Chapter 15, Problem 6AP

To determine

Prepare journal entries to record the given transaction of Company S.

Explanation of Solution

Journal entry:

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

Prepare the journal entries to record the given transactions as follows:

January 5, Year 1 – Purchase of Company K’s shares.

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
January 5, Year 1	Stock Investments (Company K)		1,560,000
	Cash			1,560,000
	(To record the purchase of bonds)

Table (1)

• Stock investment-Company K is an asset account, and it increases the value of assets by $1,560,000. Hence, debit the stock investment with $1,560,000.
• Cash is an asset account and it decreases the value of asset by $1,560,000. Therefore, credit the cash account for $1,560,000.

October 23, Year 1 – Dividend received from Company K.

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
October 23, Year 1	Cash (1)		192,000
	Dividend revenue			192,000
	(To record the cash dividend received)

Table (2)

• Cash is an asset account and it increases the value of asset by $192,000. Therefore, debit the cash account for $192,000.
• Dividend revenue is a component of owner’s equity (revenue), and it increases the value of equity by $192,000. Hence, credit dividend revenue account with $192,000.

Working note:

Calculate the dividend revenue received from Company K for the year 1:

$\begin{array}{c}\text{Dividends = }\left(\text{Number of shares}\times \text{Dividend per share}\right)\\ =\left(60,000\times \$3.20\text{per}\text{share}\right)\\ =\$192,000\end{array}$ (1)

December 31, Year 1 – Fair value adjustments:

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
December 31, Year 1	Fair value adjustment- Company K		240,000
	Unrealized gain-income (3)			240,000
	(To record the unrealized gain)

Table (3)

• Fair Value Adjustment is a contra-asset account. The account shows a credit balance since the market price has increased (gain); therefore, debit the fair value adjustment with $240,000.
• Unrealized gain–Income is an adjustment account to report the investment at fair market value. Since gain has occurred while adjusting; therefore, credit the unrealized Gain or Loss–income account with $240,000.

Working note:

Calculate the fair value of stock for the year 1:

$\begin{array}{c}\text{Fair value}=\left(\text{Number of shares}\times \text{fair value per share}\right)\\ =\left(60,000\times \$30\text{per}\text{share}\right)\\ =\$1,800,000\end{array}$ (2)

Calculate the unrealized gain (loss) from sale of stock investment:

$\begin{array}{c}\begin{array}{l}\text{unrealized Gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Fair value (2) –}\\ \text{Purchase value }\end{array}\right\}\\ \text{= \$1,800,000}-\$1,560,000\\ =\$240,000\end{array}$ (3)

October 15, Year 2 – Cash dividend received from Company K.

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
October 15, Year 2	Cash (4)		156,000
	Dividend revenue			156,000
	(To record the cash dividend received)

Table (4)

• Cash is an asset account and it increases the value of asset by $156,000. Therefore, debit the cash account for $156,000.
• Dividend revenue is a component of owner’s equity (revenue), and it increases the value of equity by $156,000. Hence, credit dividend revenue account with $156,000.

Working notes:

Calculate the dividend revenue received from Company K for the year 2:

$\begin{array}{c}\text{Dividends = }\left(\text{Number of shares}\times \text{Dividend per share}\right)\\ =\left(60,000\times \$2.60\text{per}\text{share}\right)\\ =\$156,000\end{array}$ (4)

December 31, Year 2 – Fair value adjustments:

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
December 31, Year 2	Fair value adjustment- Company K		120,000
	Unrealized gain-income (6)			120,000
	(To record the unrealized gain)

Table (5)

• Fair Value Adjustment is a contra-asset account. The account shows a credit balance since the market price has increased (gain); therefore, debit the fair value adjustment with $120,000.
• Unrealized gain–Income is an adjustment account to report the investment at fair market value. Since gain has occurred while adjusting; therefore, credit the unrealized Gain or Loss–income account with $120,000.

Working note:

Calculate the fair value of stock for the year 2:

$\begin{array}{c}\text{Fair value}=\left(\text{Number of shares}\times \text{fair value per share}\right)\\ =\left(60,000\times \$32\text{per}\text{share}\right)\\ =\$1,920,000\end{array}$ (5)

Calculate the unrealized gain (loss) from sale of stock investment:

$\begin{array}{c}\begin{array}{l}\text{unrealized Gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Fair value (5) –}\\ \text{Purchase value}\end{array}\right]-\left[\begin{array}{l}\text{Unrealized Gain}\\ \text{in year 1 (3)}\end{array}\right]\\ \text{=}\left[\text{ \$1,920,000}-\$1,560,000\right]-240,000\\ =\$120,000\end{array}$ (6)

January 2, Year 3 – Sale of equity investment:

Date	Account Titles and Description	Post Ref.	Debit ($)	Credit ($)
January2, Year 3	Cash		54,200
	Gain on sale of investment (7)			7,400
	Stock investment – Company K (8)			46,800
	(To record sale of investment and gain from sale of investment)

Table (6)

• Cash is an asset account and it increases the value of asset by $54,200. Therefore, debit the cash account for $54,200.
• Gain on sale of trading is a component of owner’s equity (revenue), and it increases the value of equity by $7,400. Hence, credit the gain on sale of trading securities account with $7,400.
• Stock investment is an asset account, and it decreases the value of assets by $46,800. Hence, credit the stock investment account with $46,800.

Calculate the purchased value of shares:

$\begin{array}{c}\text{Purchased value of stock = Stock investment }\times \text{Percentage of sales}\\ \text{=\$1,560,000}\times \frac{3}{100}\\ =\$7,400\end{array}$ (7)

Calculate the gain (loss) from sale of long-term investment:

$\begin{array}{c}\begin{array}{l}\text{Gain }\left(\text{loss}\right)\\ \text{on investments}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Purchase value}\end{array}\right\}\\ \text{= \$54,200}-\$7,400(7)\\ =\$46,800\end{array}$ (8)