Question

Instar Company has several investments in the securities of other companies. The following information regarding these investmentsis available at December 31, 2017.

1. Instar holds bonds issued by Dorsel Corp. The bonds have an amortized cost of \(320,000 and their fair value at December31, 2017, is \)400,000. Instar intends to hold the bonds until they mature on December 31, 2025.

2. Instar has invested idle cash in the equity securities of several publicly traded companies. Instar intends to sell these securitiesduring the first quarter of 2018, when it will need the cash to acquire seasonal inventory. These equity securities havea cost basis of \(800,000 and a fair value of \)920,000 at December 31, 2017.

3. Instar has a significant ownership stake in one of the companies that supplies Instar with various components Instar usesin its products. Instar owns 6% of the common stock of the supplier, does not have any representation on the supplier’sboard of directors, does not exchange any personnel with the supplier, and does not consult with the supplier on any of

the supplier’s operating, financial, or strategic decisions. The cost basis of the investment in the supplier is \(1,200,000 andthe fair value of the investment at December 31, 2017, is \)1,550,000. Instar does not intend to sell the investment in theforeseeable future. The supplier reported net income of \(80,000 for 2017 and paid no dividends.

4. Instar owns some common stock of Forter Corp. The cost basis of the investment in Forter is \)200,000 and the fair value atDecember 31, 2017, is \(50,000. Instar believes the decline in the value of its investment in Forter is permanent and thereforeimpaired, but Instar does not intend to sell its investment in Forter in the foreseeable future.

5. Instar purchased 25% of the stock of Slobbaer Co. for \)900,000. Instar has significant influence over the operating activitiesof Slobbaer Co. During 2017, Slobbaer Co. reported net income of \(300,000 and paid a dividend of \)100,000.

Accounting

(a) Determine how each of the investments described above should be classified and accounted far.

(b) Prepare any December 31, 2017, journal entries needed for Instar relating to Instar’s various investments in other companies.

Assume 2017 is Instar’s first year of operations.

Analysis

What is the effect on Instar’s 2017 net income (as reported on Instar’s income statement) of Instar’s investments in other companies?

Short answer

Some securities will increase the income, while some depositswill decrease the income.

Step-by-step solution

classification of investments

• As in the first investment, the investment is kept until maturity; hence, the given security is held-to-maturity securities.
• As the securities might be sold in the first quarter of 2018, the given security is trading securities.
• In this, the company wants to sell the securities after some years. Hence, the given securities are available-for-sale securities.
• In this, the company wants to sell the securities after some years. Hence, the given securities are available-for-sale securities.
• In this, the company wants to sell the securities after some years. Hence, the given securities are available-for-sale securities.

Journal entries

Date	Particulars	Debit	Credit
1
December 31, 2017	No entry will pass.
2.
December 31, 2017	Fair Value adjustment	$120,000
	Unrealised holding Gain or loss-incomes		$120,000
	(Being adjustment of fair value)
3
December 31, 2017	Fair Value adjustment	$350,000
	Unrealised holding Gain or loss-incomes		$350,000
	(Being adjustment of fair value)
December 31, 2017	Cash	$4,800
	Investment Revenue		$4,800
	(Share of income received)
4
December 31, 2017	Unrealised Holding Gain or Loss- Loss	$150,000
	Fair Value Adjustment		$150,000
	(Being adjustment of fair value)
5
December 31, 2017	Cash	$25,000
	Dividend Revenue		$25,000
	(Being entry for the dividend received)
December 31, 2017	Cash	$75,000
	Investment Revenue		$75,000
	(Being entry for the revenue of investment)

 Step 3: Effect on earnings

• This investment does not affect the earnings of the current year.
• This investment increases the company’s earnings as there is unrealised gain.
• This investment increases the company’s earnings as there is unrealised gain.
• This investment Decreases the income as there is unrealised loss.
• This increases the company’s net income as the amount of dividend received.