Chapter C, Problem 6E

To determine

Investment:

It is a financial term which refers to spend or deposit money to get the financial benefits.

The different ways in which a firm can invest are mentioned below:

• Long-term investments
• Short-term investments

Short-term investments:

It includes such investments which are highly liquid in nature as these can be convert in form of cash easily during the period of 1 year.

Long-term investments:

It includes such investments which are not highly liquid in nature and mature after completion of period of minimum one year.

Journal Entry:

It means record of financial data related to business transactions in a journal in a manner so that debit equals credit. It provides an audit trail to the auditor and a means to analyze the effects of transactions to an organization’s financial health.

Rules of Journal Entry:

The rules for journal entry are defined by 5 accounting components,

• Assets: Increase in asset should be debit and decrease should be credit.
• Liabilities: Increase in liabilities should be credit and decrease should be debit.
• Equity: Increase in Equity should be credit and decrease should be debit.
• Expense: Increase in expense should be debit and decrease should be credit.
• Revenue: Increase in revenue should be credit and decrease should be debit.

a.

To prepare: Journal entry for purchase of short-term investment.

Explanation of Solution

On February 15, 90-day short-term notes are purchased.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
February 15	Short-Term Investments		160,000
	Cash			160,000
	(To record short-term investment)

      Table 1

• Short-Term Investments is an asset account. Since, notes are purchased as investment, balance of assets has increased. So, debit Short-Term Investments account.
• Cash is also an asset account. Since, cash is paid, balance of assets has decreased. Hence, Cash account is credited.

b.

To determine

To prepare: Journal entry to record long-term investment.

Explanation of Solution

On March 22, 700 shares are purchased from F Company (long-term investment) at $51 per share with brokerage of $150.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
March 22	Long-Term Investments		35,850
	Cash			35,850
	(To record short-term investment with brokerage)

      Table 2 Long-Term Investments is an asset account. Since, shares are purchased under category of trading securities, balance of assets has increased. So, debit Long-Term Investments account $\left(\$35,700+\$150=35,850\right)$ .

• Cash is also an asset account. Since, cash is paid, balance of assets has decreased. Hence, Cash account is credited.

Working Note:

Computation of shares (trading securities):

  $\begin{array}{c}\text{Shares}=\text{Number of shares}\times \text{Price per share}\\ =700\times \$51\\ =35,700\end{array}$

c.

To determine

To prepare: Journal entry to record principal amount and interest received from short-term investment.

Explanation of Solution

On May 15, interest and principal amount received from A related to short-term investment.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
May 15	Cash		163,945.21
	Short-Term Investments			160,000
	Interest			3,945.21
	(To record interest on short-term investment)

      Table 3

• Cash is also an asset account. Since, cash is received, balance of assets has increased. Hence, Cash account is debited.
• Short-Term Investments is an asset account. Since, amount of investment is received back, balance of assets has decreased. So, credit Short-Term Investments account.
• Interest is a revenue account. Since, amount of interest is received, balance of revenue has increased. So, debit the Interest account.

Working note

Amount of interest:

  $\begin{array}{c}\text{Interest}=\text{Principal amount}\times \text{Rate of interest}\times \text{Time period}\\ \text{=\$160,000}\times \text{0}\text{.10}\times \frac{90}{365}\\ =\$3,945.21\end{array}$

d.

To determine

To prepare: Journal entry for purchase of notes (short-term investment).

Explanation of Solution

On July 30, short-term notes are purchased from M Company for $100,000.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
July 30	Short-Term Investments		100,000
	Cash			100,000
	(To record short-term investment)

      Table 4

• Short-Term Investments is an asset account. Since, notes are purchased as investment, balance of assets has increased. So, debit Short-Term Investments account.
• Cash is also an asset account. Since, cash is paid, balance of assets has decreased. Hence, Cash account is credited.

e.

On September 1, received dividend from F Company of $1 per share (shares purchased in part b).

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
September 1	Cash		700
	Dividend			700
	(To record dividend on short-term investment)

      Table 5

• Cash is also an asset account. Since, cash is received, balance of assets has increased. Hence, Cash account is debited.
• Dividend is a revenue account. Since, amount of dividend is received, balance of revenue has increased. So, credit the dividend account.

Working note

Computation of dividend:

  $\begin{array}{c}\text{Total dividend}=\text{Number of shares}\times \text{Dividend per share}\\ =700\times \$1\\ =\$700\end{array}$

f.

To determine

To prepare: Journal entry to record sale of 500 shares.

Explanation of Solution

On October 8, 350 shares of F Company are sold for $64 each, less $125 brokerage fee.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
October 8	Cash		22,275
	Short-Term Investments			17,925
	Gain on Sale of Investment			4,350
	(To record sale of long-term investment)

      Table 6

• Cash is also an asset account. Since, cash is received, balance of assets has increased. Hence, Cash account is debited.
• Long-Term Investments is an asset account. Since, investment is sold, balance of assets has decreased. So, credit Long-Term Investments account.
• Gain on Sale of Investment is a revenue account. Since, investment is sold at high rate than actual cost, balance of revenue has increased. So, credit the Gain on Sale of Investment account.

Working note

Actual cost of 350 shares:

  $\begin{array}{c}\text{Actual cost of share}=\frac{\text{Total cost of shares}}{\text{Total number of shares}}\times \text{Number of shares sold}\\ =\frac{\$35,850}{700}\times 350\\ =\$17,925\end{array}$

Sale amount of shares:

  $\begin{array}{c}\text{Sale amount of shares}=\left(\text{Price per unit}\times \text{Number of shares sold}\right)-\text{Brokerage fee}\\ =\left(\$64\times 350\right)-\$125\\ =\$22,400-\$125\\ =\$22,275\end{array}$

Gain on sale of 350 shares:

  $\begin{array}{c}\text{Gain on sale}=\text{Sale amount of shares}-\text{Cost of shares}\\ =\$22,275-17,925\\ =\$4,350\end{array}$

g.

To determine

To prepare: Journal entry to record interest on short-term investment.

Explanation of Solution

On October 30, interest amount received for 3 months from M Company on short-term investment.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
October 30	Cash		2,000
	Interest			2,000
	(To record interest on short-term investment)

      Table 7

• Cash is also an asset account. Since, cash is received, balance of assets has increased. Hence, Cash account is debited.
• Interest is a revenue account. Since, amount of interest is received, balance of revenue has increased. So, credit the Interest account.

Working note

Amount of interest:

  $\begin{array}{c}\text{Interest}=\text{Principal amount}\times \text{Rate of interest}\times \text{Time period}\\ \text{=\$100,000}\times \text{0}\text{.08}\times \frac{3}{12}\\ =\$2,000\end{array}$