Chapter 15 Investments and Fair Value Accounting Study Guide Solutions 1. Accrued interest 2. Dividends Fill-in-the-Blank Equations 3. Market price per share of common stock Exercises 1. A corporation has excess cash due to the introduction of a new product. The corporation expects that the sales of the product will grow in the upcoming years and would like to reduce costs by combining businesses with a supplier. Would this be an example of investing in a long-term investment, temporary investment, or current operations? Long-term investment 2. Due to a recent peak in sales during the busy season, a corporation has excess cash. The corporation would like to earn extra income from the cash but would like to be able to liquidate the investment into cash if it is needed. Is the corporation looking to invest in its current operations, a temporary investment, or long-term investment? Temporary investment 3. A corporation is looking for ways to increase its profit margin on its best-selling product by reducing costs. The manager determines that buying a new piece of equipment for $5,750 would reduce monthly costs by $400. Would the corporation be investing in its current operations, a temporary investment, or long-term investment with the purchase of this equipment? Current operations Strategy: Investing in current operations finances the day-to-day needs of the business. Temporary investments will generate extra income for the business but does not require as large of a commitment as a long-term investment, which impacts the business for many future accounting periods. 1
2 Chapter 15 4. On July 25, 2015, Pear Inc. purchases $5,000 of ABC Co. 7.5% bonds at their face amount, plus any accrued interest. The bonds pay interest semiannually, payable on June 30 and December 31. Prepare the journal entry to record the purchase. Round Interest Receivable to the nearest cent, and assume a 360-day year, with 30 days in each month. July 25 Bonds Receivable-ABC Co. 5,000.00 Interest Receivable 26.04 Cash 5,026.04 Interest Receivable: $5,000 7.5% (25/360 days) 5. Prepare the journal entry to record the receipt of interest on December 31, 2015, for Pear Inc. from Exercise 4. Dec. 31 Cash 187.50 Interest Receivable 26.04 Interest Revenue 161.46 Cash received: $5,000 7.5% ½ year 6. Tate s Place purchased $7,500 of WW Co. 10% bonds at their face amount, plus any accrued interest on June 5, 2015. Interest is paid semiannually, on March 31 and September 30. Prepare the journal entry to record the purchase. Round Interest Receivable to the nearest cent. Assume a 360-day year, with 30 days in each month. June 5 Bonds Receivable-WW Co. 7,500.00 Interest Receivable 135.42 Cash 7,5135.42 Interest Receivable: $7,500 10% (65/360 days) 7. How much interest would Tate s Place from Exercise 6 receive on September 30, 2015? Prepare the journal entry required for the receipt. Sept. 30 Cash 375.00 Interest Receivable 135.42 Interest Revenue 239.58 Cash received: $7,500 10% ½ year
Investments and Fair Value Accounting 3 8. Sunshine Books purchased $15,000 of Beckman s bonds at 102% of their face amount, plus any accrued interest on August 10, 2015. The bonds have a 5% interest rate, payable on June 30 and December 31. Prepare the journal entry to record the purchase. Round any interest accrued to the nearest cent. Assume a 360-day year, with 30 days in each month. Aug. 10 Bonds Receivable-Beckman 15,000.00 Interest Receivable 83.33 Premium on Bonds Receivable 300.00 Cash 15,383.33 Interest Receivable: $15,000 5% (40/360 days) Premium on Bonds Receivable: 2% $15,000 Strategy: If a bond is sold between interest payments, a seller prefers to sell the bond for its current value and any interest earned since the previous payment. Otherwise, the seller would lose the interest revenue since the buyer will receive the interest. The journal entry to record the purchase includes increasing Bonds Receivable and Interest Receivable with a debit and crediting Cash for the amount paid. The journal entry should also record any discount received or premium paid. Interest Receivable should be increased for the amount of the interest earned between the last interest payment and the date of purchase. 9. Use the information from Exercise 8 to prepare the receipt of interest on December 31 for Sunshine Books. The premium amortization for the period totals $60. Dec. 31 Cash 375.00 Interest Receivable 83.33 Premium on Bonds Receivable 60.00 Interest Revenue 231.67 Cash received: $15,000 5% ½ year Strategy: Upon receipt of the interest payment, debit Cash for amount of interest received. Remove the receivable by crediting Interest Receivable for the amount previously recorded. Record any amortization of the discount or premium, and any remainder should be recorded as Interest Revenue to show that the bondholder has earned that amount of interest since the purchase.
