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Chap 17

Exercise 17.24 discusses journal entries for purchasing a call option and recognizing changes in its fair value. Exercise 17.25 computes net interest expense for a note hedged by an interest rate swap. Exercise 17.28 provides journal entries for investing in a call option and recognizing changes in its fair value over time.

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273 views3 pages

Chap 17

Exercise 17.24 discusses journal entries for purchasing a call option and recognizing changes in its fair value. Exercise 17.25 computes net interest expense for a note hedged by an interest rate swap. Exercise 17.28 provides journal entries for investing in a call option and recognizing changes in its fair value over time.

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mai anh
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E17.

24 (LO5) (Derivative Transaction)


On January 2, 2019, Jones Company purchases a call option for $300 on Merchant ordinary
shares. The call option gives Jones the option to buy 1,000 shares of Merchant at a strike
price of $50 per share. The market price of a Merchant share is $50 on January 2, 2019 (the
intrinsic value is therefore $0). On March 31, 2019, the market price for Merchant shares is
$53 per share, and the time value of the option is $200. Instructions
a. Prepare the journal entry to record the purchase of the call option on January 2, 2019.
b. Prepare the journal entry(ies) to recognize the change in the fair value of the call option as
of March 31, 2019.
c. What was the effect on net income of entering into the derivative transaction for the period
January 2 to March 31, 2019? (Ignore tax effects.)

E17.25 (LO6) (Fair Value Hedge)


On January 2, 2019, MacCloud SA issued a 4-year, €100,000 note at 6% fixed interest,
interest payable semiannually. MacCloud now wants to change the note to a variable-rate
note. As a result, on January 2, 2019, MacCloud enters into an interest rate swap where it
agrees to receive 6% fixed and pay LIBOR of 5.7% for the first 6 months on €100,000. At each
6-month period, the variable rate will be reset. The variable rate is reset to 6.7% on June 30,
2019. Instructions
a. Compute the net interest expense to be reported for this note and related swap transaction
as of June 30, 2019.
b. Compute the net interest expense to be reported for this note and related swap transaction
as of December 31, 2019.

E17.28 (LO6) On August 15, 2019, Outkast Co. invested idle cash by purchasing a call option
on Counting Crows Inc. ordinary shares for $360. The notional value of the call option is 400
shares, and the option price is $40. (Market price of a Counting Crows share is $40.) (Call
Option) The option expires on January 31, 2020. The following data are available with respect
to the call option.

Date Market Price of Counting Time Value of Call Option


Crows Shares

September 30, 2019 $48 per share $180

December 31, 2019 46 per share 65

January 15, 2020 47 per share 30

Instructions: Prepare the journal entries for Outkast for the following dates
a. Investment in call option on Counting Crows shares on August 15, 2019.
b. September 30, 2019—Outkast prepares financial statements.
c. December 31, 2019—Outkast prepares financial statements.
d. January 15, 2020—Outkast settles the call option on the Counting Crows shares.
EXERCISE 17.24 (15–20 minutes)

(a) January 2, 2019


Call Option 300
Cash 300

(b) Unrealized Holding Gain or Loss—Income 100


Call Option ($300 – $200) 100

Call Option 3,000


Unrealized Holding Gain or Loss—
Income (1,000 X $3)
3,000

(c) Unrealized Holding Gain: $2,900 ($3,000 – $100)

*EXERCISE 17.25 (20–25 minutes)

(a) 6/30/19 (b) 12/31/19


Fixed-rate debt €100,000 €100,000
Fixed rate (6% ÷ 2) X3% X3%
Semiannual debt payment € 3,000 € 3,000
Swap fixed receipt (3,000) (3,000)
Net income effect € 0 € 0
Swap variable rate
5.7% X 1/2 X €100,000 € 2,850
6.7% X 1/2 X €100,000 0 € 3,350
Net interest expense € 2,850 € 3,350

*EXERCISE 17.28 (20–25 minutes)

(a) August 15, 2019


Call Option 360
Cash 360

(b) September 30, 2019


Call Option 3,200
Unrealized Holding Gain or Loss—Income
($8 X 400)
3,200
Unrealized Holding Gain or Loss—Income 180
Call Option ($360 – $180) 180

(c) December 31, 2019


Unrealized Holding Gain or Loss—Income 800
Call Option ($2 X 400) 800

Unrealized Holding Gain or Loss—Income 115


Call Option ($180 – $65) 115

(d) January 15, 2020


Call Option ($1 X 400) 400
Unrealized Holding Gain or Loss—Income 400

Unrealized Holding Gain or Loss—Income 35


Call Option ($65 – $30) 35

Cash (400 X $7) 2,800


Loss on Settlement of Call Option 30
Call Option* 2,830

*Value of Call Option at settlement:

Call Option
360 180
3,200 800
400 115
35
2,830

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