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 entries will be required on February 1,20X9?

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 entries will be required on February 1,20X9?

Quizplus · Accepted Answer

On February 1, 20X9, AMAR will need to record the following entry to recognize the change in fair value of their call options:

Dr. Unrealized Gain/Loss on Call Options: $64,000 ($3.20 × 20,000 barrels)
Cr. Call Options: $84,000 (($4.20 premium + $100 strike price) × 20,000 barrels)

This entry will be necessary because the options are being marked-to-market on the balance sheet, with the unrealized gain or loss recorded in the income statement. The other options shown do not reflect the correct amounts or accounts to be recorded.

Spiralling Crude Oil Prices Prompted AMAR Company to Purchase Call