{"id":853,"date":"2015-05-13T18:32:26","date_gmt":"2015-05-13T18:32:26","guid":{"rendered":"https:\/\/courses.candelalearning.com\/finacct2x10xmaster\/?post_type=chapter&p=853"},"modified":"2015-06-04T22:23:10","modified_gmt":"2015-06-04T22:23:10","slug":"journal-entries-for-recording-investments-in-stock","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/clinton-finaccounting\/chapter\/journal-entries-for-recording-investments-in-stock\/","title":{"raw":"Cost Method","rendered":"Cost Method"},"content":{"raw":"Accounting for short-term stock investments and for long-term stock investments of less than\u00a020 percent<\/strong>\r\n

Accountants use the cost method<\/span><\/strong> to account for all short-term stock investments. When a company owns less than 50% of the outstanding stock of another company as a long-term investment, the percentage of ownership determines whether to use the cost or equity method. A purchasing company that owns less than 20% of the outstanding stock of the investee company, and does not exercise significant influence over it, uses the cost method. A purchasing company that owns from 20% to 50% of the outstanding stock of the investee company or owns less than 20%, but still exercises significant influence over it, uses the equity method<\/span><\/strong>. Thus, firms use the cost method for all short-term stock investments and almost all long-term stock investments of less than 20%. For investments of more than 50%, they use either the cost or equity method because the application of consolidation procedures yields the same result.<\/p>\r\nCost method for short-term investments and for long-term investments of less than 20 percent<\/strong>\r\n\r\nWhen a company purchases stock (equity securities) as an investment, accountants must classify the stock according to management\u2019s intent. If management bought the security for the principal purpose of selling it in the near term, the security would be a trading security<\/strong>. If the stock will be held for a longer term, it is called an available-for-sale security<\/strong>. Trading securities are always current assets. Available-for-sale securities may be either current assets or noncurrent assets, depending on how long management intends to hold them. Each classification is accounted for differently. This topic will be discussed later in this chapter.\r\n\r\nSecurities can be transferred between classifications; however, there are specific rules that must be met for these transfers to be allowed. These rules will be addressed in intermediate accounting. Under the cost method, investors record stock investments at cost, which is usually the cash paid for the stock. They purchase most stocks from other investors (not the issuing company) through brokers who execute trades in an organized market, such as the New York Stock Exchange. Thus, cost usually consists of the price paid for the shares, plus a broker\u2019s commission.\r\n\r\nFor example, assume that Brewer Corporation purchased as a near-term investment 1,000 shares of Cowen Company\u2019s $10 par value common stock at $14.22 per share, plus a\u00a0$180 broker\u2019s commission. Brokers quote most stock prices in dollars and cents. Brewer\u2019s entry to record its investment is:\r\n\r\n\r\n\r\n\r\n\r\n
\n\n \r\n\r\nTrading securities [(1,000 shares x $14.22) + $180 commission]<\/td>\r\n\n\nDebit\r\n\r\n14,400<\/td>\r\n\n\n\u00a0Credit\r\n\r\n <\/td>\r\n<\/tr>\r\n
\u00a0\u00a0\u00a0\u00a0 Cash<\/td>\r\n<\/td>\r\n14,400<\/td>\r\n<\/tr>\r\n
\u00a0Purchased 1,000 share of Cowen common stock as a near-term investment at 14.22 plus commission.<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nAccounting for cash dividends received<\/strong> Investments in stock provide dividends revenue. As a general rule, investors debit cash dividends to Cash and credit Dividends Revenue. The only exception to this general rule is when a dividend declared in one accounting period is payable in the next. This exception allows a company to record the revenue in the proper accounting period. Assume that Cowen declared a\u00a0 $1 per share cash dividend on\u00a0December 1, to stockholders of record as of December 20, payable on\u00a0January 15 of the next year. Brewer should make the following entry in December:\r\n\r\n\r\n\r\n\r\n\r\n\r\n
<\/td>\r\n<\/td>\r\n<\/td>\r\n\u00a0Debit<\/td>\r\nCredit<\/td>\r\n<\/tr>\r\n
Dec.<\/td>\r\n1<\/td>\r\nDividends receivable<\/td>\r\n1,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0 Dividends revenue<\/td>\r\n<\/td>\r\n1,000<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0To record $1 per share cash dividend on Cowen common stock, payable 2010 January 15.<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nWhen collecting the dividend on January 15, Brewer debits Cash and credits Dividends Receivable:\r\n\r\n\r\n\r\n\r\n\r\n\r\n
<\/td>\r\n<\/td>\r\n<\/td>\r\n\u00a0Debit<\/td>\r\nCredit<\/td>\r\n<\/tr>\r\n
