On January 4, Year1, Larsen Company purchased 5,000 shares of Warner Company for $59,500 plus a broker's fee of $1,000. Warner Company has a total of 25,000 shares of common stock outstanding and it is presumed the Larsen Company will have a significant influence over Warner. During each of the next two years, Warner declared and paid cash dividends of $0.85 per share, and its net income was $72,000 and $67,000 for Year 1 and Year 2, respectively. The January 12, Year 3, entry to record the sale of 3,000 shares of Warner Company stock for $39,000 cash should be:

Question

Quizplus · Accepted Answer

To determine the cost of the shares sold, we need to use the weighted-average method. The cost of the investment is $59,500 + $1,000 = $60,500.

Year 1: Larsen Company owns 5,000 shares out of 25,000 shares (20%). Larsen's share of Warner's net income is 20% x $72,000 = $14,400. 
Year 2: Larsen Company still owns 5,000 shares out of 25,000 shares (20%). Larsen's share of Warner's net income is 20% x $67,000 = $13,400.

Total dividends received by Larsen Company = 5,000 x $0.85 x 2 = $8,500 
Total share of net income received by Larsen Company = $14,400 + $13,400 = $27,800

Weighted-average cost per share = $60,500 / 5,000 shares = $12.10

The proceeds from the sale of 3,000 shares of Warner Company stock are $39,000. The cost of these shares is 3,000 x $12.10 = $36,300.

The loss on sale of investment is the difference between the cost and the proceeds: 
Loss = $36,300 - $39,000 = $2,700

Therefore, the entry to record the sale would be: 
Debit Cash $39,000; debit Loss on Sale of Investment $8,880 ($2,700 + $6,180*); credit Long-Term Investments $47,880.

*[$2,180: ($39,000 - $36,300 - $500) x 20%] - this is to adjust for dividends that Larsen Company would have received if it still owned the 3,000 shares sold.

On January 4, Year1, Larsen Company Purchased 5,000 Shares of Warner