Jensen Company predicts need for 200,000 pounds of cotton in May. On April 11, company acquires a call option to buy 200,000 pounds of cotton in May at strike price of $0.3765 per pound for premium of $814. Spot prices and options values at selected dates follow:
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April 11
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April 30
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May 3
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Spot price per pound
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$0.37
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$0.38
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$0.38
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Fair value of option
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814
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1,137
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1,689
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Jensen Company settled option on May 3 and bought 200,000 pounds of cotton on May 17 at spot price of $0.3840 per pound. In the last half of May and starting of June the cotton was utilized to make cloth. One third of the cloth was sold in June. Change in option's time value is excluded from assessment of hedge effectiveness.
Questions:
a) Make all journal entries essential through June to record above transactions and events.
b) What would effect on earnings have been if predicted purchase were not hedged?