Dimple Patel

06/25/17
ACTP 5007 - Summer 2017

Worksheet 3 Investments

Problem 1 Investment in Bonds

On January 1, 2016, Lomax Company purchased $100,000 of 8 percent, five-year

bonds of Sherman Company for $92,278. The bonds were selling for $94,800 on July
1, 2016 and had an amortized cost of $92,892. The bonds were selling for $95,655
as of December 31, 2016 and had an amortized cost of $93,537 on that date. The
bonds pay interest semi-annually on January 1 and July 1, and they mature on
January 1 ,2021.

Required:

1. Assume that Lomax intends to sell the bond in August of 2016.

a. How would they classify this investment? (Trading, Available-for-Sale,
Held-to-Maturity)

There are three primary types of debt securities used by companies: held-to-
maturity debt securities, trading securities, and available-for-sale securities.
Because the Lomax corporation does not intend on holding the bond until it
reaches maturity in 2021, the company cannot classify the debt securities as
held-to-maturity securities, as its name clearly states that the bonds are only
held upon its specific maturity date. As such, the company must rule out the
amortized cost method because said method only pertains to held-to-maturity
securities. Two options are left: trading securities and available-for-sale
securities. Available-for-sale maturities can be used when a company does not
plan to sell the security in the near future but does not or cannot hold said
security until its specific maturity date. As such, companies utilize trading
securities when they purchase bonds with the intention of selling them in the
near future. Because Lomax intended on selling said bond in August 2016, a date
close to the date of the bond purchase, then the company must classify the bond
as a trading security.

**Answer: The bond is a trading security.

1
 b. Based on your answer to question 1, at what amount would they
report the bonds on their books at July 1, 2016?

These bonds, which are now classified as trading securities because of

Lomaxs intent on selling them in the near future, show their fair value on the
balance sheet, and net income includes any unrealized holding gains and losses.
Specifically, in the case of Lomax Companys purchase, the bonds fair value on
July 1, 2016, is $94,800. Because this quantity is more than the purchase price of
the bond, the company experiences an unrealized holding gain on the bond
(unrealized because the bond hasnt been sold yet). Therefore, the bond amount
reported on the balance sheet on July 1, 2016, would be $94,800.

**Answer: Therefore, the bond amount reported on the balance sheet

on July 1, 2016, would be $94,800.

c. Based on your answer to question 1, prepare the journal entry to

report the fair value adjustment of the security on July 1, 2016.

The initial journal entry for the purchase of the bonds would be as follows:

Purchase $
Investment in Sherman bonds 92,278
Cash 92,278

The following shows the interest revenue as there is a semiannual interest

due on July 1:

6
=
12
6
= 0.08 $92,278 = $3,691
12

Interest $
Cash 3,691
Interest Revenue 3,691

These aforementioned journal entries are needed to keep track of the trading
security. Essentially, for the adjusting journal entry, the trading securitys
purchase price and the fair value price are needed in order to calculate the
adjustment, whether it is a gain or a loss:

2
 =

= $94,800 $92,278 = $2,522 ()

**Answer: Therefore, the fair value adjustment would be as follows,

which is reported on the income statement (I/S):

Adjusting Entry $
Fair Value Adjustment 2,522
Net Realized Gain-I/S 2,522

2. Assume that Lomax does not plan to sell these securities in the short-term,
nor do they intend to hold the bonds until January 1, 2021.
a. How would they classify these bonds? (Trading, Available-for-Sale,
Held-to-Maturity).

Available-for-sale securities are debt and equity securities that are not held
for trading, not held for strategic reasons, and not held to maturity. Moreover, an
important characteristic of this changed security is that the company does into
to profit from said bond by selling them in the short-term. The companys lack of
intent to sell said securities rules out their classification as trading securities;
also, because the company will not hold the bonds until their maturity date in
2021, the bonds are not held-to-maturity securities. Therefore, Lomaxs
securities are now classified as available-for-sale securities that will be valuated
at fair value. Moreover, the securities unrealized holding gains or losses are
recognized as other comprehensive income (OCI) and as a separate component
of stockholders equity.

