Question

Firm X buys 5,000 shares of Firm Y. This investment is available-for-sale, and appreciates from $40,000 to $210,000. Firm X obtains a put option for 5,000 shares with a strike price of $20 per share on October 1st. Firm X classifies this as a fair value hedge. At Dec 31, the price per share has declined to $17.50. Firm X needs to record the change in the value of this investment on Dec 31.

What is the journal entry that Firm X will use to record the change?

Answer 1

As the market price of securities has declined to $17.50 per share on December 31 from $42 per share ($210,000/5,000 shares), an unrealized loss will be recognized of $24.50 per share ($42-$17.50) on December 31 to record the change in value of investment and as company has hedged its risk with put option with a strike price of $20 per share, an unrealized gain will be recognized of $2.50 per share ($20-$17.50) to record the change in put option. The journal entry will be as follows:-

Journal Entry (Amount in $)

Date	Account title and explanation	Debit	Credit
Dec. 31	Unrealized Holding Gain or Loss-Income ($24.50*5,000)	122,500
	Security Fair Value Adjustment (AFS)		122,500
	(To record the change in value of investment from $210,000 to $87,500)
Dec.31	Put Option ($2.50*5,000)	12,500
	Unrealized Holding Gain or Loss-Income		12,500
	(To record the unrealized gain on put option of 2.50 per share)