ACY4001 Advanced Accounting ǀ

2019-20 Semester 2

Individual Assignment 2
Chapter 17 Investments

Questions & Solutions

IA17.1 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.

Sharapova Company ordinary shares, $100 par, 200

Feb. 1, 2019 $ 37,400
shares
Government bonds, 11%, due April 1, 2025, interest
April 1 payable April 1 and October 1, 110 bonds of $1,000 par 110,000
each

McGrath Company 12% bonds, par $50,000, dated March

July 1 1, 2019 purchased at 104, plus accrued interest payable 54,000
annually on March 1, due March 1, 2039

Instructions

(Round all computations to the nearest dollar.)

a. Prepare entries necessary to classify the amounts into proper accounts, assuming
that Paz plans to actively manage these investments.

b. Prepare the entry to record the accrued interest on December 31, 2019.

c. The fair values of the investments on December 31, 2019, were:

Sharapova Company shares $ 31,800

Government bonds 124,700
McGrath Company bonds 58,600

What entry or entries, if any, would you recommend be made?

d. The government bonds were sold on July 1, 2020, for $119,200 plus accrued
interest. Give the proper entry.
Solution A

(a) Equity Investments ................................................... 37,400

Debt Investments .................................................. 162,000*
Interest Revenue ($50,000 X .12 X 4/12) ............... 2,000
Investments ................................................................. 201,400

*[$110,000 + $52,000]
Note: It’s assumed that all the investments were initially recorded in Investments. Under
this assumption, the above entry is made at the end of reporting period to classify the
investments into equity and debt investments.

(b) December 31, 2019

Interest Receivable..................................................... 8,025*

Debt Investments ($2,000 X 6/236) ............................. 51**
Interest Revenue ......................................................... 7,974

*[Accrued interest
[ $50,000 X .12 X 10/12 = $5,000
[Accrued interest
[ $110,000 X .11 X 3/12 = 3,025
$8,025]

** The amortization of bond premium for 2019 (6 months) under the

straight-line method.

Note: Under the straight-line method of amortization of bond discount or premium, the bond
discount or premium is amortized in equal amounts over the life of the bond. Compared to
the effective interest method, which is the most common method in practice and the one
discussed in the lecture notes, the straight-line method of amortization of bond premium or
discount is easier and less costly to apply. As such, it’s also acceptable especially when the
premium or discount on the bond is of low amount or the bond is long term. In this question,
the premium on the McGrath Company bonds is $2,000 and bonds are 20-year bonds, that
justify the use of the straight-line method of amortization of bond premium.
(c)
December 31, 2019
Investment Portfolio
Unrealized
Investments Cost Fair Value Gain (Loss)
Sharapova Company shares $ 37,400 $ 31,800 $(5,600)
Government bonds 110,000 124,700 14,700
McGrath Company bonds 51,949* 58,600 6,600
Total $199,349 $215,100 15,751
Previous fair value adjustment
balance 0
Fair value adjustment—Dr. $15,751

*The amortized cost of the McGrath Bonds at 31 December 2019.

Fair Value Adjustment ........................................... 15,751

Unrealized Holding Gain or Loss—
Income ................................................................... 15,751

(d) July 1, 2020

Cash ($119,200 + $3,025) .................................................. 122,225

Debt Investments ..................................................... 110,000
Interest Revenue ($110,000 X .11 X 3/12)................ 3,025
Gain on Sale of Investments ................................... 9,200
Solution B

As the premium on the McGrath bonds is immaterial, an alternative solution as

below, in which the bonds premium is ignored in the years prior to the maturity, is
also acceptable. But as the method causes a mismatch problem, it’s not
recommended.

(a) Equity Investments ................................................... 37,400

Debt Investments .................................................. 162,000*
Interest Revenue ($50,000 X .12 X 4/12) ............... 2,000
Investments ................................................................. 201,400

*[$110,000 + $52,000]

(b) December 31, 2019

Interest Receivable...................................................... 8,025

Interest Revenue ......................................................... 8,025*

*[Accrued interest
[ $50,000 X .12 X 10/12 = $5,000
[Accrued interest
[ $110,000 X .11 X 3/12 = 3,025
$8,025]

(c)
December 31, 2019
Investment Portfolio
Unrealized
Investments Cost Fair Value Gain (Loss)
Sharapova Company shares $ 37,400 $ 31,800 $(5,600)
Government bonds 110,000 124,700 14,700
McGrath Company bonds 52,000* 58,600 6,600
Total $199,400 $215,100 15,700
Previous fair value adjustment
balance 0
Fair value adjustment—Dr. $15,700
 Fair Value Adjustment ........................................... 15,700
Unrealized Holding Gain or Loss—
Income ................................................................... 15,700

(d) July 1, 2020

Cash ($119,200 + $3,025) .................................................. 122,225

Debt Investments ..................................................... 110,000
Interest Revenue ($110,000 X .11 X 3/12)................ 3,025
Gain on Sale of Investments ................................... 9,200
IA17.2 The treasurer of Miller AG has read on the Internet that the price of Wade Inc.
ordinary shares is about to take off. In order to profit from this potential development,
Miller purchased a call option on Wade shares on July 7, 2019, for €240. The call option
is for 200 shares (notional value), and the strike price is €70. (The market price of a Wade
share on that date is €70.) The option expires on January 31, 2020. The following data
are available with respect to the call option.

Market Price of Wade Time Value of

Date
Shares Call Option

September 30, 2019 €77 per share €180

December 31, 2019 65 per share 65
January 4, 2020 72 per share 30

Instructions

Prepare the journal entries for Miller for the following dates.

a. July 7, 2019—Investment in call option on Wade shares.

b. September 30, 2019—Miller prepares financial statements.

c. December 31, 2019—Miller prepares financial statements.

d. January 4, 2020—Miller settles the call option on the Wade shares.

Solution

(a) July 7, 2019

Call Option ....................................................................... 240
Cash ............................................................................... 240

(b) September 30, 2019

Call Option .................................................................... 1,400
Unrealized Holding Gain or Loss—
Income (€7 X 200) ....................................................... 1,400

Unrealized Holding Gain or Loss—Income ...................... 60

Call Option (€240 – €180) .............................................. 60

(c) December 31, 2019

Unrealized Holding Gain or Loss—Income ................ 1,400
Call Option (€7 X 200) ................................................... 1,400

Unrealized Holding Gain or Loss—Income ................... 115

Call Option (€180 – €65) ................................................ 115

(d) January 4, 2020

Call Option (€2 X 200) ..................................................... 400
Unrealized Holding Gain or Loss—Income ................. 400

Unrealized Holding Gain or Loss—Income ..................... 35

Call Option (€65 – €30) .................................................. 35

Cash (200 X €6)................................................................ 400

Loss on Settlement of Call Option................................... 30
Call Option ..................................................................... 430