Chapter E, Problem 5P

1.

To determine

Journalize the entries related to investment, in the books of Corporation J, assuming the portfolio as 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 ($)	Credit ($)
2015
August	4	Investments in TS			180,000
			Cash			180,000
		(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.

Prepare journal entry for adjusting the cost of TS to the fair market value, as on December 31, 2015.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2015
December	31	Net Unrealized Gains (Losses)			10,000
			Investments in TS			10,000
		(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, 2015.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 2,000 shares × \$85 per share}\\ \text{= \$170,000}\end{array}$ (1)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2015 – }\\ \text{Cost of investment on August 4, 2015}\end{array}\right\}\\ \text{=\$170,000–\$180,000}\\ \text{=\$}\left(\text{10,000}\right)\end{array}$

Note: Refer to Equation (1) for value and computation of fair value of investment on December 31, 2015.

Prepare journal entry for cash dividend received in 2016.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
June	1	Cash			7,000
			Dividend Revenue			7,000
		(To record receipt of dividend)

Table (3)

Description:

• 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 Notes:

Compute amount of dividend received.

$\begin{array}{c}\text{Dividend received}=\left\{\begin{array}{l}\text{Number of shares}\times \\ \text{Dividend per share}\end{array}\right\}\\ =2,000\text{ shares}\times \$3.50\text{ per share}\\ =\$7,000\end{array}$ (2)

Prepare journal entry for adjusting the TS to the fair market value, as on December 31, 2016.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
December	31	Investments in TS			12,000
			Net Unrealized Gains (Losses)			12,000
		(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, 2016.

Step 1: Compute the fair value of investment on December 31, 2016.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 2,000 shares × \$91 per share}\\ \text{= \$182,000}\end{array}$ (3)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2016 – }\\ \text{Fair value of investment on December 31, 2015}\end{array}\right\}\\ \text{=\$182,000–\$170,000}\\ \text{=\$12,000}\end{array}$

Note: Refer to Equations (3) and (1) for both the values.

Prepare journal entry for cash dividend received in 2017.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
June	1	Cash			7,000
			Dividend Revenue			7,000
		(To record receipt of dividend)

Table (5)

Description:

• 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.

Note: Refer to Equation (2) for value and computation of dividend revenue.

Prepare journal entry for adjusting the TS to the fair market value, as on December 31, 2017.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
December	31	Investments in TS			6,000
			Net Unrealized Gains (Losses)			6,000
		(To record the adjustment of investment in TS to the fair value)

Table (6)

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, 2017.

Step 1: Compute the fair value of investment on December 31, 2017.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 2,000 shares × \$94 per share}\\ \text{= \$188,000}\end{array}$ (4)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2017 – }\\ \text{Fair value of investment on December 31, 2016}\end{array}\right\}\\ \text{=\$188,000–\$182,000}\\ \text{=\$6,000}\end{array}$

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

2.

To determine

Journalize the entries related to investment, in the books of Corporation J, assuming the portfolio as 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 ($)	Credit ($)
2015
August	4	Investments in AFS Securities			180,000
			Cash			180,000
		(To record purchase of investment in AFS securities)

Table (7)

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.

Prepare journal entry for adjusting the cost of AFS securities to the fair market value, as on December 31, 2015.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2015
December	31	Net Unrealized Gains (Losses)			10,000
			Investments in AFS Securities			10,000
		(To record the adjustment of cost 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, 2015.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 2,000 shares × \$85 per share}\\ \text{= \$170,000}\end{array}$ (5)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2015 – }\\ \text{Cost of investment on August 4, 2015}\end{array}\right\}\\ \text{=\$170,000–\$180,000}\\ \text{=\$}\left(\text{10,000}\right)\end{array}$

Note: Refer to Equation (5) for value and computation of fair value of investment on December 31, 2015.

Prepare journal entry for cash dividend received in 2016.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
June	1	Cash			7,000
			Dividend Revenue			7,000
		(To record receipt of dividend)

Table (9)

Description:

• 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.

Note: Refer to Equation (2) for value and computation of dividend revenue.

Prepare journal entry for adjusting the AFS securities to the fair market value, as on December 31, 2016.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
December	31	Investments in AFS Securities			12,000
			Net Unrealized Gains (Losses)			12,000
		(To record the adjustment of investment in AFS securities to the fair value)

Table (10)

Description:

• Investments in AFS Securities 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, 2016.

Step 1: Compute the fair value of investment on December 31, 2016.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 2,000 shares × \$91 per share}\\ \text{= \$182,000}\end{array}$ (6)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2016 – }\\ \text{Fair value of investment on December 31, 2015}\end{array}\right\}\\ \text{=\$182,000–\$170,000}\\ \text{=\$12,000}\end{array}$

Note: Refer to Equations (6) and (5) for both the values.

