3.1 Investments in Equity Securities

Question 1

Ownership interest in an entity

Answer 1

Equity security

Question 2

Equity securities are characterized by the

Answer 2

percentage of ownership the investor has over the investee

Question 3

Presumed influence based on the ownership interest held:

Answer 3

0-20%: Little or none
20-50%: Significant
50-100%: Control

Question 4

Accounting method for little or none presumed influences

Answer 4

Fair value measurement

Question 5

Accounting method for significant presumed influences

Answer 5

Equity method or FVO

Question 6

Accounting method for control presumed influences

Answer 6

Consolidation

Question 7

When there’s little or no influence, dividends received from investments in equity securities are reported as

Answer 7

dividend income in the income statement

Question 8

Impairment loss

Answer 8

carrying amount - fair value

Question 9

Accounting methods for investments in equity securities according to the percentage of ownership interest

Answer 9

• Ownership under 20%
• Investment is measured at fair value at each balance sheet date
• Unrealized holding gains and losses are reported in the income statement (net income)
• Dividend received are reported as dividend income
• Ownership between 20% and 50%
• The investment should be accounted for by the equity method
• The investor should recognize in income its share of the investee’s earnings or losses
• The investor’s share of dividends increase cash and decrease the investment account
• Ownership over 50%
• The investor should issue consolidated financial statements.

Question 10

Which of the following items is not considered an equity security in the issuer?

A. Bonds convertible to common stock
B. Call options
C. Preferred stock
D. Stock warrants

Answer 10

A. Bonds convertible to common stock

An equity security is an ownership interest in an entity, such as through common or preferred stock, or a right to acquire or dispose or such an interest, such as through stock warrants or call options. However, convertible debt securities are not equity interest in the issuer.

Question 11

During Year 6, Wall Co. purchased 2,000 shares of Hemp Corp. common stock, properly classified as trading securities, for $31,500. They represent 2% of ownership in Hemp Corp. The fair value of this investment was $29,500 at December 31, Year 6. Wall sold all of the Hemp common stock for $14 per share on December 15, Year 7, incurring $1,400 in brokerage commissions and taxes. In its income statement for the year ended December 31, Year 7, Wall should report a recognized loss of

A. $3,500
B. $1,500
C. $2,900
D. $4,900

Answer 11

C. $2,900

A realized loss or gain is recognized when an individual equity security is sold or otherwise disposed of. Wall would have included the $2,000 ($31,500 - $29,500) decline in the fair value of the equity securities (an unrealized holding loss) in earnings at 12/31/Yr6. Consequently, the realized loss on disposal at 12/15/Yr 7 is $2,900 {$29,500 carrying amount - [(2,000 shares x $14) - $1,400]}.

Question 12

An entity should report an investment in marketable equity securities that does not result in significant influence or control over the investee at

A. Lower of cost or market, with holding gains and losses included in earnings.
B. Lower of cost or market, with holding gains included in earnings only to the extent of previously recognized holding losses.
C. Fair value, with holding gains included in earnings only to the extent of previously recognized holding losses
D. Fair value, with holding gains and losses included in earnings.

Answer 12

D. Fair value, with holding gains and losses included in earnings.

Unrealized holding gains and losses on an investment in equity securities that do not result in significant influence or control over the investee are reported in earnings. On a statement of financial position, these securities are reported at fair value.

Question 13

Describe the major difference between equity securities and debt securities

Answer 13

Equity securities are an ownership interest in an entity. The investee is not required to pay dividends, and there’s no fixed maturity date for repayment of capital. Equity securities are characterized by the percentage of ownership, and therefore the level of influence, the investor has over the investee.

Debt securities represent a creditor relationship with the issuer. The investee must pay stated interest and the full amount of principal by the future maturity date. Debt securities are characterized by the method and length of the investment and classified as held-to-maturity, trading, or available-for-sale.