**Answer: These bonds are available-for-sale securities.

b. Based on your answer to question 2, at what amount would the bonds

be reported on the balance sheet at December 31, 2016?

These bonds, which are now classified as available-for-sale securities

because of Lomaxs uncertain intent on selling them before their maturity date,
show their fair value on the balance sheet, and other comprehensive income, not
net income, show any unrealized holding gains and losses. Specifically, in the
case of Lomax Companys purchase, the bonds fair value on December 31, 2016,
is $95,655. Because this quantity is more than the purchase price of the bond,
the company experiences an unrealized holding gain on the bond (unrealized
because the bond hasnt been sold yet). Therefore, the bond amount reported on
the balance sheet on December 31, 2016, would be $95,655.

3
 **Answer: Therefore, the bond amount reported on the balance sheet
December 31, 2016, would be $95,655.

c. Based on your answer to question 2, prepare the journal entry to

report the fair value adjustment of the security on December 31,
2016, if applicable.

Most of the journal entries for an available-for-sale security mimic those of a

trading security; however, one key difference is the reporting of any unrealized
gains or losses, which are reported on the other comprehensive income
statement. The initial journal entry for the purchase of the bonds would be as
follows on January 1:

Purchase $
Investment in Sherman bonds 92,278
Cash 92,278

The following shows the interest revenue as there is a semiannual interest

due on July 1 and December 31:

6
=
12
6
= 0.08 $92,278 = $3,691
12
July 1
Interest $
Cash 3,691
Interest Revenue 3,691

December 31
Interest $
Cash 3,691
Interest Revenue 3,691

If a simplified and cleaner journal entry is needed that shows the aggregate
interest earned at the end of the year, the following journal entry would suffice:

Year-End Interest $
Cash 7,382
Interest Revenue 7,382

These aforementioned journal entries are needed to keep track of the

security. Essentially, for the adjusting journal entry, the available-for-sale

4
 securitys purchase price and the fair value price are needed in order to calculate
the adjustment, whether it is a gain or a loss:

= $95,655 $92,278 = $3,377 ()

**Answer: Therefore, the fair value adjustment would be as follows,

which is reported on the other comprehensive income statement (OCI):

Adjusting Entry $
Fair Value Adjustment 3,377
Net Realized Gain-OCI 3,377

3. Ignoring your answers to questions 1 and 2 assume, assume, instead, that

Lomax DOES intend to hold the bonds until January 1, 2021
a. How would Lomax classify the bonds? (Trading, Available-for-Sale,
Held-to-Maturity).

If Lomax does intend to hold the bonds until January 1, 2021, then essentially
the company will be holding the bonds until the bonds maturity date. This
attribute qualifies Lomaxs bonds as held-to-maturity securities, which are debt
investments like notes or bonds that a company holds until their maturity date.
These types of securities are primarily bought to earn interest revenue for the
purchasing company. If the security matures within 12 months, the held-to-
maturity security will be reported as a current asset on the balance sheet.
However, a maturity date that is beyond one year requires reporting of the
securities as noncurrent assets. Also, the bonds have an explicit maturity date,
further qualifies them as held-to-maturity securities. These investments are
recorded at a cost including any brokerage fees; moreover, they are reported on
the balance sheet at their amortized value.

**Answer: These bonds are held-to-maturity securities.

b. Based on your answer to question 3, at what amount would the bonds

be reported on the balance sheet at December 31, 2016?

These bonds, which are now classified as held-to-maturity securities because

of Lomaxs intent on holding them until their maturity date, show their
amortized value on the balance sheet, and any unrealized holding gains and
losses are not recognized. Specifically, in the case of Lomax Companys purchase,
the bonds amortized value is $93,537. Therefore, the bond amount reported on
the balance sheet on December 31, 2016, would be $93,537.

