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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Stock investment transactions, trading securities

Rios Financial Co. is a regional insurance company that began operations on January 1, Year 1. The following transactions relate to trading securities acquired by Rios Financial Co., which has a fiscal year ending on December 31:

Year 1  
Feb. 1 Purchased 7,500 shares of Caldwell Inc. as a trading; .security at $50 per share plus a brokerage commission of $75.
May 1. Purchased 3,000 shares of Holland Inc. as a trading security at $42 plus a brokerage commission of $90.
July 1. Sold 4,500 shares of Caldwell Inc. for $46 per share less a $110 brokerage commission.
31. Received an annual dividend of $0.50 per share on Caldwell Inc. stock.
Dec. 31 The portfolio of trading securities was adjusted to fair values of $47 and $40 per share for Caldwell Inc. and Holland Inc., respectively.
Year 2  
Apr. 1. Purchased 5,000 shares of Fuller Inc. as a trading security at $25 per share plus a $100 brokerage commission.
July 31. Received an annual dividend of $0.52 per share on Caldwell Inc. stock.
Oct. 14. Sold 1,000 shares of Fuller Inc. for $28 per share less a $110 brokerage commission.
Dec. 31. The portfolio of trading securities had a cost of $376,200 and a fair value of $420,000, requiring a debit balance in Valuation. Allowance for Trading Investments of $43,800 ($420,000−$376,200). Thus, the credit balance from December 31, Year 1, is to be adjusted to the new balance.

Instructions

  1. 1. Journalize the entries to record these transactions.
  2. 2. Prepare the investment-related current asset balance sheet presentation for Rios Financial Co. on December 31, Year 2.
  3. 3. How are unrealized gains or losses on trading investments presented in the financial statements of Rios Financial Co.?

(1)

To determine

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.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

  • Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
  • Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

To journalize: The stock investment transactions in the books of Company RF

Explanation

Prepare journal entry for the purchase of 7,500 shares of Company C, at $50 per share, and a brokerage commission of $75.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
February 1 Investments–Company C Stock   375,075  
             Cash     375,075
    (To record purchase of shares for cash)      

Table (1)

Explanation:

  • Investments–Company R Stock is an asset account. Since stock investments are purchased, asset value increased, and an increase in asset is debited.
  • Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Working Notes:

Compute amount of cash paid to purchase Company C’s stock.

Cash paid = {(Number of shares purchased× Price per share)+Brokerage commission}(7,500 shares ×$50)+$75= $375,075

Prepare journal entry for the purchase of 3,000 shares of Company H, at $42 per share, and a brokerage commission of $90.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
May 1 Investments–Company H Stock   126,090  
             Cash     126,090
    (To record purchase of shares for cash)      

Table (2)

Explanation:

  • Investments–Company H Stock is an asset account. Since stock investments are purchased, asset value increased, and an increase in asset is debited.
  • Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Working Notes:

Compute amount of cash paid to purchase Company H’s stock.

Cash paid = {(Number of shares purchased× Price per share)+Brokerage commission}(3,000 shares ×$42)+$90= $126,090

Prepare journal entry for sale of 4,500 shares of Company C, at $46, with a brokerage of $110.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
July 1 Cash   206,890  
    Loss on Sale of Investments   18,155  
            Investments–Company C Stock     225,045
    (To record sale of shares)      

Table (3)

Explanation:

  • Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
  • Loss on Sale of Investments is a loss or expense account. Since losses decrease equity, equity value is decreased, and a decrease in equity is debited.
  • Investments–Company C Stock is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.

Working Notes:

Calculate the realized gain (loss) on sale of stock.

Step 1: Compute cash received from sale proceeds.

Cash received = {(Number of shares sold× Sale price per share)Brokerage commission}(4,500 shares ×$46)$110= $206,890

Step 2: Compute cost of stock investment sold.

Cost of stock investment sold} = Number of shares sold × Price per share= Number of shares sold ×Cost of 7,500 sharesNumber of shares= 4,500 shares ×$375,0757,500 shares= $225,045

Step 3: Compute realized gain (loss) on sale of stock.

Realized gain (loss)on investments} = {Cash received –Cost of stock investment }= $206,890–$225,045= $(18,155)

Note: Refer to Steps 1 and 2 for value and computation of cash received and cost of stock investment sold.

Prepare journal entry for the dividend received from Company C for 3,000 shares.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
July 31 Cash   1,500  
             Dividend Revenue     1,500
    (To record receipt of dividend revenue)      

Table (4)

Explanation:

  • Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
  • Dividend Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Compute amount of dividend received on Company C’s stock.

Dividend received = {Number of shares × Dividend per share}(7,500–4,500) shares ×$0.50= $1,500

Prepare adjusting entry for valuation of trading securities transaction.

Table (5)

Explanation:

  • Unrealized Loss on Trading Investments is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since loss has occurred and losses reduce stockholders’ equity value, and a decrease in stockholders’ equity value is debited.
  • Valuation Allowance for Trading Investments is a contra-asset account. The account is credited because the market price was decreased (loss) to $276,120 from the cost of $261,000.

Working Notes:

Compute the unrealized gain (loss) as on December 31.

Step 1: Compute the fair value of the portfolio of the trading investment.

Security Number of Shares × Fair Market Value = Fair Market Value of Investment
Company C 3,000 shares × $47 = $141,000
Company H 3,000 shares × 40 = 120,000
Total   $261,000

Table (6)

Step 2: Compute the cost per share of Company C

(2)

To determine

To indicate: The presentation of trading investments on the current assets section of the balance sheet

(3)

To determine

To discuss: The reporting of trading investments on the financial statements

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