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Chapter 13: Q23E (page 658)

(Derivative Transaction) On January 2, 2017, Jones Company purchased a call option for \(300 on Merchantcommon stock. The call option gives Jones the option to buy 1,000 shares of Merchant at a strike price of \)50 per share. The marketprice of a Merchant share was \(50 on January 2, 2017 (the intrinsic value is, therefore, \)0). On March 31, 2017, the market pricefor Merchant stock was \(53 per share, and the option’s time value was \)200.Instructions

(a) Prepare the journal entry to record the purchase of the call option on January 2, 2017.

(b) Prepare the journal entry(ies) to recognize the change in the fair value of the call option as of March 31, 2017.

(c) What was the effect on net income of entering into the derivative transaction for the period January 2 to March 31, 2017?

Short Answer

Expert verified

a. Cash account credited with $300

b. Unrealized loss amounted to $100

c. Net income is $2,900

Step by step solution

01

Entry for the purchase of call option

Date

Particulars

Debit

Credit

January 2, 2017

Call Option

$300

Cash

$300

(Being call option purchased)

02

Entry for the change in the fair value ofthe call option

Date

Particulars

Debit

Credit

March31, 2017

Unrealized Holding Gain or loss

$100

Call Option

$100

(Being adjustment of the fair value)

03

Recording of the effect of change in the net income

Date

Transaction

Effect

March 31, 2017

Increase in the value

$3,000

March 31, 2017

Decrease in the value of call option

($100)

Total net income

$2,900

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