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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, equity method and available-for-sale securities

Forte Inc. produces and sells theater set designs and costumes. The company began operations on January 1, Year 1. The following transactions relate to securities acquired by Forte Inc., which has a fiscal year ending on December 31:

Year 1  
Jan. 22. Purchased 22,000 shares of Sankal Inc. as an available-for-sale security at $18 per share, including the brokerage commission.
Mar. 8. Received a cash dividend of $0.22 per share on Sankal Inc. stock.
Sept. 8. A cash dividend of $0.25 per share was received on the Sankal stock.
Oct. 17. Sold 3,000 shares of Sankal Inc. stock at $16 per share less a brokerage commission of $75.
Dec. 31. Sankal Inc. is classified as an available-for-sale investment and is adjusted to a fair value of $25 per share. Use the valuation allowance for available-for-sale investments account in making the adjustment.
Year 2  
Jan. 10. Purchased an influential interest in Imboden Inc. for $720,000 by purchasing 96,000 shares directly from the estate of the founder of Imboden Inc. There are 300,000 shares of Imboden Inc. stock outstanding.
Mar. 10. Received a cash dividend of $0.30 per share on Sankal Inc. Stock.
Sept. 12. Received a cash dividend of $0.25 per share plus an extra dividend of $0.05 per share on Sankal Inc. stock.
Dec. 31. Received $57,600 of cash dividends on Imboden Inc. stock. Imboden Inc. Reported net income of $450,000 in Year 2. Forte Inc. uses the equity method of accounting for its investment in Imboden Inc.
31. Sankal Inc. is classified as an available-for-sale investment and is adjusted to a fair value of $22 per share. Use the valuation allowance for available-for-sale investments account in making the adjustment for the decrease in fair value from $25 to $22 per share.

Instructions

1. Journalize the entries to record these transactions.

2. Prepare the investment-related asset and .stockholders’ equity balance sheet presentation for Forte Inc. on December 31, Year 2, assuming that the Retained Earnings balancer can December 31, Year 2, is $389,000.

(1)

To determine

Equity investments: Equity investments are stock instruments which claim ownership in the investee company and pay a dividend revenue to the investor company.

Equity method: Equity method is the method used for accounting equity investments which claim a significant influence of above 20% but less than 50% in the outstanding stock of the investee company.

Available-for-sale 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.

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 for Company F

Explanation

Prepare journal entry for the purchase of 22,000 shares of Company S, at $18 per share.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
January 22 Investments–Company S Stock   396,000  
             Cash     396,000
    (To record purchase of shares for cash)      

Table (1)

Explanation:

  • Investments–Company S 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 S’s stock.

Cash paid = (Number of shares purchased× Price per share)(22,000 shares ×$18)= $396,000

Prepare journal entry for the dividend received from Company S for 22,000 shares.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
March 8 Cash   4,840  
             Dividend Revenue     4,840
    (To record receipt of dividend revenue)      

Table (2)

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 S’s stock.

Dividend received = Number of shares ×Dividend per share= 22,000 shares ×$0.22= $4,840

Prepare journal entry for the dividend received from Company S for 22,000 shares.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
September 8 Cash   5,500  
             Dividend Revenue     5,500
    (To record receipt of dividend revenue)      

Table (3)

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 S’s stock.

Dividend received = Number of shares ×Dividend per share= 22,000 shares ×$0.25= $5,500

Prepare journal entry for sale of 3,000 shares of Company S, at $16, with a brokerage of $75.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
October 17 Cash   47,925  
    Loss on Sale of Investments   6,075  
           Investments–Company S Stock     54,000
    (To record sale of shares)      

Table (4)

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 an expense account. Since expenses and losses decrease equity, equity value is decreased, and a decrease in equity is debited.
  • Investments–Company S 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}(3,000 shares ×$16)$75= $47,925

Step 2: Compute cost of stock investment sold.

Cost of stock investment sold} = Number of shares sold × Cost price per share= 3,000 shares ×$18= $54,000

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

Realized gain (loss)on investments} = {Cash received –Cost of stock investment }= $47,925–$54,000= $(6,075)

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

Prepare adjusting entry for valuation of available-for-sale securities transaction.

Table (5)

Explanation:

  • Valuation Allowance for Available-for-Sale Investments is a contra-asset account. The account is debited because the market price was increased (loss) to $475,000 from the cost of $342,000.
  • Unrealized Gain (Loss) on Available-for-Sale Investments 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, and an increase in stockholders’ equity value is credited.

Working Notes:

Compute the unrealized gain (loss) as on December 31, Year 1.

Details Amount ($)
Available-for-sale investments at fair value, December 31, ((22,000–3,000) shares×$25) $475,000
Less: Available-for-sale investments at cost, December 31, ((22,000–3,000) shares×$18) (342,000)
Unrealized gain (loss) on available-for-sale investments $133,000

Table (6)

Prepare journal entry for the purchase of 96,000 shares out of the outstanding stock of 300,000 shares of Company I at $720,000

(2)

To determine

To indicate: The presentation of available-for-sale investments, equity method investments, and stockholders’ equity on the balance sheet as on December 31, Year 2

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