Question

P17.8 (LO 2, 3) (Fair Value and Equity Methods) Brooks Corp. is a medium-sized corporation spe- cializing in quarrying stone for building construction. The company has long dominated the market, at one time achieving a 70% market penetration. During prosperous years, the company's profits, coupled with a conservative dividend policy, resulted in funds available for outside investment. Over the years, Brooks has had a policy of investing idle cash in equity securities. In particular, Brooks has made periodic investments in the company's principal vendor of mining equipment, Norton Industries. Although the firm currently owns 12% of the outstanding common stock of Norton Industries, Brooks does not have significant influence over the operations of Norton Industries. Cheryl Thomas has recently joined Brooks as assistant controller, and her first assignment is to prepare the 2020 year-end adjusting entries for the accounts that are valued by the "fair value” rule for financial reporting purposes. Thomas has gathered the following information about Brooks' pertinent accounts. 1. Brooks has equity securities related to Delaney Motors and Patrick Electric. During 2020, Brooks pur- chased 100,000 shares of Delaney Motors for $1,400,000; these shares currently have a fair value of $1,600,000. Brooks’investment in Patrick Electric has not been profitable; the company acquired 50,000 shares of Patrick in April 2020 at $20 per share, a purchase that currently has a value of $720,000. 2. Prior to 2020, Brooks invested $22,500,000 in Norton Industries and has not changed its holdings this year. This investment in Norton Industries was valued at $21,500,000 on December 31, 2019. Brooks' 12% ownership of Norton Industries has a current fair value of $22,225,000 on December 2020. Instructions a. Prepare the appropriate adjusting entries for Brooks as of December 31, 2020, to reflect the applica- tion of the "fair value” rule for the securities described above. b. For the securities presented above, describe how the results of the valuation adjustments made in (a) would be reflected in the body of Brooks' 2020 financial statements. c. Prepare the entries for the Norton investment, assuming that Brooks owns 25% of Norton's shares. Norton reported income of $500,000 in 2020 and paid cash dividends of $100,000.

Answer 1

a.

1. Journal Entry

	Debit	Credit
Unrealized Holding Gain or Loss—Income	80,000
Fair Value Adjustment (Trading)		80,000
Investment in trading securities

Calculation :

	Cost	Fair Value	Unrealized Gain (Loss)
Delaney Motors	1,400,000	1,600,000	200,000
Patrick Electric	1,000,000	720,000	-280,000
Total of portfolio	2,400,000	2,320,000	-80,000

2. Journal Entry

	Debit	Credit
Fair Value Adjustment (Available for Sale)	725,000
Unrealized Holding Gain or Loss—Equity		725,000
Investment in available-for-sale securities

Calculation :

Computation of Unrealized Gain or Loss in 2019
	Cost	Fair Value	Unrealized Gain (Loss)
Norton Industries	22,500,000	21,500,000	-1,000,000

Computation of Unrealized Gain or Loss in 2020
	Cost	Fair Value	Unrealized Gain (Loss)
Norton Industries	22,500,000	22,225,000	-275,000
Previous Fair Value Adjustment			-1,000,000
Fair Value Adjustment			725,000

b.

In the Income statement, they will report the unrealized holding loss on the valuation of Brooks’ trading securities. The loss is classified as Other Expenses and Losses. In the balance sheet, they will disclose the trading securities portfolio. It is classified as a current asset and reported at fair value.The reduction in the fair value of the trading securities is shown in the Fair Value Adjustment valuation account. Also to report the increase in fair value of the available-for-sale securities. In the balance sheet, fair value of the securities is reported in the Investments section. In the stockholders’ equity, they will report the, unrealized holding gain on the valuation of Brooks’ available-for-sale securities. It is classified as other comprehensive income.  

A disclosure note will be added for the available-for-sale securities include the aggregate fair value, gross unrealized holding gains, and gross un-realized holding losses. Also if the net unrealized holding gain or loss account shows any differences or changes, it should also be disclosed. Change in net unrealized holding gains or losses are disclosed in the disclosure for trading securities.

c.

	Debit	Credit
Equity Investments (Norton Industries)	125,000
Investment Revenue		125,000

	Debit	Credit
Cash	25,000
Equity Investments (Norton Industries)		25,000

Calculation :

1). Reported Income = 500,000

Percentage of shares owned by Brook = 25%

Investment Revenue = $500,000 X 25% = 125,000

2). Cash Dividend = 100,000

   Percentage of shares owned by Brook = 25%

100,000*25% = 25000