Chapter C, Problem 2PSA

1.

To determine

To prepare:

The journal entries to record the transactions of the year 2015.

Answer to Problem 2PSA

Solution:

Prepare the journal entry as shown below.

Date	Particulars	Debit ($)	Credit ($)
Apr 16	Short-term investment (G Company)	97,180
	Cash		97,180
	(Being short-term investment purchase against cash)
May 1	Short-term investment (Treasury bill)	100,000
	Cash		100,000
	(Being short-term investment purchase against cash)
Jul 7	Short-term investment (P Company)	98,675
	Cash		98,675
	(Being short-term investment purchase against cash)
Jul 20	Short-term investment (X Company)	$16,955
	Cash		$16,955
	(Being short-term investment purchase against cash)
Aug 1	Cash	101,500
	Short-term investment		100,000
	Interest revenue		1,500
	(Being short-term investment mature and interest received)
Aug 15	Cash	3,400
	Dividend revenue (G Company)		3,400
	(Being cash dividend received)
Aug 28	Cash	59,775
	Short-term investment (G Company)		48,590
	Gain on sale of short-term investment		11,185
	(Being short-term investment sold at a gain of $1,990 and receive cash )
Oct 1	Cash	3,800
	Dividend revenue (P Company)		3,800
	(Being cash dividend received)
Dec 15	Cash	2,100
	Dividend Revenue (G Company)		2,100
	(Being cash dividend received)
Dec 31	Cash	2,600
	Dividend revenue (P Company)		2,600
	(Being cash dividend received)

Table 1

Explanation of Solution

• The short-term investment of R Company increases. The short-term investment is an asset to the company, which means that the current asset of R Company also increases.

The cash account decreases by $97,180. So, cash account is credited which means that the current asset of the company also decreases.

• The short-term investment of R Company increases. The short-term investment is an asset to the company, which means that the current asset of R Company also increases.

The cash account decreases by $100,000. So, cash account is credited which means that the current asset of the company also decreases.

• The short-term investment of R Company increases. The short-term investment is an asset to the company, which means that the current asset of R Company also increases.

The cash account decreases by $98,675. So, cash account is credited which means that the current asset of the company also decreases.

• The short-term investment of R Company increases. The short-term investment is an asset to the company, which means that the current asset of R Company also increases.

The cash account decreases by $98,675. So, cash account is credited which means that the current asset of the company also decreases.

• The short-term investment is credited as the investment mature and the balance of short-term investment decreases.

Cash account is debited, as cash is received when investment is matured and interest earned.

The interest revenue account is credited, as income is received in the form of interest to R Company.

• Cash account is debited, as cash is received from G Company in the form of cash dividend.

Dividend revenue account is credited, as it increases the income of R Company. The dividend revenue account has credit balance.

• Cash received at the time of sale of investment increases the cash balance, thereby increasing the assets of the company.

By the sale of short-term investment, the short-term investment account decreases and the asset of the company also decreases by $48,590.

At the time of sale, R Company receives a gain on sale of investment and this gain is credited to the gain on sale of short-term investment account.

• Cash account is debited, as cash is received from P Company in the form of cash dividend.

Dividend revenue account is credited, as it increases the income of R Company. The dividend revenue account has credit balance.

• Cash account is debited, as cash is received from G Company as cash dividend.

Dividend revenue account is credited, as it increases the income of R Company. The dividend revenue account has credit balance.

• Cash account is debited, as cash is received from G Company in the form of cash dividend.

Dividend revenue account is credited, as it increases the income of R Company. The dividend revenue account has credit balance.

Working Notes:

1. Calculate the value of purchase price of shares (G Company).

$\begin{array}{c}\text{Purchase price of shares}=\left(\text{Number of shares}\times \text{share price}\right)+\text{Commision}\\ \text{=}\left(4,000\times \$24.25\right)+\$180\\ =\$97,000+\$180\\ =\$97,180\end{array}$

2. Calculate the value of purchase price of shares (P Company).

$\begin{array}{c}\text{Purchase price of shares}=\left(\text{Number of shares}\times \text{share price}\right)+\text{Commision}\\ \text{=}\left(2,000\times \$49.25\right)+\$175\\ =\$98,500+\$175\\ =\$98,675\end{array}$

3. Calculate the value of purchase price of shares (X stock).

$\begin{array}{c}\text{Purchase price of shares}=\left(\text{Number of shares}\times \text{share price}\right)+\text{Commision}\\ \text{=}\left(2,000\times \$49.25\right)+\$175\\ =\$98,500+\$175\\ =\$98,675\end{array}$

4. Calculate the interest on US Treasury bills.

$\begin{array}{c}\text{Interest}=\text{Amount}\times \text{Rate}\times \text{Time period}\\ =\$100,000\times \frac{6}{100}\times \frac{3}{12}\\ =1,500\end{array}$

5. Calculate cash dividend of G Company.

$\begin{array}{c}\text{Cash dividend}=\text{Number of share}\times \text{Rate of dividend}\\ =4,000\times \$0.85\\ =\$3,400\end{array}$

6. Calculate sale price of shares of F Company.

$\begin{array}{c}\text{Sale price of shares}=\left(\text{Number of shares}\times \text{share price}\right)-\text{Broker fee}\\ \text{=}\left(2,000\times \$30\right)-\$225\\ =\$60,000-\$225\\ =\$59,775\end{array}$

7. Calculate the gain in the sale of investment of F Company.

$\begin{array}{c}\text{Gain}=\text{Sale Price}-\text{Cost of short term investment}\\ =\$59,775-\$48,590\\ =\$11,185\end{array}$

8. Calculate cash dividend of P Company as on October 1.

$\begin{array}{c}\text{Cash dividend}=\text{Number of share}\times \text{Rate of dividend}\\ =2,000\times \$1.90\\ =\$3,800\end{array}$

9. Calculate cash dividend of G Company.

$\begin{array}{c}\text{Cash dividend}=\text{Number of share}\times \text{Rate of dividend}\\ =2,000\times \$1.05\\ =\$2,100\end{array}$

10. Calculate cash dividend of P Company as on December 31.

$\begin{array}{c}\text{Cash dividend}=\text{Number of share}\times \text{Rate of dividend}\\ =2,000\times \$1.30\\ =\$2,600\end{array}$

Conclusion

Hence, the journal entries are prepared as above.

