Chapter D, Problem D.1EX

To determine

Stock investments: Stock investments are equity securities which claim ownership in the investee company and pay a dividend revenue to the investor company.

Fair value method: Fair value method is the accounting method used for accounting stock or equity investments which claim less than 20% of the outstanding stock of the investee company.

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 under the fair value method

Explanation of Solution

Prepare journal entry for the purchase of 4,000 shares of Company A at $50 price per share and a brokerage of $400.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
September	12	Investments–Company A Stock		200,400
		Cash			200,400
		(To record purchase of shares of Company A for cash)

Table (1)

Description:

• Investments–Company A 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 A’s stock.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\text{+}\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{4,000 shares ×\$50}\right)+\$400\\ \text{= \$200,400}\end{array}$

Prepare journal entry for the dividend received from Company A for 4,000 shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
October	15	Cash		2,400
		Dividend Revenue			2,400
		(To record receipt of dividend revenue)

Table (2)

Description:

• 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 A’s stock.

$\begin{array}{c}\text{Dividend received = }\left\{\begin{array}{l}\text{Number of shares × }\\ \text{Dividend per share}\end{array}\right\}\\ \text{= 4,000 shares ×\$0}\text{.60}\\ \text{= \$2,400}\end{array}$

Prepare journal entry for sale of 3,000 shares of Company A at $40 per share, and a brokerage of $200.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
November	10	Cash		119,800
		Loss on Sale of Investments		30,500
		Investments–Company A Stock			150,300
		(To record sale of shares)

Table (3)

Description:

• 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 losses and expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Investments–Company A 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.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares sold× }\\ \text{Sale price per share}\end{array}\right)–\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{3,000 shares ×\$40}\right)–\$200\\ \text{= \$119,800}\end{array}$

Step 2: Compute cost of stock investment sold Refer to Table (1) for value of cost of 4,000 shares.

$\begin{array}{c}\begin{array}{l}\text{Cost of stock }\\ \text{investment sold}\end{array}\}\text{ = Number of shares sold × Price per share}\\ \text{= Number of shares sold ×}\frac{\text{Cost of 4,000 shares}}{\text{Number of shares}}\\ \text{= 3,000 shares ×}\frac{\text{\$200,400}}{\text{4,000 shares}}\\ \text{= \$150,300}\end{array}$

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

$\begin{array}{c}\begin{array}{l}\text{Realized gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of stock investment }\end{array}\right\}\\ \text{= \$119,800–\$150,300}\\ \text{= \$}\left(\text{30,500}\right)\end{array}$

Note: Refer to Steps 1 and 2 for value and computation of cash received and cost of stock investment sold.