Chapter 10 Investments

Question 1

Why do companies invest?

Answer 1

A debt security represents a credit relationship with another company and typically pays interest for a fixed period. An Equity security represents stock ownership in another company and sometimes pays dividends
Companies invest in debt or equity securities to generate investment income or to pursue a certain business strategy. Investments are classified as either short-term or long-term investments and can be further classified into five categories

Question 2

What are trading investments?

Answer 2

Debt securities or equity securities in which the investor holds less than 20% of the voting stock and that the investor plans to sell in the very near future

Question 3

What are Held-to-maturity investments? (HTM)

Answer 3

debt securities the investments or HTM investments tor intends to hold until they mature

Question 4

what are available for sale investments (AFS)

Answer 4

debt securities or equity securities in which the investor holds less than 20% of the voting stock and that aren’t trading investments or held-to-maturity investments

Question 5

What are significant interest investments?

Answer 5

equity securities in which the investor owns 20% or more, but less than 50% of the investee’s voting stock

Question 6

what are controlling investments?

Answer 6

Equity securities in which the investor owns 50% or more of the investee’s voting stock

Question 7

How are investments in debt securities accounted for?

Answer 7

investments in debt securities are recorded at cost, including any brokerage fees paid. The receipt of interest revenue is recorded with a DR Cash and CR Interest revenue. Debt securities disposed of at a maturity are recorded with a DR Cash and CR Short-term or Long-term Investments account

Question 8

How are investments in equity securities accounted for?

Answer 8

Equity securities with less than 20% ownership are recorded using the cost method. The purchase of equity securities is recorded at cost, including any brokerage fees paid. The receipt of dividend revenue is recorded with a DR Cash and CR Dividend Revenue. Equity securities with 20% or more, but less than 50%, ownership are recorded using the equity method. The purchase of the equity securities is recorded at cost. Dividends declared and received are recorded with a DR Cash and CR Long-term investments. A dividend reduces the investor’s investment. The investor’s share of net income is recorded as revenue from investments. Disposition of equity securities could involve either a gain or loss. Equity securities with a 50% or more ownership are recorded using the consolidation method, which involves the parent company preparing consolidated statements.

Question 9

How are debt and equity securities reported?

Answer 9

Trading investments and available-for-sale investments are reported at fair value on the balance sheet. The unrealized holding gain or loss incurred on trading investments is reported on the income statement as Other Revenues and (Expenses). The unrealized holding gain or loss incurred on available-for-sale investments is not included in net income. It is, instead, reported as part of accumulated other comprehensive income included in stockholders’ equity on the balance sheet. Held-to-maturity investments are reported at amortized cost on the balance sheet.

Question 10

How do we use the rate of return on total assets to evaluate business performance?

Answer 10

The rate of return on total assets measures a company’s success in using its assets earn a profit. (Net income + Interest expense) / Average total assets

Question 11

define available-for-sale (AFS) investment

Answer 11

a debt security or an equity security in which the investor holds less than 20% of the voting stock and that isn’t a trading investment or a held-to-maturity investment

Question 12

define comprehensive income

Answer 12

a company’s change in total stockholders’ equity from all sources other than owners’ investments and dividends

Question 13

Define consolidation accounting

Answer 13

they way to combine the financial statements of 2 or more companies that have the same owners

Question 14

define consolidated statements

Answer 14

financial statements that combine the balance sheets, income statements, and cash flow statements of the parent company with those of its controlling affiliates

Question 15

Define controlling interest investment

Answer 15

an equity security in which the investor owns 50% or more of the investee’s voting stock

Question 16

define debt security

Answer 16

represents a credit relationship with another company or governmental entity that typically pays interest for a fixed period

Question 17

define equity security

Answer 17

represents stock ownership in another company that sometimes pays dividends

Question 18

define fair value

Answer 18

the price that would be used if investments were sold on the market

Question 19

define HTM investment

Answer 19

a debt security the investor intends to hold until it matures

Question 20

define investee

Answer 20

the corporation that issued the bond or stock to the investor

Question 21

define investor

Answer 21

the owner of a bond or stock of a corporation

Question 22

define long-term investments

Answer 22

investments in debt or equity securities the investor intends to hold for longer than 1 year

Question 23

define parent company

Answer 23

a company that owns a controlling interest in another company

Question 24

define rate of return on total assets

Answer 24

a ratio that measures the success a company has in using its assets to earn income (Net income + interest expense ) / Average total assets

Question 25

define security

Answer 25

a share or interest representing financial value

Question 26

Short-term investments

Answer 26

investments in debt and equity securities that are highly liquid and that the investor intends to sell in one year or less

Question 27

define significant interest investment

Answer 27

an equity security in which the investor owns 20% or more, but less than 50% of the investee’s voting stock

Question 28

define subsidiary company

Answer 28

a company that is controlled by another corporation

Question 29

define trading investment

Answer 29

a debt security or an equity security in which the investor holds less than 20% of the voting stock and that the investor plans to sell in the very near future