In: Accounting
a. On January 1, 20X1, Stella Entity purchases bonds issued by Gragas Entity for $900,000. Stella Entity will receive an annual coupon payment of $75,000 and an additional $1,000,000 when the bond expires. On January 1, 20X3, Stella Entity is short on cash and needs to purchase new equipment to replace equipment that was destroyed in a factory fire. Stella Entity agrees with Cash Entity to sell all of its rights to future payments on the bond for $875,000. The value of the bond on the statement of financial position on January 1, 20X3 is $934,320. Provide the journal entries to reflect the purchase and eventual derecognition of the bonds.
b. On April 1, 20X1, Peanut Company purchased a call option for 10,000 shares of Sax Company that expires on October 1, 20X1. On the date that Peanut Company purchases the option, the strike price is $25. Additionally, the option is purchased for $10,000. On April 2, 20X1, the price per share of Sax Company stock is $23.75. The price remains at $23.75 through the date of the expiration of the call option. Prepare the journal entries to record the initial acquisition of the option and the expiration of the option 6 months later.
A)
Journal entry to record the purchase of Bond as on January 1, 20X1 by Stella Entity:
Journal | Debit | Credit |
Investment in bond | $900000 | |
To cash | $900000 |
Journal entry for eventual derecognition of the bonds by Stella Entity:
Sale price of Bond as on January 1, 20X3 = 875000
Value of Bond as on January 1, 20X3 = 934320
Loss on sale of bond = Value of Bond - Sale price of Bond
= 934320 - 875000 = 59320
Journal:
Journal | Debit | Credit |
Cash | $875000 | |
Loss on sale of investment | $59320 | |
To investment in bond | $934320 |
B)
Exercise date of option on 10000 shares = April 1, 20X1
Expiry date of option = October 1, 20X1
Strike price = $25
Option premium paid = $10000
Call option is taken for upside betting and it is exercised only when the price of share on which call option is taken is above exercise price i.e. strike price. If the price of share is below exercise price then call option is lapsed and premium paid to take call option is considered as net loss to the buyer of option.
In our question, Strike price which is also known as exercise price is $25 and price of share on the date of expiration is $23.75 which is below the strike price of $25. It means that call option is lapsed and loss to the buyer is option premium paid i.e. $10000.
Journal entry to record the initial acquisition of the option:
Date | journal | Debit | Credit |
April 1 20X1 | call option | $10000 | |
To cash | $10000 | ||
(Option premium paid to purchase call option) |
Journal entry to record the loss on expiration of option:
Date | Journal | Debit | Credit |
Oct. 1 20X1 | loss on expiry of option | $1000/ | |
To call option | $10000 | ||
(Loss recognized on expiry of option) |
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