Jan.<\/td>\r\n15<\/td>\r\nCash<\/td>\r\n1,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0 Dividends receivable<\/td>\r\n<\/td>\r\n1,000<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0To record the receipt of a cash dividend on Cowen common stock.<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nStock dividends and stock splits<\/strong> As discussed in Unit 15, a company might declare a stock dividend rather than a cash dividend. An investor does not recognize revenue on receipt of the additional shares from a stock dividend. The investor merely records the number of additional shares received and reduces the cost per share for each share held. For example, if Cowen distributed a 10% stock dividend in February, Brewer, which held 1,000 shares at a cost of\u00a0$14,400 (or\u00a0$14.40 per share), would receive another 100 shares and would then hold 1,100 shares at a cost per share of\u00a0 $13.09 (computed as\u00a0$14,400\/1,100 shares). Similarly, when a corporation declares a stock split, the investor would note the shares received and the reduction in the cost per share.\r\n\r\nFASB Statement No. 115<\/em> (1993) governs the subsequent valuation of marketable equity securities accounted for under the fair market value method.[1]<\/a> Marketable refers to the fact that the stocks are readily saleable; equity securities are common and preferred stocks. The Statement also addresses the subsequent valuation of debt securities. FASB Statement No. 159<\/em> (2007) amends FASB<\/em> Statement No. 115<\/em> and gives a fair value alternative that allows companies to elect to measure certain items at fair value at a specified date. The subsequent valuation of debt securities will be addressed in intermediate accounting classes.\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Company<\/strong><\/td>\r\n\n\nNo. of<\/strong>\r\n\r\nshares<\/strong><\/td>\r\n\n\nCost per<\/strong>\r\n\r\nShare<\/strong><\/td>\r\n\n\nMarket Price<\/strong>\r\n\r\nper share<\/strong>\r\n\r\n\u00a0Dec 31<\/strong><\/td>\r\n\n\nTotal<\/strong>\r\n\r\ncost<\/strong><\/td>\r\n\n\nTotal<\/strong>\r\n\r\nmarket<\/strong>\r\n\r\nDec 31\u00a0\u00a0\u00a0 <\/strong><\/td>\r\n\n\nIncrease\/(decrease)<\/strong>\r\n\r\nin market value<\/strong><\/td>\r\n<\/tr>\r\n
A<\/td>\r\n200<\/td>\r\n$35<\/td>\r\n$40<\/td>\r\n$ 7,000<\/td>\r\n$ 8,000<\/td>\r\n$ 1,000<\/td>\r\n<\/tr>\r\n
B<\/td>\r\n400<\/td>\r\n10<\/td>\r\n15<\/td>\r\n4,000<\/td>\r\n6,000<\/td>\r\n2,000<\/td>\r\n<\/tr>\r\n
C<\/td>\r\n100<\/td>\r\n90<\/td>\r\n50<\/td>\r\n9,000<\/td>\r\n5,000<\/td>\r\n(4,000)<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/td>\r\n$20,000<\/td>\r\n$19,000<\/td>\r\n$ (1,000)<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nExhibit 1: Stock portfolio of Hanson company\r\n\r\nThe FASB Statement<\/em> requires that at year-end, companies adjust the carrying value of each of their two portfolios (trading securities and available-for-sale securities) to their fair market value. Fair market value is considered to be the market price of the securities or what a buyer or seller would pay to exchange the securities. An unrealized holding gain or loss will usually result in each portfolio.\r\n\r\nTrading securities<\/strong> To illustrate the application of the fair market value to trading securities, assume that Hanson Company has the securities shown in Exhibit 1 in its trading securities portfolio. Applying the fair market value method reveals that the total fair market value of the trading securities portfolio is\u00a0 $1,000 less than its cost. The journal entry required at the end of\u00a0the year\u00a0is:\r\n\r\n\r\n\r\n\r\n\r\n\r\n
<\/td>\r\n<\/td>\r\n<\/td>\r\n\u00a0Debit<\/td>\r\nCredit<\/td>\r\n<\/tr>\r\n
Dec.<\/td>\r\n31<\/td>\r\nUnrealized loss on trading securities<\/td>\r\n1,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0 Trading securities<\/td>\r\n<\/td>\r\n1,000<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0To record unrealized loss from market decline of trading securities.<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nNote that the debit is to the Unrealized Loss on Trading Securities account. This loss is unrealized because the securities have not been sold. However, the loss is reported in the income statement as a deduction in arriving at net income<\/strong>. The credit in the preceding entry is to the Trading Securities account so as to adjust its balance to its fair market value. (An unrealized holding gain would be an addition to net income.)\r\n\r\nIf Hanson sold investment C on\u00a0January 1 of the next year, the company would receive\u00a0$5,000 (assuming no change in market values from the previous day). The loss on the sale results from market changes last year rather than in the current year; the fair market value procedure placed that loss in the proper year. The entry for the sale is:\r\n\r\n\r\n\r\n\r\n\r\n\r\n
<\/td>\r\n<\/td>\r\n<\/td>\r\n\u00a0Debit<\/td>\r\nCredit<\/td>\r\n<\/tr>\r\n
