Question

(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

a. Cash account credited with $300

b. Unrealized loss amounted to $100

c. Net income is $2,900

Step-by-step solution

Entry for the purchase of call option

Date	Particulars	Debit	Credit
January 2, 2017	Call Option	$300
	Cash		$300
	(Being call option purchased)

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)

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