Chapter 12 (Reporting and Analyzing Financial Investments)

Question 1

Short-term investment of excess cash

Answer 1

Excess cash for investment either during slow times or for liquidity needs

Question 2

Alliances for strategic purposes

Answer 2

Acquiring an interest in another company for strategic purposes, such as R&D, supply or distribution markets, or to their production and marketing expertise.

Question 3

Market penetration or expansion

Answer 3

Acquisition of controlling interests in other companies can achieve vertical or horizontal integration in existing markets or can be avenues to penetrate new and growing markets.

Question 4

Financial investments

Answer 4

Investments in government securities and in the securities of other companies

Question 5

Passive influence

Answer 5

An investor but can’t exert influence over the investee organization

Question 6

Significant influence

Answer 6

An investor can exert significant influence over, but not control, the activities of an investee company.

Question 7

Controlling influence

Answer 7

When a company has control over another, it has the ability to elect a majority of the board of directors and, as a result, the ability to determine its strategic direction and hiring of executive management.

Question 8

Fair value

Answer 8

The amount an independent buyer would be willing to pay for an asset in an orderly transaction

Question 9

Fair value hierarchy

Answer 9

Level 1: Values based on quoted prices in active markets.

Level 2: Values based on observable inputs other than Level 1 (e.g., quote prices for similar assets/liabilities or interest rates or yield curves)

Level 3: Values based on inputs observable only to the reporting entity (e.g. management estimates or assumptions).

Question 10

Fair value option

Answer 10

Provides companies with the option of using fair value to measure the value of most financial assets and liabilities, including accounts and notes receivable, accounts and notes payable, and bonds payable.

Question 11

Two types of marketable securities that require the investment to be reported on the balance sheet at current fair value

Answer 11

Trading (T) securities and Available-for-sale (AFS) securities

Question 12

Trading (T) securities

Answer 12

Investments in securities that management intends to actively buy and sell for trading profits as market prices fluctuate.

Question 13

Available-for-sale (AFS) securities

Answer 13

These are investments in securities that management intends to hold for capital gains and dividend revenue; although it may sell them if the price is right or if the organization needs cash.

Question 14

How are holding gains/losses recorded for trading securities?

Answer 14

They are recognized in income in the period in which they occur

Question 15

How are holding gains/losses recorded for AFS securities?

Answer 15

The gain/loss is recorded as an increase in accumulated other comprehensive income (AOCI)

Question 16

How is the amount determined for the gain/loss when selling AFS securities?

Answer 16

By comparing the amount received when the shares are sold to the amount paid for the shares when originally purchased.

Question 17

What’s the principal difference between trading securities and AFS securities?

Answer 17

Reporting on the income statement for trading securities

Question 18

How can you manage earnings with securities?

Answer 18

If management wants to report higher net income, investments that have increased in value could be classified as trading securities while investments that have declined in value could be classified as available-for-sale securities.

Question 19

Cost method

Answer 19

Investments for which fair value cannot be determined must be accounted for using the cost method

Question 20

Held-to-maturity (HTML)

Answer 20

Debt securities that management intends to hold to maturity are also reported using the cost method

Question 21

Intercorporate investments are usually made for strategic reasons, including:

Answer 21

Prelude to acquisition, strategic alliance, and pursuit of research and development

Question 22

Equity method

Answer 22

Investments with significant influence must be accounted for using the equity method. The method of accounting for investments reports the investment on the balance sheet at an amount equal to the proportion of the investee’s equity and investor: Hence the name Equity method.

Question 23

Summary of the equity method

Answer 23

Investments are initially recorded after purchase cost. Dividends received or treated as a recovery of the investment and, thus, produce investment balance.The investor reports income equal to its proportionate share of the reported income of the investee; the investment account is increased by that income were decreased by its share of any loss. The Investment is not reported at fair value as is the case with most passive investments.

Question 24

Are the assets and liabilities to which the investment relates reported when using the equity method?

Answer 24

Under a clean method accounting, only the net equity owned is reported on the balance sheet not the assets and liabilities to which the investment relates. Only the net equity and earnings is reported in the income statement not the investee’s sales and expenses.Both the balance sheets and income statements bar, therefore, markedly affected.

Question 25

What does consolidated accounting do?

Answer 25

It replaces the investment balance with the investee’s assets and liabilities to which it relates, and replaces the equity income reported by the investor with investee’s sales and expenses to which it relates. Specifically, consolidated balance sheet includes the gross assets and liabilities of the nasty company, and the income statement includes the gross sales and expenses of investee.

Question 26

How should the excess purchase price be allocated to the assets and liabilities?

Answer 26

Adjust the book value of all tangible assets acquired and all liabilities assumed to fair value. Assign the fair value to any identifiable intangible assets. Assign the residual amount to goodwill.

Question 27

How do you test goodwill?

Answer 27

The fair value of the investee company is compared with the book value of the investors investment account. If the fair value is less then better than the investment balance, the investment is deemed impaired the company must’ve then estimate the goodwill value as if the subsidiary required for its current for value and the imputed balance for goodwill becomes the amount which it is recorded.

Question 28

Noncontrolling interests

Answer 28

Represent the equity of shareholders who own a minority of the shares of one or more of the subsidiaries in a consolidated entity.