Chapter 15, Problem 15.2BPR

(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 Z

Explanation of Solution

Prepare journal entry for the purchase of 4,800 shares of Company AP, at $26 per share, and a brokerage commission of $192.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
February	14	Investments–Company AP Stock		124,992
		Cash			124,992
		(To record purchase of shares for cash)

Table (1)

• Investments–Company AP 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 AP’s stock.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\text{+}\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{4,800 shares ×\$26}\right)+\$192\\ \text{= \$124,992}\end{array}$

Prepare journal entry for the purchase of 2,300 shares of Company AR, at $19 per share, and a brokerage commission of $92.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
April	1	Investments–Company AR Stock		43,792
		Cash			43,792
		(To record purchase of shares for cash)

Table (2)

• Investments–Company AR 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 AR’s stock.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\text{+}\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{2,300 shares ×\$19}\right)+\$92\\ \text{= \$43,792}\end{array}$

Prepare journal entry for sale of 600 shares of Company AP, at $32, with a brokerage of $100.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
June	1	Cash		19,100
		Gain on Sale of Investments			3,476
		Investments–Company AP Stock			15,624
		(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 AP 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.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares sold× }\\ \text{Sale price per share}\end{array}\right)–\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{600 shares ×\$32}\right)–\$100\\ \text{= \$19,100}\end{array}$

Step 2: Compute cost of stock investment sold.

$\begin{array}{c}\begin{array}{l}\text{Cost of stock }\\ \text{investment sold}\end{array}\}\text{ = Number of shares sold × Price per share}\\ \text{= Number of shares sold ×}\frac{\text{Cost of 4,800 shares}}{\text{Number of shares}}\\ \text{= 600 shares ×}\frac{\text{\$124,992}}{\text{4,800 shares}}\\ \text{= \$15,624}\end{array}$

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

$\begin{array}{c}\begin{array}{l}\text{Realized gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of stock investment }\end{array}\right\}\\ \text{= \$19,100–\$15,624}\\ \text{= \$3,476}\end{array}$

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 AP for 4,200 shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2016
June	27	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 AP’s stock.

$\begin{array}{c}\text{Dividend received = }\left\{\begin{array}{l}\text{Number of shares × }\\ \text{Dividend per share}\end{array}\right\}\\ \text{= }\left(\text{4,800–600}\right)\text{ shares ×\$0}\text{.20}\\ \text{= \$840}\end{array}$

Prepare adjusting entry for valuation of trading securities transaction.

Figure(1)

• Valuation Allowance for Trading Investments is a contra-asset account. The account is credited because the market price was increased (gain) to $181,150 from the cost of $153,160.

• 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 increase stockholders’ equity value, and an increase in stockholders’ equity value is debited.

Working Notes:

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

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 AP	4,200 shares	$\times$	$33.00	=	$138,600
Company AR	2,300 shares	$\times$	18.50	=	42,550
Total					$181,150

Table (5)

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

$\begin{array}{c}\text{Cost per share = }\frac{\text{Cost of 4,800 shares}}{\text{Number of shares}}\\ \text{= }\frac{\text{\$124,992}}{\text{4,800 shares}}\\ \text{= \$26}\text{.04}\end{array}$

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

$\begin{array}{c}\text{Cost per share = }\frac{\text{Cost of 2,300 shares}}{\text{Number of shares}}\\ \text{= }\frac{\text{\$43,792}}{\text{2,300 shares}}\\ \text{= \$19}\text{.04}\end{array}$

Step 4: Compute the cost of the portfolio of the trading investment, as on December 31, 2016.

Security	Number of Shares	$\times$	Cost per Share	=	Cost of Investment
Company AP	4,200 shares	$\times$	$26.04	=	$109,368
Company AR	2,300 shares	$\times$	19.04	=	43,792
Total					$153,160

Table (6)

Note: Refer to Steps 3 and 4 for cost per share of Company AP and Company AR.

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

Details	Amount ($)
Trading investments at fair value, December 31 (From Table-5)	$181,150
Less: Trading investments at cost, December 31 (From Table-6)	(153,160)
Unrealized loss on trading investments	$27,990

Table (7)

Prepare journal entry for the purchase of 1,200 shares of Company AT, at $65 per share, and a brokerage commission of $120.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
March	14	Investments–Company AT Stock		78,120
		Cash			78,120
		(To record purchase of shares for cash)

Table (8)

• Investments–Company AT 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 AT’s stock.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\text{+}\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{1,200 shares ×\$65}\right)+\$120\\ \text{= \$78,120}\end{array}$

Prepare journal entry for the dividend received from Company AP for 4,200 shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
June	26	Cash		882
		Dividend Revenue			882
		(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 AP’s stock.

$\begin{array}{c}\text{Dividend received = }\left\{\begin{array}{l}\text{Number of shares × }\\ \text{Dividend per share}\end{array}\right\}\\ \text{= }\left(\text{4,800–600}\right)\text{ shares ×\$0}\text{.21}\\ \text{= \$882}\end{array}$

Prepare journal entry for sale of 480 shares of Company AT at $60, with a brokerage of $50.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2017
July	30	Cash		28,750
		Loss on Sale of Investments		2,498
		Investments–Company AT Stock			31,248
		(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.

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

• Investments–Company AT 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.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares sold× }\\ \text{Sale price per share}\end{array}\right)–\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{480 shares ×\$60}\right)–\$50\\ \text{= \$28,750}\end{array}$

Step 2: Compute cost of stock investment sold.

$\begin{array}{c}\begin{array}{l}\text{Cost of stock }\\ \text{investment sold}\end{array}\}\text{ = Number of shares sold × Price per share}\\ \text{= Number of shares sold ×}\frac{\text{Cost of 5,000 shares}}{\text{Number of shares}}\\ \text{= 480 shares ×}\frac{\text{\$78,120}}{\text{1,200 shares}}\\ \text{= \$31,248}\end{array}$

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

$\begin{array}{c}\begin{array}{l}\text{Realized gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of stock investment }\end{array}\right\}\\ \text{= \$28,750–\$31,248}\\ \text{= \$}\left(\text{2,498}\right)\end{array}$

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)

• 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 decrease 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).

Working Notes:

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

Details	Amount ($)
Unrealized loss as on December 31, 2017	$12,032
Add: Unrealized gain as on December 31, 2016 (From Table-7)	27,990
Unrealized loss on trading investments	$40,022

Table (11)

(2)

To determine

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

Explanation of Solution

Balance sheet presentation:

Company Z
Balance Sheet (Partial)
December 31, 2017
Assets
Current assets:
Trading investments (at cost)	$200,032
Less valuation allowance for trading investments	(12,032)
Trading investments (at fair value)		$188,000

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 Z would report $27,990 of unrealized gain as Other Income on the income statement. In the 2017, Company Z would report $40,022 of unrealized loss as Other Losses on the income statement.