Chapter 12, Problem 12.7P

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.

Held-to-maturity security: The debt securities which are held by the investor with the intent to hold the investment till its maturity are referred to as held-to-maturity securities.

Available-for-sale (AFS) securities: These are short-term or long-term investments in debt and equity securities with an intention of holding the investment for some strategic purposes like meeting liquidity needs, or manage interest risk.

Trading securities: These are short-term investments in debt and equity securities with an intention of trading and earning profits due to changes in market prices.

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.

Journal: Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.
•  

To Journalize: The transactions of Company AG.

Explanation of Solution

Purchased preferred shares of Company M:

Prepare the journal entry to record the investment made in Company M.

Date	Account Title	Debit ($)	Credit ($)
10.16.16	Investment in shares of Company M	$58,000,000
	Cash		$58,000,000
	(To record the investment made in Company M)

Table (1)

• Investments is being made, this increases the assets; hence debit the investment.
• Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.

Received the semiannual interest on the bonds of Company K:

Prepare the journal entry to record the semiannual interest received from Company K.

Date	Account Title	Debit ($)	Credit ($)
10.31.16	Cash	$1,500,000
	Interest revenue		$1,500,000
	(To record the interest received )

Table (2)

• Cash is received, cash is an asset which is being increased; hence debit the cash account.
• Interest revenue is a gain, which increases the stockholder's equity; hence credit the interest revenue account.

Purchased the bonds of Company HE on November 1, 2016:

Prepare the journal entry to record the investment made in Company HE.

Date	Account Title	Debit ($)	Credit ($)
11.01.16	Investment in  bonds of Company HE	$18,000,000
	Cash		$18,000,000
	(To record the investment made in Company HE)

Table (3)

• Investments is being made, this increases the assets; hence debit the investment.
• Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.

Sold the bonds of Company K on November 1, 2016:

1. i. Prepare the journal entry to record the loss on sale of the bonds of Company K.

Date	Account Title	Debit ($)	Credit ($)
11.01.16	Unrealized holding loss—NI  (1)	$2,000,000
	Fair value adjustment		$2,000,000
	(To record the loss through adjustment)

Table (4)

• 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 November 1, 2016.

Working Notes:

Compute the unrealized loss as on November 1, 2016, by adjusting the cost to the fair value.

Details	Amount ($)
Investments balance as on November 1, 2016	30,000,000
Adjustment needed to update fair value (Balancing figure) (1)	2,000,000
Fair value adjustment balance needed on November 1, 2016	28,000,000

Table (5) (1)

1. ii. Prepare the journal entry to record the sale of the bonds of Company K.

Date	Account Title	Debit ($)	Credit ($)
11.01.16	Cash	$28,000,000
	Fair value adjustment	$2,000,000
	Investment in  bonds of Company K		$30,000,000
	(To record the sale of investment)

Table (6)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is debited due to loss.
• Investment in bonds of Company K is an asset account. Since investments are sold, asset value decreased, and a decrease in asset is credited.

Purchased the bonds of Company HP on December 1, 2016:

Prepare the journal entry to record the investment made in Company HP.

Date	Account Title	Debit ($)	Credit ($)
12.01.16	Investment in  bonds of Company HP	$60,000,000
	Cash		$60,000,000
	(To record the investment made in Company HP)

Table (7)

• Investments is being made, this increases the assets; hence debit the investment.
• Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.

Purchased the Treasury Bonds on December 20, 2016:

Prepare the journal entry to record the investment made in Treasury Bills and Bonds.

Date	Account Title	Debit ($)	Credit ($)
12.20.16	Investment in Treasury Bonds	$5,600,000
	Cash		$5,600,000
	(To record the investment made )

 Table (8)

• Investments is being made, this increases the assets; hence debit the investment.
• Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.

Purchased shares of Company N on December 21, 2016:

Prepare the journal entry to record the investment made in Company N.

Date	Account Title	Debit ($)	Credit ($)
12.21.16	Investment in shares of Company N	$44,000,000
	Cash		$44,000,000
	(To record the investment made in Company N)

Table (9)

• Investments is being made, this increases the assets; hence debit the investment.
• Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.