4 Chapter 15 10. On August 15, 2015, Pear Inc. sells $10,000 of ABC Co. 9% bonds at 99% of their face amount, plus any accrued interest. The bonds pay interest semiannually, on June 30 and December 31. Prepare the journal entry to record the sale, rounding any interest accrued to the nearest cent. Assume a 360-day year, with 30 days in each month. Aug. 15 Cash 10,012.50 Loss on Sale of Investments 100 Bonds Receivable-ABC Co. 10,000.00 Interest Revenue 112.50 Interest Revenue: $10,000 9% (45/360 days) Cash: ($10,000 99%) + $112.50 11. Tate s Place sells $8,000 of WW Co. s bonds for 104% of their face amount, plus any accrued interest on February 5, 2015. The bonds pay interest semiannually at a 12% rate, on June 30 and December 31. Prepare the journal entry to record the sale. Round Interest Receivable to the nearest cent. Assume a 360-day year, with 30 days in each month. Feb. 5 Cash 8,413.33 Gain on Sales of Investments 320.00 Bonds Receivable-WW Co. 8,000.00 Interest Revenue 93.33 Interest Revenue: $8,000 12% (35/360 days) Cash: ($8,000 104%) + 93.33 12. On November 25, 2015, Sunshine Books sells $15,000 of Beckman s bonds for 101% of their face value, plus any accrued interest. The bonds pay interest at a 10% rate, payable on June 30 and December 31. Prepare the journal entry to record the sale, rounding any interest accrued to the nearest cent. Assume a 360-day year, with 30 days in each month. Nov. 25 Cash 15,754.17 Gain on Sale of Investments 150.00 Bonds Receivable-Beckman 15,000.00 Interest Revenue 604.17 Interest Revenue: $15,000 10% (145/360 days) Cash: ($15,000 101%) + $604.17
Investments and Fair Value Accounting 5 Strategy: To record the sale of a bond, credit Bonds Receivable for its face amount. If any unamortized premium or discount still exists for the bond, it should also be removed from the books. Credit Interest Revenue for the amount of interest earned since the last payment date because the bondholder has earned the income for holding the bond. If the cash received is greater than the carrying value of the bond and interest earned, a gain should be recorded (as a credit). If the cash received is less than the carrying value of the bond and interest earned, a loss should be recorded (as a debit). 13. Brady s Brunch purchases 10% of the outstanding stock of Texas Suppliers for $35,000 on January 1, 2015. On May 15, 2015, Brady s Brunch receives $1,000 in dividends from Texas Suppliers. Brady s Brunch sells half of the stock in Texas Suppliers for $18,900 on November 25, 2015. Prepare the journal entries for the following: a. Purchase of Texas Suppliers stock Jan. 1 Investments-Texas Suppliers 35,000 Cash 35,000 b. Receipt of dividends May 15 Cash 1,000 Dividend Revenue 1,000 c. Sale of Texas Suppliers stock Nov. 25 Cash 18,900 Gain on Sale of Investments 1,400 Investments-Texas Suppliers 17,500
6 Chapter 15 14. Prepare the journal entries required for the following transactions: a. Purchase of 15% of WFU Stock for $15,000 on March 3, 2015 Mar. 3 Investments-WFU 15,000 Cash 15,000 b. Receipt of $10,000 of dividends on July 15, 2015 July 15 Cash 10,000 Dividend Revenue 10,000 c. Sale of ¼ of stock for $3,000 on August 22, 2015 Aug. 22 Cash 3,000 Loss on Sale of Investments 750 Investments-WFU 3,750 15. Prepare the journal entries required for the following transactions associated with the investment in Charleston Carriers: a. Purchase of 5% of stock for $12,000 on May 5, 2015 May 5 Investments-Charleston Carriers 12,000 Cash 12,000 b. Receipt of $7,200 of dividends on August 9, 2015 Aug. 9 Cash 7,200 Dividend Revenue 7,200 c. Sale of ⅓ of stock for $7,500 on December 31, 2015 Dec. 31 Cash 7,500 Gain on Sale of Investments 3,500 Investments-Charleston Carriers 4,000 Strategy: Under the cost method, equity investments should be recorded at their cost when purchased. Dividend revenue should be recorded when earned. Upon sale, credit the Investment account for its cost since the account does not reflect any changes in value. If the cash received is greater than its cost, credit Gain on Sale of Investments. If the cash received is less than the cost of the investment, debit Loss on Sale of Investments.
