Chapter C, Problem 4PSA

Part 1

1.

To determine

To prepare: Journal entries to record the transactions.

Explanation of Solution

For the year 2017,

To record purchase of K common stock

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Jan 5	Long term investment Trading securities		1,560,000
	Cash			1,560,000
	(Being long term investment purchase against cash)
Table (1)

• The long term investment of S Company is increase. The long term investment is the asset of the company and the current asset of S Company also increases.
• The cash account is decrease by $1,560,000, and the credit of cash means that the current asset of the company also decreases.

To record dividend received in cash from K

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
October 23	Cash		192,000
	Long term investment			192,000
	(Being cash dividend received)
Table (2)

• Cash account debit as cash is received from K Company as cash dividend,
• As per equity method the dividend amount is credited to the long term investment account.

To record closing entry as on December 31, 2017

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
December 31	Long term investment		232,800
	Earnings from long term investment			232,800
	(Being equity in investee earning recorded)
Table (3)

• The long term investment is increase by $232,800 because of the dividend calculation as on December 31, 2017.
• Earnings from long term investment account are link with the net income, if this account is credited the net income of S Company increases.

For the year 2018,

To record dividend received in cash from K

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
October 15	Cash		156,000
	Long term investment			156,000
	(Being cash dividend received)
Table (4)

• Cash account debit as cash is received from K Company as cash dividend,
• As per equity method the dividend amount is credited to the long term investment account.

To record closing entry as on December 31, 2018

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
December 31	Long term investment		295,200
	Earnings from long term investment			295,200
	(Being equity in investee earning recorded)
Table (5)

• The long term investment is increase by $232,800 because of the dividend calculation as on December 31, 2017.
• Earnings from long term investment account are link with the net income, if this account is credited the net income of S Company increases.

For the year 2019,

To record sale of K stock

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
January 2	Cash		1,894,000
	Gain on sale of long term investment			150,000
	Long term investment			1,744,000
	(Being long term investment sold at a gain of $154,000 and receive cash )
Table (6)

• Cash receive at the time of sale of investment it increases the cash balance and the asset of the company also increases.
• By the sale of long term investment, the long term investment account decreases and the asset of the company also decreases with $1,744,000 amount.
• At the time of sale S Company receives the gain on sale of investment and this gain is credited to the gain on sale of long term investment account.

Working notes:

Calculation of cash dividend of K Company,

$\begin{array}{c}\text{Cash dividend}=\text{Number of share}\times \text{Rate of dividend}\\ =60,000\times \$3.20\\ =\$192,000\end{array}$

Calculation of amount of dividend as on December 31, 2017,

$\begin{array}{c}\text{Dividend}=\text{Amount}\times \text{Rate}\\ \text{=\$1,164,000}\times 20\%\\ =\$232,800\end{array}$

Calculation of cash dividend of K Company,

$\begin{array}{c}\text{Cash dividend}=\text{Number of share}\times \text{Rate of dividend}\\ =60,000\times \$2.60\\ =\$156,000\end{array}$

Calculation of amount of dividend as on December 31, 2018,

$\begin{array}{c}\text{Dividend}=\text{Amount}\times \text{Rate}\\ \text{=\$1,476,000}\times 20\%\\ =\$295,200\end{array}$

Calculation of value of K stock,

$\begin{array}{c}\text{Cost of K}=\$1,560,000-\$192,000+\$232,800-\$152,000+\$295,200\\ =\$1,744,000\end{array}$

Calculation of Gain in the sale of investment of K Company

$\begin{array}{c}\text{Gain}=\text{Sale Price}-\text{Cost of short term investment}\\ =\$1,894,000-\$1,744,000\\ =\$150,000\end{array}$

2.

To determine

To compute: carrying book value per share of S Company investment in K common stock.

Explanation of Solution

Calculated values,
Carrying value as on sale of date is $1,744,000.
Number of share is 60,000.

Formula to calculate carrying value per share is,

$\text{Carrying value per share}=\frac{\text{Carrying value}}{\text{Number of share}}$

Substitute $ 1,744,000 for carrying value and 60,000 for number of share in the above equation.

$\begin{array}{c}\text{Carrying value per share}=\frac{\$1,744,000}{60,000}\\ =\$29\text{ per share}\end{array}$

Working note:

Statement showing carrying book value of K common stock

Particulars	Amount ($)
Actual cost	1,560,000
Less: Dividend 2017	192,000
Add: Earning in 2017	232,800
Less: Dividend 2018	152,000
Add: Earning in 2018	295,200
Carrying value as on sale of date	1,744,000
Table (7)

Thus, carrying value per share is $29.

3.

To determine

To compute: The net increase or decrease in S Company equity.

Explanation of Solution

Statement shows increase or decrease in the amount of equity of S Company,

Particulars	Amount ($)
Earning from K in 2017	232,800
Earning from K in 2018	295,200
Gain on sale of investment	150,000
Net increase in equity	678,000
Table (8)

Thus, increase in equity is $678,000.

Part 2

2.

To determine

To prepare: Journal entries when the investment is available for sale security.

Explanation of Solution

For the year 2017,

To record purchase of K common stock

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
Jan 5	Long term investment Trading securities		1,560,000
	Cash			1,560,000
	(Being long term investment purchase against cash)
Table (9)

• The long term investment of S Company is increase. The long term investment is the asset of the company and the current asset of S Company also increases.
• The cash account is decrease by $1,560,000, and the credit of cash means that the current asset of the company also decreases.

