Chapter 16 Quizzes Flashcards
Morgan Company invests in Jones, Inc. bonds that mature in 10 years. The investment was purchased at 102. The bonds pay interest annually. Morgan intends to use the cash flow generated by the interest payments on the bond to provide employee bonuses during the next fiscal year.
- What type of investment is this?
- What method should be used to account for the investment?
- Will it be restated to fair value each year?
- If any unrealized gain or loss is to be accounted for, will it be through income or equity?
Type: Debt security
(bonds = debt)
Classification: Available-for-sale (AFS)
(Not trading or HTM; purpose is liquidity/flexibility)
Measurement: Fair value
(AFS requires fair value)
Unrealized Gain/Loss: Equity
(AFS changes go to OCI)
Premium Handling: Amortized through the “Investment” account (not via a separate “Premium” account)
Morgan Company purchases 1,000 shares of common stock of Smith, Inc. as an investment based on a recommendation from the CEO’s broker. The broker believes the price will increase substantially over the next couple of months. Smith, Inc. has 100,000 shares of common stock outstanding.
- What type of investment is this?
- What method should be used to account for the investment?
- Will it be restated to fair value each year?
- If any unrealized gain or loss is to be accounted for, will it be through income or equity?
Type: Equity security
(Stock = equity)
Ownership Level: <20%
(No significant influence)
Classification: Trading security
(Meant for quick sale)
Measurement: Fair value
(Trading always marked-to-market)
Unrealized Gain/Loss: Reported in net income
(Trading gains/losses hit income)
Initial Recognition: Record at cost
A 4-year $50,000 investment grade bond issued by Martin, Inc. was purchased at a discount by Morgan Company. The company intends to use the proceeds from the investment to expand their manufacturing to an additional site in Tennessee in 2029.
- What type of investment is this?
- What method should be used to account for the investment?
- Will it be restated to fair value each year?
- If any unrealized gain or loss is to be accounted for, will it be through income or equity?
Type: Debt security
(Bond = debt)
Classification: Held-to-maturity (HTM)
(Intent/ability to hold to maturity)
Measurement: Amortized cost
(HTM not revalued)
Unrealized Gain/Loss: Not applicable
(No fair value adjustment)
Key Criteria: Intent and ability to hold until maturity
Morgan Company routinely invests their excess cash in a portfolio of stocks. The portfolio may be liquidated within the next year if needed.
- What type of investment is this?
- What method should be used to account for the investment?
- Will it be restated to fair value each year?
- If any unrealized gain or loss is to be accounted for, will it be through income or equity?
Type: Equity security
(Stocks = equity)
Ownership Level: <20%
(Passive investment)
Classification: Trading security
(Frequent trading suggests trading classification)
Measurement: Fair value (mark-to-market)
(Trading requires fair value)
Unrealized Gain/Loss: Reported in net income
(Trading gains/losses in income)
Initial Recognition: Record at cost
Morgan Company purchased 40% of the outstanding stock of Latham, Inc., a supplier of parts used in Morgan’s manufacturing process. Morgan is considering purchasing another 11% of Latham.
- What type of investment is this?
- What method should be used to account for the investment?
- Will it be restated to fair value each year?
- If any unrealized gain or loss is to be accounted for, will it be through income or equity?
Type: Equity security
(Stock = equity)
Ownership Level: 20%–50%
(Presumed significant influence)
Classification: Significant influence → Equity method
(Must use equity method)
Recognition Approach:
- Increase “Investment” by proportionate share of investee’s net income
- Decrease “Investment” by dividends received
On January 1, 2025, Jones Company purchased, as an investment, 5% bonds, having a maturity value of $150,000, for $138,400. The bonds provide the bondholders with a 7% yield. They are dated January 1, 2025, and mature January 1, 2035, with interest receivable June 30 and December 31 of each year. Jones Company uses the effective-interest method to allocate unamortized discount or premium.
The fair value of the bonds at December 31 of each year-end is as follows:
2025 - 145,000
2026 - 143,000
2027: 157,000
Prepare the schedule of interest revenue and bond amortization from January 1, 2025 through December 31, 2027. Round to whole dollars!
