Chapter AH, Problem H.5E

(a)

To determine

Cost method: It refers to an accounting technique used by an investor to determine the income earned on investments made in short-term equity securities of a company.  Thus, the investor who own a non-significant interest by having less than 20% of ownership, accounts for investments in short-term equity securities under this method.

Equity method:  It refers to an accounting technique used by an investor to determine the income earned on investments made in long-term equity securities of a company.  Thus, the investor who owns a significant interest by having more than 20%, but less than 50% of ownership, accounts for investments in long-term equity securities under this method.

To Record: The stock transactions in the books of S Cosmetics.

Explanation of Solution

Available-for-sale securities: Available-for-sale are short-term or long-term debt equity securities that are not classified as trading or held to maturity securities. These securities are readily sold in the short-term to receive return on investment.

Record the purchase entry of stock.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
March 18, 2017	Stock Investments		504,000 (1)
	Cash			504,000
	(To record the purchase of stock investments.)

Table (1)

Working Note:

Compute cost of stock investment.

$\begin{array}{c}\text{Cost of investment = Number of shares × Cost per share}\\ =\left(\begin{array}{l}\text{Percentage of stock invetsment}\\ \times \text{Number of shares of investee}\end{array}\right)\text{× Cost per share}\\ \text{=}\left(\text{12\%}\times 300,0\text{00 shares}\right)\text{×}\text{\$14}\\ \text{=}\text{36,000 shares}\text{×}\text{\$14}\\ \text{= \$504,000}\end{array}$ (1)

Description:

• Stock Investments is an asset account. The amount has increased due to purchase of stock investment. Therefore, debit Stock Investments account with $504,000.
• Cash is an asset account. The amount has decreased because the stock investment is purchased for cash. Therefore, credit Cash account with $504,000.

Record the journal entry for the receipt of dividend revenue for S Cosmetics.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
June 30, 2017	Cash		9,000
	Dividend Revenue			9,000 (2)
	(To record the receipt of dividend revenue.)

Table (2)

Working Note:

Compute the amount of dividend received.

$\begin{array}{c}\text{Dividend received = Number of shares × Dividend per share}\\ =\left\{\text{Number of shares × }\left(\frac{\text{Dividend declared}}{\text{Number of shares}}\right)\right\}\\ \text{=36,000 shares}\text{×}\left(\frac{\text{\$75,000}}{\text{300,000 shares}}\right)\\ =\text{36,000 shares}\text{×}\$0.25\\ \text{= \$9,000}\end{array}$ (2)

Description:

• Cash is an asset account. The amount has increased because interest is received; therefore, debit Cash account with $9,000.
• Dividend Revenue is a revenue account. Revenue increases stockholders’ equity account. Therefore, credit Dividend Revenue account with $9,000.

Record the adjusting entry for the unrealized gain on available-for-sale-securities.

Date	Accounts and Description	Post Ref.	Debit ($)	Credit ($)
December 31, 2017	Fair Value Adjustment-Available-for-sale		72,000
	Unrealized Gain or Loss-Equity			72,000 (3)
	(To record the unrealized gain on available-for-sale securities)

Table (3)

Description:

• Fair Value Adjustment–Available-for-Sale is a contra-asset account. The account shows a debit balance since the market price has increased (gain); therefore, debit Fair Value Adjustment–Available-for-Sale with $72,000.
• Unrealized Gain or Loss–Equity is an adjustment account to report the investment at fair market value. Since gain has occurred while adjusting; therefore, credit Unrealized Gain or Loss–Equity account with $72,000.

Working Notes:

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

Fair value = $576,000 (4)

Cost = $504,000 (1)

$\begin{array}{c}\text{Amount of unrealized gain(loss)}\text{=}\left[\begin{array}{l}\left(\begin{array}{l}\text{Fair value of }\\ \text{available-for-sale securities}\end{array}\right)\\ -\text{Cost}\end{array}\right]\\ =\$576,000-\$504,000\\ =\$72,000\end{array}$ (3)

Compute fair market value of 36,000 shares.

$\begin{array}{c}\text{Market value = Number of shares × Market value per share}\\ \text{= 36,000 shares × \$16}\\ \text{= \$576,000}\end{array}$ (4)

(b)

To determine

To Record: The stock transactions in the books of W Incorporation.

Explanation of Solution

Record the purchase entry of stock.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
January 1, 2017	Stock Investments		82,500 (5)
	Cash			82,500
	(To record the purchase of stock investments.)

Table (4)

Working Note:

Compute cost of stock investment.

$\begin{array}{c}\text{Cost of investment = Number of shares × Cost per share}\\ =\left(\begin{array}{l}\text{Percentage of stock invetsment}\\ \times \text{Number of shares of investee}\end{array}\right)\text{× Cost per share}\\ \text{=}\left(\text{25\%}\times 30,0\text{00 shares}\right)\text{×}\text{\$11}\\ \text{=}7\text{,500 shares}\text{×}\text{\$11}\\ \text{= \$82,500}\end{array}$ (5)

Description:

• Stock Investments is an asset account. The amount has increased due to purchase of stock investment. Therefore, debit Stock Investments account with $82,500.
• Cash is an asset account. The amount has decreased because the stock investment is purchased for cash. Therefore, credit Cash account with $82,500.

Record the journal entry for the dividends recognized by investor.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
June 15, 2017	Cash		8,750
	Stock Investments			8,750 (6)
	(To record the dividends received from the investee company.)

Table (5)

Working Note:

Compute amount of dividends received from investee.

$\begin{array}{c}\text{Dividends received = }\left\{\begin{array}{l}\text{Dividends declared by investee in 2017 × }\\ \text{Percentage share of ownership of investor}\end{array}\right\}\\ \text{= \$35,000×25\%}\\ \text{= \$8,750}\end{array}$ (6)

Description:

• Cash is an asset account. Since cash is received as dividends, cash amount has been increased. Therefore, debit Cash account with $8,750.
• Stock Investments is an asset account. Since Stock investment account is reduced, credit Stock Investments account with $8,750.

Record the journal entry for the equity on net income.

Date	Account Title and Description	Post Ref.	Debit ($)	Credit ($)
December 31, 2017	Stock Investments		30,000
	Revenue from Stock Investments			30,000 (7)
	(To record the equity on the net income of the investee company.)

Table (6)

Working Note:

Compute amount of income received from investee.

$\begin{array}{c}\text{Income reported = }\left\{\begin{array}{l}\text{Net inocme reported by investee × }\\ \text{Percentage share of ownership of investor}\end{array}\right\}\\ \text{= \$120,000×25\%}\\ \text{= \$30,000}\end{array}$ (7)

Description:

• Stock Investments is an asset account. The asset is increased as the stock investment is increased. Therefore, debit Stock Investments account with $30,000.
• Revenue from Stock Investments is a revenue account. Revenue increases the value of stockholders’ equity account. Therefore, credit Revenue from Stock Investments account with $30,000.