5
**Answer: Therefore, the bond amount reported on the balance sheet on
December 31, 2016, would be $93,537.

c. Based on your answer to question 3, prepare the journal entry to

report the fair value adjustment of the security on December 31,
2016, if applicable.

The first journal entry for this type of bond would relate to its purchase. However,
because the value of the bonds and the purchase price of said bonds are different,
the discount on the bond investment needs to be calculated with the following
formula and then inputted into the journal entry:

=
= $100,000 $92,278 = $7,722

Purchase $
Investment in Sherman bonds 100,000
Discount on Bond Investment 7,722
Cash 92,278

However, because this bond is a held-to-maturity one, there are no required journal
entries for fair value adjustment as such adjustments are only recorded for trading
securities and available-for-sale securities, but not held-to-maturity ones.

**Answer: No journal entry is required for a held-to-maturity bond showing

its fair value adjustment.

6
Problem 2 Investment in Stock

On January 1, 2015, Resnick Company purchased 800 shares of Vallejo Company

stock for $22.50 per share plus $1,200 of brokerage fees and 500 shares of Rodman
Company stock for $90 per share plus $1,500 of brokerage fees. The fair market
value per share at December 31, 2015 and 2016 was as follows:

2015 2016
Fair Market Value Fair Market Value

Vallejo Co. $28 $27

Rodman Co. 91 95

Resnick Company intended to hold both stocks for several years. Assume that the
two stock holdings are the only securities in their investment portfolio.

Required:

1. How would Resnick classify this stock? (Trading, Available-for-sale, Held-to-

Maturity, Equity security or other?)

This stock would not qualify as an equity security because typically the
investor owns between 20% and 50% of the voting stock of the investee; here,
the ownership interest is not clearly indicated. Other types of securities quality
for reporting methodology when the investor lacks significant influence over the
operating and financial policies of the investees; these securities include trading
securities, available-for-sale securities, and held-to-maturity securities. Because
the securities will be held for several years, they are not trading securities as the
latter are held in active trading accounts. Moreover, if investors have the
positive intent and ability to hold the security to its maturity date, the investors
reporting method would qualify as a held-to-maturity security. Resnicks stock
qualifies as neither, as they intend on holding both of their stocks in their
portfolio for only several years. Therefore, this stock is classified as securities
available-for-sale.

**Answer: Therefore, this stock is classified as securities available-for-

sale.

7
 2. Prepare the entries necessary to adjust the securities to market value at the
end of 2015 and 2016. (Be sure to specify whether your unrealized holding
gains/losses are reported in income or equity).
First, Resnicks two purchasing amounts must be calculated for shares of
Vallejo Company and shares of Rodman company. The formula entails
multiplying the number of purchased shares with cost per share and adding the
relevant brokerage fee.

= ( ) ( )
+
$22.50
= (800 ) ( ) + $1,200
1
= $19,200
$90.00
= (500 ) ( ) + $1,500
1
= $46,500

Therefore, in regards to the purchase amounts for the respective stock

shares, Resnick company would have to record the following initial journal
entries:

Investment in Vallejo Stock $

Investment in Vallejo stock shares 19,200
Cash 19,200

Investment in Rodman Stock $

Investment in Rodman stock shares 46,500
Cash 46,500

Moreover, in regards to the fair market value adjustments, the brokerage fee
does not need to be included as the fee cancels out of the fair market value
adjustment equation. Therefore, the focus shall be on the effect of the fair market
values on the original values of the various stock prices; the net unrealized
holding gains or losses are given by these equations:

2015
= ( ) ( 2015
2015 )

2015
= (800 ) ($28 $22.50 ) = $4,400 ()

8
 2015
= (500 ) ($91 $90 ) = $500 ()

