Question

Passive Equity Investment Portfolio Practice Problem

Martin Company has a portfolio of passive equity investments with a cost basis of $34,600 and a fair value of $41,650 on December 31, 2015. Martin Company sells $5,300 (cost) of equity investments on April 1, 2016 for $6,200. Martin Company purchases additional equity investments for $7,125 on August 10, 2016. On November 30, 2016 Martin Company receives $1,350 in dividends from its equity investments. The fair value of Martin’s equity investments is $40,575 on December 31, 2016.

Provide all journal entries for 2016 for Martin Company. Also describe how each equity investment will affect the firm’s 2016 financial statements.

Answer 1

These are the small investment by the Martin company hence it has been assumed that it does not have more than 20% interest in the other company. Hence the method used will be Fair value method. Otherwise we would have used Equity Method.

It is also given in the question that the Fair value as of dec 15 was 41,650 and the cost is 34,600. We need to book the unrealized gains as follows -

Investment value is increased hence investment account will be debited and Unrealized gain account is credited -

1. Investment of costing 5300 is sold for $6200. Also, on Dec 31, 2015 we have already revalued the investment on its fair value therefore the fair value has become the book value in the books. 41650 is the fair value of 34600 hence fair value of 5300 will be 41650/34600*5300 = 6379.91 - this is the new book value - this investment is sold for 6200 incurring a loss of 179.91. The investment has been sold thus the cash will come in which means that the Cash will be debited. further, investment is an asset and will be going out as we are selling it hence investment account will be credited (Remember the rule of Real account). The difference due to loss will be debited in loss on sale account. The entry will be -

2. Purchased equity for 7,125.

Equity investments are purhcased i.e. Investments will get increased and hence will be debited and cash will be going out hence credited.

3. Dividend received of $1350. Dividend is an income hence will be credited ( Remember the rule of nominal account - Expenses are debited and Income are credited). Also, Cash is coming in hence debited. the entry is -

4.The Fair value is 40,575 as of Dec 31, 2016.

Now, calculation of book value as of Dec 31, 2016 -

Hence, investment will be devalued 42395.91-40575 = 1,820 as of Dec 31, 2016. The Unrealized loss will be debited in devaluing the investment here. the entry will be -

thanks