Chapter 15, Problem 2AP

Mead Inc. began operations in Year 1. Following is a series of transactions and events involving its long-term debt investments in available-for-sale securities.

Required

1. 1. Prepare journal entries to record these transactions and the year-end fair value adjustments to the portfolio of long-term available-for-sale debt securities.
2. 2. Prepare a table that summarizes the (a) total cost, (b) total fair value adjustment, and (c) total fair value of the portfolio of long-term available-for-sale debt securities at each year-end.
3. 3. Prepare a table that summarizes (a) the realized gains and losses and (b) the unrealized gains or losses for the portfolio of long-term available-for-sale debt securities at each year-end.

To determine

Prepare journal entries to record the given transaction.

Explanation of Solution

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

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

Journal
Date	Account Title and Explanation	Post	Debit	Credit
		Ref.	($)	($)
January 20, Year 1	Debt Investments -AFS (Company J&J)		20,500
	Cash			20,500
	(To record the purchase of bonds)
February 9, Year 1	Debt Investments—AFS (Company S)		55,440
	Cash			55,440
	(To record the purchase of  S notes)
June 12, Year 1	Debt Investments —AFS (Company M)		40,500
	Cash			40,500
	(To record the purchase of bonds)
December 31, Year 1	Fair Value Adjustment—AFS		3,910
	Unrealized Gain—Equity (Company LT) (2)			3,910
	(To record the annual adjustment to fair value of securities)
April 15, Year 2	Cash		23,500
	Gain on sale of debt investments (3)			3,000
	Debt investment—AFS (Company J&J)			20,500
	(To record the gain on sale of bond)
July 5, Year 2	Cash		35,850
	Loss on Sale of Investments (4)		4,650
	Debt Investments—AFS (Company M)			40,500
	(To record the loss on sale of bond)
July 22, Year 2	Debt Investments—AFS (Company SL)		13,500
	Cash			13,500
	(To record the purchase of  bond)
August 19, Year 2	Debt Investments —AFS (Company EK)		15,300
	Cash			15,300
	(To record the purchase of  bond)
December 31, Year 2	Fair Value Adjustment-AFS (Company LT)		1,175
	Unrealized gain Equity (6)			1,175
	(To record the Annual adjustment to fair value of securities)
February 27, Year 3	Debt Investments—AFS (Company M)		160,800
	Cash			160,800
	(To record the purchase of bonds)
June 21, Year 3	Cash		57,600
	Gain on Sale of Investments  (7)			2,160
	Debt Investments—AFS (Company S)			55,440
	(To record the  sale of bonds)
June 30, Year 3	Debt Investments—AFS (Company B&D)		50,400
	Cash			50,400
	(To record the purchase of bonds)
August 3, Year 3	Cash		9,750
	Loss on Sale of Investments (8)		3,750
	Debt Investments—AFS (Company SL)			13,500
	(To record the sale of bond)
November   1, Year 3	Cash		20,475
	Gain on Sale of Investments  (9)			5,175
	Debt Investments—AFS (Company E.K)			15,300
	(To record the sale of bond)
December 31, Year 3	Unrealized Gain—Equity		3,085
	Fair Value Adjustment—AFS (Company LT) (10)			3,085
	(To record the Annual adjustment to fair value of securities)

Table (1)

Working note:

Calculate the total cost and fair value of the bonds for Year 1:

Name of the company	Cost of debt investment	Fair value of debt investment
Company J&J	$20,500	$21,500
Company S	$55,440	$52,500
Company M	$40,500	$46,350
Total	$116,440	$120,350

Table (2)

…… (1)

Calculate the unrealized gain or loss for year 1:

$\begin{array}{c}\text{Unrealized gain or }\left(\text{loss}\right)=\left[\begin{array}{l}\text{Cost of longterm investment}-\text{Fair}\\ \text{value of long-term investment}\end{array}\right]\\ =\$116,440-\$120,350\\ =\$3,910\end{array}$ (2)

Calculate the value of cash received from the sale of stock investment (Company J&J stocks)

$\begin{array}{c}\text{Gain on sale of debt = }\left(\begin{array}{l}\text{Sales value of Company J}-\\ \text{Purchase valueof Company J}\end{array}\right)\\ =\$23,500-\$20,500\\ =\$3,000\end{array}$ (3)

Calculate the value of cash received from the sale of stock investment (Company M stocks)

