Chapter C, Problem 12E

To determine

Investment:

It is a financial term which refers to spend or deposit money to get the financial benefits.

The different ways in which a firm can invest are mentioned below:

• Long-term investments
• Short-term investments

Short-term investments:

It includes such investments which are highly liquid in nature as these can be convert in form of cash easily during the period of 1 year.

Long-term investments:

It includes such investments which are not highly liquid in nature and mature after completion of period of minimum one year.

Journal Entry:

It means record of financial data related to business transactions in a journal in a manner so that debit equals credit. It provides an audit trail to the auditor and a means to analyze the effects of transactions to an organization’s financial health.

Rules of Journal Entry:

The rules for journal entry are defined by 5 accounting components,

• Assets: Increase in asset should be debit and decrease should be credit.
• Liabilities: Increase in liabilities should be credit and decrease should be debit.
• Equity: Increase in Equity should be credit and decrease should be debit.
• Expense: Increase in expense should be debit and decrease should be credit.
• Revenue: Increase in revenue should be credit and decrease should be debit.

To prepare: Journal entry for given transactions.

Explanation of Solution

2017

On January 2, 30,000 shares are purchased from G Company for $408,000 with $3,000 brokerage fee.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
Jan 2, 2017	Long-Term Investments		411,000
	Cash			411,000
	(To record short-term investment with brokerage)

      Table 1 Long-Term Investments is an asset account. Since, shares are purchased under category of trading securities, balance of assets has increased. So, debit Short-Term Investments account $\left(\$408,000+\$3,000=\$411,000\right)$ .

• Cash is also an asset account. Since, cash is paid, balance of assets has decreased. Hence, Cash account is credited.

On September 1, received dividend from G Company of $1.50 per share (shares purchased above).

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
September 1	Cash		45,000
	Long-Term Investments			45,000
	(To record dividend on investment)

      Table 2

• Cash is also an asset account. Since, cash is received, balance of assets has increased. Hence, Cash account is debited.
• Long-Term Investments is an asset account. Since earnings are already recorded on long-term investments, balance debited to long-term investment as earnings should be transferred to cash. So, credit Long-Term Investments account.

Working note

Computation of dividend:

  $\begin{array}{c}\text{Total dividend}=\text{Number of shares}\times \text{Dividend per share}\\ \end{array}$

=30,000×$1.50=$45,000

On December 31, record earnings from investment on basis of net income of the company.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
December 31	Long-Term Investments		162,000
	Earnings from Investments			162,000
	(To record dividend on investment)

      Table 3

• Long-Term Investments is an asset account. Since earnings are earned on long-term investments, balance of assets has increased. So, debit Long-Term Investments account.
• Earnings from Investment is a revenue account. The portion of net income related to equity will be treated as earnings, balance of revenue has increased. So, credit the Earnings from Investments account.

Working note

Computation of equity earnings:

  $\begin{array}{c}\text{Equity earnings}=\text{Net income}\times \frac{\text{Number of share hold}}{\text{Total number of shares}}\\ =486,000\times \frac{30,000}{90,000}\\ =\$162,000\end{array}$

2018

On June 1, received dividend from G Company of $2.10 per share (shares purchased on January 2, 2017).

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
June 1	Cash		63,000
	Long-Term Investments			63,000
	(To record dividend on investment)

      Table 4

• Cash is also an asset account. Since, cash is received, balance of assets has increased. Hence, Cash account is debited.
• Long-Term Investments is an asset account. Since earnings are already recorded on long-term investments, balance debited to long-term investment as earnings should be transferred to cash. So, credit Long-Term Investments account.

Working note

Computation of dividend:

  $\begin{array}{c}\text{Total dividend}=\text{Number of shares}\times \text{Dividend per share}\\ =30,000\times \$2.10\\ =\$63,000\end{array}$

On December 31, record earnings from investment on basis of net income of the company.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
December 31	Long-Term Investments		234,250
	Earnings from Investments			234,250
	(To record dividend on investment)

      Table 5

• Long-Term Investments is an asset account. Since earnings are earned on long-term investments, balance of assets has increased. So, debit Long-Term Investments account.
• Earnings from Investment is a revenue account. The portion of net income related to equity will be treated as earnings, balance of revenue has increased. So, credit the Earnings from Investments account.

Working note

Computation of equity earnings:

  $\begin{array}{c}\text{Equity earnings}=\text{Net income}\times \frac{\text{Number of share hold}}{\text{Total number of shares}}\\ =702,750\times \frac{30,000}{90,000}\\ =\$234,250\end{array}$

On December 31, 10,000 shares of G Company are sold for $320,000.

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
December 31	Cash		233,083
	Long-Term Investments			320,000
	Gain on Sale of Investment			86,917
	(To record sale of long-term investment)

      Table 6

• Cash is also an asset account. Since, cash is received, balance of assets has increased. Hence, Cash account is debited.
• Long-Term Investments is an asset account. Since, investment is sold, balance of assets has decreased. So, credit Long-Term Investments account.
• Gain on Sale of Investment is a revenue account. Since, investment is sold at high rate than actual cost, balance of revenue has increased. So, credit the Gain on Sale of Investment account.

Working note

Book value of securities:

  $\begin{array}{c}\text{Book value of shares}=\left(\begin{array}{l}\text{Original cost}-\text{Dividends 2017}+\text{Share of earnings 2017}\\ -\text{Dividends 2018}+\text{Share of earnings 2017}\end{array}\right)\\ =\$411,000-\$45,000+\$162,000-\$63,000+234,250\\ =\$699,250\end{array}$

Actual cost of 10,000 shares:

  $\begin{array}{c}\text{Actual cost of share}=\frac{\text{Book value of shares}}{\text{Total number of shares}}\times \text{Number of shares sold}\\ =\frac{\$699,250}{30,000}\times 10,000\\ =\$233083.33\end{array}$

Gain on sale of 10,000 shares:

  $\begin{array}{c}\text{Gain on sale}=\text{Sale amount of shares}-\text{Cost of shares}\\ =\$320,000-233,083.33\\ =\$86,916.67\end{array}$