Investments and Fair Value Accounting 7 16. On January 1, 2015, a corporation purchased 35% of Showman s outstanding stock for $25,000. For the 2015 calendar year-end, Showman s earned net income of $90,000 and paid $45,000 of total dividends on September 30, 2015. Prepare the journal entries required for the year to record the changes in the investment s account balance. Also determine the ending balance on December 31, 2015. Jan. 1 Investment in Showman Stock 25,000 Cash 25,000 Sept. 30 Cash 15,750 Investment in Showman Stock 15,750 Dec. 31 Investment in Showman Stock 31,500 Income of Showman 31,500 Investment in Showman Stock 25,000 15,750 31,500 40,750 17. A corporation purchased 40% of Tiger Lily s outstanding stock for $62,000 on January 1, 2015. Tiger Lily paid total dividends of $40,000 on June 30 and $10,000 on October 1. The investee suffered a net loss of $10,400 for the 2015 fiscal year. Assuming the corporation has a calendar year-end, prepare the journal entries to record the investment. Also determine the balance of the investment account at the end of the year. Jan. 1 Investment in Tiger Lily 62,000 Cash 62,000 June 30 Cash 16,000 Investment in Tiger Lily Stock 16,000 Oct. 1 Cash 4,000 Investment in Tiger Lily Stock 4,000 Dec. 31 Loss of Showman 4,160 Investment in Tiger Lily Stock 4,160 Investment in Tiger Lily Stock 62,000 16,000 4,000 4,160 37,840
8 Chapter 15 18. On June 30, 2015, a corporation purchased 25% of the outstanding common stock of Old Fashioned Corp. for $48,000. Old Fashioned Corp. paid $28,000 in dividends to its shareholders on September 5, 2015, and earned a net income of $72,000. Prepare the journal entries to record the investment and determine the ending balance of the investment account at the calendar year-end. June 30 Investment in Old Fashion Corp. Stock 48,000 Cash 48,000 Sept. 5 Cash 7,000 Investment in Old Fashioned Corp. Stock 7,000 Dec. 31 Investment in Old Fashioned Corp. Stock 9,000 Income of Old Fashioned Corp. 9,000 Income of Old Fashioned Corp.: ($72,000 25% ½ year) Old Fashioned Corp. 48,000 7,000 9,000 50,000 Strategy: Under the equity method, record the investment at its cost by debiting the account and crediting Cash for the amount paid. The account should also reflect income earned or loss of the investee. If the investee produced income, credit Income of the Investee and debit the investment account to reflect the increase. Record a loss of the investee with a debit to Loss of the Investee and a credit to the investment account to reflect the decrease. Dividend received also decrease the investment account because the investor has received income from its investment.
Investments and Fair Value Accounting 9 19. On March 15, 2015, MSA Corporation purchased a portfolio of the trading securities below. Prepare the journal entries to record the purchase and change in fair value of the investment on December 31, 2015. No. Shares Cost, Mar. 15 Fair Value, Dec. 31 Red Co. 1,000 $14,500 $17,900 White Co. 2,500 32,100 31,500 Blue Co. 500 10,000 8,500 Total $56,600 $57,900 Mar. 15 Investments in Trading Securities 56,600 Cash 56,600 Dec. 31 Valuation Allowance for Trading Investments 1,300 Unrealized Gain on Trading Investments 1,300 20. Assume that the investments in Exercise 19 are classified as available-for-sale securities. Prepare the journal entries required for the purchase and change in fair value for MSA Corporation. Mar. 15 Investments in Available-for-Sale Securities 56,600 Cash 56,600 Dec. 31 Valuation Allowance for Available-for-Sale Investments 1,300 Unrealized Gain on Available-for-Sale Investments 1,300 21. Voglen Corporation had the following investments as of the end of its fiscal year on September 30, 2015. Prepare the journal entry required to reflect the change in fair value of the trading securities. No. Shares Cost Fair Value, Sept. 30 ABC Inc. 1,250 $ 9,850 $ 9,700 XYZ Co. 2,500 10,500 8,750 LMN Corp. 750 3,100 3,250 Total $23,450 $21,700 Sept. 30 Unrealized Loss on Trading Investments 1,750 Valuation Allowance for Trading Investments 1,750
10 Chapter 15 22. Voglen Corporation s portfolio in Exercise 21 consists of all available-for-sale securities rather than trading securities. Prepare the journal entry on September 30, 2015, to record the decrease in fair value. Sept. 30 Unrealized Loss on Available-for-Sale Investments 1,750 Valuation Allowance for Available-for-Sale Investments 1,750 23. Old Fashioned Corp. had the following investments as of the end of its 2015 calendar year-end, which were purchased on April 1, 2015. Prepare the journal entry to record the purchase and change in fair value of the trading securities. No. Shares Cost, Apr. 1 Fair Value, Dec. 31 Tall's Clothing 1,100 $ 5,100 $ 4,950 Shoes Inc. 6,500 12,900 13,400 Dress Express 2,350 9,900 10,500 Total $27,900 $28,850 Apr. 1 Investment in Trading Securities 27,900 Cash 27,900 Dec. 31 Valuation Allowance for Trading Investments 950 Unrealized Gain on Trading Investments 950 Strategy: Record the purchase of trading securities at cost, with a debit to Investment in Trading Securities and credit to Cash. Since the balance sheet presents the trading securities at fair value, a valuation allowance is used for any changes. Increase Valuation Allowance for Trading Investments for any gains using a debit and a corresponding credit to Unrealized Gain on Trading Investments. Losses decrease Valuation Allowance for Trading Investments with a credit and a corresponding debit to Unrealized Loss on Trading Investments. The balance in the valuation account should reflect the difference between the cost and fair value of the investments.
