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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

Glacier Products Inc. is a wholesaler of rock climbing Gear. The Company began operations on January 1. Year 1. The following transactions relate to securities acquired by Glacier Products Inc., which has a fiscal year ending on December 31:

Year 1  
Jan. 18. Purchased 9,000 shares of Malmo Inc. as an available-for-sale: investment at $40 per share, including the brokerage commission.
July 22. A cash dividend of $3 per share was received on the Malmo stock. Oct. 5. Sold 500 shares of Malmo Inc. stock at $58 per share less a brokerage commission of $100.
Dec. 18 Received a regular cash dividend of $30 per share on Malmo Inc. stock.
31. Malmo Inc. is classified as an available-for-sale investment and is adjusted to a fair value of $36 per share. Use the valuation allowance for available-for-sale investments account in making the adjustment.
Year 2  
Jan. 25. Purchased an influential interest in Helsi Co. for $800.000 by purchasing 75.000 shares directly from the estate of the founder of Helsi. There are 250,000 shares of Helsi Co. stock outstanding.
July 16. Received a cash dividend of $3 per share on Malmo Inc. stock.
Dec. 16. Received a cash dividend of $3 per share plus an extra dividend of $0.20 per share on Malmo Inc. stock.
31. Received $38,000 of cash dividends on Helsi Co. stock, Helsi Co. reported net income of $170,000 in Year 2. Glacier Products Inc. uses the equity method of accounting for its investment in Helsi Co.
31. Malmo Inc. is classified as an available-for-Sale investment and is adjusted to a fair value of $44 per share. Use the valuation allowance for available-for-sale investments account in making the adjustment for the increase in fair value from $36 to $44 per share.

Instructions

1. Journalize the entries to record the preceding transactions.

2. Prepare the investment-related asset and .stockholders’ equity balance sheet presenta­tion for Glacier Products Inc. on December 31, Year 2, assuming that the Retained Earnings balance on December 31, Year 2, is $700,000.

(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 G

Explanation

Prepare journal entry for the purchase of 9,000 shares of Company M, at $40 per share.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
January 18 Investments–Company M Stock   360,000  
             Cash     360,000
    (To record purchase of shares for cash)      

Table (1)

Explanation:

  • Investments–Company M 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 M’s stock.

Cash paid = (Number of shares purchased× Price per share)(9,000 shares ×$40)= $360,000

Prepare journal entry for the dividend received from Company M for 9,000 shares.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
July 22 Cash   27,000  
             Dividend Revenue     27,000
    (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 M’s stock.

Dividend received = Number of shares ×Dividend per share= 9,000 shares ×$3= $27,000

Prepare journal entry for sale of 500 shares of Company M, at $58, with a brokerage of $100.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
October 5 Cash   28,900  
           Gain on Sale of Investments     8,900
           Investments–Company M Stock     20,000
    (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.
  • Gain 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 M 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}(500 shares ×$58)$100= $28,900

Step 2: Compute cost of stock investment sold.

Cost of stock investment sold} = Number of shares sold × Cost price per share= 500 shares ×$40= $20,000

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

Realized gain (loss)on investments} = {Cash received –Cost of stock investment }= $28,900–$20,000= $8,900

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 M for 8,500 shares.

Date Account Titles and Explanations Post. Ref. Debit ($) Credit ($)
Year 1        
December 18 Cash   25,500  
             Dividend Revenue     25,500
    (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 M’s stock.

Dividend received = Number of shares ×Dividend per share(9,000–500) shares ×$3= $25,500

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

Table (5)

Explanation:

  • 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 loss has occurred and losses reduce stockholders’ equity value, and a decrease in stockholders’ equity value is debited.
  • Valuation Allowance for Available-for-Sale Investments is a contra-asset account. The account is credited because the market price was decreased (loss) to $306,000 from the cost of $340,000.

Working Notes:

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

Details Amount ($)
Available-for-sale investments at fair value, December 31, ((9,000–500) shares×$36) $306,000
Less: Available-for-sale investments at cost, December 31, ((9,000–500) shares×$40) (340,000)
Unrealized gain (loss) on available-for-sale investments $(34,000)

Table (6)

Prepare journal entry for the purchase of 75,000 shares out of the outstanding stock of 250,000 shares of Company H at $800,000

(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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