Question

On January 2, 2020, Buffalo Company purchases a call option for $330 on Merchant common stock. The call option gives Buffalo the option to buy 910 shares of Merchant at a strike price of $53 per share. The market price of a Merchant share i $53 on January 2, 2020 (the intrinsic value is therefore $0). On March 31, 2020, the market price for Merchant stock is $56 per share, and the time value of the option is $200. Prepare the journal entry to record the purchase of the call option on January 2, 2020. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry for the account titles and enter for the amounts.) Date Account Titles and Explanation Debit Credit Jan. 2020 e Textbook and Media List of Accounts Prepare the journal entries to recognize the change in the fair value of the call option as of March 31, 2020. (Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry for the account titles and enter for the amounts) Date Account Titles and Explanation Debit Credit Mar. 31. 2020 (To record the time value change.) Mar 31. 2020 (To record the change in intrinsic value.)

Answer 1

According to the requirement of the question, we have to record the journal entries and calculate the effect on net income.

Requirement 1. Prepare the Journal entry to record the purchase of Call Option on January 2,2020.

Solution:-

Date	Account Titles and Explanation	Debit ($)	Credit ($)
Jan. 2 ,2020	Call Option (Given)	$330
	Cash		$330
	(To record purchase of Call option)

Requirement 2. Prepare the Journal entries to recognize the change in fair value of the call option as of March 31,2020.

Solution:-

Date	Account Titles and Explanation	Debit ($)	Credit ($)
Mar. 31,2020	Call Option (Working Note)	$2,730
	Unrealized holding gain or loss income		$2,730
Mar. 31,2020	Unrealized Holding gain or loss income	$130
	Call Option		$130
	($330 - $200)

Working Note:- Calculation of Value

= Shares * (Market price of Merchant Stock - Strike price)

= 910 * ($56 - $53)

= 910 * $3 = $2,730

Requirement 3. What was the effect on net income of entering into the derivative transaction for the period January 2 to March 31, 2020?

Solution:-

Unrealized Holding -

Gain

$2,600

Working Note:- Calculation of Unrealized Holding Gain.

= $2,730 - $130 = $2,600

Thank you..

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