Question

 

Question (Call Option) On August 15, 2016, Outkast Co. invested idle cash by purchasing a call option on Counting

Crows Inc. common shares for $360. The notional value of the call option is 400 shares, and the option price is $40. The option

expired on January 31, 2017. The following data are available concerning the call option.

Market Price of Counting Time Value of Call

Date Crows Shares Option

September 30, 2016 $48 per share $180

December 31, 2016, 46 per share 65

January 15, 2017, 47 per share 30

Instructions

Prepare the journal entries for Outkast for the following dates.

(a) Investment in a call option on Counting Crows shares on August 15, 2016.

(b) September 30, 2016—Outkast prepares financial statements.

(c) December 31, 2016—Outkast prepares financial statements.

(d) January 15, 2017—Outkast settles the call option on the Counting Crows shares.

Answer 1

 

Step-by-Step Solution

Step 1: Definition of the call option

It is an option that gives the right to buy an asset at an agreed price before the agreement’s expiration.

Step 2: Entry of purchase of call option

Date	Particulars	Debit	Credit
August 15, 2016	Call Option	$360
	Cash		$360
	(Being purchase of call option)

 

Step 3: Entry related to financial statement

Date	Particulars	Debit	Credit
September 30, 2016	Call Option	$3,200
	Unrealized holding income		$3,200
	(Being entry of unrealized income)
September 30, 2016	Unrealized holding income	$180
	Call option		$180
	(Being entry of time value change)

 

Step 4: Entry related to financial statement

Date	Particulars	Debit	Credit
December 31, 2016	Unrealized holding income	$800
	Call option		$800
	(Being entry of unrealized income)
December 31, 2016	Unrealized holding income	$115
	Call option		$115
	(Being entry of unrealized income)

 

Step 5: Entry related to the settlement of call option

Date	Particulars	Debit	Credit
January 15, 2017	Call Option	$400
	Unrealized holding income		$400
	(Being entry of unrealized income)
January 15, 2017	Unrealized holding income	$35
	Call option		$35
	(Being entry of time value changed)
January 15, 2017	Cash	$2,830
	Unrealized holding income	$2,470
	Call Option		$2,830
	Profit on settlement of call option		$2,470
	(Being settlement of the profit)

 

 

 

Profit on the settlement of call option is $2,470.