Chapter 12, Problem 12.11P

1)

To determine

Investment: The act of allocating money to buy a monetary asset, in order to generate wealth in the future is referred to as investment.

Equity investments: The financial instruments which claim ownership in the issuing company and pay a dividend revenue to the investor company, are referred to as equity securities. The investments in equity securities are referred to as equity investments.

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.

Fair value: Fair value is the price at which, both seller and buyer agree to exchange the asset. So, fair value is the selling price to the seller and the purchase price for the buyer.

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 entries related to the investments during 2016, for Company R assuming the investment is made under fair value option method.

Explanation of Solution

Prepare the journal to record the investment in the books.

Date	Account Title	Debit ($)	Credit ($)
01.04.16	Investment in L shares	$324,000,000
	Cash		$324,000,000
	(To record the investment in shares of Company L)

 Table (1)

• Investment in is an asset account. Since stock investments are purchased, asset value increases, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreases, and a decrease in asset is credited.

Prepare the journal entry to record the dividend in the books.

Date	Account Title	Debit ($)	Credit ($)
12.15.16	Cash	$20,000,000
	Investment in L shares  (1)		$20,000,000
	(To record the issue of the dividends)

 Table (2)

• Cash is an asset account. Since cash is received, asset account increases, and an increase in asset is debited.
• Investment revenue is a revenue account. Since revenues increases equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Calculate the investments.

$\begin{array}{c}\text{Dividends = \$}2\times \text{ Number of shares}\\ =\$2\times 10,000,000\\ =\$20,000,000\end{array}$ (1)

Prepare the adjusting entry to record the holding loss in the books.

Date	Account Title	Debit ($)	Credit ($)
12.31.16	Unrealized holding loss—NI  (2)	$14,000,000
	Fair value adjustment		$14,000,000
	(To record the loss through adjustment)

 Table (3)

• Unrealized Holding Loss–NI 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, stockholders’ equity value is debited.
• Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is adjusted to update the fair value as on December 31, 2016.

Working Notes:

Compute the unrealized loss as on December 31, 2016, by adjusting the cost to the fair value.

Details	Amount ($)
Fair value adjustment balance as on January 4, 2016	324,000,000
Adjustment needed to update fair value (Balancing figure) (2)	14,000,000
Fair value adjustment balance needed on December 31, 2016 $\left(10\text{ million shares }\times \text{ \$31 per share}\right)$	310,000,000

Table (4) (2)

The Net income of Company R would show no change as the investment is made under fair value option method. The net income would be $6,000,000.

Working Notes:

Compute the net income.

$\begin{array}{c}\text{Net income = Investment Revenue }-\text{ Unrealized gains}\\ \text{= \$20,000,000 }-\$14,000,000\\ =\$6,000,000\end{array}$

Thus the Net income shown by Company R would be $6,000,000

2)

To determine

To Journalize: The entries related to the investments during 2016, for Company R assuming the investment are recorded under fair value but is made under equity method.

Explanation of Solution

Prepare the journal to record the investment in the books.

Date	Account Title	Debit ($)	Credit ($)
01.04.16	Investment in L shares	$324,000,000
	Cash		$324,000,000
	(To record the investment in shares of Company L)

 Table (5)

• Investment in is an asset account. Since stock investments are purchased, asset value increases, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreases, and a decrease in asset is credited.

Prepare the journal entry to record the net income in the books.

Date	Account Title	Debit ($)	Credit ($)
12.15.16	Investment in L shares  (3)	$48,000,000
	Investment revenue		$48,000,000
	(To record the net income in the books)

 Table (6)

• Investment in L shares is an asset account. Since investment increases assets, asset value is increased, and the increase in asset is debited.
• Investment revenue is a revenue account. Since revenues increases equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Calculate the investments.

$\begin{array}{c}\text{Net income = }30\%\times \text{Investment value}\\ =30\%\times \$160,000,000\\ =\$48,000,000\end{array}$ (3)

Prepare the journal entry to record the dividend in the books.

Date	Account Title	Debit ($)	Credit ($)
12.15.16	Cash	$20,000,000
	Investment in L shares  (1)		$20,000,000
	(To record the issue of the dividends)

 Table (7)

• Cash is an asset account. Since cash is received, asset account increases, and an increase in asset is debited.
• Investment in L shares is an asset account. Since investment decreases assets, asset value is decreased, and the decrease in asset is credited.

Prepare the adjusting entry to record the depreciation in the books.

Date	Account Title	Debit ($)	Credit ($)
12.31.16	Investment revenue  (4)	$4,000,000
	Investment in L shares		$4,000,000
	(To record the depreciation)

 Table (9)

• Investment revenue is a revenue account. Since revenue is depreciated, it decreases equity, equity value is decreased, and the decrease in equity is debited.
• Investment in L shares is an asset account. Since deprecation reduces the asset value, the asset is credited.

Working Notes:

Calculate the depreciation amount.

$\begin{array}{c}\text{Depreciation = }\left(30\%\times \text{Fair value }-30\%\times \text{Book value}\right)÷\text{6years}\\ =\left(\begin{array}{l}\left(30\%\times \$880,000,000\right)-\\ \left(30\%\times \$800,000,000\right)\end{array}\right)÷\text{6 years}\\ =\left(\$264,000,000-\$240,000,000\right)÷\text{6 years}\\ =\$24,000,000÷\text{6 years}\\ \text{= \$4,000,000}\end{array}$ (4)

Prepare the adjusting entry to record the holding loss in the books.

Date	Account Title	Debit ($)	Credit ($)
12.31.16	Unrealized holding loss—NI  (5)	$38,000,000
	Fair value adjustment		$38,000,000
	(To record the loss through adjustment)

 Table (8)

• Unrealized Holding Loss–NI 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, stockholders’ equity value is debited.
• Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is adjusted to update the fair value as on December 31, 2016.

Working Notes:

Compute the unrealized loss as on December 31, 2016.

$\begin{array}{c}\text{Unrealized holding loss =}\left(\text{Number of shares }\times \text{\$31}\right)-\$348,000,000\\ =\left(\text{10,000,000 }\times \text{\$31}\right)-\$348,000,000\\ =\$310,000,000-\$348,000,000\\ \text{= \$38,000,000}\end{array}$ (5)