P17-3 (Available-for-Sale Investments) Cardinal Paz Corp. carries an account in its general ledger called Investments, which contained debits for investment purchases, and no credits, with the following descriptions.
Feb. 1, 2010 Sharapova Company common stock, $100 par, 200 shares $ 37,400
April 1 U.S. government bonds, 11%, due April 1, 2020, interest payable April 1 and October 1, 110 bonds of $1,000 par each 110,000
July 1 McGrath Company 12% bonds, par $50,000, dated March 1, 2010 purchased at 104 plus accrued interest, interest payable annually on March 1, due March 1, 2030 54,000
Instructions
(Round all computations to the nearest dollar.)
(a) Prepare entries necessary to classify the amounts into proper accounts, assuming that all the securities are classified as available-for-sale.
(b) Prepare the entry to record the accrued interest and the amortization of premium on December 31, 2010 using the straight-line method.
(c) The fair values of the securities on December 31, 2010, were:
Sharapova Company common stock $ 31,800
U.S. government bonds 124,700
McGrath Company bonds 58,600
What entry or entries, if any, would you recommend be made?
(d) The U.S. government bonds were sold on July 1, 2011, for $119,200 plus accrued interest. Give the proper entry.
P17-8 (Fair Value and Equity Methods) Brooks Corp. is a medium-sized corporation specializing in quarrying stone for building construction. The company has long dominated the market, at one time achieving a 70% market penetration. During prosperous years, the company's profits, coupled with a conservative dividend policy, resulted in funds available for outside investment. Over the years, Brooks has had a policy of investing idle cash in equity securities. In particular, Brooks has made periodic investments in the company's principal supplier, Norton Industries. Although the firm currently owns 12% of the outstanding common stock of Norton Industries, Brooks does not have significant influence over the operations of Norton Industries.
Cheryl Thomas has recently joined Brooks as assistant controller, and her first assignment is to prepare the 2010 year-end adjusting entries for the accounts that are valued by the “fair value” rule for financial reporting purposes. Thomas has gathered the following information about Brooks's pertinent accounts.
1. Brooks has trading securities related to Delaney Motors and Patrick Electric. During this fiscal year, Brooks purchased 100,000 shares of Delaney Motors for $1,400,000; these shares currently have a market value of $1,600,000. Brooks' investment in Patrick Electric has not been profitable; the company acquired 50,000 shares of Patrick in April 2010 at $20 per share, a purchase that currently has a value of $720,000.
2. Prior to 2010, Brooks invested $22,500,000 in Norton Industries and has not changed its holdings this year. This investment in Norton Industries was valued at $21,500,000 on December 31, 2009. Brooks' 12% ownership of Norton Industries has a current market value of $22,225,000.
Instructions
(a) Prepare the appropriate adjusting entries for Brooks as of December 31, 2010, to reflect the application of the “fair value” rule for both classes of securities described above.
(c) Prepare the entries for the Norton investment, assuming that Brooks owns 25% of Norton's shares. Norton reported income of $500,000 in 2010 and paid cash dividends of $100,000.
To answer these questions, you will need to understand the concepts of available-for-sale investments, accrued interest, amortization of premium, fair value, and equity method. You will also need to know how to make journal entries.
(a) To classify the amounts into proper accounts assuming all securities are classified as available-for-sale, the following entries need to be recorded:
- Feb. 1, 2010: Dr. Investments (Available-for-Sale) $37,400 and Cr. Cash $37,400 (for the purchase of Sharapova Company common stock)
- April 1: Dr. Investments (Available-for-Sale) $110,000 and Cr. Cash $110,000 (for the purchase of U.S. government bonds)
- July 1: Dr. Investments (Available-for-Sale) $54,000 and Cr. Cash $54,000 (for the purchase of McGrath Company bonds)
(b) To record the accrued interest and the amortization of premium on December 31, 2010 using the straight-line method, the following entry needs to be recorded:
- Dr. Interest Receivable $2,750 ([$110,000 * 11% * 9/12] - [$110,000 * $1,000 / $1,100])
Dr. Premium on Bonds Payable $250 ([($54,000 - $50,000) / 20] * 9/12)
Cr. Interest Revenue $2,750
Cr. Premium on Bonds Payable $250
(c) To record the fair values of the securities on December 31, 2010, the following entries need to be recorded:
- Dr. Unrealized Holding Gain or Loss - Income $5,600 ([$31,800 - $37,400] + [$58,600 - $54,000])
- Dr. Unrealized Holding Gain or Loss - Other Comprehensive Income $700 ($124,700 - $110,000)
- Cr. Allowance to Adjust Investments to Fair Value $6,300 (net of the income tax effect)
(d) To record the sale of U.S. government bonds on July 1, 2011, the following entry needs to be recorded:
- Dr. Cash $119,200
- Dr. Accumulated Other Comprehensive Income $5,600 ([$31,800 - $37,400] + [$58,600 - $54,000])
- Dr. Allowance to Adjust Investments to Fair Value $700 ($124,700 - $110,000)
- Cr. Investments (Available-for-Sale) $110,000
- Cr. Gain on Sale of Investments $15,500 ($119,200 - $110,000 - $5,600 - $700)
(a) To reflect the fair value of trading securities, the following adjusting entries need to be recorded:
- Dr. Unrealized Holding Gain or Loss - Income $200,000 ([$1,600,000 - $1,400,000] + [$720,000 - $1,000,000])
- Cr. Allowance to Adjust Trading Securities to Fair Value $200,000
(b) To reflect the fair value of the Norton investment, the following adjusting entry needs to be recorded:
- Dr. Unrealized Holding Gain or Loss - Income $725,000 ($22,225,000 - $21,500,000)
- Cr. Allowance to Adjust Norton Investment to Fair Value $725,000
(c) To record the Norton investment assuming Brooks owns 25% of Norton's shares and Norton reported income of $500,000 and paid dividends of $100,000, the following entries need to be recorded:
- Dr. Investment in Norton $125,000 (25% of $500,000)
- Cr. Equity in Investee Income $125,000
- Dr. Cash $25,000 (25% of $100,000)
- Cr. Investment in Norton $25,000
I hope this helps! Let me know if you have any further questions.