For all of the adjusting fair value journal entries, the entries need to be made
in the other comprehensive income section as the type of security dealt with
here is the available-for-sale security. The adjusting entries for December 31,
2015 would be provided by the following:

Vallejo Stock Investment-Dec. 2015

Net Unrealized Fair Value Change $
Net Unrealized Fair Value Gain or Loss-OCI 4,400
Fair Value Adjustment 4,400

Rodman Stock Investment-Dec. 2015

Net Unrealized Fair Value Change $
Net Unrealized Fair Value Gain or Loss-OCI 500
Fair Value Adjustment 500

The calculation for the fair value changes is used again for the 2016 period.
However, it is important to note that instead of using the fair values of the
previous year (December 31, 2015), the purchase price from the original time of
purchase will be used:

2016
= ( ) ( 2016
2016 )

2016
= (800 ) ($27 $22.50 ) = $3,600 ()

2016
= (500 ) ($95 $90 ) = $2500 ()

However, before the appropriate fair value adjusting entries can be made, it
is important to note that the relative change in the fair market value prices need
to be recorded, not the absolute fair value adjustment for 2016.

Vallejo Share Investment Fair value adjustment

Balance needed in fair value adjustment: $3,600
Existing balance in fair value adjustment: $4,400
Increase/Decrease needed in fair value adjustment: ($800)

$4,400 $3,600 $2,800 $2,000

-$800
9
 Rodman Share Investment Fair value adjustment
Balance needed in fair value adjustment: $2,500
Existing balance in fair value adjustment: $500
Increase/Decrease needed in fair value adjustment: $2,000

$500 $1,500 $2,500 $3,500

+$2500

Therefore, given the relative change in the fair value prices of the various
stocks, the following journal entries suffice in showing the necessary
adjustments:

*Answer
Vallejo Stock Investment-Dec. 2016
Net Unrealized Fair Value Change $
Fair Value Adjustment 800
Net Unrealized Fair Value Gain or Loss-OCI 800

Rodman Stock Investment-Dec. 2016

Net Unrealized Fair Value Change $
Net Unrealized Fair Value Gain or Loss-OCI 2500
Fair Value Adjustment 2500

*Answer
Vallejo Stock Investment-Dec. 2015
Net Unrealized Fair Value Change $
Net Unrealized Fair Value Gain or Loss-OCI 4,400
Fair Value Adjustment 4,400

Rodman Stock Investment-Dec. 2015

Net Unrealized Fair Value Change $
Net Unrealized Fair Value Gain or Loss-OCI 500
Fair Value Adjustment 500

10
 3. Assume that, at the beginning of 2016, Resnick sold half of its shares of the
Vallejo Company stock for $30 per share plus $600 in brokerage selling fees.
Prepare the journal entry to record the sale of the Vallejo Company stock.

If no adjustments are to be made, then the initial investment placed for half
of the Vallejo company shares needs to be calculated.

= ( ) ( )
+

1 $22.50
= (800 ) ( ) + $1,200 1/2 = $9,600
2 1

Then the gain from the Vallejo stock sale needs to be calculated with a similar
formula; the resulting quantity needs to then be compares to the Vallejo stock
investment cost in order to yield the gain or loss on sale of the investment.

= ( ) ( )
+

1 $30.00
= (800 ) ( ) + $600
2 1
= $12,600

= ( ) ( )

= $12,600 $9,600 = $3,000 ()

**Answer:
Sale of Vallejo Stock $
Cash $12,600
Gain on Sale of Investment $3,000
Investment in Vallejo Stock $9,600

11
 4. What other adjustments would Resnick need to make to its financials to
account for the sale of the Vallejo stock?

