Problem 17-8 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 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 2010 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. 1Brooks 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 2010 at $20 per share, a purchase that currently has a value of $720,000. 2Prior to 2010, 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, 2009.
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, 2010, 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' 2010 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 2007 and paid cash dividends of $100,000. Solutions (a) 1. Investment in trading securities: Unrealized Holding Gain or Loss – Income80000 Securities Fair Value Adjustment – Trading80000 2. Investment in available-for-sale securities: Securities Fair Value Adjustment (Available-for-sale)725000 Unrealized Holding Gain or Loss - Equity 725000 Computations: 1. Investment in trading securities: SecurityCostFair ValueUnrealized Gain/Loss Delaney Motors1,400,0001,600,000 200,000 Patrick Electric1,000,000 720,000-280,000
Total Portfolio2,400,0002,320,000 (80,000) 2. Investment in available-for-sale securities: Computation of Unrealized Gain or Loss in 2009 SecurityCostFair ValueUnrealized Gain/Loss Norton22,500,000 21,500,000 (1,000,000) Computation of Unrealized Gain or Loss in 2010 SecurityCostFair ValueUnrealized Gain/Loss Norton 22,500,00022,225,000(275,000) Previous Securities Fair Value Adjustment(1,000,000) Securities Fair Value Adjustment725,000 (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 Securities 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-than-comprehensive income and as a separate component of stockholders’ equity.
The Securities 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 unrealized 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) Investment in Norton (500,000 * 25%)125,000 Investment Revenue125,000 Cash (100,000 * 25%)25,000 Investment in Norton25,000 With 25%, Brooks has significant influence and should apply the equity method. No fair value adjustments are recorded under this method.