To record dividend received in cash from K

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
October 23	Cash		192,000
	Long term investment			192,000
	(Being cash dividend received)
Table (10)

• Cash account debit as cash is received from K Company as cash dividend,
• As per equity method the dividend amount is credited to the long term investment account.

To record the unrealized gain occurs on December 31, 2017.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
December 31	Fair value adjustment long term investment		240,000
	Unrealized gain			240,000
	(Being unrealized gain earned of $240,000 at the time of closing)
Table (11)

• The fair value adjustment account is an adjustment account to account for the unrealized gain earn by S Company.
• The fair value of long term investment is less than the cost of share so the S Company earn an unrealized gain of $240,000, and unrealized gain increases the balance of income.

For the year 2018,

To record dividend received in cash from K

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
October 15	Cash		156,000
	Long term investment			156,000
	(Being cash dividend received)
Table (12)

• Cash account debit as cash is received from K Company as cash dividend,
• As per equity method the dividend amount is credited to the long term investment account.

To record the unrealized gain occurs on December 31, 2018.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
December 31	Fair value adjustment long term investment		120,000
	Unrealized gain			120,000
	(Being unrealized gain earned of $120,000 at the time of closing)
Table (13)

• The fair value adjustment account is an adjustment account to account for the unrealized gain earn by S Company.
• The fair value of long term investment is less than the cost of share so the S Company earn an unrealized gain of $120,000, and unrealized gain increases the balance of income.

For the year 2019,

To record sale of K stock

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
January 2	Cash		189,4000
	Gain on sale of long term investment			334,000
	Long term investment			1,560,000
	(Being long term investment sold at a gain of $154,000 and receive cash )
Table (14)

• Cash receive at the time of sale of investment it increases the cash balance and the asset of the company also increases.
• By the sale of long term investment, the long term investment account decreases and the asset of the company also decreases with $1,560,000 amount.
• At the time of sale S Company receives the gain on sale of investment and this gain is credited to the gain on sale of long term investment account.

To record the unrealized gain occurs on December 31, 2019.

Date	Account Title and Explanation	Post ref	Debit ($)	Credit ($)
January 2, 2019	Unrealized gain Equity		360,000
	Fair value adjustment long term investment			360,000
	(Being fair value adjustment recorded)
Table (15)

• The unrealized gain account is debit to set off the account.
• The fair value of long term investment is less than the cost of share so the S Company earn an unrealized gain of $360,000, and fair value adjustment account credited to set off the account.

Working notes:

Calculation of cash dividend of K Company,

$\begin{array}{c}\text{Cash dividend}=\text{Number of share}\times \text{Rate of dividend}\\ =60,000\times \$3.20\\ =\$192,000\end{array}$

Calculation of fair value of shares as on December 31, 2017,

$\begin{array}{c}\text{Fair value}=\text{Number of share}\times \text{Price per share}\\ =60,000\times \$30\\ =\$1,800,000\end{array}$

Calculation of fair value adjustment as on December 31, 2017,

$\begin{array}{c}\text{Fair value adjustment}=\text{Fair value}-\mathrm{Cos}\text{t of share}\\ =\$1,800,000-\$1,560,000\\ =\$240,000\end{array}$

Calculation of cash dividend of K Company,

$\begin{array}{c}\text{Cash dividend}=\text{Number of share}\times \text{Rate of dividend}\\ =60,000\times \$2.60\\ =\$156,000\end{array}$

Calculation of fair value of shares as on December 31, 2018,

$\begin{array}{c}\text{Fair value}=\text{Number of share}\times \text{Price per share}\\ =60,000\times \$32\\ =\$1,920,000\end{array}$

Calculation of fair value adjustment as on December 31, 2018,

$\begin{array}{c}\text{Fair value adjustment}=\text{Fair value}-\mathrm{Cos}\text{t of share}\\ =\$1,920,000-\$1,560,000\\ =\$360,000\end{array}$

Determine the unadjusted amount that has to be adjusted,

$$ $\begin{array}{c}\text{Amount to be adjusted}=\text{Total amount}-\text{Amount adjusted in 2017}\\ =\$360,000-\$240,000\\ =\$120,000\end{array}$

Calculation of Gain in the sale of investment of K Company,

$\begin{array}{c}\text{Gain}=\text{Sale Price}-\text{Cost of short term investment}\\ =\$1,894,000-\$1,560,000\\ =\$334,000\end{array}$

2.

To determine

To compute:Carrying book value per share of S Company investment in K common stock.

Explanation of Solution

Calculated values,
Carrying value as on sale of date is $1,560,000.
Number of share is 60,000.

Formula to calculate carrying value per share is,

$\text{Carrying value per share}=\frac{\text{Carrying value}}{\text{Number of share}}$

Substitute $ 1,560,000 for carrying value and 60,000 for number of share in the above equation.

$\begin{array}{c}\text{Carrying value per share}=\frac{\$1,560,000}{60,000}\\ =\$26\text{ per share}\end{array}$

Thus, carrying value per share is $26.

3.

To determine

To compute: The net increase or decrease in S Company equity.

Explanation of Solution

Statement shows increase or decrease in the amount of equity of S Company,

Particulars	Amount ($)
Earning from K in 2017	192,000
Earning from K in 2018	156,000
Gain on sale of investment	334,000
Net increase in equity	682,000
Table (16)

Thus, increase in equity is $682,000.