Jan.<\/td>\r\n1<\/td>\r\nCash<\/td>\r\n5,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0 Trading securities- Company C Stock<\/td>\r\n<\/td>\r\n5,000<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0To record sale of Company C Stock.<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nNo adjustment needs to be made to the unrealized loss account previously debited because the unrealized loss recorded last year has flowed through the income statement and been closed to retained earnings through the closing process.\r\n\r\nAvailable-for-sale securities<\/strong>\r\n\r\nhttps:\/\/youtu.be\/k6yAgMbyFFg\r\n\r\nFor another example assume a marketable equity security that management does not intend to sell in the near term has a cost of\u00a0 $32,000 and a current market value on December 31 of\u00a0 $31,000. The treatment of the loss depends on whether it results from a temporary decline in market value of the stock or a permanent decline in the value. Assume first that the loss is related to a \u201ctemporary\u201d decline in the market value of the stock. The required entry is:\r\n\r\n\r\n\r\n\r\n\r\n\r\n
<\/td>\r\n<\/td>\r\n<\/td>\r\n\u00a0Debit<\/td>\r\n\u00a0Credit<\/td>\r\n<\/tr>\r\n
Dec.<\/td>\r\n31<\/td>\r\nUnrealized loss on available-for-sale securities<\/td>\r\n1,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0 Available-for-sale securities<\/td>\r\n<\/td>\r\n1,000<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0To record unrealized loss from market decline of available-for-sale securities.<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nThese accounts would appear on the balance sheet as follows:\r\n\r\nHanson Company<\/strong>\r\n\r\nPartial Balance Sheet<\/strong>\r\n\r\nDecember 31<\/strong>\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Investments (or Current Assets)*:<\/td>\r\n<\/td>\r\n<\/tr>\r\n
\u00a0 Available-for-sale securities<\/td>\r\n$31,000<\/td>\r\n<\/tr>\r\n
Stockholders\u2019 equity:<\/td>\r\n<\/td>\r\n<\/tr>\r\n
\u00a0 Capital stock<\/td>\r\n$xxx,xxx<\/td>\r\n<\/tr>\r\n
\u00a0 Additional paid-in capital<\/td>\r\nX,xxx<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Total paid-in capital<\/td>\r\n$xxx,xxx<\/td>\r\n<\/tr>\r\n
\u00a0 Less: Unrealized loss on available-for-sale securities<\/td>\r\n1,000<\/td>\r\n<\/tr>\r\n
<\/td>\r\n$xxx,xxx<\/td>\r\n<\/tr>\r\n
\u00a0 Retained earnings<\/td>\r\nXx,xxx<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 Total stockholders\u2019 equity<\/td>\r\n$xxx,xxx<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n*Depending on the length of time management intends to hold the securities.\r\n\r\nNote that the unrealized loss for available-for-sale securities appears in the balance sheet as a separate negative component of stockholders\u2019 equity rather than in the income statement (as it does for trading securities). An unrealized gain would be shown as a separate positive component of stockholders\u2019 equity. An unrealized loss or gain on available-for-sale securities is not included in the determination of net income because it is not<\/strong> expected to be realized in the near future. These securities will probably not be sold soon.\r\n\r\nThe sale of an available-for-sale security results in a realized gain or loss and is reported on the income statement for the period. Any unrealized gain or loss on the balance sheet must be recognized at that time. Assume the stock discussed above is sold on\u00a0January 1 of the next year\u00a0for\u00a0$31,000 (assuming no change in market value from the previous day) after the company had held the stock for three years. The entries to record this sale are:\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
<\/td>\r\n<\/td>\r\n<\/td>\r\n\u00a0Debit<\/td>\r\nCredit<\/td>\r\n<\/tr>\r\n
Jan.<\/td>\r\n1<\/td>\r\nRealized loss on available-for-sale securities<\/td>\r\n1,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0 Unrealized loss on available-for-sale securities<\/td>\r\n<\/td>\r\n1,000<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\nCash<\/td>\r\n31,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
<\/td>\r\n<\/td>\r\n\u00a0 Available-for-sale securities<\/td>\r\n<\/td>\r\n31,000<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nThe account debited in the first entry shows that the unrealized loss has been realized with the sale of the security; the amount is reported in the income statement. The second entry writes off the security and records the cash received and is similar to the entry for the sale of trading securities.\r\n\r\nA loss on an individual available-for-sale security that is considered to be \u201cpermanent\u201d is recorded as a realized loss and deducted in determining net income. The entry to record a permanent loss of\u00a0 $1,400 reads:\r\n\r\n\r\n\r\n\r\n\r\n
Realized loss on available-for-sale securities<\/td>\r\n1,400<\/td>\r\n<\/td>\r\n<\/tr>\r\n
\u00a0 Available-for-sale securities<\/td>\r\n<\/td>\r\n1,400<\/td>\r\n<\/tr>\r\n
\u00a0To record loss in value of available-for-sale securities.<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nNo part of the\u00a0$1,400 loss is subject to reversal if the market price of the stock recovers. The stock\u2019s reduced value is now its \u201ccost\u201d. When this stock is later sold, the sale will be treated in the same manner as trading securities. The loss or gain has already been recognized on the income statement. Therefore, the entry would simply record the cash received and write off the security sold for its fair market value. If the market value of the security has fluctuated since the last time the account had been adjusted (end of the year), then an additional gain or loss may have to be recorded to account for this fluctuation.","rendered":"

