Mega Company believes the price of oil will increase in the coming months. There
ID: 2391359 • 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 10,000 barrels of oil at $31 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:
The information for the change in the fair value of the options follows:
On March 1, 20X2, Mega sells the options at their value on that date and acquires 10,000 barrels of oil at the spot price. On June 1, 20X2, Mega sells the oil for $35 per barrel.
Required:
a. 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.)
b. Prepare the adjusting journal entry required on December 31, 20X1, to record the change in time and intrinsic value of the options. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)
c. Prepare the entries required on March 1, 20X2, to record the expiration of the time value of the options, the sale of the options, and the purchase of the 10,000 barrels of oil. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)
d. Prepare the entries required on June 1, 20X2, to record the sale of the oil and any other entries required as a result of the option. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)
Date Spot Price Futures Price(for March 1, 20X2, delivery) November 30, 20X1 $ 31 $ 32 December 31, 20X1 32 33 March 1, 20X2 34
Explanation / Answer
Part a)
The journal entry required on November 30, 20X1, to record the purchase of the call options is provided as below:
_____
Part b)
The adjusting journal entry required on December 31, 20X1, to record the change in time and intrinsic value of the options is given as follows:
_____
Part c)
The journal entries to record each event are prepared as below:
_____
Part d)
The journal entries to record different events are given as follows:
Date Account Titles Debit Credit November 30, 20X1 Purchased Call Options (10,000*2) $20,000 Cash $20,000 (Tp record purchase of call options at a premium of $2 per barrel)