Chapter 13, Problem 7P

Investment in Trading Securities The following information relates to Sanders Company’s investment in trading securities for 2019:

Required:

1. 1. Prepare journal entries to record the previous information for 2019. Use the effective interest method and round all amounts to the nearest dollar. Assume that Sanders prepares semiannual financial statement.
2. 2. Show the items of income or loss from investment transactions that Sanders reports for each 2019 semiannual income statement.
3. 3. Show how the investment items are reported on each of the 2019 semiannual balance sheets, assuming that management expects to dispose of all investments within one year of purchase.

To determine

Record the journal entries in the books of Company S related to the investments made in the trading securities.

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.

Trading securities: these are the securities which are purchased to earn the profits due to changes in their market prices.

Record the journal entries in the books of Company S related to the investments made in the trading securities.

Date	Account Title and Explanation	Debit ($)	Credit ($)
2019	Investment in trading securities	29,100
January 1	Cash		29,100
	(To record the purchase of Available-for-sale securities at discount)
January 1	Investment in trading securities	40,400
	Cash		40,400
	(To record the purchase of Available-for-sale securities at premium)
June 30	Cash (1)	1,200
	Investment in trading securities	255
	Interest income (2)		1,455
	(To record the earned interest and amortization of discount)
June 30	Cash (3)	2,000
	Investment in trading securities		20
	Interest income (4)		1,980
	(To record the earned interest and amortization of premium)
June 30	Investment in trading securities (5)	225
	Unrealized holding gain/loss: Trading securities		225
	(To adjust the allowance and the unrealized gain on holding the Securities)
July 1	Investment in trading securities	23,000
	Cash		23,000
	(To record the purchase of Available-for-sale securities at discount)
November 30	Interest receivable (6)	1,146
	Investment in trading securities	4
	Interest income (7)		1,150
	(To record the interest earned for 5 months)
November 30	Cash $\left(\$22,750+\$1,146\right)$	23,896
	Loss on sale of Available-for-sale Securities  $\left(\text{\$23,000}+\$4-\$22,750\right)$	254
	Investment in trading securities		23,004
	Interest receivable		1,146
	(To record the sale of Corporation W's bond on loss)
December 31	Cash (8)	1,200
	Investment in trading securities	268
	Interest income (9)		1,468
	(To record the earned interest and amortization of discount)
December 31	Cash (10)	2,000
	Investment in trading securities		21
	Interest income (11)		1,979
	(To record the earned interest and amortization of premium)
December 31	Cash	41,000
	Gain on sale of trading securities $\left(\$40,800-\$21\right)$		40,779
	Investment in trading securities		221
	(To record the sale of Company M's bond at gain)
December 31	Unrealized holding gain/loss: Available-for-sale securities	628
	Investment in trading securities (12)		628
	(To adjust the allowance and the unrealized loss on holding the Securities)

Table (1)

Working note (1):

Calculate the amount of cash received as interest.

$\begin{array}{c}\text{Cash = Face value of bond }\times \text{Stated interest rate }\times \frac{6\text{months}}{\text{12months}}\\ =\$30,000\times 8\%\times \frac{6}{12}\\ =\$1,200\end{array}$

Working note (2):

Calculate the amount of interest income:

$\begin{array}{c}\text{Interest income= Purchase price of bond }\times \text{Market interest rate }\times \frac{6\text{months}}{\text{12months}}\\ =\$29,100\times 10\%\times \frac{6}{12}\\ =\$1,455\end{array}$

Working note (3):

Calculate the amount of cash received as interest.

$\begin{array}{c}\text{Cash = Face value of bond }\times \text{Stated interest rate }\times \frac{6\text{months}}{\text{12months}}\\ =\$40,000\times 10\%\times \frac{6}{12}\\ =\$2,000\end{array}$

Working note (4):

Calculate the amount of interest income:

$\begin{array}{c}\text{Interest income= Purchase price of bond }\times \text{Market interest rate }\times \frac{6\text{months}}{\text{12months}}\\ =\$40,400\times 9.8\%\times \frac{6}{12}\\ =\$1,980\end{array}$

Working note (5):

Calculate the amount of investment in trading securities:

Investment	Book value at 06/30/2019	Fair value at 06/30/2019 (b)	Change in value (c) $\left(\text{c}=\text{b}-\text{a}\right)$
$30,000 face value of Company B' bonds	$29,355 (a)	$29,160	($195)
$40,000 face value of Company M' bonds	$40,380 (a)	$40,800	$420
Total	$69,735	$69,960	$225

Table (2)

Working note (a):

Determine the fair value of the investment as at June 30, 2019.

