Pacers 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, Pacers has had a policy of investing idle cash in equity securities. In particular, Pacers has made periodic investments in the company’s principal supplier, Pierce Industries. Although the firm currently owns 12% of the outstanding common stock of Pierce Industries, Pacers does not have significant influence over the operations of Pierce Industries. Cheryl Miller has recently joined Pacers as assistant controller, and her first assignment is to prepare the 2008 year-end adjusting entries for the accounts that are valued by the “fair value” rule for financial reporting purposes. Miller has gathered the following information about Pacers’ pertinent accounts.
1. Pacers has trading securities related to Dale Davis Motors and Rik Smits Electric. During this fiscal year, Pacers purchased 100,000 shares of Davis Motors for $1,400,000; these shares currently have a market value of $1,600,000. Pacers’ investment in Smits Electric has not been profitable; the company acquired 50,000 shares of Smits in April 2008 at $20 per share, a purchase that currently has a value of $620,000.
2. Prior to 2008, Pacers invested $22,500,000 in Pierce Industries and has not changed its holdings this year. This investment in Pierce Industries was valued at $21,500,000 on December 31, 2007. Pacers’ 12% ownership of Pierce Industries has a current market value of $22,275,000.
Instructions
(a) Prepare the appropriate adjusting entries for Pacers as of December 31, 2008, 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 Pacers’ 2008 financial statements.
(c) Prepare the entries for the Pierce investment, assuming that Pacers owns 30% of Pierce’s shares. Pierce reported income of $500,000 in 2008 and paid cash dividends of $100,000.