Question

Fairbanks Corporation purchased 400 shares of Sherman Inc. common stock for \(13,200 (Fairbanks does not have significant influence). During the year, Sherman paid a cash dividend of \)3.25 per share. At year-end, Sherman stock was selling for $34.50 per share. Prepare Fairbanks’ journal entries to record

(a) the purchase of the investment,

(b) the dividends received, and

(c) the fair value adjustment. (Assume a zero balance in the Fair Value Adjustment account.)

Short answer

1. The amount debited to equity investment is $13,200.
2. The amount of dividend received is $1,300.
3. The gain on the investment is $600.

Step-by-step solution

Definition of common stock 

Common stock is the stock in which the dividend amount is not fixed. The amount of dividends fluctuate.

 Journal entry of the purchase of the investment

Date	Description	Debit	Credit
A.	Equity Investment	$13,200
	Cash		$13,200
	Being entry to record the purchase of common stock

Journal entry for the interest received

Date	Description	Debit	Credit
B	Cash	$1,300
	Investment Revenue		$1,300
	Being entry of dividend received

Adjustment entry for the fair value

Date	Description	Debit	Credit
C	Investment in Equity*	$600
	Gain on investment		$600
	Being gained on the sale of common stock

Note:

$\begin{array}{c}\mathbf{Gain}\mathbf{on}\mathbf{Investment}\mathbf{=}\mathbf{Sale}\mathbf{price}\mathbf{of}\mathbf{common}\mathbf{stock}\mathbf{-}\mathbf{Purchase}\mathbf{price}\mathbf{of}\mathbf{common}\mathbf{stock}\\ \mathbf{=}\mathbf{\$}\mathbf{13}\mathbf{,}\mathbf{800}\mathbf{-}\mathbf{\$}\mathbf{13}\mathbf{,}\mathbf{200}\\ =\$600\end{array}$