Sold the Treasury Bonds on December 23, 2016:

1. i. Prepare the journal entry to record the gain from sale of the Treasury Bonds.

Date	Account Title	Debit ($)	Credit ($)
12.23.16	Fair value adjustment (2)	$100,000
	Unrealized holding gain—NI		$100,000
	(To record the gain on adjustment)

Table (10)

• 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 23, 2016.
• Unrealized Holding Gain–NI 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, it is credited.

Working Notes:

Compute the unrealized loss as on December 23, 2016, by adjusting the cost to the fair value.

Details	Amount ($)
Fair value adjustment balance as on December 20, 2016	5,600,000
Adjustment needed to update fair value (Balancing figure) (2)	100,000
Fair value adjustment balance needed on December 23, 2016	5,700,000

Table (11) (2)

1. ii. Prepare the journal entry to record the sale of the Treasury Bonds.

Date	Account Title	Debit ($)	Credit ($)
12.23.16	Cash	$5,700,000
	Investment in  Treasury Bonds		$5,600,000
	Fair value adjustment		$100,000
	(To record the sale of Treasury Bonds)

 Table (12)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is credited due to gain.
• Investment in Treasury Bills is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.

Record the dividends received from the shares of Company M on December 29, 2016:

Prepare the journal entry to record the dividends received from Company M.

Date	Account Title	Debit ($)	Credit ($)
12.29.16	Cash	$3,000,000
	Dividend Revenue		$3,000,000
	(To record the Dividends from the shares of Company M)

Table (13)

• Investments is being made, this increases the assets; hence debit the investment.
• Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.

Record the necessary adjusting entries as on December 31, 2016:

1. i. Prepare the journal entry to record the interest receivable.

Date	Account Title	Debit ($)	Credit ($)
12.31.16	Interest Receivable from Company HE  (3)	$300,000
	Interest Receivable from Company HP  (4)	$600,000
	Interest revenue		$900,000
	(To record the interest received )

Table (14)

• Interest Receivable, is a liability which is being increased; hence debit the interest receivable account.
• Interest revenue is a gain, which increases the stockholder's equity; hence credit the interest revenue account.

Working Notes:

Compute the interest receivable from Company HE.

$\begin{array}{c}\text{Interest Receivable from Company HE = Face value }\times \text{Time Period}\times \text{Interest Rate}\\ \text{=}\$18,000,000\times \frac{2}{12}\times 10\%\\ =\$3,000,000\times 10\%\\ =\$300,000\end{array}$ (3)

Compute the interest receivable from Company HP.

$\begin{array}{c}\text{Interest Receivable from Company HP = Face value }\times \text{Time Period}\times \text{Interest Rate}\\ \text{=}\$60,000,000\times \frac{1}{12}\times 12\%\\ =\$5,000,000\times 12\%\\ =\$600,000\end{array}$ (4)

1. ii. Prepare the journal entry to adjust the loss from the investment in Company M.

Date	Account Title	Debit ($)	Credit ($)
12.31.16	Unrealized holding loss—NI	$3,000,000
	Fair value adjustment  (5)		$3,000,000
	(To record the loss through adjustment)

Table (15)

• 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 October 18, 2016	58,000,000
Adjustment needed to update fair value (Balancing figure) (5)	3,000,000
Fair value adjustment balance needed on December 31, 2016	55,000,000

Table (16) (5)

1. iii. Prepare the journal entry to adjust the gain from the investment in Company N.

Date	Account Title	Debit ($)	Credit ($)
12.31.16	Fair value adjustment  (6)	$2,000,000
	Unrealized holding gain—OCI		$2,000,000
	(To record the gain on adjustment)

Table (17)

• 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 26, 2016.
• Unrealized Holding Gain–NI 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, it is credited.

Working Notes:

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

Details	Amount ($)
Fair value adjustment balance as on November 21, 2016	44,000,000
Adjustment needed to update fair value (Balancing figure) (6)	2,000,000
Fair value adjustment balance needed on December 31, 2016	46,000,000

Table (18) (6)

1. iv. Prepare the journal entry to close the accounts of Company AG.