Resnick would have to make an adjustment to its net unrealized fair value
change, as the original calculation accounted for all 800 shares. Now that the
shares are halved, the adjusted fair value can be altered to accommodate the
stock sale:

2015
= ( ) ( 2015
2015 )

2015
1
= (800 ) ($30 $22.50 ) = $3,000 ()
2

For all of the adjusting fair value journal entries, the entries need to be made
in the other comprehensive income section as the type of security dealt with
here is the available-for-sale security. The adjusting entries would have to be
changed to the following for the start of 2016 if the net fair value was already
calculated for December 31, 2015:

Vallejo Stock Investment-Dec. 2015

Net Unrealized Fair Value Change $
Net Unrealized Fair Value Gain or Loss-OCI 4,400
Fair Value Adjustment 4,400

*Answer:
Vallejo Stock Investment-Jan. 2016
Net Unrealized Fair Value Change $
Fair Value Adjustment 3,000
Net Unrealized Fair Value Gain or Loss-OCI 3,000

The previous had to be calculated such that the $3,000 was a loss as those
stocks were sold and no longer under the companys jurisdiction.

On January 1, 2015, Resnick Company purchased 800 shares of Vallejo Company

stock for $22.50 per share plus $1,200 of brokerage fees and 500 shares of
Rodman Company stock for $90 per share plus $1,500 of brokerage fees. The
fair market value per share at December 31, 2015 and 2016 was as follows:

12
 2015 2016
Fair Market Value Fair Market Value

Vallejo Co. $28 $27

Rodman Co. 91 95

5. Assume that Resnick had, instead, elected to use the fair value option to
account for these stocks. Where would it report unrealized holding
gains/losses each period?

Choosing the fair value option for HTM and AFS investments means
reclassifying these investments as TS investments

Under the original conditions, Resnick would have to implement the

reporting option on other comprehensive income as both stocks are
available-for-sale ones, which do not report on the income statement like
trading securities do. In fact, once Resnick decides to implement the fair
value option for these stocks, Resnick must add a supplementary note
explaining the change.

If the stocks were normally available-for-sale, then the company must

classify the stocks as trading securities under the fair value option.
Choosing this option for the companys future leads to a fixed change in the
security type; unfortunately, the company cannot change the security back to
an available-for-sale type from changes in the climate of the market.
Normally, for trading securities, any unrealized holding gains and losses for
the period would be reported on the Income Statement. Therefore, the newly
minted trading securities will be reported in the net income (I/S) in regards
to its sale of investments and purchases.

*Answer: Therefore, the newly minted trading securities will be

reported in the net income (I/S) in regards to its sale of investments
and purchases.

13
Problem 3 Fair value vs. Equity Method

On January 1, 2015, Doral Company purchased 20,000 of the 100,000 outstanding

common shares of Guise Company for $10 per share. During the year, Guise
Company declared net income of $400,000 and paid $50,000 of dividends. On
December 31, 2015, Guise Companys stock had a fair value of $13 per share.

Required:

a. Prepare all necessary entries, assuming that Doral Company is able to exert
significant influence over Guise Company.

Significant influence is assumed to exist if the investor, like Doral Company,

owns between 20% and 50% of Guise Companys voting shares. There is a
distinct absence of control as this does not refer to a >50% ownership interest.
Doral Company could influence both the operating and financial policies of Guise
Company, and Guise Companys decisions could be swayed toward Doral
Companys preference.

The first journal entry on behalf of Doral Company will cover Doral
Companys acquisition of Guise Companys shares. If Doral Company acquired
20,000 shares at $10 per share, then the resulting total investment in the Guise
Company stock would be as follows:

= ( ) ( )
$10.00
= (20,000 ) ( ) = $200,000
1

Then, using the equity method of reporting since the investing company has
a significant influence over Guise:

Doral Company
Purchase $
Investment in Guise Company outstanding shares 200,000
Cash 200,000

Next, in regards to the Guise Company declaring an income of $400,000, the

following equations not only calculate the income declared by the significant
influencing company, Doral, but they also calculate Dorals ownership interest in
percentage:

= ( )
( )

14

= 100%

20,000
= 100% = 20%
100,000

= ($400,000) (20%) = $80,000

Then, using the equity method of reporting since the investing company has
a significant influence over Guise:

