000 pounds (sell futures)

2.Complete the missing parts of the following excerpt from the cash flow hedge documentation for this hedging relationship:

Risk management objective and nature of the risk being hedged

Date of designation

Hedging instrument

Hedged item

3.Complete the indicated missing values in the following table.Use parentheses for negative numbers:

Fair value of the hedging instrumentasset/(liability)

Expected future cash flows on hedged transaction- gain/(loss)

Cumulative

Effectiveness %

Period ending

Change during the period

Cumulative change

Change during the period

Cumulative change

9/30/15

12/31/15

4. What is the actual effectiveness percentage of this hedge program using the cumulative dollar offset method as of September 30 and at December 31?

Sept.Dec.

5. Assume the hedge program is expected to continue to be highly effective as of September 30. Also assume that the CME futures contract is settled in cash once per quarter.Ignore performance deposit requirements and income taxes. Prepare the required journal entry for this cash flow hedge program as of September 30

Date

Account description

Dr.

Cr.

6. Assume the hedge program continues to be assessed as highly effective as of December 31. Prepare the required journal entry for this cash flow hedge program as of December 31

Date

Account description

Dr.

Cr.

7. Prepare the required journal entry to account for the purchase of soybean oil on December 31.

Date

Account description

Dr.

Cr.

8. Assume all of the soybean oil was used to fry French fries which were sold to customers for $50,000 in January.Ignore the other ingredients for French fries (potatoes, salt, labor and "secret seasonings") and ignore income taxes.Prepare the required journal entries.

Date

Account description

Dr.

Cr.

9.Prepare the entries for the hedging, purchase and sale transactions if no cash flow hedge accounting program was employed.

Date

Account description

Dr.

Cr.

10.Compare the impact on net income (before income taxes) with and without the hedge program.

Impact on net income before tax

Quarter ending

Hedge accounting

No hedge accounting

9/30

12/31

3/31

Total

11. Comment on the relative merits of the income impacts as presented in your answer to #10, from a financial statement user's perspective.