On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per pound. The option is considered to be a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot exchange rates apply:

What is the amount of option expense for 2012 from these transactions?

A) $1,000.
B) $1,600.
C) $2,500.
D) $2,600.
E) $0.

Question

On October 1, 2011, Eagle Company forecasts the purchase of inventory from a British supplier on February 1, 2012, at a price of 100,000 British pounds. On October 1, 2011, Eagle pays $1,800 for a three-month call option on 100,000 pounds with a strike price of $2.00 per pound. The option is considered to be a cash flow hedge of a forecasted foreign currency transaction. On December 31, 2011, the option has a fair value of $1,600. The following spot exchange rates apply:

What is the amount of option expense for 2012 from these transactions?

A) $1,000. 
B) $1,600. 
C) $2,500. 
D) $2,600. 
E) $0.

Quizplus · Accepted Answer

The option expense for 2012 is calculated as:
Option expense = Change in fair value of the option during the period + Option premium paid
= ($1,600 - $1,800) + $1,800
= -$200 + $1,800
= $1,600
Therefore, the option expense for 2012 is $1,600. The correct choice is B.

On October 1, 2011, Eagle Company Forecasts the Purchase of Inventory