On May 11, McElroy Inc.purchased a call option on 5,000 bushels of wheat with delivery on August 31 for a premium of $750.The strike price is $1.85 per bushel.The values of the option at the end of May and June are $790 and $810, respectively.The option is sold on July 26 for $804.McElroy Inc.prepares quarterly and annual financial statements.Its year end is June 30.McElroy Inc.will
A)recognize a gain on options of $60 on its fourth quarter income statement.
B)recognize a gain on options of $20 on its fourth quarter income statement.
C)recognize a gain on options of $40 on its fourth quarter income statement.
D)record a gain on options of $54 in the July 26 entry to sell the option.

Question

On May 11, McElroy Inc.purchased a call option on 5,000 bushels of wheat with delivery on August 31 for a premium of $750.The strike price is $1.85 per bushel.The values of the option at the end of May and June are $790 and $810, respectively.The option is sold on July 26 for $804.McElroy Inc.prepares quarterly and annual financial statements.Its year end is June 30.McElroy Inc.will
A)​recognize a gain on options of $60 on its fourth quarter income statement.
B)​recognize a gain on options of $20 on its fourth quarter income statement.
C)​recognize a gain on options of $40 on its fourth quarter income statement.
D)​record a gain on options of $54 in the July 26 entry to sell the option.

Quizplus · Accepted Answer

The option was purchased on May 11 and sold on July 26, which is within the fourth quarter (April 1 - June 30). The gain on the option is calculated as the difference between the selling price and the purchase price, which is $804 - $750 = $54. However, since the option was sold before the end of the fourth quarter, only a portion of the gain is recognized in the fourth quarter income statement. The portion of the gain recognized is based on the number of days the option was held during the fourth quarter divided by the total number of days the option was held. In this case, the option was held for 56 days during the fourth quarter (July 1 - July 26) and for a total of 76 days (May 11 - July 26). Therefore, the portion of the gain recognized in the fourth quarter income statement is $54 * (56 / 76) = $40.