Chapter D, Problem 3AP

To determine

Journalize the transactions related to stock investments in the books of Corporation S.

Explanation of Solution

Trading securities: These are short-term investments in debt and equity securities purchased with an intention of trading and earning profits due to changes in market prices.

Available-for-sale securities: These are short-term or long-term investments in debt and equity securities with an intention of not selling the investment in the near future but holding the investment for some longer time period, and not till maturity (for debt securities).

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.

Journalize the transactions related to stock investments in the books of Corporation S.

Transaction on July 1, 2016:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
July	1	Stock Investment–Trading			66,200
			Cash			66,200
		(Record purchase of investment in trading securities)

Table (1)

Description:

• Stock Investments–Trading 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.

Transaction on October 1, 2016:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
October	1	Stock Investment–Available-for-Sale, Incorporation W			78,000
		Stock Investment–Available-for-Sale, Incorporation M			64,000
			Cash			142,000
		(Record purchase of investment in available-for-sale securities)

Table (2)

Description:

• Stock Investment–Available-for-Sale, Incorporation W is an asset account. Since stock investments are purchased, asset value increased, and an increase in asset is debited.
• Stock Investment–Available-for-Sale, Incorporation M 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.

Transaction on November 9, 2016:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
November	9	Cash			2,700
			Dividend Income			2,700
		(Record receipt of dividend income)

Table (3)

Description:

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

Working Notes:

Compute amount of dividend received.

$\begin{array}{c}\text{Dividend received}=\left\{\begin{array}{l}\text{Number of shares}\times \\ \text{Dividend per share}\end{array}\right\}\\ =3,000\text{ shares}\times \$0.90\text{ per share}\\ =\$2,700\end{array}$

Transaction on December 31, 2016 (adjusting entry for trading stock investments):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
December	31	Unrealized Loss on Investments			3,200
			Stock Investment–Trading			3,200
		(Record the adjustment of cost of investment to the fair value)

Table (4)

Description:

• Unrealized Loss on Investments is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since loss has occurred and losses decrease stockholders’ equity value, a decrease in stockholders’ equity value is debited. This loss is reported as loss under net income.
• Stock Investment–Trading is an asset account. The account is credited because the market price was decreased, and eventually the asset value decreased.

Working Notes:

Determine the unrealized gain or loss on investment.

Step 1: Compute the fair value of investment in trading securities as on December 31, 2016.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 1,000 shares × \$63 per share}\\ \text{= \$63,000}\end{array}$ (1)

Step 2: Compute unrealized gain or loss on investment in trading securities.

$\begin{array}{c}\text{Unrealized gain or }\left(\text{loss}\right)\text{= }\left\{\begin{array}{l}\text{Fair value of investment – }\\ \text{Cost of investment}\end{array}\right\}\\ \text{=\$63,000–\$66,200}\\ \text{=\$}\left(\text{3,200}\right)\end{array}$

Note: Refer to Equation (1) for fair value of the investment.

Transaction on December 31, 2016 (adjusting entry for available-for-sale stock investments):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
December	31	Fair Value Adjustment to Stock Investment			2,500
			Unrealized Gain/Loss on Investments			2,500
		(Record the adjustment of cost of investment to the fair value)

Table (5)

Description:

• Fair Value Adjustment to Stock Investment is a valuation account to stock investment account. The account is debited to increase the carrying value of investment.
• Unrealized Gain/Loss on Investments is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since gain has occurred and gains increase stockholders’ equity value, an increase in stockholders’ equity value is credited. This gain is reported as component of stockholders’ equity section of balance sheet.

Working Notes:

Determine the unrealized gain or loss on investment.

Step 1: Compute the fair value of investment in available-for-sale securities as on December 31, 2016.

Security	Number of Shares	$\times$	Fair Value	=	Fair Value of Investment
Incorporation W	3,000 shares	$\times$	$27.50	=	$82,500
Incorporation M	2,000 shares	$\times$	31.00	=	62,000
Total					$144,500

Table (6)

Step 2: Compute unrealized gain or loss on investment in available-for-sale securities.

$\begin{array}{c}\text{Unrealized gain or }\left(\text{loss}\right)\text{= }\left\{\begin{array}{l}\text{Fair value of investment – }\\ \left(\begin{array}{l}\text{Cost of Incorporation W stock+}\\ \text{Cost of Incorporation M stock}\end{array}\right)\end{array}\right\}\\ \text{=\$144,500–}\left(\text{\$78,000+\$64,000}\right)\\ =\$144,500–\$142,000\\ \text{=\$2,500}\end{array}$

Note: Refer to Table (6) for value and computation of fair value.

Transaction on February 1, 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
February	1	Cash			62,000
		Loss on Sale of Investments			1,000
			Stock Investment–Trading			63,000
		(Record the disposal of investment in trading securities)

Table (7)

Description:

• 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 account. Since losses and expenses decrease equity, and a decrease in equity is debited, so, Loss on Sale of Investments is debited.
• Stock Investment–Trading is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.

Working Notes:

Compute gain or loss on sale of trading securities.

Step 1: Compute the cash received on sale of investment in trading securities.

$\begin{array}{c}\text{Cash received}=\text{Number of shares×Sale price per share}\\ \text{= 1,000 shares × \$62 per share}\\ \text{= \$62,000}\end{array}$ (2)

Step 2: Compute gain or loss on disposal.

$\begin{array}{c}\text{Gain }\left(\text{loss}\right)\text{ on disposal = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Fair value of investment on December 31, 2016 }\end{array}\right\}\\ \text{=\$62,000–\$63,000}\\ \text{=\$}\left(\text{1,000}\right)\end{array}$

Note: Refer to Equations (1) and (2) for both the values.

Transaction on December 31, 2017 (adjusting entry for available-for-sale stock investments):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
December	31	Fair Value Adjustment to Stock Investment			11,500
			Unrealized Gain/Loss on Investments			11,500
		(Record the adjustment of cost of investment to the fair value)

Table (8)

Description:

• Fair Value Adjustment to Stock Investment is a valuation account to stock investment account. The account is debited to increase the carrying value of investment.
• Unrealized Gain/Loss on Investments is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since gain has occurred and gains increase stockholders’ equity value, an increase in stockholders’ equity value is credited. This gain is reported as component of stockholders’ equity section of balance sheet.

Working Notes:

Determine the unrealized gain or loss on investment.

Step 1: Compute the fair value of investment in available-for-sale securities as on December 31, 2017.

Security	Number of Shares	$\times$	Fair Value	=	Fair Value of Investment
Incorporation W	3,000 shares	$\times$	$30.00	=	$90,000
Incorporation M	2,000 shares	$\times$	33.00	=	66,000
Total					$156,000

Table (9)

Step 2: Compute unrealized gain or loss on investment in available-for-sale securities.

$\begin{array}{c}\text{Unrealized gain or }\left(\text{loss}\right)\text{= }\left\{\begin{array}{l}\text{Fair value of investment as on December 31, 2017– }\\ \text{Fair value of investment as on December 31, 2016 }\end{array}\right\}\\ \text{=\$156,000–\$144,500}\\ \text{=\$11,500}\end{array}$

Note: Refer to Tables (6) and (9) for both the values.