Various transactions related to securities available-for-sale
• LO12-1, LO12-4
The following selected transactions relate to investment activities of Ornamental Insulation Corporation during 2018. The company buys debt securities, not intending to profit from short-term differences in price and not necessarily to hold debt securities to maturity, but to have them available for sale when circumstances warrant. Ornamental’s fiscal year ends on December 31. No investments were held by Ornamental on December 31, 2017.
Mar. 31 | Acquired 8% Distribution Transformers Corporation bonds costing $400,000 at face value. |
Sep. 1 | Acquired $900,000 of American Instruments’ 10% bonds at face value. |
Sep. 30 | Received semiannual interest payment on the Distribution Transformers bonds. |
Oct. 2 | Sold the Distribution Transformers bonds for $425,000. |
Nov. 1 | Purchased $1,400,000 of M&D Corporation 6% bonds costing at face value. |
Dec. 31 | Recorded any necessary adjusting entry(s) relating to the investments. The market prices of the investments are: |
American Instruments bonds | $ 850,000 |
M&D Corporation bonds | $1,460,000 |
(Hint: Interest must be accrued.) |
Required:
1. Prepare the appropriate
2. Indicate any amounts that Ornamental Insulation would report in its 2018 income statement, 2018 statement of comprehensive income, and 12/31/2018 balance sheet as a result of these investments.
1.
Investment: The act of allocating money to buy a monetary asset, in order to generate wealth in the future is referred to as investment.
Debt securities: The financial instruments which are bought by investors, or corporations, or mutual funds, are referred to as debt securities. The companies issue debt securities to raise capital for the purposes of purchasing assets, or paying debts.
Trading securities: These are short-term investments in debt and equity securities with an intention of trading and earning profits due to changes in market prices.
Fair value: Fair value is the price at which, both seller and buyer agree to exchange the asset. So, fair value is the selling price to the seller and the purchase price for the buyer.
Journal: Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.
Rules of Debit and Credit:
Following rules are followed for debiting and crediting different accounts while they occur in business transactions:
- Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
- Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.
To Journalize: Each transaction or event during 2018.
Explanation of Solution
Prepare the journal entry to record the investment made by Company O.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
03.31.18 | Investment in bonds of Company DT | $400,000 | ||
Cash | $400,000 | |||
(To record the investment made in Company DT) |
Table (1)
- Investments is being made, this increases the assets; hence debit the investment.
- Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.
Prepare the journal entry to record the investment made by Company O.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
09.01.18 | Investment in bonds of Company AI | $900,000 | ||
Cash | $900,000 | |||
(To record the investment made in Company AI) |
Table (2)
- Investments is being made, this increases the assets; hence debit the investment.
- Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.
Prepare the journal entry to record the semiannual interest received by Company O.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
09.30.18 | Cash | $16,000 | ||
Interest Revenue (1) | $16,000 | |||
(To record the interest received) |
Table (3)
- Cash is received, cash is an asset which is being increased; hence debit the cash account.
- Interest revenue is a gain, which increases the stockholder's equity; hence credit the interest revenue account.
Working Note:
Calculate the interest revenue value.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
10.02.18 | Fair value adjustment, AFS adjustment | $25,000 | ||
Unrealized holding gain—OCI (2) | $25,000 | |||
(To record the gain on adjustment) |
Table (4)
- Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is adjusted to update the fair value as on October 02, 2018.
- Unrealized Holding Gain–NI is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since gain has occurred and gains increase stockholders’ equity value, stockholders’ equity value is credited.
Working Note:
Compute the unrealized gain as on October 02, 2018, by adjusting the cost of $400,000 to the fair value of $425,000.
Details | Amount ($) |
Fair value adjustment balance as on March 31, 2018 | $400,000 |
Adjustment needed to update fair value (2) | $25,000 |
Fair value adjustment balance needed on October 02,2018 | $425,000 |
Table (5)
(2)
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
10.02.18 | Reclassification adjustment—OCI | $25,000 | ||
Fair value adjustment, AFS investment | $25,000 | |||
(To record the gain on adjustment) |
Table (6)
- Reclassification Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is adjusted to update the fair value as on October 02, 2018.
- Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is adjusted to update the fair value as on October 02, 2018.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
10.2.18 | Cash | $425,000 | ||
Investment in bonds of Company DT | $400,000 | |||
Gain -NI | $25,000 | |||
(To record the sale of the bonds of Company DT ) |
Table (7)
- Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
- Gain increases the stockholder's equity; hence credit the gain account.
- Investment in Bonds is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.
Prepare the journal entry to record the investment made by Company O.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
11.01.18 | Investment in bonds | $1,400,000 | ||
Cash | $1,400,000 | |||
(To record the investment made in Company MD) |
Table (8)
- Investments is being made, this increases the assets; hence debit the investment.
- Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.
Adjusting entries: Adjusting entries are the journal entries which are recorded at the end of the accounting period to correct or adjust the revenue and expense accounts, to concede with the accrual principle of accounting.
Prepare the journal entry to record the accrued interest as on December 31, 2018.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
12.31.18 | Interest receivable | $30,000 | ||
Investment revenue (3) | $30,000 | |||
(To record the accrued interest of Company AI) | ||||
12.31.18 | Interest receivable | $14,000 | ||
Investment revenue (4) | $14,000 | |||
(To record the accrued interest of Company MD ) |
Table (9)
Working Note:
Calculate the interest revenue value for the bonds of Company AI.
Calculate the interest revenue value for the bonds of Company MD.
Available-for-sale (AFS) securities: These are short-term or long-term investments in debt and equity securities with an intention of holding the investment for some strategic purposes like meeting liquidity needs, or manage interest risk.
Available-for-Sale Securities | Cost | Fair Value | Accumulated Unrealized Gains / Loss |
Bonds of Company MD | $1,400,000 | $1,460,000 | $60,000 |
Bonds of Company AI | $900,000 | $850,000 | (-) $50,000 |
Total as on Dec. 31, 2018 | $2,300,000 | $2,310,000 | (-) $10,000 |
Table (10)
Prepare the journal entry to record the value of bonds available with Company O as on December 31, 2018.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
12.31.18 | Fair value adjustment | $10,000 | ||
Unrealized holding gain—OCI | $10,000 | |||
(To record the gain on adjustment) |
Table (11)
- Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is adjusted to update the fair value as on October 02, 2018.
- Unrealized Holding Gain–NI is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since gain has occurred and gains increase stockholders’ equity value, stockholders’ equity value is credited.
2.
To Prepare: The income statement, statement of comprehensive income, and balance sheet of Company O as on December 31, 2018.
Explanation of Solution
Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.
Company O | ||
Income Statement | ||
For the year ended December 31 , 2018 | ||
Particulars | Amount ($) | Amount ($) |
Revenues | ||
Investment revenue | $60,000 | |
Gain on sale of investments | $25,000 | |
Net income | $85,000 |
Table (12)
The net income of Company O is $85,000.
Comprehensive income: The total of net income and other comprehensive income (OCI) is referred to as comprehensive income. OCI includes all financial items which result in changes in the stockholders’ equity, other than stock investments and dividends. Comprehensive income should be reported on income statement, and statement of comprehensive income.
Company O | ||
Statement of Comprehensive Income | ||
For the year ended December 31 , 2018 | ||
Particulars | Amount ($) | Amount ($) |
Net income | $85,000 | |
Other Comprehensive Income | ||
Unrealized holding gains (5) | $35,000 | |
Reclassification adjustments | $25,000 | $10,000 |
Comprehensive Income | $95,000 |
Table (13)
The Comprehensive Income of Company O is $95,000.
Working Notes:
Calculate the value of Unrealized holding gains.
Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.
Company O | ||
Balance Sheet | ||
December 31 , 2018 | ||
Particulars | Amount ($) | Amount ($) |
Assets | ||
Current Assets | ||
Interest Receivable | $44,000 | |
Trading securities | $2,300,000 | |
Fair value adjustment | $10,000 | |
Total current assets | $2,354,000 | |
Liabilities and Stockholders’ Equity | ||
Owner's equity | ||
Retained earnings | $95,000 | |
Total liabilities and stockholders’ equity | $95,000 |
Table (14)
The balance sheet of Company O shows the assets total as $2,354,000 and the stockholder's equity total as $95,000.
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