Analysis of Investing Activities
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At the end of its most recent fiscal year, Shangri-La Company., owned the following investments:
Investment Historical Cost Fair Market Value
Company A $650,000 $765,000
Company B $840,000 $730,000
Other Shangri-La assets: Book Value: $2.4 million
Other Shangri-La Liabilities: Book Value: $2.8 million.
Shangri-La's net income 2004: $280,000
If the company sold its investment in Company A at the end of the year for cash:
1.What effect would the sale have on its financial statements and return on assets
(Ignoring the effect of income taxes)?
Assume that assets are reported on the financial statements at historical cost.
2.What effect would the sale of investment in Company B have on the company's financial statements and return on assets?
3.Compare these amounts to those that would be reported if no investments were sold.
4.Does this example help explain why mark-to-market accounting is often required by
GAAP?
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Solution Summary
The solution explains the effect on financial statements of a sale of investments.
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1.What effect would the sale have on its financial statements and return on assets
(Ignoring the effect of income taxes)?
Assume that assets are reported on the financial statements at historical cost.
The cost is 650,000 and the sale price is 765,000 so there is a gain on sale of 765,000-650,000=115,000
We will see the effect on the following financial statements
a. Income statement - The gain would be reported on the income statement and the net income will increase by 115,000
b. Balance Sheet - In the balance sheet, investments will reduce by 650,000 and cash will increase by 765,000 and so the net increase in assets is 115,000. The retained earnings (due to increase in income) will increase by 115,000
c. Statement of cash Flows - ...
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