Far West Clothing Mills uses approximately 250,000 pounds of cotton each month to make the cotton fabric used in its patented no-wrinkle, long-sleeved white shirts. On December 1, 2011, Far West purchased an option to buy 250,000 pounds of cotton on January 1, 2012, at a price of $0.50 per pound. The market price on December 1 is $0.50 per pound. Far West had to pay $2,000 to purchase the cotton option. Far West designated the option as a hedge against price fluctuations for its January purchases of cotton.

Make all journal entries necessary on Far West’s books on December 1, 2011, December 31, 2011, and January 1, 2012, to record this option and to record the purchase of 250,000 pounds of cotton on January 1. On December 31, 2011, and on January 1, 2012, the market price of cotton is $0.42 per pound.