$\begin{array}{c}\text{Gain on sale of debt = }\left(\begin{array}{l}\text{Sales value of Company M}-\\ \text{Purchase valueof Company M}\end{array}\right)\\ =\$35,850-\$40,500\\ =\$(4,650)\end{array}$ (4)

Calculate the total cost and fair value of the bonds for Year 2:

Name of the company	Cost of debt investment	Fair value of debt investment
Company K	$15,300	$17,325
Company SL	$13,500	$12,000
Company S	$55,440	$60,000
Total	$84,240	$89,325

Table (3)

…… (5)

Calculate the unrealized gain or loss for year 2:

$\begin{array}{c}\text{Unrealized gain or }\left(\text{loss}\right)=\left[\begin{array}{l}\text{Cost of long-terminvestment}\\ -\text{Fair value of long-term}\\ \text{investment}\end{array}\right]-\left[\begin{array}{l}\text{Unrealized gain }\\ \text{or loss on Year 1}\end{array}\right]\\ =\left[\$84,240-\$89,325\right]-\$3,910\text{ (2)}\\ =\$5,085\end{array}$ (6)

Calculate the value of cash received from the sale of stock investment (Company S stocks)

$\begin{array}{c}\text{Gain on sale of debt = }\left(\begin{array}{l}\text{Sales value of Company S}-\\ \text{Purchase valueof Company S}\end{array}\right)\\ =\$57,600-\$55,440\\ =\$2,160\end{array}$ (7)

Calculate the value of cash received from the sale of stock investment (Company SL stocks)

$\begin{array}{c}\text{Loss on sale of debt = }\left(\begin{array}{l}\text{Sales value of Company SL}-\\ \text{Purchase valueof Company SL}\end{array}\right)\\ =\$13,500-\$9,750\\ =\$(3,750)\end{array}$ (8)

Calculate the value of cash received from the sale of stock investment (Company E.K stocks)

$\begin{array}{c}\text{Gain on sale of debt = }\left(\begin{array}{l}\text{Sales value of Company SL}-\\ \text{Purchase valueof Company SL}\end{array}\right)\\ =\$20,475-\$15,300\\ =\$5,175\end{array}$ (9)

Calculate the total cost and fair value of the bonds for Year 3:

Name of the company	Cost of debt investment	Fair value of debt investment
Company B&D	$50,400	$54,600
Company SL	$160,800	$158,600
Total	$211,200	$213,200

Table (4)

  …… (10)

Calculate the unrealized gain or loss for year 3:

$\begin{array}{c}\text{Unrealized gain or }\left(\text{loss}\right)=\left[\begin{array}{l}\text{Cost of long-terminvestment}\\ -\text{Fair value of long-term}\\ \text{investment}\end{array}\right]-\left[\begin{array}{l}\text{Unrealized gain }\\ \text{or loss on Year 2}\end{array}\right]\\ =\left[\$211,200-\$213,200\right]-\$5,085\text{ (6)}\\ =\$1,175\end{array}$ (11)

To determine

Prepare a table that summarizes the following

1. a. Total cost,
2. b. Total fair value adjustments,
3. c. Total fair value of the portfolio of long-term available-for-sale securities at year-end.

Explanation of Solution

Prepare a table that summarizes the total cost, total fair value adjustments, and the total fair value as follows:

Particulars	December 31, Year 1	December 31, Year 2	December 31, Year 3
a. Long-term AFS Securities (cost)	$116,440	$84,240	$211,200
b. Fair Value Adjustment	3,910	5,085	2,000
c. Long-term AFS Securities (fair value)	$120,350	$89,325	$213,200

Table (5)

To determine

Prepare a table that summarizes the following

1. a. The realized gains and losses,
2. b. The unrealized gains and losses for the portfolio of long-term available-for-sale securities at year-end.

Explanation of Solution

1. a. Prepare a table that summarizes the realized gains and losses as follows:

Particulars	Year 1	Year 2	Year 3
Realized gains (losses)
Sale of J & J shares		$3,000
Sale of M shares		(4,650)
Sale of SL shares			$2,160
Sale of S shares			$(3,750)
Sale of E.K shares			5,175
Total realized gain (loss)	$0	($1,650)	$3,585

Table (6)

1. b. Prepare a table that summarizes the Unrealized gains and losses as follows

Particulars	Year 1	Year 2	Year 3
Unrealized gains (losses) at year-end	$3,910	$5,085	$2,000

 Table (7)