Mega Company believes the price of oil will increase in the coming months. There
ID: 2340991 • Letter: M
Question
Mega Company believes the price of oil will increase in the coming months. Therefore, it decides to purchase call options on oil as a price-risk-hedging device to hedge the expected increase in prices on an anticipated purchase of oil. On November 30, 20X1, Mega purchases call options for 15,000 barrels of oil at $38 per barrel at a premium of $2 per barrel with a March 1, 20X2, call date. The following is the pricing information for the term of the call: Navember 30, 20x1 December 31,20x1 March 1, 20X2 5 38 8 39 The information for the change in the fair value of the options $300000- S 30000 600045000 December 31, 20x1 March 1, 20x2 45.000 On March 1, 20X2, Mega sells the options at their value on that date and acquires 15,000 barrels of oil at the spot price. On June 1, 20X2, Mega sells the oil for $42 per barrel. Required Prepare the journal entry required on November 30, 20X1, to record the purchase of the call options. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.) Journal entry worksheet ecord the purchase of call options. Note: Enter debits beforeExplanation / Answer
a) Journal entry to record the purchase of the call option nov 30 Particulars Debit Credit Purchase call options 30000 Cash 30000 Purchase call options for 15000 barrels of oil at a primium of $2 per barrel for march 1 20X2 b) Adjusting entry on December 31 20X1 Loss on Hedge activity 24000 purchase call options 24000 Record the decrase in the time value of the option to current earning purchase call options 15000 other comprehensive income 15000 to record the increase in the intrinsic value of the option to other comprehensive income journal entry to record march 1 20X2 expiration of option the sale of the option and purchase of oil Loss on hedge activity 6000 purchase call options 6000 Record the decrease in the time value of the option to current earning the option have expired purchase call option 30000 other comprehensive income 30000 Record the increase in the intrinsic value of the option to other comprehensive income Cash 45000 purchase call options 45000 record the sale of the call options oil inventory 615000 cash 615000 Record the purchase of 15000 barrels of oil at the spot price of $ 41 per barrels d) june 1 20X2 journal entries to record the sale of the oil and other Cash 630000 Sales 630000 record the sales of 15000 barrels of oil @42 cost of goods sold 615000 oil inventory 615000 recognize the cost of goods sold other comprehensive income-reclassification 45000 cost of goods sold 45000 reclassifying into earning the other comprehensive income form the cash flow hedge