Investments and Fair Value Accounting 11 24. If Old Fashioned Corp. s investments in Exercise 23 were classified as available-for-sale securities, how would the corporation record the purchase and change in fair value? Apr. 1 Investment in Available-for-Sale Securities 27,900 Cash 27,900 Dec. 31 Valuation Allowance for Available-for-Sale Investments 950 Unrealized Gain on Available-for-Sale Investments 950 Strategy: Available-for-sale investments should be recorded similar to trading investments. Record the purchase of available-for-sale investments at cost and use a valuation allowance to reflect any changes in value. 25. Poppy s Place has the account balances listed below as of December 31, 2015. Ignoring any other accounts, prepare the asset section of the balance sheet for the company. Dr. Cr. Trading Investments (at cost) $ 43,000 Valuation allowance for trading investments $1,850 Investment in Shelli's Sea Spot (equity method) 790,550 Held-to-maturity securities (face value, receivable in 4 years) 2,500,000 Unamortized premium on held-to-maturity securities 497,300 Available-for-sale securities (at cost, will sell in upcoming period) 22,300 Valuation allowance for available-for-sale securities 220 Poppy's Place Balance Sheet December 31, 2015 Assets: Current assets: Trading investments (at cost) $ 43,000 Less valuation allowance for trading investments 1,850 $ 41,150 Available-for-sale securities (at cost) $ 22,300 Plus valuation allowance for available-for-sale securities 220 22,520 Total current assets $ 63,670 Investments: Held-to-maturity securities $2,500,000 Plus unamortized premium 497,300 $2,997,300 Investment in Shelli's Sea Spot (equity method) 790,550 Total investments $3,787,850 Total assets $3,851,520
12 Chapter 15 27. Use the account balances below to prepare the asset section of RPC Corporation s balance sheet as of September 30, 2015. Ignore any other accounts the business may have. Dr. Cr. Trading investments (at cost) $21,500 Valuation allowance for trading investments 577 Investment in Shelli's Sea Spot (equity method) 98,000 Held-to-maturity securities (face value, receivable in 20 months) 3,200,000 Unamortized discount on held-to-maturity securities $121,561 Available-for-sale securities (at cost, will sell in upcoming period) 12,300 Valuation allowance for available-for-sale securities 1,050 RPC Corporation Balance Sheet September 30, 2015 Assets: Current assets: Trading investments (at cost) $ 21,500 Plus valuation allowance for trading investments 577 $ 22,077 Available-for-sale securities (at cost) $ 12,300 Less valuation allowance for available-for-sale securities 1,050 11,250 Total current assets $ 33,327 Investments: Held-to-maturity securities $3,200,000 Less unamortized discount 121,561 $3,078,439 Investment in Shelli's Sea Spot (equity method) 98,000 Total investments $3,176,439 Total assets $3,209,766
Investments and Fair Value Accounting 13 28. Using the account balances below, prepare the asset section of Tortoise Cleaning Corporation s balance sheet as of December 31, 2015. Dr. Cr. Trading investments (at cost) $15,400 Valuation allowance for trading investments 995 Investment in Shelli's Sea Spot (equity method) 22,300 Held-to-maturity securities (face value, receivable in 5 months) 1,500,000 Unamortized premium on held-to-maturity securities 11,200 Available-for-sale securities (at cost, will sell in upcoming period) 9,875 Valuation allowance for available-for-sale securities 430 Tortoise Cleaning Corporation Balance Sheet December 31, 2015 Assets: Current assets: Trading investments (at cost) $ 15,400 Plus valuation allowance for trading investments 995 $ 16,395 Available-for-sale securities (at cost) $ 9,875 Less valuation allowance for available-for-sale securities 430 9,445 Held-to-maturity securities $1,500,000 Plus unamortized premium 11,200 1,511,200 Total current assets $1,537,040 Investments: Investment in Shelli's Sea Spot (equity method) $ 22,300 Total assets $1,559,340 Strategy: Trading investments and available-for-sale securities should be shown at their fair value, using a valuation allowance account. A debit in the valuation allowance account means an increase in value of the securities, while a credit indicates a decrease in value of the securities. Held-to-maturity securities should be presented at carrying cost. 29. A corporation uses fair value accounting to account for its trading investments. The investments were purchased for $56,000, but are now worth $62,000. How will this be shown on the balance sheet and income statement? Balance sheet: Use a valuation allowance account to record the $6,000 increase in value Income statement: Report the unrealized gain of $6,000
