SHARP INC. INVESTMENTS IN EQUITY SECURITIES ACTG 344 BARIL INTRODUCTION On January 1, 1998, Sharp Inc. began operations by purchasing the factory of Dull Inc., a manufacturer of specialty calculators that went out of business in 1997. Mr. Kelly, the founder and president of Sharp, was convinced that poor management alone led to the demise of Dull. Mr. Kelly has hired you as the corporation's controller. This decision is sure to keep the fate of Dull from recurring. Because of the many other demands of starting a business, Sharp did not begin investing in securities until 2000 when sufficient cash was available. In 2000, the following transactions involving investments in securities took place: On 1/16/00, acquired Security P, an available-for-sale equity security, for $13,000 including brokerage fees: Investment in Equity Security P - AFS $13,000 Cash 13,000 On 2/1/00, acquired Security M, a trading equity security, for $10,000 including $300 in brokerage fees: Investment in Equity Security M - Trading $10,000 Cash 10,000 On 4/15/00, acquired Security E, an available-for-sale equity security, for $28,000 including brokerage fees: Investment in Equity Security E - AFS $28,000 Cash 28,000 On 5/1/00, acquired Security N, a trading security, for $15,000 including brokerage fees: Investment in Equity Security N - Trading $15,000 Cash 15,000 On 11/1/00, sold Security M. The market value at this date was $11,000: Cash $11,000 Investment in Equity Security M - Trading Realized Gain on Sale of Security 10,000 1,000 On 12/31/00, the market values of securities E, N, and P were $28,600, $13,500, and $10,000 respectively. You revalue these in accordance with FASB Statement No. 115 as follows: Investment in Equity Security E $600 Net Unrealized Holding Gain - AFS Securities Unrealized Holding Loss on Valuation of Trading Securities Investment in Equity Security N 600 $1,500 1,500 Net Unrealized Holding Loss - AFS Securities $3,000 Investment in Equity Security P 3,000 Pertinent 2000 year-end financial statement information follows. See FASB Statement No. 115 or our textbook for a summary of disclosure requirements. Balance Sheet Current Assets Marketable Equity Securities - Trading (N) Non-Current Assets Investment in Available-for-Sale Equity Securities (P,E) Stockholder's Equity Net Unrealized Holding Loss Income Statement Other Revenues and Expenses Realized Gain on Sale of Security M Unrealized Holding Loss on Valuation of Trading Securities $13,500 $38,600 ($2,400) Footnote A $1,000 (1,500) Statement of Cash Flows Operating Activities Proceeds from Sale of Trading Securities (M) $11,000 Cash used to acquire Trading Security (M,N) (25,000) Investment Activities Cash Used to Acquire AFS Securities (P,E) (41,000) Footnotes A. During 2000, $2400 in unrealized holding losses on available-for-sale securities were included in the net unrealized holding loss component of stockholders equity. In 2001, the following transactions involving investments in securities took place: On 2/1/01, sold security N for $14,000. Cash $14,000 Investment in Equity Security N - Trading Realized Gain on Sale of Security 13,500 500 During the fourth quarter of 2001 Sharp acquired the equity securities presented in Exhibit 1 that follows, except for Securities E and P that were acquired in 2000. Sharp sold no securities other than Security N during 2001. PROBLEM The date is January 2, 2002. Given Sharp's December 31 year-end, this is a hectic time for you. You are in the process of preparing reclassification, adjusting, and closing entries in preparation for issuing 2001 financial statements. Despite this, Mr. Kelly has invited Mr. Rebek (the Treasurer) and you into his office to discuss a financing proposal. Sharp is experiencing financing problems for a proposed production expansion program. Mr. Kelly has determined that rather outmoded facilities have led to inefficiencies in production over the last three years resulting in a reported net loss each year. To finance the new expansion program, Mr. Kelly, wishes to obtain financing on a long-term basis. Mr. Rebek notes that due to the reported net losses over the last three years, obtaining a loan for the total amount needed will be difficult. He expects that Sharp will have to sell some of its securities investments to cover the deficiency between the amount of financing needed and the loan obtained. Based on preliminary discussions with the bank, Mr. Rebek believes that Sharp will need to generate approximately $50,000 from the sale of securities investments in early 2002. Mr. Rebek further points out that Sharp's ability to obtain a loan at all is partially contingent on reported 2001 net income. Mr. Kelly agrees with Mr. Rebek and suggests that he is willing to sell any of the securities investments if required to meet the expansion program financing needs. You are given two objectives: (1) To raise $50,000 through securities sales to cover the difference between the loan proceeds and the capital expenditures project, and (2) to minimize the negative impact of equity investment transactions on the 2001 income statement. See Exhibit 1 for a listing of Sharp's securities investments at December 31, 2001. REQUIRED: A. In a memo to Mr. Kelly and Mr. Rebek, communicate the actions you would take in response to this situation. Briefly outline your financing recommendations and classification recommendation for each equity security in the portfolio and explain how your suggestions will help Sharp achieve its two objectives. B. Prepare a transparency summarizing your recommendations for each security to aid your presentation to our class. C. Prepare all adjusting and reclassification journal entries necessary at December 31, 2001 related to securities transactions and valuation adjustments, assuming your financing recommendations for 2002 and investment classification recommendations for 12/31/01 are accepted. D. Present the financial statement and additional disclosures required under FASB Statement No. 115 for Sharp Inc. at 12/31/01, assuming your financing recommendations for 2002 and investment classification recommendations for 12/31/01 are accepted. EXHIBIT I Sharp, Inc. Equity Securities Owned As of: December 31, 2001 Unadjusted Carrying Value $10,000 5,000 15,000 20,000 28,600 45,000 31,000 11,000 10,000 $175,600 Security A B C D E F G H P Totals Market $12,000 6,500 10,000 17,000 30,000 30,000 29,000 11,000 10,800 $156,300 Notes: 1. Security B is pledged as collateral against a three-year note, payable in 2004. The note prohibits sale of or substitution for the pledged security. In October 2001, Security B was acquired for $5000 plus brokerage fees of $400. 2. Security D was a redeemable preferred stock issue purchased in 2001 at par value. Sharp intends to hold this security until the 10/1/2004 redemption date. Market value of Security F in early 2002 had dropped to $27,500. Management wonders whether the stock’s price will ever rebound. Market value of Security G at the date of the meeting between Mr. Kelly, Mr. Rebek, and you (in early January, 2002) was $30,000. Security H was common stock of a privately-held corporation obtained from that corporation to replace a current note receivable. There is no ready market for this security. 3. 4. 5.
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