Chapter 17

Question 1

How are investment categories described under SFAS 115?

Answer 1

1) Debt Securities and Equity Securities, 2) Types of Debt Securities: Trading, Available for Sale, and Held to Maturity, 3) Types of Equity Securities: Trading and Available for Sale

Question 2

To what kind of securities does SFAS 115 apply to?

Answer 2

marketable securities, those that are traded on an exchange with observable values

Question 3

Why would investors choose to own debt securities?

Answer 3

because of interest payments

Question 4

Why would investors choose to own equity securities?

Answer 4

for ownership

Question 5

When is the equity method used to account for equity securities?

Answer 5

If own 20-50% of the voting stock

Question 6

When is the consolidation method used to account for equity securities?

Answer 6

If own more than 50% of the voting stock

Question 7

How are trading debt securities accounted for?

Answer 7

recorded at fair value and the market value changes are recorded as part of income (mark to market), gains and losses are recorded and impounded into EPS

Question 8

What classifies a debt security as trading?

Answer 8

based on management intent to sell in less than 1 year (more like 3 months)

Question 9

How are available for sale debt securities accounted for?

Answer 9

recorded at fair value and market value changes are recorded as part of equity, do not effect EPS

Question 10

How are held to maturity debt securities accounted for?

Answer 10

recorded at amortized cost and market value changes are not recognized

Question 11

What are the problems with the way debt securities are currently accounted for?

Answer 11

can tweak income by cherry picking which securities to put in which categories and determining management intent

Question 12

What classifies a debt security as held to maturity?

Answer 12

positive intent to hold the securities and the ability to hold them to maturity

Question 13

How is intent to hold a debt security as held to maturity determined?

Answer 13

through paper trails

Question 14

What are held to maturity debt securities recorded at?

Answer 14

amortized cost, not fair value

Question 15

What are available for sale debt securities recorded at?

Answer 15

fair value in the balance sheet with differences between the fair value and amortized cost reported as unrealized holding gains and losses (part of equity)

Question 16

How are gains and losses on available for sale securities reported when realized?

Answer 16

reported as part of net income

Question 17

What makes a gain/loss unrealized?

Answer 17

if the security has not been sold yet

Question 18

What are trading debt securities used for?

Answer 18

to generate profits from short-term differences in prices

Question 19

What is the holding period of a trading security?

Answer 19

usually less than 3 months

Question 20

What are trading debt securities recorded at?

Answer 20

fair value and unrealized gains and losses are reported as part of net income, any discount or premium is not amortized

Question 21

Why are trading debt securities unamortized?

Answer 21

because amortization is usually immaterial in practice, if held for year, must be amortized

Question 22

What are equity securities?

Answer 22

represent ownership interests such as common, preferred, stock options, warrants, or other capital stock

Question 23

What rights are included in equity securities?

Answer 23

rights to buy and sell ownership interest

Question 24

Are convertible debt and redeemable preferred stock considered equity securities?

Answer 24

no because convertible debt is a debt security and redeemable preferred stock has a maturity date so is considered debt

Question 25

What determines the accounting treatment for equity securities?

Answer 25

extent of ownership in common stock by an investor in an investee

Question 26

What are the levels of influence in equity interests?

Answer 26

1) 0-20% = little or none influence, 2) 20-50% = significant influence, 3) 50-100% control

Question 27

Where do most companies investments fall?

Answer 27

Below 20%

Question 28

What are some cases in which significant influence may not exist?

Answer 28

1) Investee opposes investor’s acquisition of stock, 2) Investor surrenders significant shareholder rights, 3) Investor is unable to obtain needed financial information from investee, 4) Investor is unable to obtain representation on investee’s board of directors

Question 29

When is the equity method used to account for equity securities?

Answer 29

when the investor has significant influence over the investee

Question 30

How is a significant security investment initially accounted for under the equity method?

Answer 30

recorded at cost

Question 31

How is the investment’s carrying value increased?

Answer 31

by investor’s proportionate share of earnings

Question 32

How is the investment’s carrying value decreased?

Answer 32

1) by investor’s proportionate share of losses, 2) dividends declared by the investee

Question 33

When is consolidation used to account for equity securities?

Answer 33

when there is a voting interest of more than 50% that results in a controlling interest

Question 34

What is the relationship between the investor and investee in a controlling interest relationship?

Answer 34

investor is parent corporation and investee is subsidiary corporation

Question 35

What is the result of the parent-subsidiary relationship?

Answer 35

investor prepares consolidated financial statements for the parent and subsidiary

Question 36

How are securities presented on the financial statements?

Answer 36

amounts must be reported for each category of investment

Question 37

How are trading securities recorded?

Answer 37

Reported at aggregate fair value as current assets

Question 38

How are available-for-sale securities recorded?

Answer 38

reported at aggregate fair value and either current or noncurrent assets, usually noncurrent

Question 39

How are held-to-maturity securities recorded?

Answer 39

reported at amortized cost and either current or noncurrent assets, always noncurrent except in year of maturity

Question 40

When is a bond sold at a discount or premium?

Answer 40

Premium = stated rate higher than yield rate, Discount = yield rate higher than stated rate

Question 41

When is the PV of 1 table used?

Answer 41

when calculating the PV of a lump sum (use yield rate)

Question 42

When is the annuity table used?

Answer 42

when calculating the value of interest payment

Question 43

How are the values of an amortization table calculated?

Answer 43

1) Cash = face value x stated rate, 2) Interest Revenue = carrying value x yield rate, 3) face value = final carrying value

Question 44

When is a unrealized holding gain/loss credited?

Answer 44

when a gain occurs

Question 45

When is the fair value adjustment account debited?

Answer 45

when the fair value increases

Question 46

What is a derivative?

Answer 46

type of financial instrument that derives its value from some asset

Question 47

What accounting standard applies to derivatives?

Answer 47

SFAS 113

Question 48

What are types of derivatives?

Answer 48

Hedge, Speculate, and arbitrage

Question 49

What is a hedge?

Answer 49

the goal is to budget, control cost, set prices, and manage cash flows in order to lower risk (jet fuel, commodities)

Question 50

What is speculation?

Answer 50

taking a risk but can make lots of profit

Question 51

What is arbitrage?

Answer 51

insider information used to buy and sell and make a profit, informational advantage

Question 52

How are derivatives accounted for on the balance sheet?

Answer 52

fair value

Question 53

How are derivatives accounted for on the income statement?

Answer 53

fair value with the gain/loss to income

Question 54

What are derivatives treated similarly to?

Answer 54

trading securities