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 will be the difference between the fair value of the option at the end of the reporting period and the cost of the option. In this case, the option expense for 2012 is ($1,600 - $1,800) = -$200. This amount is recognized in Other Comprehensive Income (OCI) as a component of the cash flow hedge. Therefore, the correct answer is B) $1,600.

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