Chapter 15, Problem 3PB

(1)

To determine

Journalize the stock investment transactions for Company G.

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 9,000 shares of Company M, at $40 per share.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
January	18	Investments–Company M Stock		360,000
		Cash			360,000
		(To record purchase of shares for cash)

Table (1)

• ■ 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.

$\begin{array}{c}\text{Cash paid = }\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\\ \text{= }\left(\text{9,000 shares ×\$40}\right)\\ \text{= \$360,000}\end{array}$

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

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
July	22	Cash		27,000
		Dividend Revenue			27,000
		(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 M’s stock.

$\begin{array}{c}\text{Dividend received = Number of shares ×Dividend per share}\\ \text{= 9,000 shares ×\$3}\\ \text{= \$27,000}\end{array}$

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 ($)	Credit ($)
2016
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)

• ■ 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.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares sold× }\\ \text{Sale price per share}\end{array}\right)–\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{500 shares ×\$58}\right)–\$100\\ \text{= \$28,900}\end{array}$

Step 2: Compute cost of stock investment sold.

$\begin{array}{c}\begin{array}{l}\text{Cost of stock }\\ \text{investment sold}\end{array}\}\text{ = Number of shares sold × Cost price per share}\\ \text{= 500 shares ×\$40}\\ \text{= \$20,000}\end{array}$

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

$\begin{array}{c}\begin{array}{l}\text{Realized gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of stock investment }\end{array}\right\}\\ \text{= \$28,900–\$20,000}\\ \text{= \$8,900}\end{array}$

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 ($)	Credit ($)
2016
December	18	Cash		25,500
		Dividend Revenue			25,500
		(To record receipt of dividend revenue)

Table (4)

• ■ 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.

  $\begin{array}{c}\text{Dividend received = Number of shares ×Dividend per share}\\ \text{= }\left(\text{9,000–500}\right)\text{ shares ×\$3}\\ \text{= \$25,500}\end{array}$

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

Figure (1)

• ■ 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, 2016.

Details	Amount ($)
Available-for-sale investments at fair value, December 31, 2016$\left(\left(\text{9,000–500}\right)\text{ shares×\$36}\right)$	$306,000
Less: Available-for-sale investments at cost, December 31, 2016$\left(\left(\text{9,000–500}\right)\text{ shares×\$40}\right)$	(340,000)
Unrealized gain (loss) on available-for-sale investments	$(34,000)

Table (5)

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.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
January	25	Investment in Company H Stock		800,000
		Cash			800,000
		(To record purchase of shares of Company H for cash)

Table (6)

• ■ Investment in 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.

Prepare journal entry for the dividend received from Company M for 8,500 shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
July	16	Cash		25,500
		Dividend Revenue			25,500
		(To record receipt of dividend revenue)

Table (7)

• ■ 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.

$\begin{array}{c}\text{Dividend received = Number of shares ×Dividend per share}\\ \text{= }\left(\text{9,000–500}\right)\text{ shares ×\$3}\\ \text{= \$25,500}\end{array}$

Prepare journal entry for the dividend received from Company M for 8,500 shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
December	16	Cash		27,200
		Dividend Revenue			27,200
		(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 M’s stock.

$\begin{array}{c}\text{Dividend received = Number of shares ×Dividend per share}\\ \text{= }\left(\text{9,000–500}\right)\text{ shares × }\left(\text{\$3+\$0}\text{.2}\right)\\ \text{= \$27,200}\end{array}$

Prepare journal entry for dividends received from Company H.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
December	31	Cash		38,000
		Investment in Company H Stock			38,000
		(To record dividends received from Company H)

Table (9)

• ■ Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• ■ Investment in Company H 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 H.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
December	31	Investment in Company H Stock		51,000
		Income of Company H			51,000
		(To record income realized from Company H)

Table (10)

• ■ Investment in Company H 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 H 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 H.

$\begin{array}{c}\text{Income reported = }\left\{\begin{array}{l}\text{Net income reported by Company I × }\\ \text{Percentage share of ownership of Company F}\end{array}\right\}\\ \text{= \$170,000×}\frac{\text{Number of shares bought by Company I}}{\text{Number of shares of Company F}}\\ \text{= \$170,000}\times \frac{\text{75,000 shares}}{\text{250,000 shares}}\\ =\$51,000\end{array}$

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

Figure (2)

• ■ Valuation Allowance for Available-for-Sale Investments is a contra-asset account. The account is debited because the market price was increased (loss) to $374,000 from the cost of $306,000.
• ■ 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, 2017.

Details	Amount ($)
Available-for-sale investments at fair value, December 31, 2017 $\left(\left(\text{9,000–500}\right)\text{ shares×\$44}\right)$	$374,000
Less: Available-for-sale investments at cost, December 31, 2017 $\left(\left(\text{9,000–500}\right)\text{ shares×\$36}\right)$	(306,000)
Unrealized gain (loss) on available-for-sale investments	$68,000

Table (11)

(2)

To determine

Indicate the presentation of available-for-sale investments, equity method investments, and stockholders’ equity on the balance sheet as on December 31, 2017.

Explanation of Solution

Balance sheet presentation:

Company G
Balance Sheet (Partial)
December 31, 2017
Assets
Current assets:
Available-for-sale investments (at cost)	$340,000
Add valuation allowance for available-for-sale investments	34,000
Available-for-sale investments (at fair value)		$374,000
Investments:
Investment in Company I Stock		813,000
Stockholders’ equity:
Retained earnings		700,000
Unrealized gain (loss) on available-for-sale investments		34,000

Table (12)

Working Notes:

Compute the cost of available-for-sale investments.

$\begin{array}{c}\text{Cost of investment = Number of shares × Cost per share}\\ \text{= }\left(\text{9,000–500}\right)\text{ shares × \$40}\\ \text{=8,500 shares × \$40}\\ \text{= \$340,000}\end{array}$

Compute valuation allowance balance as on December 31, 2017.

Details	Amount ($)
Valuation allowance credit balance, December 31, 2016	$34,000
Valuation allowance debit balance, December 31, 2017	68,000
Valuation allowance balance	$34,000

Table (13)

Prepare Investment in Company H Stock account to find the stock investment balance as on December 31, 2017.

Investment in Company H Stock account

Investment in Company H Stock
Date	Details	Debit ($)		Date	Details	Credit ($)
	Cash	800,000			Cash(dividends)	38,000
	Income	51,000
	Total	851,000			Total	38,000
	Balance	$813,000

Table (14)