Chapter 15, Problem 1AP

1.

To determine

Prepare the journal entries to record the given transactions.

Explanation of Solution

Debt investments:

The investments which are made by the investors in debts instrument is called as debt investment. Debt investments lend funds to the borrowing company with predetermined agreement for interest and maturity date. Corporate bonds, government bonds and certificate of deposits are examples of debt investment.

Prepare the journal entries to record the given transactions as follows:

August 2 – Purchased Company V’s bonds

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
August, 2	Debt investment - Trading		10,000
	Cash			10,000
	(To record purchase of trading securities)

Table (1)

• Debt investment – Trading is an asset account, and it increases the value of assets by $10,000. Hence, debit the debt investment –trading with $10,000.
• Cash is an asset account and it decreases the value of asset by $10,000. Therefore, credit the cash account for $10,000.

September 7– Purchased Company A’s bonds

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
September 7	Debt investment - Trading		35,000
	Cash			35,000
	(To record purchase of trading securities)

Table (2)

• Debt investment – Trading is an asset account, and it increases the value of assets by $35,000. Hence, debit the debt investment –trading with $35,000.
• Cash is an asset account and it decreases the value of asset by $35,000. Therefore, credit the cash account for $35,000.

September 12– Purchased Company M’s bonds

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
September 12	Debt investment - Trading		20,000
	Cash			20,000
	(To record purchase of trading securities)

Table (3)

• Debt investment – Trading is an asset account, and it increases the value of assets by $20,000. Hence, debit the debt investment –trading with $20,000.
• Cash is an asset account and it decreases the value of asset by $20,000. Therefore, credit the cash account for $20,000.

October 21 – Company K sold Company V’s bond at $2,000 cost.

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
October 21	Cash		2,100
	Gain on sale of debt investment (1)			100
	Debt investment-Trading			2,000
	(To record the sale of trading securities in cash)

Table (4)

• Cash is an asset account and it increases the value of asset by $2,100. Therefore, debit the cash account for $2,100.
• Gain on sale of trading is a component of owner’s equity (revenue), and it increases the value of equity by $100. Hence, credit the gain on sale of trading securities account with $100.
• Debit investment – Trading is an asset account, and it decreases the value of assets by $2,000. Hence, credit the debt investment account with $2,000.

Working note:

Calculate the gain on sale debt investment

$\begin{array}{c}\begin{array}{l}\text{Gain on sale}\\ \text{of trading securities}\end{array}\}\text{ = Cash received }-\text{Cost of trading securities}\\ \text{=\$2,100}-\$2,000\\ =\$100\end{array}$ (1)

October 23 – Company K sold Company V’s bond at $15,000 cost.

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
October 23	Cash		15,400
	Gain on sale of debt investment (2)			400
	Debt investment-Trading			15,000
	(To record the sale of trading securities in cash)

Table (5)

• Cash is an asset account and it increases the value of asset by $15,400. Therefore, debit the cash account for $15,400.
• Gain on sale of trading is a component of owner’s equity (revenue), and it increases the value of equity by $400. Hence, credit the gain on sale of trading securities account with $400.
• Debit investment – Trading is an asset account, and it decreases the value of assets by $15,000. Hence, credit the debt investment account with $15,000.

Working note:

Calculate the gain on sale debt investment

$\begin{array}{c}\begin{array}{l}\text{Gain on sale}\\ \text{of trading securities}\end{array}\}\text{ = Cash received }-\text{Cost of trading securities}\\ \text{=\$15,400}-\$15,000\\ =\$400\end{array}$ (2)

November 1– Purchased Company W’s bonds

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
November 1	Debt investment - Trading		40,000
	Cash			40,000
	(To record purchase of trading securities)

Table (6)

• Debt investment – Trading is an asset account, and it increases the value of assets by $40,000. Hence, debit the debt investment –trading with $40,000.
• Cash is an asset account and it decreases the value of asset by $40,000. Therefore, credit the cash account for $40,000.

December 10– Company K sold Company M’s bond at $18,000 cash.

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
December 10	Cash		18,000
	Loss on sale of debt investment (3)		2,000
	Debt investment-Trading			20,000
	(To record the sale of trading securities in cash)

Table (7)

• Cash is an asset account and it increases the value of asset by $18,000. Therefore, debit the cash account for $18,000.
• Loss on sale of trading is a component of owner’s equity (loss), and it decreases the value of equity by $2,000. Hence, debit the loss on sale of trading securities account with $2,000.
• Debit investment – Trading is an asset account, and it decreases the value of assets by $20,000. Hence, credit the debt investment account with $20,000.

Working note:

Calculate the loss on sale debt investment

$\begin{array}{c}\begin{array}{l}\text{Loss on sale}\\ \text{of trading securities}\end{array}\}\text{ = Cost of trading securities}-\text{Cash received}\\ \text{=\$20,000}-\$18,000\\ =\$2,000\end{array}$ (3)

2.

To determine

Prepare a table to compare the year-end cost and fair values of the given debt securities.

Explanation of Solution

Prepare a table to compare the year-end cost and fair values of the given debt securities as follows:

Portfolio of Trading Securities	Cost	Fair Value	Unrealized Gain (Loss)
Company V's bonds	8,000 (4)	8,500
Company A's bonds	20,000 (5)	22,000
Company W's bonds	40,000	39,000
	68,000	69,500	1,500 (6)

Table (8)

Working note:

Calculate the cost of company V’s bond after sales are made.

$\begin{array}{c}\text{Cost of bonds = Purchased cost of bonds}-\text{Sales made}\\ \text{=\$10,000}-\$2,000\\ =\$8,000\end{array}$ (4)

Calculate the cost of company A’s bond after sales are made.

$\begin{array}{c}\text{Cost of bonds = Purchased cost of bonds}-\text{Sales made}\\ \text{=\$35,000}-\$15,000\\ =\$20,000\end{array}$ (5)

Calculate the unrealized gain (or loss).

$\begin{array}{c}\text{Unrealized gain (or loss)}\text{= Total fair value }-\text{ Total cost of trading securities}\\ \text{=\$69,500}-\$68,000\\ =\$1,500\end{array}$ (6)

3.

To determine

Prepare the year-end fair value adjustment entry for the trading securities’ portfolio.

Explanation of Solution

Prepare the year-end fair value adjustment entry for the trading securities’ portfolio as follows:

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
December 31	Fair Value Adjustment-Trading (6)		1,500
	Unrealized Gain-Income			1,500
	(To record the unrealized gain in fair value of trading securities)

Table (9)

• Fair Value Adjustment is a contra-asset account. The account shows a debit balance since the market price has increased (gain). Therefore, debit the fair value adjustment with $1,500.
• Unrealized Gain–income is an adjustment account to report the investment at fair market value. Since gain has occurred while adjusting. Therefore, credit the unrealized gain–income account with $1,500.