Brooks
Corp. is a medium-sized corporation specializing 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 supplier, 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 2012 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’ s pertinent
accounts.
1.
Brooks has trading securities related to Delaney Motors and Patrick Electric.
During this fiscal year, Brooks purchased 100,000 shares of Delaney Motors for
$1,400,000; these shares currently have a market value of $1,600,000. Brooks’
investment in Patrick Electric has not been profitable; the company acquired
50,000 shares of Patrick in April 2012 at $20 per share, a purchase that
currently has a value of $720,000.
2.
Prior to 2012, 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, 2011. Brooks’ 12% ownership of Norton Industries
has a current market value of $22,225,000.
Instructions
(a)
Prepare the appropriate adjusting entries for Brooks as of December 31, 2012,
to reflect the application of the “fair value” rule for both classes of
securities described above.
(b) For
both classes of securities presented above, describe how the results of the
valuation adjustments made in (a) would be reflected in the body of and notes
to Brooks’ 2012 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 2012 and paid cash
dividends of $100,000.
(a) 1. Investment in trading securities:
Unrealized
Holding Gain or Loss—
Income...................................................................... 80,000
Fair
Value Adjustment (Trading)............................... 80,000
2. Investment in available-for-sale
securities:
Fair
Value Adjustment (Available-for-Sale)........ 725,000
Unrealized
Holding Gain or Loss—
Equity.......................................................................... 725,000
Computations:
1.
|
Security
|
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.
|
Computation of Unrealized Gain
or Loss in 2011
|
|||
|
Security
|
Cost
|
Fair
Value
|
Unrealized Gain (Loss)
|
|
Norton Ind.
|
$22,500,000
|
$21,500,000
|
(($1,000,000)
|
|
Computation
of Unrealized Gain or Loss in 2012
|
|||
|
Security
|
Cost
|
Fair
Value
|
Unrealized Gain (Loss)
|
|
Norton Ind.
|
$22,500,000
|
$22,225,000
|
$ (275,000)
|
|
Previous Fair Value
Adjustment (Cr)
|
|
|
($1,000,000) |
|
Fair Value Adjustment
(Dr)
|
|
|
$ 725,000 |
(b) The unrealized holding loss on the
valuation of Brooks’ trading securities is reported on the income statement.
The loss would appear in the “Other Expenses and Losses” section of the income
statement. The Fair Value Adjustment is a valuation account and it will be used
to show the reduction in the fair value of the trading securities. The trading
securities portfolio is disclosed in the balance sheet as a current asset and
reported at its fair value.
The unrealized holding gain on the
valuation of Brooks’ available-for-sale securities is reported as other
comprehensive income and as a separate component of stockholders’ equity. The
Fair Value Adjustment is used to report the increase in fair value of the
available-for-sale securities. The fair value of the securities is reported in
the Investments section of the balance sheet. It should be noted that a
combined statement of income and comprehensive income, a statement of
comprehensive income, or a statement of stockholders’ equity would report the
components of comprehensive income.
The note disclosures for the
available-for-sale securities include the aggregate fair value, gross
unrealized holding gains, and gross un-realized holding losses. Any change in
the net unrealized holding gain or loss account should also be disclosed. The
disclosure for trading securities includes the change in net unrealized holding
gains or losses which was included in earnings.
(c) Equity
Investments (Norton Industries)............................. 125,000
Investment
Revenue ($500,000 X 25%)................................. 125,000
Cash
($100,000 X 25%)......................................................... 25,000
Equity
Investments (Norton Industries).................................. 25,000
With 25%, Brooks has significant
influence and should apply the equity method. No fair value adjustments are
recorded under the equity method.
