Chapter 13, Problem 21P

1.

To determine

Determine the dividend income for 2019, unrealized holding gain or loss for Equity securities and the carrying value of the investment as at December 31, 2019.

Answer to Problem 21P

Dividend income for the year 2019 is $10,000.

Unrealized gain on holding available-for-sale-securities at December 31, 2019 is $30,000.

Carrying value of investment at December 31, 2019 is $630,000.

Explanation of Solution

Investment: It refers to the process of using the currently held excess cash to earn profitable returns in future. The investments can be made in equity securities such as shares or debt securities such as bonds.

Determine the amount of dividend income earned by Company L on October 2, 2019.

$\begin{array}{c}\text{Dividend income for 2019 = }\left[\text{Number of shares purchased}\times \text{Dividend per share}\right]\\ =10,000\text{shares}\times \text{\$1}\text{.00}\\ \text{=\$10,000}\end{array}$

Hence, the amount of dividend for 2019 is $10,000.

On January 1, 2019, Company L purchased Company W’s 10,000 shares for $600,000.

Therefore Company L paid $60 per share $\left(\frac{\$600,000}{10,000\text{shares}}\right)$ .

Determine the amount of unrealized gain or loss on holding equity securities at December 31, 2019.

$\begin{array}{c}\begin{array}{l}\text{Unrealized gain or loss on holding}\\ \text{equity securities}\end{array}\}=\left[\begin{array}{l}\text{Number of shares purchased}\times \\ \left(\begin{array}{l}\text{Market price per share}-\\ \text{Purchase price per share}\end{array}\right)\end{array}\right]\\ =\left[10,000\text{shares}\left(\$63-\$60\right)\right]\\ =10,000\text{shares}\left(\$3\right)\\ =\$30,000\left(\text{gain}\right)\end{array}$

Hence, the unrealized gain on holding available-for-sale-securities at December 31, 2019 is $30,000.

Determine the amount of carrying value of investment at December 31, 2019.

$\begin{array}{c}\text{Carrying value of investment=}=\left[\begin{array}{l}\text{Number of shares purchased}\times \\ \text{Market price per share}\end{array}\right]\\ =\left[10,000\text{shares}\times \$63\right]\\ =\$630,000\end{array}$

Hence, the carrying value of investment at December 31, 2019 is $630,000.

2.

To determine

Determine the investment income for 2019 and 2020, and the carrying value of the investment account as at December 31, 2019 and 2020.

Answer to Problem 21P

Investment income for 2019 is $40,000.

Investment income for 2019 is $110,000.

Carrying value of investment account at December 31, 2019 is $630,000.

Carrying value of investment account at December 31, 2020 is $2,626,000.

Explanation of Solution

Equity method:

If the investor company owns a large amount of common stock of another company, then it is able to exercise its significant influence over the operating and the financial policy of the investee company. The investor might be able to influence the investee company’s dividend policy with respect to the own cash needs or to raise its income or for the consideration of the tax. In addition to this, the investor may use this influence to create a favorable operating relationship with the investee. Thus, the equity method is used for this type of investment.

Determine the amount of investment income for 2019.

$\begin{array}{c}\text{Investment income = }\left[\begin{array}{l}\text{Net income for the year ended December 2019 was}\\ \text{reported by Company W}\times \text{Percentage of Company W's}\\ \text{shares held by Company L at December 31, 2019}\end{array}\right]\\ =\$400,000\times 10\%\\ =\$40,000\end{array}$

Hence, the amount of investment income for 2019 is $40,000.

On July 2, 2020, Company L purchased 30,000 additional shares of Company W for $1,950,000, which constitutes 30% investment in Company W.

Company W reported net income of $500,000 for the year ended December 31, 2020. Out of this $500,000, $200,000 is the net income for the 6months ended December 31, 2020. Hence, $300,000$\left(\$500,000-\$200,000\right)$ is considered as the net income earned during January 1, 2020 to June 30, 2020.

Determine the amount of investment income for 2020.

$\begin{array}{c}\begin{array}{l}\text{Investment}\\ \text{income }\end{array}\}\text{= }\left[\begin{array}{l}\left(\begin{array}{l}\text{Net income earned from January 1, 2020 to June 30, 2020 }\\ \text{by Company W}\times \text{Percentage of Company W's}\\ \text{shares held by Company L until June 30, 2019}\end{array}\right)+\\ \left(\begin{array}{l}\text{Net income for 6month ended December 31, 2020 was}\\ \text{reported by Company W}\times \text{Percentage of Company W's}\\ \text{shares held by Company L from July 2, 2020}\end{array}\right)\end{array}\right]\\ =\left[\left(\$300,000\times 10\%\right)+\left(\$200,000\times 40\%\right)\right]\\ =\$30,000+\$80,000\\ =\$110,000\end{array}$

Hence, the amount of investment income for 2020 is $110,000.

Determine the carrying value of investment account as on December 31, 2020.

Step 1: Determine the market value of company W’s share as on July 2, 2020.

$\begin{array}{c}\text{Market value = }\frac{\text{Purchase price of Company W's 30,000 shares}}{\text{30,000 shares}}\\ =\frac{\$1,950,000}{\text{30,000 shares}}\\ =\$65\end{array}$

Step 2: Determine the market value of 10,000 shares as on July 2, 2020.

$\begin{array}{c}\text{Market value of 10,000 shares = }\left[\begin{array}{l}\text{Market value per share }\times \text{Company W's}\\ 1\text{0,000 shares held by Company L}\end{array}\right]\\ =\$65\times 10,000\text{shares}\\ \text{=\$650,000}\end{array}$

Step 4: Determine the amount of dividend received on October 1, 2020.

$\begin{array}{c}\text{Dividend = }\left[\begin{array}{l}\text{Number of shares of Company W held by Company L as}\\ \text{on October 1, 2020}\times \text{Dividend per share}\end{array}\right]\\ =40,000\text{shares}\times \text{\$1}\text{.35}\\ \text{=\$54,000}\end{array}$

Step 3: Determine the carrying value of investment account as on December 31, 2020.

$\begin{array}{c}\begin{array}{l}\text{Carrying value of investment}\\ \text{account as on December 31, 2020}\end{array}\}=\left[\begin{array}{l}\text{Market value of 10,000shares of}\\ \text{Company W+ Cost of additionaly}\\ \text{purchased 30,000shares of Company W}\\ \text{+Investment income for second}\\ \text{half of 2020}-\text{Dividends}\end{array}\right]\\ =\$650,000+\$1,950,000+\$80,000-\$54,000\\ =\$2,626,000\end{array}$

Hence, the carrying value of investment account as on December 31, 2020 is $2,626,000.

Note:

Dividend paid on April 2, 2020 is not taken into consideration for above calculation of carrying value of investment account as on December 31, 2020, as 10,000 shares are recorded at July 2, 2020 at its market rate.