Ch. 12: Reporting & Analysing Financial Investments

Question 1

Passive influence

Answer 1

Investor cannot exert influence over the investee company

Generally less than 20% of the outstanding voting stock of the investee is owned by investor

Can be investments in stock, bonds or notes of other companies

Question 2

Significant influence

Answer 2

Investor can exert influence over, but not control, the investee company

Level of influence can result from:

• Percentage of voting stock owned.
• Legal agreements.
• Result of being a sole supplier or customer

Influence generally assumed if ownership is between 20% to 50% of the outstanding voting stock

Question 3

Controlling influence

Answer 3

Investor has control over investee:

• Ability to elect a majority of the board of directors
• Ability to affect the strategic corporate direction
• Can affect hiring of executive management

Control presumed when ownership is 50% or more of the outstanding voting stock

However, can occur at less than 50% through:

• Legal agreements
• Technology licensing

Question 4

Available-for-sale (ASF) securities

Answer 4

Management intends to hold for capital gains and interest or dividend revenue; may sell if the price is right or if cash is needed.

Question 5

Trading (T) securities

Answer 5

Management intends to actively buy and sell for trading profits
as market prices fluctuate

Question 6

Marked to fair value method

Answer 6

To increase (mark up) or decrease (mark down) the investment’s value to fair value as of the date of the balance sheet

Question 7

Cost method

Answer 7

Applicable for investments with no current fair value

Used for debt securities that management intends to hold to maturity

• Called held-to-maturity (HTM) securities
• Accounting treatment

Question 8

Reasons for making investments with significant influence

Answer 8

Prelude to acquisition -> May allow an investor to gain a seat on the board to learn inside information.

Strategic alliance -> For purposes of expanding to a new location. Such as a company that provides inputs for the investor’s production process.

Pursuit of research and development-> Joint efforts can reduce risk or amount of capital invested

Question 9

Consolidation method

Answer 9

Replaces the investment balance with the investee’s
assets and liabilities

Replaces the equity income reported by the investor with the investee’s sales and expenses

Equity method plus one additional step