Accounting for short-term stock investments and for long-term stock investments of less than\u00a020 percent<\/strong><\/p>\n

Accountants use the cost method<\/span><\/strong> to account for all short-term stock investments. When a company owns less than 50% of the outstanding stock of another company as a long-term investment, the percentage of ownership determines whether to use the cost or equity method. A purchasing company that owns less than 20% of the outstanding stock of the investee company, and does not exercise significant influence over it, uses the cost method. A purchasing company that owns from 20% to 50% of the outstanding stock of the investee company or owns less than 20%, but still exercises significant influence over it, uses the equity method<\/span><\/strong>. Thus, firms use the cost method for all short-term stock investments and almost all long-term stock investments of less than 20%. For investments of more than 50%, they use either the cost or equity method because the application of consolidation procedures yields the same result.<\/p>\n

Cost method for short-term investments and for long-term investments of less than 20 percent<\/strong><\/p>\n

When a company purchases stock (equity securities) as an investment, accountants must classify the stock according to management\u2019s intent. If management bought the security for the principal purpose of selling it in the near term, the security would be a trading security<\/strong>. If the stock will be held for a longer term, it is called an available-for-sale security<\/strong>. Trading securities are always current assets. Available-for-sale securities may be either current assets or noncurrent assets, depending on how long management intends to hold them. Each classification is accounted for differently. This topic will be discussed later in this chapter.<\/p>\n

Securities can be transferred between classifications; however, there are specific rules that must be met for these transfers to be allowed. These rules will be addressed in intermediate accounting. Under the cost method, investors record stock investments at cost, which is usually the cash paid for the stock. They purchase most stocks from other investors (not the issuing company) through brokers who execute trades in an organized market, such as the New York Stock Exchange. Thus, cost usually consists of the price paid for the shares, plus a broker\u2019s commission.<\/p>\n

