Jan. | 1 | Grain Put Option.......................................................... | 90,000 — Pratt Agriculture sells approximately 600 bushels each month January 2013
Pratt Agriculture sells approximately 600,000 bushels of grain each month. On January 1, 2013, Pratt purchased an option to sell 600,000 bushels of grain on January 1, 2015, at a price of $1.25 per bushel. The market price on January 1, 2013, is $1.25 per bushel. Pratt had to pay $90,000 to purchase this grain put option, which it designated as a hedge against price decreases for its January 2015 sales of grain.
On December 31, 2013, the price of grain is $1.75 per bushel. Because there is still time for the price of grain to potentially fall below $1.25 per bushel before the option expires (thus making it advantageous to exercise the put option), the option has a value on December 31, 2013, of $23,000. (Note: This December 31, 2013, option value already takes into account an appropriate adjustment for the time value of money.) On December 31, 2014, the price of grain is $1.35 per bushel.
Instructions:
Make all journal entries necessary on Pratt’s books in 2013, 2014, and 2015 to record this option and the sale of 600,000 bushels of grain in January 2015.
SOLUTION
🔒
Unlock the complete assignment
You are viewing the free preview. Purchase this assignment once to reveal the complete resource.
$9.99 USD
Secure checkout is completed by Stripe.
2013
Jan.
1
Grain Put Option..........................................................
No entry is made on January 1, 2013, to record the forecasted sale of grain
No entry is made on January 1, 2013, to record the forecasted sale of grain
to occur in January 2015.
Dec. 31
Dec. 31
Other Comprehensive Income...................................
67,000
Grain Put Option......................................................
67,000
This entry adjusts the recorded value of the option to its fair value as of the end of the year. After this entry, the recorded value of the option is $23,000 ($90,000 – $67,000).
2014
Dec. 31
Dec. 31
Other Comprehensive Income...................................
23,000
Grain Put Option......................................................
23,000
With the price of grain above the option put price, there is no reason to exercise the option; it is better to sell the grain on the open market. Thus, the option will not be exercised on January 1, 2015, and has no value. After this entry, the recorded value of the option is $0.
Loss on Grain Put Option...........................................
90,000
Accumulated Other Comprehensive Income.......
90,000
The grain put option is allowed to expire unused. The deferred loss initially recorded in Other Comprehensive Income in 2013 and 2014 is recognized in earnings on January 1, 2015, the date of the forecasted transaction (grain sales) that was hedged using the grain put option. Both the revenue from the grain sales and the loss from the unused put option will be included in the income statement in the same period.