Homework Answers
1A - There are multiple methods of accounting for investment in associates and usually the right method is chosen based on the intention or the reason for which the stock is purchased or sometimes also depending on the influence exerted by the purchasing company. When stocks are purchased for long term investment, they are mostly accounted for using the cost method under which no changes to the value of the investment is made until the date of sale/transfer. Dividend income is recorded as income in this method. There is also the equity method and the fair value method of accounting for investments. Usually the equity method is used when the purchasing firm has a significant influence in the associate which is based on a 20-50% voting stock. Since Hattiesburg has purchased 40% stock in Senatoba, i would recommend the equity method.
1B -
| Debit Amt | Credit Amt | ||
| 1/1/X1 | Investment in Senatoba A/c | $ 400,000 | |
| Cash A/c | $ 400,000 |
2 - Fair value method journal entries
| Debit Amt | Credit Amt | ||
| 1/1/X1 | Available for Sale Securities | $ 400,000 | |
| Cash A/c | $ 400,000 | ||
| (40,000 shares of Senatoba purchased @ $10/share) | |||
| 12/31/X1 | Cash A/c ($1 *40,000 shares) | $ 40,000 | |
| Dividend Income | $ 40,000 | ||
| (Cash dividend paid by Senatoba for X1 @ $1 per share) | |||
| 12/31/X1 | Securities Fair Value Adjustment A/c [(12-10)*40,000 shares)] | $ 80,000 | |
| Unrealised gains/losses - Equity | $ 80,000 | ||
| (Adjustment investment value to the current market value as of 12/31/X1) | |||
Since Hattiesburg is using the fair value method of accounting for investment, there will be no investment income recorded until the actual sale of the investment in Senatoba. The only income that will be recorded from this investment will be the dividend income of $40,000 as shown in the journal entries above. The unrealised gain on fair value adjustment is recorded under equity shareholder's funds.
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