For example, assume that Brewer Corporation purchased as a near-term investment 1,000 shares of Cowen Company\u2019s $10 par value common stock at $14.22 per share, plus a\u00a0$180 broker\u2019s commission. Brokers quote most stock prices in dollars and cents. Brewer\u2019s entry to record its investment is:<\/p>\n\n\n\n\n\n
\n

 <\/p>\n

Trading securities [(1,000 shares x $14.22) + $180 commission]<\/td>\n

\n

Debit<\/p>\n

14,400<\/td>\n

\n

\u00a0Credit<\/p>\n

 <\/td>\n<\/tr>\n

\u00a0\u00a0\u00a0\u00a0 Cash<\/td>\n<\/td>\n14,400<\/td>\n<\/tr>\n
\u00a0Purchased 1,000 share of Cowen common stock as a near-term investment at 14.22 plus commission.<\/td>\n<\/td>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

Accounting for cash dividends received<\/strong> Investments in stock provide dividends revenue. As a general rule, investors debit cash dividends to Cash and credit Dividends Revenue. The only exception to this general rule is when a dividend declared in one accounting period is payable in the next. This exception allows a company to record the revenue in the proper accounting period. Assume that Cowen declared a\u00a0 $1 per share cash dividend on\u00a0December 1, to stockholders of record as of December 20, payable on\u00a0January 15 of the next year. Brewer should make the following entry in December:<\/p>\n\n\n\n\n\n\n
<\/td>\n<\/td>\n<\/td>\n\u00a0Debit<\/td>\nCredit<\/td>\n<\/tr>\n
Dec.<\/td>\n1<\/td>\nDividends receivable<\/td>\n1,000<\/td>\n<\/td>\n<\/tr>\n
<\/td>\n<\/td>\n\u00a0 Dividends revenue<\/td>\n<\/td>\n1,000<\/td>\n<\/tr>\n
<\/td>\n<\/td>\n\u00a0To record $1 per share cash dividend on Cowen common stock, payable 2010 January 15.<\/td>\n<\/td>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

When collecting the dividend on January 15, Brewer debits Cash and credits Dividends Receivable:<\/p>\n\n\n\n\n\n\n
<\/td>\n<\/td>\n<\/td>\n\u00a0Debit<\/td>\nCredit<\/td>\n<\/tr>\n
Jan.<\/td>\n15<\/td>\nCash<\/td>\n1,000<\/td>\n<\/td>\n<\/tr>\n
<\/td>\n<\/td>\n\u00a0 Dividends receivable<\/td>\n<\/td>\n1,000<\/td>\n<\/tr>\n
<\/td>\n<\/td>\n\u00a0To record the receipt of a cash dividend on Cowen common stock.<\/td>\n<\/td>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

Stock dividends and stock splits<\/strong> As discussed in Unit 15, a company might declare a stock dividend rather than a cash dividend. An investor does not recognize revenue on receipt of the additional shares from a stock dividend. The investor merely records the number of additional shares received and reduces the cost per share for each share held. For example, if Cowen distributed a 10% stock dividend in February, Brewer, which held 1,000 shares at a cost of\u00a0$14,400 (or\u00a0$14.40 per share), would receive another 100 shares and would then hold 1,100 shares at a cost per share of\u00a0 $13.09 (computed as\u00a0$14,400\/1,100 shares). Similarly, when a corporation declares a stock split, the investor would note the shares received and the reduction in the cost per share.<\/p>\n

FASB Statement No. 115<\/em> (1993) governs the subsequent valuation of marketable equity securities accounted for under the fair market value method.[1]<\/a> Marketable refers to the fact that the stocks are readily saleable; equity securities are common and preferred stocks. The Statement also addresses the subsequent valuation of debt securities. FASB Statement No. 159<\/em> (2007) amends FASB<\/em> Statement No. 115<\/em> and gives a fair value alternative that allows companies to elect to measure certain items at fair value at a specified date. The subsequent valuation of debt securities will be addressed in intermediate accounting classes.<\/p>\n\n\n\n\n\n\n\n
Company<\/strong><\/td>\n\n