Prepare the adjusting entry to record the closing entries of Company AG.

Date	Account Title	Debit ($)	Credit ($)
12.31.16	Net unrealized holding gains and losses—I/S (Company N)	$2,000,000
	Investment revenue   (7)	$5,400,000
	Gain on sale of investments  (Treasury Bonds)	$100,000
	Loss on sale of investments (Treasury Bills)		$2,000,000
	Income Summary  (8)		$5,500,000
	(To record the loss through adjustment)

Table (19)

• Net unrealized holding gains and losses—I/S, denotes the gains, which increase stockholders’ equity value. However to close the gain account it is debited.
• Investment revenue is a revenue account. In order to close the investment revenue, this account it is debited.
• Gain on sale of investments is a revenue account. In order to close the gain on sale of investment, this account it is debited.
• Loss on sale of investments, decrease stockholders’ equity value. However to close the loss account it is credited.
• Income Summary has been credited to close the income summary account.

Working Notes:

Compute the investment revenue.

$\begin{array}{c}\text{Investment revenue = \$3,000,000 + \$1,500,000+ \$900,000}\\ \text{= \$5,400,000}\end{array}$ (7)

Compute the income Summary.

$\begin{array}{c}\text{Income Summary = \$2,000,000 + \$5,400,000 + \$100,000 }-\text{\$2,000,000}\\ \text{= \$7,500,000 }-\text{ \$2,000,000}\\ \text{= \$5,500,000}\end{array}$ (8)

Record the sale of shares of Company N as on January 7, 2017:

1. i. Prepare the journal entry to record the loss on sale of shares.

Date	Account Title	Debit ($)	Credit ($)
01.07.17	Unrealized holding loss—NI	$3,000,000
	Fair value adjustment   (9)		$3,000,000
	(To record the loss through adjustment)

Table (20)

• 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 January 7, 2017.

Working Notes:

Compute the unrealized loss as on January 7, 2017, by adjusting the cost to the fair value.

Details	Amount ($)
Fair value adjustment balance as on December 31, 2016	46,000,000
Adjustment needed to update fair value (Balancing figure) (9)	3,000,000
Fair value adjustment balance needed on January 7, 2017	43,000,000

Table (21) (9)

1. ii. Prepare the journal entry to reclassify the loss on shares of Company N.

Date	Account Title	Debit ($)	Credit ($)
01.07.17	Fair value adjustment	$1,000,000
	Reclassification adjustment—OCI (10)		$1,000,000
	(To record the reclassification of adjustment)

Table (22)

• 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 January 7, 2017, by adjusting the cost to the fair value.

Details	Amount ($)
Fair value adjustment balance as on December 31, 2016	2,000,000
Reclassification adjustment (Balancing figure) (10)	1,000,000
Fair value adjustment balance needed on January 7, 2017	3,000,000

Table (23) (10)

1. iii. Prepare the journal entry to record the sale of the investment in Company N.

Date	Account Title	Debit ($)	Credit ($)
01.07.17	Cash	$43,000,000
	Loss NI	$1,000,000
	Investment in shares of Company N		$44,000,000
	(To record the sale of shares of Company N)

Table (24)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Loss reduces the stockholder's equity; hence debit the loss.
• Investment is an asset, which is reduced; hence credit the investments account.

Record the closing entry for the gain from Company N as on December 31, 2017:

1. v. Prepare the journal entry to adjust the gain from the investment in Company N.

Date	Account Title	Debit ($)	Credit ($)
12.31.17	Unrealized holding gain and losses —I/S	$2,000,000
	Fair value adjustment  (11)		$2,000,000
	(To record the gain on adjustment)

Table (25)

• Unrealized holding gain and losses –I/S is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since the account is closed, the unrealized gain 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, 2017.

Working Notes:

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

Details	Amount ($)
Fair value adjustment balance as on December 31, 2016	46,000,000
Adjustment needed to update fair value (Balancing figure) (11)	2,000,000
Fair value adjustment balance needed on December 31, 2017	44,000,000

Table (26) (11)