On December 1,2008,Winston Corporation acquired 100 shares of Linked Corporation at a cost of $40 per share.Winston classifies them as available-for-sale securities.On this same date,it decides to hedge against a possible decline in the value of the securities by purchasing,at a cost of $250,an at-the-money put option to sell the 100 shares at $40 per share.The option expires on February 20,2009.Selected information concerning the fair values of the investment and the options follow:
Assume that Winston exercises the put option and sells Linked shares on February 20,2009.

-Based on the preceding information,which of the following journal entries will be made on February 20,2009?
A)Option A
B)Option B
C)Option C
D)Option D

Question

On December 1,2008,Winston Corporation acquired 100 shares of Linked Corporation at a cost of $40 per share.Winston classifies them as available-for-sale securities.On this same date,it decides to hedge against a possible decline in the value of the securities by purchasing,at a cost of $250,an at-the-money put option to sell the 100 shares at $40 per share.The option expires on February 20,2009.Selected information concerning the fair values of the investment and the options follow:
Assume that Winston exercises the put option and sells Linked shares on February 20,2009.
 
-Based on the preceding information,which of the following journal entries will be made on February 20,2009?
A)Option A 
B)Option B 
C)Option C 
D)Option D

Quizplus · Accepted Answer

On February 20, 2009, Winston Corporation exercises the put option and sells 100 shares of Linked Corporation at $40 per share. The fair value of the shares on that date is $30 per share, resulting in a loss of $10 per share or $1,000 for the entire investment. The journal entry to record the sale of the shares and the exercise of the put option is:

Debit: Cash $4,000 (100 shares x $40 per share)
Credit: Investment in Linked Corporation $3,000 (100 shares x $30 per share)
Credit: Gain on put option $250 (the cost of the put option)
Credit: Unrealized loss on available-for-sale securities $750 [$1,000 (loss on sale) - $250 (gain on put option)]

Option A is incorrect because it does not account for the loss on the sale of the shares.
Option C is incorrect because it does not account for the gain on the put option.
Option D is incorrect because it records the gain on the put option as a loss.

On December 1,2008,Winston Corporation Acquired 100 Shares of Linked Corporation