Chapter 15, Problem 15.2APR

(1)

To determine

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.

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 stock investment transactions in the books of Company SF.

Explanation of Solution

Prepare journal entry for the purchase of 5,000 shares of Company W, at $40 per share, and a brokerage commission of $500.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
March	14	Investments–Company W Stock		200,500
		Cash			200,500
		(To record purchase of shares for cash)

Table (1)

• Investments–Company W Stock 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 amount of cash paid to purchase Company W’s stock.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\text{+}\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{5,000 shares ×\$40}\right)+\$500\\ \text{= \$200,500}\end{array}$

Prepare journal entry for the purchase of 1,800 shares of Company M, at $50 per share, and a brokerage commission of $198.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
April	24	Investments–Company M Stock		90,198
		Cash			90,198
		(To record purchase of shares for cash)

Table (2)

• Investments–Company M Stock 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 amount of cash paid to purchase Company M’s stock.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\text{+}\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{1,800 shares ×\$50}\right)+\$198\\ \text{= \$90,198}\end{array}$

Prepare journal entry for sale of 2,600 shares of Company W, at $38, with a brokerage of $100.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
June	1	Cash		98,700
		Loss on Sale of Investments		5,560
		Investments–Company W Stock			104,260
		(To record sale of shares)

Table (3)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.

• Loss on Sale of Investments is a loss or expense account. Since losses decrease equity, equity value is decreased, and a decrease in equity is debited.

• Investments–Company W Stock is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.

Working Notes:

Calculate the realized gain (loss) on sale of stock.

Step 1: Compute cash received from sale proceeds.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares sold× }\\ \text{Sale price per share}\end{array}\right)–\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{2,600 shares ×\$38}\right)–\$100\\ \text{= \$98,700}\end{array}$

Step 2: Compute cost of stock investment sold.

$\begin{array}{c}\begin{array}{l}\text{Cost of stock }\\ \text{investment sold}\end{array}\}\text{ = Number of shares sold × Price per share}\\ \text{= Number of shares sold ×}\frac{\text{Cost of 5,000 shares}}{\text{Number of shares}}\\ \text{= 2,600 shares ×}\frac{\text{\$200,500}}{\text{5,000 shares}}\\ \text{= \$104,260}\end{array}$

Step 3: Compute realized gain (loss) on sale of stock.

$\begin{array}{c}\begin{array}{l}\text{Realized gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of stock investment }\end{array}\right\}\\ \text{= \$98,700–\$104,260}\\ \text{= \$}\left(5,560\right)\end{array}$

Note: Refer to Steps 1 and 2 for value and computation of cash received and cost of stock investment sold.

Prepare journal entry for the dividend received from Company W shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
June	30	Cash		840
		Dividend Revenue			840
		(To record receipt of dividend revenue)

Table (4)

• 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.

Working Notes:

Compute amount of dividend received on Company W’s stock.

$\begin{array}{c}\text{Dividend received = }\left\{\begin{array}{l}\text{Number of shares × }\\ \text{Dividend per share}\end{array}\right\}\\ \text{= }\left(\text{5,000–2,600}\right)\text{ shares ×\$0}\text{.35}\\ \text{= \$840}\end{array}$

Prepare adjusting entry for valuation of trading securities transaction.

Figure (1)

• Unrealized Loss on Trading Investments 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 reduce stockholders’ equity value, and a decrease in stockholders’ equity value is debited.

• Valuation Allowance for Trading Investments is a contra-asset account. The account is credited because the market price was decreased (loss) to $179,400 from the cost of $136,438.

Working Notes:

Compute the unrealized gain (loss) as on December 31, 2016.

Step 1: Compute the fair value of the portfolio of the trading investment.

Security	Number of Shares	$\times$	Fair Market Value	=	Fair Market Value of Investment
Company W	2,400 shares	$\times$	$38	=	$91,200
Company M	1,800 shares	$\times$	49	=	88,200
Total					$179,400

Table (5)

Step 2: Compute the cost per share of Company W.

$\begin{array}{c}\text{Cost per share = }\frac{\text{Cost of 5,000 shares}}{\text{Number of shares}}\\ \text{= }\frac{\text{\$200,500}}{\text{5,000 shares}}\\ \text{= \$40}\text{.1}\end{array}$

Step 3: Compute the cost per share of Company M.

$\begin{array}{c}\text{Cost per share = }\frac{\text{Cost of 3,000 shares}}{\text{Number of shares}}\\ \text{= }\frac{\text{\$90,198}}{\text{1,800 shares}}\\ \text{= \$50}\text{.11}\end{array}$

Step 4: Compute the cost of the portfolio of the trading investment, as on December 31.

