Spiralling crude oil prices prompted AMAR Company 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 30,20X8,AMAR purchases call options for 20,000 barrels of oil at $100 per barrel at a premium of $4 per barrel,with a February 1,20X9,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 February 1,20X9,AMAR sells the options at their value on that date and acquires 20,000 barrels of oil at the spot price.On April 1,20X9,AMAR sells the oil for $112 per barrel.

-Based on the preceding information,which of the following adjusting entries would be required on December 31,20X8?
A)Option A
B)Option B
C)Option C
D)Option D

Question

Spiralling crude oil prices prompted AMAR Company 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 30,20X8,AMAR purchases call options for 20,000 barrels of oil at $100 per barrel at a premium of $4 per barrel,with a February 1,20X9,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 February 1,20X9,AMAR sells the options at their value on that date and acquires 20,000 barrels of oil at the spot price.On April 1,20X9,AMAR sells the oil for $112 per barrel.
  
-Based on the preceding information,which of the following adjusting entries would be required on December 31,20X8?
A)Option A 
B)Option B 
C)Option C 
D)Option D

Quizplus · Accepted Answer

The adjusting entry required on December 31,20X8, would be to debit "Prepaid Options Premium" for $80,000 ($4 x 20,000 barrels x 2 call options) and credit "Cash" for $80,000. This entry reflects the cost of the call options as a prepayment for the anticipated purchase of oil in the future. Option A, C, and D do not reflect the correct adjusting entry based on the information provided.

Spiralling Crude Oil Prices Prompted AMAR Company to Purchase Call