Chapter E, Problem 4P

1.

To determine

Indicate the method used to account for the investment in D common stock and F bonds, and explain.

Explanation of Solution

Available-for-sale (AFS) securities: The category of passive investments which are held as idle funds to serve the future operating and strategic purposes, are referred to as available-for-sale securities. The percentage of passive investments in debt or equity will be less than 20%.

Fair value method: The method of accounting the investments in short-term debt, and short-term and long-term equity securities, with an ownership of less than 20% of the outstanding stock of the investee, is referred to as fair value method.

Method used to account investment in stock of Corporation D: Since the investor company, Company OG purchased 14.74% $\left(\text{14,000 shares}\left(\text{shares purchased}\right)\text{÷95,000 shares}\left(\text{total shares}\right)\right)$ of investment in Corporation D, which is less than 20% of the outstanding stock of the investee, fair value method is appropriate to account equity investments.

Method used to account investment in bonds of Corporation F: Since the bonds are not intended to hold till maturity, they are considered as short-term, and hence, fair value method is used.

2.

a.

To determine

Journalize the purchase of investment in available-for-sale securities’ transaction in the years 2014 and 2015.

Explanation of Solution

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 purchase of investment in AFS.

Table (1)

Note: No purchases were made in 2015.

Description:

• Investments in AFS Securities 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 cost of investment in AFS securities.

Step 1: Compute cost of investment in stock.

$\begin{array}{c}\text{Cost of investment }=\text{Number of shares}\times \text{Price per share}\\ =14,00\text{0 shares}\times \text{\$11 per share}\\ =\$154,000\end{array}$ (1)

Step 2: Compute cost of investment in AFS securities.

$\begin{array}{c}\text{Total cost = }\left\{\begin{array}{l}\text{Cost of investment in stock + }\\ \text{Cost of investment in bonds}\end{array}\right\}\\ \text{= \$154,000+\$400,000}\\ \text{= \$554,000}\end{array}$

Note: Refer to Equation (1) for value and computation of cost of investment in stock.

b.

To determine

Journalize the entry for income reported by investee companies for the years 2014 and 2015.

Explanation of Solution

The income reported by Corporations D and F are not recorded by Company OG because the type of investment is passive, and not of significant influence. So, for the two years 2014 and 2015, Company OG will not record any entry for the net income of the investee.

c.

To determine

Journalize the entry for receipt of dividend and interest revenue for the years 2014 and 2015.

Explanation of Solution

Prepare journal entry for cash dividend received and interest received.

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.
• Interest 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 in 2014.

$\begin{array}{c}\text{Dividend received}=\left\{\begin{array}{l}\text{Number of shares}\times \\ \text{Dividend per share}\end{array}\right\}\\ =14,000\text{ shares}\times \$0.50\text{ per share}\\ =\$7,000\end{array}$

Compute amount of dividend received in 2015.

$\begin{array}{c}\text{Dividend received}=\left\{\begin{array}{l}\text{Number of shares}\times \\ \text{Dividend per share}\end{array}\right\}\\ =14,000\text{ shares}\times \$0.70\text{ per share}\\ =\$9,800\end{array}$

d.

To determine

Journalize the adjusting entry for the changes in fair value of AFS securities for 2014 and 2015.

Explanation of Solution

Prepare journal entry for adjusting the cost of AFS securities to the fair market value, as on December 31, 2014, and 2015.

Table (3)

Description:

2014:

• Net Unrealized Gains (Losses) 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 decrease stockholders’ equity value, a decrease in stockholders’ equity value is debited. This loss is reported as component of Other Comprehensive Income (OCI) on the Statement of Comprehensive Income.
• Investments in AFS Securities is an asset account. The account is credited because the market price was decreased, and eventually the asset value decreased.

2015:

• Investments in AFS Securities is an asset account. The account is debited because the market price was increased, and eventually the asset value increased.
• Net Unrealized Gains (Losses) 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, an increase in stockholders’ equity value is credited. This gain is reported as component of Other Comprehensive Income (OCI) on the Statement of Comprehensive Income.

Working Notes:

Determine the unrealized gain or loss on investment on December 31, 2014.

Step 1: Compute the fair value of investment on December 31, 2014.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 14,000 shares × \$10 per share}\\ \text{= \$140,000}\end{array}$ (2)

Step 2: Compute total fair value of investment in AFS securities on December 31, 2014.

$\begin{array}{c}\text{Total fair value in 2014 = }\left\{\begin{array}{l}\text{Fair value of investment in stock + }\\ \text{Fair value of investment in bonds}\end{array}\right\}\\ \text{= \$140,000+\$375,000}\\ \text{= \$515,000}\end{array}$ (3)

Note: Refer to Equation (2) for value and computation of fair value of investment in stock.

Step 3: Compute unrealized gain or loss on investment in AFS securities.

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Total fair value of investment on December 31, 2014 – }\\ \text{Total cost of investment}\end{array}\right\}\\ \text{=\$515,000–\$554,000}\\ \text{=\$}\left(\text{39,000}\right)\end{array}$

Note: Refer to Equations (1) and (3) for both the values.

Determine the unrealized gain or loss on investment on December 31, 2015.

Step 1: Compute the fair value of investment on December 31, 2015.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 14,000 shares × \$11}\text{.50 per share}\\ \text{= \$161,000}\end{array}$ (4)

Step 2: Compute total fair value of investment in AFS securities on December 31, 2015.

$\begin{array}{c}\text{Total fair value in 2015 = }\left\{\begin{array}{l}\text{Fair value of investment in stock + }\\ \text{Fair value of investment in bonds}\end{array}\right\}\\ \text{= \$161,000+\$385,000}\\ \text{= \$546,000}\end{array}$ (5)

Note: Refer to Equation (2) for value and computation of fair value of investment in stock.

Step 3: Compute unrealized gain or loss on investment in AFS securities.

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Total fair value of investment on December 31, 2015 – }\\ \text{Total fair value of investment on December 31, 2014}\end{array}\right\}\\ \text{=\$546,000–\$515,000}\\ \text{=\$31,000}\end{array}$

Note: Refer to Equations (3) and (5) for both the values.

3.

a.

To determine

Show the reporting of long-term assets related to AFS investments, on the balance sheet of Company OG, on December 31, 2014 and 2015.

Explanation of Solution

Reporting of long-term assets on balance sheet:

Company OG
Balance Sheet
December 31
Assets:	2014	2015
Long-term assets:
Investment in Available-For-Sale-Securities	515,000	546,000

Table (4)

b.

To determine

Show the reporting of net unrealized gains (losses) related to AFS investments, on the stockholders’ equity section of Company OG, on December 31, 2014 and 2015.

Explanation of Solution

Reporting of net unrealized gains (losses) on statement of stockholders’ equity:

Company OG
Statement of Stockholders’ Equity
December 31
	2014	2015
Stockholders’ Equity:
Common Stock	XXX
Retained Earnings	XXX
Accumulated other comprehensive income:
Net unrealized gains (losses)	(39,000)	(8,000)

Table (5)

c.

To determine

Show the revenue related to AFS investments, reported on the income statement of Company OG, for the years ended December 31, 2014 and 2015.

Explanation of Solution

Income statement presentation:

Company OG
Income Statement (Partial)
For the Year Ended December 31
Other Revenue:	2014	2015
Interest revenue	$28,000	$28,000
Dividend revenue	7,000	9,800

Table (6)