Security	Number of Shares	$\times$	Cost per Share	=	Cost of Investment
Company W	2,400 shares	$\times$	$40.10	=	$96,240
Company M	1,800 shares	$\times$	50.11	=	90,198
Total					$186,438

Table (6)

Note: Refer to Steps 3 and 4 for cost per share of Company W and Company M.

Step 5: Compute the unrealized gain (loss) as on December 31, 2016.

Details	Amount ($)
Trading investments at fair value, December 31 (From Table-5)	$179,400
Less: Trading investments at cost, December 31 (From Table-6)	(186,438)
Unrealized loss on trading investments	$(7,038)

Table (7)

Prepare journal entry for the purchase of 3,500 shares of Company D, at $30 per share, and a brokerage commission of $175.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
April	4	Investments–Company D Stock		105,715
		Cash			105,715
		(To record purchase of shares for cash)

Table (8)

:

• Investments–Company D Stock 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 amount of cash paid to purchase Company D’s stock.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\text{+}\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{3,500 shares ×\$30}\right)+\$175\\ \text{= \$105,175}\end{array}$

Prepare journal entry for the dividend received from Company W shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
June	28	Cash		960
		Dividend Revenue			960
		(To record receipt of dividend revenue)

Table (9)

• 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.

Working Notes:

Compute amount of dividend received on Company W’s stock.

$\begin{array}{c}\text{Dividend received = }\left\{\begin{array}{l}\text{Number of shares × }\\ \text{Dividend per share}\end{array}\right\}\\ \text{= }\left(\text{5,000–2,600}\right)\text{ shares ×\$0}\text{.40}\\ \text{= \$960}\end{array}$

Prepare journal entry for sale of 700 shares of Company D at $32, with a brokerage of $50.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
September	9	Cash		22,350
		Gain on Sale of Investments			1,315
		Investments–Company D Stock			21,035
		(To record sale of shares)

Table (10)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.

• Gain on Sale of Investments is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

• Investments–Company D Stock is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.

Working Notes:

Calculate the realized gain (loss) on sale of stock.

Step 1: Compute cash received from sale proceeds.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares sold× }\\ \text{Sale price per share}\end{array}\right)–\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{700 shares ×\$32}\right)–\$50\\ \text{= \$22,350}\end{array}$

Step 2: Compute cost of stock investment sold.

$\begin{array}{c}\begin{array}{l}\text{Cost of stock }\\ \text{investment sold}\end{array}\}\text{ = Number of shares sold × Price per share}\\ \text{= Number of shares sold ×}\frac{\text{Cost of 5,000 shares}}{\text{Number of shares}}\\ \text{= 700 shares ×}\frac{\text{\$105,175}}{\text{3,500 shares}}\\ \text{= \$21,035}\end{array}$

Step 3: Compute realized gain (loss) on sale of stock.

$\begin{array}{c}\begin{array}{l}\text{Realized gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of stock investment }\end{array}\right\}\\ \text{= \$22,350–\$21,035}\\ \text{= \$1,315}\end{array}$

Note: Refer to Steps 1 and 2 for value and computation of cash received and cost of stock investment sold.

Prepare adjusting entry for valuation of trading securities transaction.

Figure (2)

• Valuation Allowance for Trading Investments is a contra-asset account. The account is debited because the market price was increased (gain).

• Unrealized Gain on Trading Investments 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, and an increase in stockholders’ equity value is credited.

Working Notes:

Compute the unrealized gain (loss) as on December 31, 2017.

Details	Amount ($)
Unrealized gain as on December 31, 2017	$79,422
Add: Unrealized loss as on December 31, 2016 (From Table-8)	7,038
Unrealized gain on trading investments	$86,460

Table (11)

(2)

To determine

To indicate: The presentation of trading investments on the current assets section of the balance sheet.

Explanation of Solution

Solution:

Balance sheet presentation:

Company S
Balance Sheet (Partial)
December 31, 2017
Assets
Current assets:
Trading investments (at cost)	$270,578
Add valuation allowance for trading investments	79,422
Trading investments (at fair value)		$350,000

Table (12)

(3)

To determine

To discuss: The reporting of trading investments on the financial statements.

Explanation of Solution

Unrealized gain or loss is the result of change in trading investments cost and fair values, and reported as Other Revenues (Losses) on the income statement. The unrealized gain will be added to the net income and unrealized loss will be deducted from the net income. In 2016, Company S would report $7,038 of unrealized loss as Other Losses on the income statement. In 2017, Company S would report $86,460 of unrealized gain as Other Income on the income statement.