2.

To determine

To prepare:

A table to compare the year-end cost and fair values of R’s short-term investments in available-for-sale securities.

Explanation of Solution

Prepare the comparative table as shown below.

Particulars	Cost ($) (A)	Fair Value ($) (B)	Unrealized Loss $\left(A-B\right)$
G Company	48,590	53,000	(4,410)
P Company	98,675	93,000	5,675
X Company	16,955	13,750	3205
Total	164,220	159,750	4,470

Table 2

Thus, the unrealized loss is $4,470.

Working notes:

1. Calculate cost of share of G Company.

$\begin{array}{c}\text{Cost}=\left(\text{Number of share}\times \text{Rate}\right)+\text{Brokerage Fee}\\ =\left(2,000\times \$24.25\right)+\$90\\ =\$48,500+\$90\\ =\$48,590\end{array}$

2. Calculate the fair value for G Company.

$\begin{array}{c}\text{Fair value }=\text{Number of share}\times \text{Rate}\\ =2,000\times 26.50\\ =53,000\end{array}$

3. Calculate the cost of share of P Company.

$\begin{array}{c}\text{Cost}=\left(\text{Number of share}\times \text{Rate}\right)+\text{Brokerage Fee}\\ =\left(2,000\times \$49.25\right)+\$175\\ =\$98,500+\$175\\ =\$98,675\end{array}$

4. Calculate the fair value of P Company.

$\begin{array}{c}\text{Fair value }=\text{Number of share}\times \text{Rate}\\ =2,000\times 46.50\\ =93,000\end{array}$

5. Calculate the cost of share of X Company.

$\begin{array}{c}\text{Cost}=\left(\text{Number of share}\times \text{Rate}\right)+\text{Brokerage Fee}\\ =\left(1,000\times \$16.75\right)+\$205\\ =\$16,750+\$205\\ =\$16,955\end{array}$

6. Calculate the fair value of X Company.

$\begin{array}{c}\text{Fair value }=\text{Number of share}\times \text{Rate}\\ =1,000\times 13.75\\ =13,750\end{array}$

Conclusion

Hence, the table to compare the year-end cost and fair values of R’s short-term investments is prepared as above.

3.

To determine

To prepare:

The journal entries to record the year end adjustment for portfolio of short-term investments.

Answer to Problem 2PSA

Solution:

Prepare the adjustment entry as shown below.

Date	Particulars	Debit ($)	Credit ($)
Dec 31,	Unrealized loss- (Equity)	4,470
	Fair value adjustment account		4,470
	(Being unrealized loss recorded of $4,470)

Table 3

Explanation of Solution

• The fair value per share is less than the cost of share as calculated in part 2, so unrealized loss is debited. The balance of equity decreases by $4,470.

The fair value adjustment account is an adjustment account to account for the unrealized loss suffered by R Company.

4.

To determine

To explain:

The balance sheet presentation of the fair value adjustment.

Explanation of Solution

The balance sheet is prepared as per the cost value of the short-term investment.

Any change in the fair value of available-for-sale security on the balance sheet date is not recorded in the profit and loss statement. However, it is adjusted in the balance sheet. For fair value gains, the available-for-sale investment value will be marked to market, hence, it will also include gains on the assets side. On the liability side, it will be recorded as change in fair value under the shareholder's equity section.

The balance sheet of R Company shows a short-term investment of $164,220 on the assets side and a deduction of $4,470 for fair value adjustment on the liability side. The resultant is a fair value of the short-term investment.

Conclusion

Thus, the short-term investment is shown at cost price and adjustment has been made into it.

5.

(a)

To determine

The effect of short-term investment on R’s income statement.

Explanation of Solution

Given information:

Dividend accrued is $11,900.

Interest earned is $1,500.

Gain on sale of short-term investment is $11,185.

Required formula:

$\text{Net Income}=\text{Dividend}+\text{Interest}+\text{Gain on sale of investment}$

Calculation:

$\begin{array}{c}\text{Net Income}=\text{Dividend}+\text{Interest}+\text{Gain on sale of investment}\\ =\$11,900+\$1,500+\$11,185\\ =\$24,585\end{array}$

Thus, the net income is increase by $24,585.

Working notes:

Calculate total dividend earned.

$\begin{array}{c}\text{Total dividend}=\$3,400+\$3,800+\$2,100+\$2,600\\ =\$11,900\end{array}$

Conclusion

Hence, the effect of short-term investment is that it increases the net income to $24,585.

(b)

To determine

The effect of short-term investment on the balance sheet.

Explanation of Solution

The following are the effects of short-term investment on equity,

• Increase in the income of $24,585 increases the equity.

• A deduction of $4,470 is made as unrealized loss from the equity.

Working notes:

Calculate the net effect on equity.

$\begin{array}{c}\text{Equity}=\text{Net income}-\text{Unrealized loss}\\ =\$24,585-\$4,470\\ =\$20,115\end{array}$

Thus, the effect on equity is $20,115.

Conclusion

Hence, the effect of short-term investment on the income statement and balance sheet is explained as above.