Question

On January 2, 2017, Jones Company purchases a call option for $300 on Merchant common stock. The call option gives Jones the option to buy 1,000 shares of Merchant at a strike price of $50 per share. The market price of a Merchant share is $50 on January 2, 2017. On March 31, 2017, the market price for Merchant stock is $53 per share, and the time value of the option is $200.
REQUIRED:
(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, 2017 to March 31, 2017?

Answer 1

Answer and Explanation:

The journal entries and the impact on the net income is as follows:

1  Call option   $300  

           To Cash  $300

(To record the purchase of the call option

2 Unrealized gain or loss -income $100  ($300 - $100)

           To Call option $100

Call option $3000 ( ($53 - $50) × 1000) $3,000

       To Unrealized gain or loss- income $3000

(Being the change in fair value is recorded)  

3. The impact would be

Unrealized holding gain is

= $3,000 - $100

=$2,900