Question

American Surety and Fidelity buys and sells securities expecting to earn profits on short-term differences in price. For the first 11 months of 2021, gains from selling trading securities totaled $7 million, losses from selling trading securities were $11 million, and the company had earned $5 million in interest revenue. The following selected transactions relate to American's investments in trading securities and equity securities during December 2021, and the first week of 2022. The company's fiscal year ends on December 31. No trading securities or equity investments were held by American on December 1, 2021. Assume that the bonds are purchased at face value.2021 Dec. 12 Purchased FF&G Corporation bonds for $12 million.13 Purchased 2 million Ferry Intercommunications common shares for $22 million.15 Sold the FF&G Corporation bonds for $12.1 million.22 Purchased U.S. Treasury bills for $56 million and Treasury bonds for $65 million.23 Sold half the Ferry Intercommunications common shares for $10 million.26 Sold the U.S. Treasury bills for $57 million.27 Sold the Treasury bonds for $63 million.28 Received cash dividends of $200,000 from the Ferry Intercommunications common shares.31 Recorded any necessary adjusting entry(s) and closing entries relating to the investments. The market price of the Ferry Intercommunications stock was $10 per share.2022 Jan. 2 Sold the remaining Ferry Intercommunications common shares for $10.2 million.5 Purchased Warehouse Designs Corporation bonds for $34 million.Required:1. Prepare the appropriate journal entry for each transaction or event during 2021.

Answer 1

Answer:

Since the answer requires journal entries, to better illustrate the same in a well formatted version, I have attached an excel file. Please refer to the explanation section below for point-wise commentary

Explanation:

The attached excel file contains details of each journal entry. I have added explanations against each transaction (and the corresponding entry in the excel file) below.

(1) The company decreased cash (credit) and increased an asset which is its investment in trading securities (debit)

(2) The company decreased cash (credit) and increased an asset which is its investment in trading securities (debit)

(3) Now, the company sold its investment in point number 1 at a profit of 100,000. To record the gain and since the company uses the fair value method of accounting for recording investments, we must first created a fair value adjustment account account of 100,000 to reflect the increase in asset value and correspondingly credit the realized gain of sale of investment. Then, we must increase cash (debit) and decrease both the investment in security and the fair value adjustment account.

(4) The company will increase two additional investment accounts and decreased cash by the same amounts.

(5) The company sold the investment made in point number 2 at a loss of one million. The illustrate the change in fair value, the company will credit a fair value adjustment account to reflect the decrease in the fair value of the security and then debit the loss of sale of investment that has been realized. The company will need debit (increase) cash with the proceeds from the sale, and decrease the investment value of shares sold. Note that the shares sold for 10 million were actually bought for 11 million (at $2 per share x 1 million). Therefore, to off-set the higher amount of investment being decreased with respect to a lower increase in cash, we will debit the fair value adjustment account as well.

(6) Similar to the transaction explained in point number 3, we will make entries to show the impact of the change in fair value, the increase in cash, and the decrease in recorded investment.

(7) This is similar to the transaction explained in point number 4. We will make entries to show the impact of the decrease in fair value, the increase in cash, and the associated decrease in recorded investment,

(8) The company received dividend which is an income and must therefore be credited. The cash account will be debited to show the increase in cash.

As noted in the explanation provided above, the double entry accounting method is used to illustrate the impact of one must be offset by an impact on another account. Furthermore, the accounting equation must always hold true i.e Assets = Capital + Liabilities. Therefore, each debit must be equal to a credit.

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