$\begin{array}{c}\text{Fair value of Company B's 8\% bonds}=\text{Cost +Amortization of discount}\\ \text{=\$29,100+\$255}\\ \text{=\$29,355}\end{array}$

$\begin{array}{c}\text{Fair value of Company M's 10\% bonds}=\text{Cost }-\text{Amortization of premium}\\ \text{=\$40,400}-\text{\$20}\\ \text{=\$40,380}\end{array}$

Working note (6):

Calculate the Actual interest receivable from Corporation W.

$\begin{array}{c}\text{Interest receivable= Face value of bond }\times \text{Stated interest rate }\times \frac{\text{5months}}{\text{12months}}\\ =\$25,000\times 11\%\times \frac{5}{12}\\ =\$1,146\end{array}$

Working note (7):

Calculate the interest income earned.

$\begin{array}{c}\text{Interest income = Purchase price of bond}\times \text{Effective interest rate }\times \frac{\text{5months}}{\text{12months}}\\ =\$23,000\times 12\%\times \frac{5}{12}\\ =\$1,150\end{array}$

Working note (8):

Calculate the amount of cash received as interest.

$\begin{array}{c}\text{Cash = Face value of bond }\times \text{Stated interest rate }\times \frac{6\text{months}}{\text{12months}}\\ =\$30,000\times 8\%\times \frac{6}{12}\\ =\$1,200\end{array}$

Working note (9):

Calculate the amount of interest income earned.

$\begin{array}{c}\text{Interest income= }\left[\begin{array}{l}\text{Value of investment in trading securities}\times \\ \text{Market interest rate }\times \frac{6\text{months}}{\text{12months}}\end{array}\right]\\ =\$29,355\times 10\%\times \frac{6}{12}\\ =\$1,468\end{array}$

Working note (10):

Calculate the amount of cash received as interest.

$\begin{array}{c}\text{Cash = Face value of bond }\times \text{Stated interest rate }\times \frac{6\text{months}}{\text{12months}}\\ =\$40,000\times 10\%\times \frac{6}{12}\\ =\$2,000\end{array}$

Working note (11):

Calculate the amount of interest income earned.

$\begin{array}{c}\text{Interest income= }\left[\begin{array}{l}\text{Value of investment in trading securities}\times \\ \text{Market interest rate }\times \frac{6\text{months}}{\text{12months}}\end{array}\right]\\ =\$40,380\times 9.8\%\times \frac{6}{12}\\ =\$1,979\end{array}$

Working note (12):

Calculate the amount of investment in trading securities:

Investment	Book value at 12/31/2019	Fair value at 12/31/2019 (b)	Change in value (c) $\left(\text{c}=\text{b}-\text{a}\right)$
$30,000 face value of Company B' bonds	$29,428 (b)	$28,800	($668)
Total	$29,428	$28,800	$668

Table (3)

Working note (b):

Calculate the book value of Company B’s bonds at 12/31/2019:

$\begin{array}{c}\text{Book value of the bonds}=\left(\begin{array}{l}\text{Book value of the bonds as at June 30, 2019}+\\ \text{Amortization at discount}\end{array}\right)\\ =\left(\$29,160+\$268\right)\\ =\$29,428\end{array}$

To determine

Show the items that would be reported as income or loss from the investment in the income statement.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Particulars	For semiannual period ended
	06/30/2019	12/31/2019
Interest income	$3,435 (c)	$4,597 (d)
Unrealized holding gain/ (Loss)	225	($628)
Loss on sale of available-for-sale securities	$0	($254)
Gain on sale of available-for-sale securities	$0	$221

Table (4)

Working note (c):

Calculate the amount of interest income as on 06/30/2019:

$\begin{array}{c}\text{Interest income}=\left(\$1,455+\$1,980\right)\\ =\$3,435\end{array}$

Working note (d):

Calculate the amount of interest income as on 12/31/2019:

$\begin{array}{c}\text{Interest income}=\left(\$1,150+\$1,468+\$1,979\right)\\ =\$4,597\end{array}$

To determine

Show the way in which the investments items are reported in the 2019 balance sheet.

Explanation of Solution

Balance sheet: Balance Sheet is one of the financial statements that summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Show the way in which the investments items are reported in the 2019 balance sheet:

Company S
Balance sheet Statement (Partial)
Assets	06/30/2019	12/31/2019
Current assets:
Investment in trading securities (Fair value)	$69,735	$29,623

Table (5)