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Mega Company believes the price of oil will increase in the coming months. Therefore, it...

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Accounting

Mega Company believes the price of oil will increase in the coming months. Therefore, it decides to purchase call options on oil as a price-risk-hedging device to hedge the expected increase in prices on an anticipated purchase of oil. On November 30, 20X1, Mega purchases call options for 11,000 barrels of oil at $32 per barrel at a premium of $2 per barrel with a March 1, 20X2, call date. The following is the pricing information for the term of the call:

Date Spot Price Futures Price (for March 1, 20X2, delivery)
November 30, 20X1 $ 32 $ 33
December 31, 20X1 33 34
March 1, 20X2 35

The information for the change in the fair value of the options follows:

Date Time Value Intrinsic Value Total Value
November 30, 20X1 $ 22,000 $ 0 $ 22,000
December 31, 20X1 6,000 11,000 17,000
March 1, 20X2 33,000 33,000

On March 1, 20X2, Mega sells the options at their value on that date and acquires 11,000 barrels of oil at the spot price. On June 1, 20X2, Mega sells the oil for $36 per barrel. Required: a. Prepare the journal entry required on November 30, 20X1, to record the purchase of the call options.

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