150,000 x 2.5% = 3,750
6/30: 138,400 x 3.5% = 4,844
4,844 - 3,750 = 1,094
138,400 + 1,094 = 139,494
… and so on
On January 1, 2025, Jones Company purchased, as an investment, 5% bonds, having a maturity value of $150,000, for $138,400. The bonds provide the bondholders with a 7% yield. They are dated January 1, 2025, and mature January 1, 2035, with interest receivable June 30 and December 31 of each year. Jones Company uses the effective-interest method to allocate unamortized discount or premium.
The fair value of the bonds at December 31 of each year-end is as follows:
2025 - 145,000
2026 - 143,000
2027: 157,000
Assume the bonds are classified in the held-to-maturity category.
a) Prepare the journal entry at the date of the investment purchase.
b) Prepare the journal entry to record the interest received on December 31, 2025.
c) Prepare the journal entry to record the recognition of fair value on December 31, 2025.
d) Prepare the journal entry to record the interest received on December 31, 2027.
e) Prepare the journal entry to record the recognition of fair value at December 31, 2027.
a)
D - Debt Investments: 138,400
C - Cash: 138,400
b) 12/31/25
D - Cash: 3,750
D - Debt Investments: 1,132
C - Interest Revenue: 4,882
c) 12/31/25
No entry
d) 12/31/27
D - Cash: 3,750
D - Debt Investment: 1,299
C - Interest Revenue: 5,049
e) 12/31/27
No entry
On January 1, 2025, Jones Company purchased, as an investment, 5% bonds, having a maturity value of $150,000, for $138,400. The bonds provide the bondholders with a 7% yield. They are dated January 1, 2025, and mature January 1, 2035, with interest receivable June 30 and December 31 of each year. Jones Company uses the effective-interest method to allocate unamortized discount or premium.
The fair value of the bonds at December 31 of each year-end is as follows:
2025 - 145,000
2026 - 143,000
2027: 157,000
Assume the securities are classified as avaliable-for-sale.
a) Prepare the journal entry at the date of the investment purchase.
b) Prepare the journal entry to record the interest received on December 31, 2025.
c) Prepare the journal entry to record the recognition of fair value on December 31, 2025.
d) Prepare the journal entry to record the interest received on December 31, 2027.
e) Prepare the journal entry to record the recognition of fair value at December 31, 2027.
a)
D - Debt Investments: 138,400
C - Cash: 138,400
b) 12/31/25
D - Cash: 3,750
D - Debt Investments: 1,132
C - Interest Revenue: 4,882
c) 12/31/25
145,000 - 140,626 = 4,374
D - Fair Value Adjustment: 4,374
C - Unrealized Holding Gain/Loss - Equity: 4,374
d) 12/31/27
D - Cash: 3,750
D - Debt Investment: 1,299
C - Interest Revenue: 5,049
e) 12/31/27
157,000 - 145,565 = 11,435 + 11 = 11,446
D - Fair Value Adjustment: 11,446
C - Unrealized Holding Gain/Loss - Equity: 11,446
Rose Company acquired 10% of the 750,000 shares of common stock of Thorn Company at a total cost of $5.00 per share on June 1, 2025. On October 1, Thorn Company declared and paid a $5,000 cash dividend. On December 31, Thorn Company stock has a market price of $6.25 per share and the company reported net income of $850,000 for the year. The securities are classified as avaliable-for-sale. Prepare all journal entries for 2025.
750,000 x 10% = 75,000
6/1:
750,000 x 10% = 75,000
D - Equity Investment: 375,000
C - Cash (75,000 x 5): 375,000
10/1:
D - Cash (10% x 5,000): 500
C - Dividend Revenue: 500
12/31:
D - Fair Value Adjustment: 93,750
C - Unrealized Holding Gain/Loss - Equity (75,000 x (6.25 - 5)): 93,750
On January 1, 2025, Martin Company purchased 45% of Lawson Corporation’s 500,000 outstanding shares at a cost of $8 per share. On July 15, Lawson declared and paid a cash dividend of $1.50 per share. On December 31, Lawson reported a net income of $2,500,000 for the year and the market price of its common stock was $12 per share. The securities are classified as avaliable-for-sale. Prepare all journal entries for 2025.
45% x 500,000 = 225,000 shares
1/1:
D - Equity Investments: 1,800,000
C - Cash (225,000 x 8): 1,800,000
6/15:
D - Cash: 337,500
C - Equity Investments (225,000 x 1.50): 337,500
12/31
D - Equity Investments: 1,125,000
C - Investment Income (2,500,000 x 45%): 1,125,000
