Chapter 15, Problem 2BPSB

To determine

Introduction:

Available-for-sale (AFS) securities are securities/shares which are purchased to earn dividend, interest or to increase fair market value. When these securities are sold in the short term, then they become short term investments else they are considered as long term investments.

To determine:

1. Journal entries to record the preceding transaction and events.
2. A table to compare the year-end cost and fair values of Rose’s short-term investments in available-for sale securities.
3. The adjusting entry to record the year-end fair value adjustment for the portfolio of short-term investments in available-for sale securities.
4. The balance sheet presentation of the fair value adjustment for Slip’s short-term investments.
5. The effect of short term investment on (a)income statement for the year 2015 and (b) equity section of its balance sheet at the yearend 2015.

Answer to Problem 2BPSB

Solution:

1. The required journal entries and adjustment entries are shown in the explanation section.
2. The table is shown in the explanation section.
3. The adjustment entry is mentioned in the explanation section.
4. Balance sheet presentation of the fair value adjustment for Slip’s short-term investment is shown in the explanation section.
5. The net effect is shown in the explanation section.

Explanation of Solution

Explanation:

1. The required journal entries and adjustment entries are as follows:

Entries to record purchase of shares:

Date	Particulars	Debit($)	Credit($)
Feb 6	STI- Trading (G Company)	143250
	Cash (To record shares purchased)		143250
Feb 15	STI-Trading(T-Bills)	20000
	Cash (To record shares purchased)		20000
April 7	STI-Trading(D Company)	48655
	Cash (To record shares purchased)		48655
June 2	STI-Trading(M Company)	184140
	Cash (To record shares purchased)		184140

Working notes:
Calculation of Purchases: We use the formula mentioned below:

  $Purchases=\left(Numberofshares*Price/Unit\right)+Commision$

Date	Number of Shares	Price per unit	Commission	Purchases
Feb 6	3400	$41.25	$3000	$143250
April 7	1200	$39.50	$1255	$48655
June2	2500	$72.50	$2890	$184140

Entries to record dividend received for investment:

Date	Particulars	Debit($)	Credit($)
June 30	Cash	646
	Dividend (Dividend received)		646
24.08.2015	Cash	120
	Dividend (Dividend received)		120
Nov. 9	Cash	510
	Dividend (Dividend received)		510
Dec.18	Cash	180
	Dividend (Dividend received)		180

  $Dividend=Amount*Rate$

=$3400*0.19=$646
=$2000*$1.30=$3800
=$2000*$1.30=$3800
=$1200*$0.15=$180

Entries to record the sale of shares:

Date	Particulars	Debit($)	Credit($)
11.08.2015	Cash	38050
	Gain on sale of Short term investment (STI)		2237
	STI − Trading (G Company) (Entry for sales of shares)		35813
16.08.2015	Cash	20600
	Gain on sale of investments		20000
	Interest (sale of shares)		600

Calculation of Sales received from shares:
We use the formula mentioned below:

  $Sales=\left(Numberofshares*Price/Unit\right)-Commision$

Date	Number of Shares	Price/unit	Commission	Sales
11.08.2015	850	$46	$1050	$38050

Calculation of goods sold:

  $Cost=Totalvalue*\frac{Sharessold}{Totalshares}$

  $=\$143250*\frac{850shares}{3400shares}=\$35813$

Calculation of interest received:

  $Interest=Amount*Rate*Timeperiod$

  $=\$20000*0.06*\frac{6months}{12months}=\$600$

2. Preparation of Cost and Fair value for Slip’s AFS portfolio:

Particulars	Cost($)	Fair Value($)	Unrealized Gain/Loss
N Company	107437	102638
D Company	48655	48600
M Company	184140	147500
Total	340232	298738	41494

Calculation of Cost, Brokerage and Fair value (FV) for the following:

  $Cost=\left(NumberofShares*Rate\right)+Brokeragefees$

Company	Number of Shares	Rate	Brokerage	Cost
N Company	2550	$41.25	$2250	$107437.50
D Company	1200	$39.25	$1255	$48655
M Company	2500	$72.50	$2890	$184140

Calculation of Fair Value:
  $FairValue(FV)=\left(NumberofShares*Rate\right)$

Company	Number of Shares	Rate	Fair Value
N Company	2550	$40.25	$102637.50
D Company	1200	$40.50	$48600
M Company	2500	$59	$147500

Calculation of Brokerage fees:
  $Fees=Totalamount*\frac{Remainingshares}{TotalShares}$

Company	Total Amount	Remaining Shares	Total Shares	Brokerage Fees
N Company	$3000	(3400-850)=2550	3400	$2250

Note: Brokerage fees are same for Company’s D & M as all the shares are sold.

3. The Fair Value adjustment entry is as follows:

Date	Particulars	Debit($)	Credit($)
Dec.31, 2015	Unrealized loss −(Equity)	41494
	Fair Value adjustment-Trading (ST) (To record purchase of shares)		41494

4. The cost of the above calculated short term investments in AFS securities will be shown in the balance Sheet as $340232. A deduction of $441494 towards fair value adjustment is also shown in the balance sheet. Therefore, the net fair value for securities will be $298738 in the current assets. There is one more way of showing this representation as showing the balance at fair value of $298738 with a note of disclosure of the cost.

5. a) Short term investment will effect Slip’s statement of income for 2015 as follows:

1. Interest earned is $600.
2. Dividend earned amounts to $1456 which is calculated as:

  $TotalDividend=Dividendfrom\left(N+D+N+D\right)Company$


  $=\$646+\$120+\$510+\$180=\$1456$

3. We can see a net gain of $2237 arising from the sale of short term investments
4. Calculation of total net income:

  $NewIncome=Interest+Dividend+Gainarisingonsale$


  $=\$600+\$1456+\$2237=\$4293$

b) Effect of equity on the balance sheet:

1. Deduct unrealized loss of $41494 from the equity
   
2. Increase in income of $4293 will increase the equity
   
3. The net effect on equity can be calculated as
   
     $Neteffect=Income-Unrealizedloss$

   
     $=\$41494-\$4293=\$37201$