Doral Company
Net Income $
Investment in Guise Company outstanding shares 80,000
Investment Revenue 80,000

In regards to the dividends earned by Doral via Guise, the same concept
implemented for the investment revenue is utilized:

= ( )
( )

= 100%

20,000
= 100% = 20%
100,000

= ($50,000) (20%) = $10,000

Doral Company
Dividends $
Cash 10,000
Investment Revenue 10,000

In regards to the net unrealized gains or losses due to changes in fair value,
the investing company, Doral, will not recognize the net gains or losses in their
financial statements as the company is pursuing an equity method of reporting,
not the fair value method, because they have a significant influencing interest
over Guise company.

15
 *Answer
Doral Company
Purchase $
Investment in Guise Company outstanding shares 200,000
Cash 200,000

Doral Company
Net Income $
Investment in Guise Company outstanding shares 80,000
Investment Revenue 80,000

Doral Company
Dividends $
Cash 10,000
Investment Revenue 10,000

*No adjusting entry for net losses or gains due to fair value.

b. Prepare all necessary entries, assuming that Doral Company is NOT able to
exert significant influence over Guise Company.

In this case, Doral company is assumed to not have a significant influence

over Guise Company, so Doral company will no longer have any control over the
finances or operations of the investee. As such, it can be assumed that these
purchased securities are available-for-sale as Doral Companys intention with
said securities is ambiguous in terms of holding periods and potential selling
time frames.

The first journal entry on behalf of Doral Company will cover Doral
Companys purchase of Guise Companys shares. If Doral Company acquired
20,000 shares at $10 per share, then the resulting total investment in the Guise
Company stock would be as follows:

= ( ) ( )
$10.00
= (20,000 ) ( ) = $200,000
1

16
 Then, using the fair value method of reporting since the investing company
has a significant influence over Guise:

Doral Company
Purchase $
Investment in Guise Company outstanding shares 200,000
Cash 200,000

Next, in regards to the Guise Company declaring an income of $400,000, its

imperative to note that available-for-sale securities do not influence net income.
They can, however, be reported under other comprehensive income since net
income is no longer an option.

= ( )
( )

= 100%

20,000
= 100% = 20%
100,000

= ($400,000) (20%) = $80,000

Then, using the fair value method of reporting since the investing company
has no significant influence over Guise:

Doral Company
Other Comprehensive Income $
Investment in Guise Company outstanding shares 80,000
Cash 800,000

In regards to the dividends earned by Doral via Guise, the methodology in the
equity method of reporting is used for the fair value method of reporting:

= ( )
( )

= 100%

17
 20,000
= 100% = 20%
100,000

= ($50,000) (20%) = $10,000

Doral Company
Dividends $
Cash 10,000
Investment Revenue 10,000

In regards to the net unrealized gains or losses due to changes in fair value,
the investing company, Doral, will recognize the net gains or losses in their
financial statements as the company is pursuing a fair value method of reporting,
not the equity method, because they have not significant influencing interest
over Guise company. The following equation and subsequent journal entry
report Doral Companys net gains or losses for the fair value adjustment:

= ( ) ( )
= (20,000 ) ($13) = $260,000

= ( 2015 2015 )

2015
= ($260,000 $200,000) = $60,000 ()

Doral Company
Adjusting Entry $
Fair Value Adjustment 60,000
Net unrealized holding gains or losses 60,000

18
**Answer

Doral Company
Purchase $
Investment in Guise Company outstanding shares 200,000
Cash 200,000

Doral Company
Dividends $
Cash 10,000
Investment Revenue 10,000

Doral Company
Other Comprehensive Income $
Investment in Guise Company outstanding shares 80,000
Cash 800,000

Doral Company
Adjusting Entry $
Fair Value Adjustment 60,000
Net unrealized holding gains or losses 60,000

19