Prepare journal entry for cash dividend received in 2017.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
June	1	Cash			7,000
			Dividend Revenue			7,000
		(To record receipt of dividend)

Table (11)

Description:

• 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.

Note: Refer to Equation (2) for value and computation of dividend revenue.

Prepare journal entry for adjusting the AFS securities to the fair market value, as on December 31, 2017.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
December	31	Investments in AFS Securities			6,000
			Net Unrealized Gains (Losses)			6,000
		(To record the adjustment of investment in AFS securities to the fair value)

Table (12)

Description:

• Investments in AFS Securities 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, 2017.

Step 1: Compute the fair value of investment on December 31, 2017.

$\begin{array}{c}\text{Fair value}=\text{Number of shares×Market price per share}\\ \text{= 2,000 shares × \$94 per share}\\ \text{= \$188,000}\end{array}$ (7)

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

$\begin{array}{c}\begin{array}{l}\text{Unrealized }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31, 2017 – }\\ \text{Fair value of investment on December 31, 2016}\end{array}\right\}\\ \text{=\$188,000–\$182,000}\\ \text{=\$6,000}\end{array}$

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

3.

To determine

Journalize the entries related to equity method investment, in the books of Corporation J, assuming the portfolio as investment in stock for significant influence.

Explanation of Solution

Investments in stock for significant influence: The investments in stock securities which claim significant influence with an ownership of 20% to 50% in the outstanding stock of the affiliate, are referred to as investments in stock for significant influence.

Equity method: The method of accounting such investments is referred to as equity method. Investments under equity method are valued and reported, at a proportionate value of increase in investment value when affiliate reports net income, and decrease in investment value when affiliate declares dividends.

Prepare journal entry to record the purchase of investment.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2015
August	4	Investments in Affiliates			180,000
			Cash			180,000
		(To record the purchase of equity-method investment)

Table (13)

Description:

• Investments in Affiliates is an asset account. Since 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.

Prepare journal entry for share of income received from Company K in 2015.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2015
December	31	Investments in Affiliates			9,000
			Equity in Affiliate Earnings			9,000
		(To record income received from affiliates)

Table (14)

Description:

• Investments in Affiliates is an asset account. Since share of income received from investee increases the investment value, asset value increased, and an increase in asset is debited.
• Equity in Affiliate Earnings is a revenue account. Revenues increase stockholders’ equity value, and an increase in stockholders’ equity is credited.

Working Notes:

Compute amount of income received from Company K.

$\begin{array}{c}\text{Investment revenue = }\left\{\begin{array}{l}\text{Net income reported by Company K × }\\ \text{Percentage share of ownership of Corporation J}\end{array}\right\}\\ \text{= \$30,000×30\%}\\ \text{= \$9,000}\end{array}$ (8)

Prepare journal entry for dividends received from affiliate, in 2016.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
June	1	Cash			7,000
			Investments in Affiliates			7,000
		(To record dividends received from investee)

Table (15)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Investments in Affiliates is an asset account. Since stock investments are reduced as an effect of receipt of dividends, asset value decreased, and a decrease in asset is credited.

Note: Refer to Equation (2) for value and computation of dividend revenue.

Prepare journal entry for share of income received from Company K in 2016.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
December	31	Investments in Affiliates			9,000
			Equity in Affiliate Earnings			9,000
		(To record income received from affiliates)

Table (16)

Description:

• Investments in Affiliates is an asset account. Since share of income received from investee increases the investment value, asset value increased, and an increase in asset is debited.
• Equity in Affiliate Earnings is a revenue account. Revenues increase stockholders’ equity value, and an increase in stockholders’ equity is credited.

Note: Refer to Equation (8) for value and computation of investment revenue.

Prepare journal entry for dividends received from affiliate, in 2017.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
June	1	Cash			7,000
			Investments in Affiliates			7,000
		(To record dividends received from investee)

Table (17)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Investments in Affiliates is an asset account. Since stock investments are reduced as an effect of receipt of dividends, asset value decreased, and a decrease in asset is credited.

Note: Refer to Equation (2) for value and computation of dividend revenue.

Prepare journal entry for share of income received from Company K in 2017.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
December	31	Investments in Affiliates			9,000
			Equity in Affiliate Earnings			9,000
		(To record income received from affiliates)

Table (18)

Description:

• Investments in Affiliates is an asset account. Since share of income received from investee increases the investment value, asset value increased, and an increase in asset is debited.
• Equity in Affiliate Earnings is a revenue account. Revenues increase stockholders’ equity value, and an increase in stockholders’ equity is credited.

Note: Refer to Equation (8) for value and computation of investment revenue.