14 Chapter 15 30. A corporation uses fair value accounting to report its available-for-sale securities. The investments were purchased for $31,000, but are now worth only $29,750. How will the balance sheet and income statement reflect the change in value? Balance sheet: Use a valuation allowance account to record the $1,250 decrease in value, stockholders equity should include the unrealized loss of $1,250 in other comprehensive income Income statement: none 31. A corporation uses fair value accounting to account for its available-for-sale securities. The corporation s balance sheet shows a balance in accumulated other comprehensive income that increases stockholders equity by $1,750. If the securities were purchased for $21,600, what is the fair value of the securities? If the accumulated other comprehensive income increases stockholders equity, the securities have an increase in value (unrealized gain). The value of the securities is $23,350 ($21,600 + $1,750). Strategy: The balance sheet should reflect the fair value of available-for-sale and trading securities using a valuation allowance account. Changes in value of trading securities should be shown on the income statement, as an unrealized gain or loss. Changes in value of available-for-sale securities should be shown on the balance sheet, under stockholders equity as other comprehensive income. 32. Use the information below to calculate MSA Corporation s dividend yield as of the 2015 and 2016 year-end. Round percentages to two decimal places. Determine if the change makes the corporation s stock more or less attractive to investors. 2016 2015 Dividends per share of common stock $3.25 $4.25 Market price per share of common stock 57.20 59.35 Dividend yield 5.68% 7.16% The decrease in the dividend yield may cause the stock to seem less attractive to investors because they will receive less income compared to their investment. However, if the company didn t pay dividends in order to invest in internal projects and grow, the investment may be attractive to investors.
Investments and Fair Value Accounting 15 33. Use the information below to calculate the dividend yield for the two corporations. Round percentages to two decimal places. If an investor would like to receive a high dividend from his investment, which stock should he purchase? ABC Corp. XYZ Inc. Total dividends paid $95,400 $18,500 Preferred stock dividends 30,500 6,700 Number of common shares outstanding 10,000 3,800 Market price per share of common stock 45.10 25.67 Dividends per share of common stock 6.49 3.11 ($95,400 $30,500)/10,000 shares ($18,500 $6,700)/3,800 shares Dividend yield 14.39% 12.12% An investor looking for a high dividend from the investment should purchase stock of ABC Corp. because it has the higher dividend yield. 34. Calculate WFU Corporation s dividend yield for 2015 and 2016. Round percentages to two decimal places. If an investor is looking for a high dividend for his investment, does the corporation s stock seem more or less attractive in 2015 or 2016? 2016 2015 Total dividends paid $102,900 $100,200 Preferred stock dividends 35,850 34,100 Number of common shares outstanding 20,100 20,850 Market price per share of common stock 31.22 30.95 Dividends per share of common stock 3.34 3.17 ($102,900 $35,850)/20,100 shares ($100,200 $34,100)/20,850 shares Dividend yield 10.70% 10.24% If an investor is looking for a high dividend, the corporation will look like a better investment in 2016 because it produces a higher dividend yield. Strategy: First, determine the dividends allocable to the common stock and dividends per share of common stock. Calculate the dividend yield by dividing the dividends per share of common stock by the market price per share of common stock. The yield is the percentage return the investor will receive for the investment. A higher dividend yield suggests a higher return of dividends per dollar invested.