Chapter 15, Problem 3PA

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:

Instructions

1. 1. Journalize the entries to record these transactions.
2. 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 balance on December 31, Year 2, is $389,000.

To determine

Journalize the stock investment transactions for Company F.

Explanation of Solution

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.

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)

• 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.

$\begin{array}{c}\text{Cash paid = }\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\\ \text{= }\left(\text{22,000 shares ×\$18}\right)\\ \text{= \$396,000}\end{array}$

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)

• 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.

$\begin{array}{c}\text{Dividend received = Number of shares ×Dividend per share}\\ \text{= 22,000 shares ×\$0}\text{.22}\\ \text{= \$4,840}\end{array}$

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)

• 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.

$\begin{array}{c}\text{Dividend received = Number of shares ×Dividend per share}\\ \text{= 22,000 shares ×\$0}\text{.25}\\ \text{= \$5,500}\end{array}$

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)

• 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.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares sold× }\\ \text{Sale price per share}\end{array}\right)–\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{3,000 shares ×\$16}\right)–\$75\\ \text{= \$47,925}\end{array}$

Step 2: Compute cost of stock investment sold.

$\begin{array}{c}\begin{array}{l}\text{Cost of stock }\\ \text{investment sold}\end{array}\}\text{ = Number of shares sold × Cost price per share}\\ \text{= 3,000 shares ×\$18}\\ \text{= \$54,000}\end{array}$

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

$\begin{array}{c}\begin{array}{l}\text{Realized gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of stock investment }\end{array}\right\}\\ \text{= \$47,925–\$54,000}\\ \text{= \$}\left(6,075\right)\end{array}$

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)

• 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, $\left(\left(\text{22,000–3,000}\right)\text{ shares×\$25}\right)$	$475,000
Less: Available-for-sale investments at cost, December 31, $\left(\left(\text{22,000–3,000}\right)\text{ shares×\$18}\right)$	(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.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 2
January	10	Investment in Company I Stock		720,000
		Cash			720,000
		(To record purchase of shares of Company I for cash)

Table (7)

• Investment in Company I 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.

Prepare journal entry for the dividend received from Company S for 19,000 shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 2
March	10	Cash		5,700
		Dividend Revenue			5,700
		(To record receipt of dividend revenue)

Table (8)

• 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.

$\begin{array}{c}\text{Dividend received = Number of shares ×Dividend per share}\\ \text{= }\left(\text{22,000–3,000}\right)\text{ shares ×\$0}\text{.30}\\ \text{= \$5,700}\end{array}$

Prepare journal entry for the dividend received from Company S for 19,000 shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 2
September	12	Cash		5,700
		Dividend Revenue			5,700
		(To record receipt of dividend revenue)

Table (9)

• 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.

$\begin{array}{c}\text{Dividend received = Number of shares × Dividend per share}\\ \text{= }\left(\text{22,000–3,000}\right)\text{ shares × }\left(\text{\$0}\text{.25+\$0}\text{.05}\right)\\ \text{=19,000 shares × \$0}\text{.30}\\ \text{= \$5,700}\end{array}$

Prepare journal entry for dividends received from Company I.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 2
December	31	Cash		57,600
		Investment in Company I Stock			57,600
		(To record dividends received from Company I)

Table (10)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Investment in Company I Stock is an asset account. Since stock investments are reduced as an effect of receipt of dividends, asset value decreased, and a decrease in asset is credited.

Prepare journal entry for share of income received from Company I.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
		Investment in Company I Stock		144,000
		Income of Company T			144,000
		(To record income realized from Company I)

Table (11)

• Investment in Company I Stock is an asset account. Since income of the investee is reported as the increase in the investment, asset value increased, and an increase in asset is debited.
• Income of Company I is a revenue account. Revenues increase stockholders’ equity value, and an increase in stockholders’ equity is credited.

Working Notes:

Compute amount of income received from Company I.

$\begin{array}{c}\text{Income reported = }\left\{\begin{array}{l}\text{Net income reported by Company I × }\\ \text{Percentage share of ownership of Company F}\end{array}\right\}\\ \text{= \$450,000×}\frac{\text{Number of shares bought by Company I}}{\text{Number of shares of Company F}}\\ \text{= \$450,000}\times \frac{\text{96,000 shares}}{\text{300,000 shares}}\\ =\$144,000\end{array}$

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

Table (12)

• 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 $364,100 from the cost of $430,300.

Working Notes:

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

Details	Amount ($)
Available-for-sale investments at fair value, December 31, $\left(\left(\text{22,000–3,000}\right)\text{ shares×\$22}\right)$	$418,000
Less: Available-for-sale investments at cost, December 31, $\left(\left(\text{22,000–3,000}\right)\text{ shares×\$25}\right)$	(475,000)
Unrealized gain (loss) on available-for-sale investments	$(57,000)

Table (13)

To determine

Indicate the presentation of available-for-sale investments, equity method investments, and stockholders’ equity on the balance sheet as on December 31, Year 2.

Explanation of Solution

Balance sheet presentation:

Company F
Balance Sheet (Partial)
December 31, Year 2
Assets
Current assets:
Available-for-sale investments (at cost)	$342,000
Add valuation allowance for available-for-sale investments	76,000
Available-for-sale investments (at fair value)		$418,000
Investments:
Investment in Company I Stock		806,400
Stockholders’ equity:
Retained earnings		389,000
Unrealized gain (loss) on available-for-sale investments		76,000

Table (14)

Working Notes:

Compute the cost of available-for-sale investments.

$\begin{array}{c}\text{Cost of investment = Number of shares × Cost per share}\\ \text{= }\left(\text{22,000–3,000}\right)\text{ shares × \$18}\\ \text{=19,000 shares × \$18}\\ \text{= \$342,000}\end{array}$

Compute valuation allowance balance as on December 31, Year 2.

Details	Amount ($)
Valuation allowance debit balance, December 31, Year 1	$133,000
Valuation allowance credit balance, December 31, Year 2	(57,000)
Valuation allowance balance	$76,000

Table (15)

Prepare Investment in Company I Stock account to find the stock investment balance as on December 31, Year 2.

Investment in Company I Stock account

Investment in Company I Stock
Date	Details	Debit ($)		Date	Details	Credit ($)
	Cash	720,000			Cash(dividends)	57,600
	Income	144,000
	Total	864,000			Total	57,600
	Balance	$806,400

Table (16)