Chapter D, Problem 2E

To determine

Journalize the stock investment transactions in the books of Industries S under the fair value method.

Explanation of Solution

Stock investments: Stock investments are equity securities which claim ownership in the investee company and pay dividend revenue to the investor company.

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

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

1)

Prepare journal entry for the purchase of 1,000 shares of Company T at $85 per share and a brokerage of $150.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
February	24	Investments–Company T Stock		160,200
		Cash (1)			160,200
		(To record purchase of shares for cash)

Table (1)

• Investments–Company T Stock is an asset account. Since stock investments are purchased, asset value increased, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Working Note (1):

Compute amount of cash paid to purchase Company T’s stock.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\text{+}\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{2,000 shares ×\$80}\right)+\$200\\ \text{= \$160,200}\end{array}$

Prepare journal entry for the purchase of 2,000 shares of Company I at $40 per share and a brokerage of $100.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
March	16	Investments–Company I Stock		80,100
		Cash (2)			80,100
		(To record purchase of shares for cash)

Table (2)

• Investments–Company I Stock is an asset account. Since stock investments are purchased, asset value increased, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Working Note (2):

Compute amount of cash paid to purchase Company I’s stock.

$\begin{array}{c}\text{Cash paid = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased× }\\ \text{Price per share}\end{array}\right)\text{+}\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{2,000 shares ×\$40}\right)+\$100\\ \text{= \$80,100}\end{array}$

Prepare journal entry for sale of 500 shares of Company T at $100, with a brokerage of $50.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
July	14	Cash (3)		49,950
		Gain on Sale of Investments(5)			9,900
		Investments–Company T Stock     (4)			40,050
		(To record sale of shares)

Table (3)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Gain on Sale of Investments is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.
• Investments–Company T Stock is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.

Working Note (3):

Compute cash received from sale proceeds.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares sold× }\\ \text{Sale price per share}\end{array}\right)–\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{500 shares ×\$100}\right)–\$50\\ \text{= \$49,950}\end{array}$

Working Note (4):

Compute cost of stock investment sold.

$\begin{array}{c}\begin{array}{l}\text{Cost of stock }\\ \text{investment sold}\end{array}\}\text{ = Number of shares sold × Price per share}\\ \text{= Number of shares sold ×}\frac{\text{Cost of 2,000 shares}}{\text{Number of shares}}\\ \text{= 500 shares ×}\frac{\text{\$160,200}}{\text{2,000 shares}}\\ \text{= \$40,050}\end{array}$

Working Note (5):

Compute realized gain (loss) on sale of stock.

$\begin{array}{c}\begin{array}{l}\text{Realized gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of stock investment }\end{array}\right\}\\ \text{= \$49,950–\$40,050}\\ \text{= \$9,900}\end{array}$

Prepare journal entry for sale of 1,000 shares of Company I at $34, with a brokerage of $80.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
August	12	Cash (6)		33,920
		Loss on Sale of Investments (8)		6,130
		Investments–Company I Stock      (7)			40,050
		(To record sale of shares)

Table (4)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Loss on Sale of Investments is a loss or expense account. Since losses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Investments–Company I Stock is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.

Working Note (6):

Compute cash received from sale proceeds.

$\begin{array}{c}\text{Cash received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares sold× }\\ \text{Sale price per share}\end{array}\right)–\\ \text{Brokerage commission}\end{array}\right\}\\ \text{= }\left(\text{1,000 shares ×\$34}\right)–\$80\\ \text{= \$33,920}\end{array}$

Working Note (7):

Compute cost of stock investment sold.

$\begin{array}{c}\begin{array}{l}\text{Cost of stock }\\ \text{investment sold}\end{array}\}\text{ = Number of shares sold × Price per share}\\ \text{= Number of shares sold ×}\frac{\text{Cost of 2,000 shares}}{\text{Number of shares}}\\ \text{= 1,000 shares ×}\frac{\$80,100}{\text{2,000 shares}}\\ \text{= \$40,050}\end{array}$

Working Note (8):

Compute realized gain (loss) on sale of stock.

$\begin{array}{c}\begin{array}{l}\text{Realized gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of stock investment }\end{array}\right\}\\ \text{= \$33,920–\$6,130}\\ \text{= \$}\left(6,130\right)\end{array}$

Prepare journal entry for the dividend received from Company T shares.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
October	31	Cash		450
		Dividend Revenue (9)			450
		(To record receipt of dividend revenue)

Table (5)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Dividend Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Note (9):

Compute amount of dividend received on Company T’s stock.

$\begin{array}{c}\text{Dividend received = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Number of shares purchased–}\\ \text{Number of shares sold}\end{array}\right)\text{× }\\ \text{Dividend per share}\end{array}\right\}\\ =\left\{\left(\text{2,000 shares – 500 shares}\right)\text{× \$0}\text{.30}\right\}\\ \text{= 1,500 shares ×\$0}\text{.30}\\ \text{= \$450}\end{array}$