Question

Derivatives: Accounting for Options Pratt Agriculture sells approximately 600,000 bushels of grain each month. On January 1, 2015, Pratt purchased an option to sell 600,000 bushels of grain on January 1, 2017, at a price of $1.25 per bushel. The market price on January 1, 2015, 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 2017 sales of grain. On December 31, 2015, 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, 2015, of $23,000. (Note: This December 31, 2015, option value already takes into account an appropriate adjustment for the time value of money.) On December 31, 2016, the price of grain is $1.35 per bushel. Instructions: Make all journal entries necessary on Pratt’s books in 2015, 2016, and 2017 to record this option and the sale of 600,000 bushels of grain in January 2017.

Answer 1

Solution:

The Journal entries necessary on Pratt’s books in 2015, 2016, and 2017 to record this option and the sale of 600,000 bushels of grain in January 2017.

Date	Account Titles and Explanation	Debit($)	Credit($)
Jan 1, 15	Options A/c Dr	$90,000
	To Cash A/c		$90,000
	(To record purchase of Options recognized)
Dec 31,15	Unrealized gain or loss A/c Dr	$67,000
	To Options A/c		$67,000
	(To record decrease in price of option recognized)
Dec 31, 16	Unrealized gain or loss A/c Dr	$23,000
	To Options A/c		$23,000
	(To record decrease in price of option recognized)
Jan 1, 17	Cash A/c Dr ( 600,000*$1.35)	$810,000
	To Sales A/c		$810,000
	(To record sales of bushels)
Jan 1, 17	Income summary A/c Dr	$90,000
	To Unrealized gain or loss A/c		$90,000
	(To record excess amount over fair value reversed)