No. of<\/strong><\/p>\n

shares<\/strong><\/td>\n

\n

Cost per<\/strong><\/p>\n

Share<\/strong><\/td>\n

\n

Market Price<\/strong><\/p>\n

per share<\/strong><\/p>\n

\u00a0Dec 31<\/strong><\/td>\n

\n

Total<\/strong><\/p>\n

cost<\/strong><\/td>\n

\n

Total<\/strong><\/p>\n

market<\/strong><\/p>\n

Dec 31\u00a0\u00a0\u00a0 <\/strong><\/td>\n

\n

Increase\/(decrease)<\/strong><\/p>\n

in market value<\/strong><\/td>\n<\/tr>\n

A<\/td>\n200<\/td>\n$35<\/td>\n$40<\/td>\n$ 7,000<\/td>\n$ 8,000<\/td>\n$ 1,000<\/td>\n<\/tr>\n
B<\/td>\n400<\/td>\n10<\/td>\n15<\/td>\n4,000<\/td>\n6,000<\/td>\n2,000<\/td>\n<\/tr>\n
C<\/td>\n100<\/td>\n90<\/td>\n50<\/td>\n9,000<\/td>\n5,000<\/td>\n(4,000)<\/td>\n<\/tr>\n
<\/td>\n<\/td>\n<\/td>\n<\/td>\n$20,000<\/td>\n$19,000<\/td>\n$ (1,000)<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

Exhibit 1: Stock portfolio of Hanson company<\/p>\n

The FASB Statement<\/em> requires that at year-end, companies adjust the carrying value of each of their two portfolios (trading securities and available-for-sale securities) to their fair market value. Fair market value is considered to be the market price of the securities or what a buyer or seller would pay to exchange the securities. An unrealized holding gain or loss will usually result in each portfolio.<\/p>\n

Trading securities<\/strong> To illustrate the application of the fair market value to trading securities, assume that Hanson Company has the securities shown in Exhibit 1 in its trading securities portfolio. Applying the fair market value method reveals that the total fair market value of the trading securities portfolio is\u00a0 $1,000 less than its cost. The journal entry required at the end of\u00a0the year\u00a0is:<\/p>\n\n\n\n\n\n\n
<\/td>\n<\/td>\n<\/td>\n\u00a0Debit<\/td>\nCredit<\/td>\n<\/tr>\n
Dec.<\/td>\n31<\/td>\nUnrealized loss on trading securities<\/td>\n1,000<\/td>\n<\/td>\n<\/tr>\n
<\/td>\n<\/td>\n\u00a0 Trading securities<\/td>\n<\/td>\n1,000<\/td>\n<\/tr>\n
<\/td>\n<\/td>\n\u00a0To record unrealized loss from market decline of trading securities.<\/td>\n<\/td>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

Note that the debit is to the Unrealized Loss on Trading Securities account. This loss is unrealized because the securities have not been sold. However, the loss is reported in the income statement as a deduction in arriving at net income<\/strong>. The credit in the preceding entry is to the Trading Securities account so as to adjust its balance to its fair market value. (An unrealized holding gain would be an addition to net income.)<\/p>\n

If Hanson sold investment C on\u00a0January 1 of the next year, the company would receive\u00a0$5,000 (assuming no change in market values from the previous day). The loss on the sale results from market changes last year rather than in the current year; the fair market value procedure placed that loss in the proper year. The entry for the sale is:<\/p>\n\n\n\n\n\n\n
<\/td>\n<\/td>\n<\/td>\n\u00a0Debit<\/td>\nCredit<\/td>\n<\/tr>\n
Jan.<\/td>\n1<\/td>\nCash<\/td>\n5,000<\/td>\n<\/td>\n<\/tr>\n
<\/td>\n<\/td>\n\u00a0 Trading securities- Company C Stock<\/td>\n<\/td>\n5,000<\/td>\n<\/tr>\n
<\/td>\n<\/td>\n\u00a0To record sale of Company C Stock.<\/td>\n<\/td>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

No adjustment needs to be made to the unrealized loss account previously debited because the unrealized loss recorded last year has flowed through the income statement and been closed to retained earnings through the closing process.<\/p>\n

Available-for-sale securities<\/strong><\/p>\n