Chapter E, Problem 1CC

1.

To determine

Journalize the entries related to investment in trading securities.

Explanation of Solution

Trading securities (TS): The category of passive investments which are bought with a purpose to sell in the near future are referred to as trading securities.  The percentage of passive investments in debt or equity will be less than 20%.

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.

Prepare journal entry for purchase of investment in TS.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2012
November	21	Investments in TS			19,200,000
			Cash			19,200,000
		(To record purchase of investment in TS)

Table (1)

Description:

• Investments in TS 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 Notes:

Compute cost of investment in TS.

$\begin{array}{c}\text{Cost of investment }=\text{Number of shares}\times \text{Price per share}\\ =400,00\text{0 shares}\times \text{\$48 per share}\\ =\$19,200,000\end{array}$ (1)

Prepare journal entry for adjusting the cost of TS to the fair market value, as on December 31, 2012.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2012
December	31	Net Unrealized Gains (Losses)			1,200,000
			Investments in TS			1,200,000
		(To record the adjustment of cost of investment in TS to the fair value)

Table (2)

Description:

• Net Unrealized Gains (Losses) 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.
• Investments in TS 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 in TS.

Step 1: Compute the fair value of investment on December 31, 2012.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 400,000 shares × \$45 per share}\\ \text{= \$18,000,000}\end{array}$ (2)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2012 – }\\ \text{Cost of investment on November 21, 2012}\end{array}\right\}\\ \text{=\$18,000,000–\$19,200,000}\\ \text{=\$}\left(\text{1,200,000}\right)\end{array}$

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

Prepare journal entry for adjusting TS to the fair market value, as on December 31, 2013.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2013
December	31	Net Unrealized Gains (Losses)			1,600,000
			Investments in TS			1,600,000
		(To record the adjustment of investment in TS to the fair value)

Table (3)

Description:

• Net Unrealized Gains (Losses) 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.
• Investments in TS 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 in TS.

Step 1: Compute the fair value of investment on December 31, 2013.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 400,000 shares × \$41 per share}\\ \text{= \$16,400,000}\end{array}$ (3)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2013 – }\\ \text{Fair value of investment on December 31, 2012}\end{array}\right\}\\ \text{=\$16,400,000–\$18,000,000}\\ \text{=\$}\left(\text{1,600,000}\right)\end{array}$

Note: Refer to Equations (2) and (3) for both the values.

Prepare journal entry for adjusting the TS to the fair market value, as on December 31, 2014.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2014
December	31	Investments in TS			3,200,000
			Net Unrealized Gains (Losses)			3,200,000
		(To record the adjustment of investment in TS to the fair value)

Table (4)

Description:

• Investments in TS is an asset account. The account is debited because the market price was increased, and eventually the asset value increased.
• Net Unrealized Gains (Losses) 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 gain under net income.

Working Notes:

Determine the unrealized gain or loss on investment on December 31, 2014.

Step 1: Compute the fair value of investment in TS.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 400,000 shares × \$49 per share}\\ \text{= \$19,600,000}\end{array}$ (4)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2014 – }\\ \text{Fair value of investment on December 31, 2013}\end{array}\right\}\\ \text{=\$19,600,000–\$16,400,000}\\ \text{=\$3,200,000}\end{array}$

Note: Refer to Equations (3) and (4) for both the values.

Prepare journal entry to record the sale of investment in TS.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2015
September	15	Cash			20,000,000
			Investments in TS			19,600,000
			Gain on Sale of Investment			400,000
		(To record the disposal of investment in TS)

Table (5)

Description:

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

Working Notes:

Compute gain or loss on disposal of TS.

Step 1: Compute the cash received from sale of investment in TS.

$\begin{array}{c}\text{Cash received}=\text{Number of shares×Sale price per share}\\ \text{= 400,000 shares × \$50 per share}\\ \text{= \$20,000,000}\end{array}$ (5)

Step 2: Compute gain or loss on disposal of TS.

$\begin{array}{c}\text{Gain }\left(\text{loss}\right)\text{ on disposal = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Fair value of investment on December 31, 2014 }\end{array}\right\}\\ \text{=\$20,000,000–\$19,600,000}\\ \text{=\$400,000}\end{array}$

Note: Refer to Equations (4) and (5) for value and computation of both values.

2.

To determine

Journalize the entries related to investment in available-for-sale securities.

Explanation of Solution

Available-for-sale (AFS) securities: The category of passive investments which are held as idle funds to serve the future operating and strategic purposes, are referred to as available-for-sale securities. The percentage of passive investments in debt or equity will be less than 20%.

Prepare journal entry for purchase of investment in AFS securities.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2012
November	21	Investments in AFS Securities			19,200,000
			Cash			19,200,000
		(To record purchase of investment in AFS securities)

Table (6)

Description:

• Investments in AFS Securities 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 Notes:

Compute cost of investment in AFS securities.

