Dioda Gas Corporation is a successful oil and gas exploration business in the south-western United States. At the beginning of 2011, the company made investments in three companies that perform services in the oil and gas industry. The details of each of these long-term investments follow.
Dioda purchased 100,000 shares of Ink Service Corporation at a cost of $16 per share. Ink has 1.5 million shares outstanding and during 2011 paid dividends of $0.80 per share on earnings of $1.60 per share. At the end of the year, Ink’s shares were selling for $24 per share.
Dioda also purchased 2 million shares of Reef Drilling Company at $8 per share. Reef has 10 million shares outstanding. In 2011, Reef paid a dividend of $0.40 per share on earnings of $0.80 per share. During the year, the president of Dioda was appointed to Reef’s board of directors. At the end of the year, Reef’s stock was selling for $12 per share.
In another action, Dioda purchased 1 million shares of Bloom Oil Field Supplies Company’s 5 million outstanding shares at $12 per share. The president of Dioda sought membership on Bloom’s board of directors but was rebuffed when a majority of shareholders stated they did not want to be associated with Dioda. Bloom paid a dividend of $0.80 per share and reported a net income of only $0.40 per share for the year. By the end of the year, its stock price had dropped to $4 per share.
1. For each investment, prepare journal entries to record the
(a) Initial investment,
(b) Receipt of cash dividend,
(c) Recognition of income (if appropriate).
2. What adjusting entry (if any) is required at the end of the year?
3. Assume that Dioda sells its investment in Bloom after the first of the year for $6 per share. Prepare the appropriate journal entry.
4. Assume that no other transactions occur and that the market value of Dioda’s investment in Ink exceeds cost by $2,400,000 at the end of the second year. What adjusting entry (if any) would be required?
5. What principal factors should be considered in determining how to account for Dioda’s investments? Should Dioda’s investments be shown on the balance sheet as short- or long-term investments? Why?