$\begin{array}{c}\text{Cost of investment }=\text{Number of shares}\times \text{Price per share}\\ =400,00\text{0 shares}\times \text{\$48 per share}\\ =\$19,200,000\end{array}$ (6)

Prepare journal entry for adjusting the cost of AFS securities to the fair market value, as on December 31, 2012.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2012
December	31	Net Unrealized Gains (Losses)			1,200,000
			Investments in AFS Securities			1,200,000
		(To record the adjustment of cost of investment in AFS securities to the fair value)

Table (7)

Description:

• Net Unrealized Gains (Losses) 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 component of Other Comprehensive Income (OCI) on the Statement of Comprehensive Income.
• Investments in AFS Securities 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 in AFS securities.

Step 1: Compute the fair value of investment on December 31, 2012.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 400,000 shares × \$45 per share}\\ \text{= \$18,000,000}\end{array}$ (7)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2012 – }\\ \text{Cost of investment on November 21, 2012}\end{array}\right\}\\ \text{=\$18,000,000–\$19,200,000}\\ \text{=\$}\left(\text{1,200,000}\right)\end{array}$

Note: Refer to Equations (6) and (7) for both the values.

Prepare journal entry for adjusting AFS securities to the fair market value, as on December 31, 2013.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2013
December	31	Net Unrealized Gains (Losses)			1,600,000
			Investments in AFS Securities			1,600,000
		(To record the adjustment of investment in AFS securities to the fair value)

Table (8)

Description:

• Net Unrealized Gains (Losses) 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 component of Other Comprehensive Income (OCI) on the Statement of Comprehensive Income.
• Investments in AFS Securities 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 in AFS securities.

Step 1: Compute the fair value of investment on December 31, 2013.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 400,000 shares × \$41 per share}\\ \text{= \$16,400,000}\end{array}$ (8)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2013 – }\\ \text{Fair value of investment on December 31, 2012}\end{array}\right\}\\ \text{=\$16,400,000–\$18,000,000}\\ \text{=\$}\left(\text{1,600,000}\right)\end{array}$

Note: Refer to Equations (7) and (8) for both the values.

Prepare journal entry for adjusting the AFS securities to the fair market value, as on December 31, 2014.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2014
December	31	Investments in AFS Securities			3,200,000
			Net Unrealized Gains (Losses)			3,200,000
		(To record the adjustment of investment in AFS securities to the fair value)

Table (9)

Description:

• Investments in AFS is an asset account. The account is debited because the market price was increased, and eventually the asset value increased.
• Net Unrealized Gains (Losses) 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 Other Comprehensive Income (OCI) on the Statement of Comprehensive Income.

Working Notes:

Determine the unrealized gain or loss on investment on December 31, 2014.

Step 1: Compute the fair value of investment in AFS securities.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 400,000 shares × \$49 per share}\\ \text{= \$19,600,000}\end{array}$ (9)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2014 – }\\ \text{Fair value of investment on December 31, 2013}\end{array}\right\}\\ \text{=\$19,600,000–\$16,400,000}\\ \text{=\$3,200,000}\end{array}$

Note: Refer to Equations (8) and (9) for both the values.

Prepare journal entry to record the sale of investment in AFS securities.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2015
September	15	Cash			20,000,000
		Net Unrealized Gains (Losses)			400,000
			Investments in AFS Securities			19,600,000
			Gain on Sale of Investment			800,000
		(To record the disposal of investment in AFS securities)

Table (10)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Net Unrealized Gains (Losses) is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since the investment is for sale, the gain is cancelled by reversing (debiting) the entry.
• Investments in AFS Securities is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.
• Gain on Sale of Investment is a revenue account. Since gains and revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Compute net balance of unrealized gains (losses).

Details	Amount ($)
Net unrealized gains (losses) on December 31, 2012	$(1,200,000)
Net unrealized gains (losses) on December 31, 2013	(1,600,000)
Net unrealized gains (losses) on December 31, 2014	3,200,000
Net balance of unrealized gains (losses)	$400,000

Table (11)

Note: The net balance of unrealized gains (losses) should be cancelled both debit and credit sides. S, the Net Unrealized Gains (Losses) and Investments in AFS Securities accounts are debited and credited respectively to cancel the effect of net balance of unrealized gain of $400,000. Therefore, the balance of Investments in AFS Securities is $19,600,000$\left(\text{\$19,200,000 }\left(\text{cost}\right)\text{+\$400,000 }\left(\text{net balance of unrealized gain}\right)\right)$.

Compute gain or loss on disposal of AFS securities.

Step 1: Compute the cash received from sale of investment in AFS securities.

$\begin{array}{c}\text{Cash received}=\text{Number of shares×Sale price per share}\\ \text{= 400,000 shares × \$50 per share}\\ \text{= \$20,000,000}\end{array}$ (10)

Step 2: Compute gain or loss on disposal of AFS securities.

$\begin{array}{c}\text{Gain }\left(\text{loss}\right)\text{ on disposal = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Cost of investment on November 21, 2012 }\end{array}\right\}\\ \text{=\$20,000,000–\$19,200,000}\\ \text{=\$800,000}\end{array}$

Note: Refer to Equations (6) and (10) for value and computation of both values.