Chapter 17 Derivatives Self-Assessment Quiz

Question 1

Derivatives should be recognized in the financial statements as assets and liabilities.

True
False

Answer 1

True

Question 2

Derivatives should be reported at amortized cost.

True
False

Answer 2

False

Derivatives should be reported at fair value.

Question 3

Which of the following statements regarding accounting for derivatives is false?

they should be reported at fair value.

gains and losses resulting from hedge transactions are reported in different ways, depending upon the type of hedge.

gains and losses resulting from speculation should be deferred.

they should be recognized in the financial statements as assets and liabilities.

Answer 3

gains and losses resulting from speculation should be deferred.

Question 4

A fair value hedge may be used to offset the exposure to changes in the fair value of an unrecognized commitment.

True
False

Answer 4

True

In a fair value hedge , a company uses a derivative to hedge (offset) the exposure to changes in the fair value of a recognized asset or liability or of an unrecognized commitment. In a perfectly hedged position, the gain or loss on the fair value of the derivative equals and offsets that of the hedged asset or liability.

Question 5

Derivatives such as fair value hedges are recorded at amortized cost.

True
False

Answer 5

False

Question 6

Derivatives such as fair value hedges are recorded at

fair value.

carrying value.

historical cost.

amortized cost.

Answer 6

fair value.

Question 7

Gains and losses on cash flow hedges are recorded in equity as part of other comprehensive income.

True
False

Answer 7

True

Cash flow hedges are reported at fair value with gains and losses reported in equity as part of other comprehensive income.

Question 8

Unrealized holding gains and losses on cash flow hedges are included in net income.

True
False

Answer 8

False

Question 9

To qualify for special accounting for hedges treatment, the hedging transaction must be at least moderately effective.

True
False

Answer 9

True

To qualify for special accounting for hedges treatment, the hedging transaction must be highly effective.

Question 10

An option to convert a convertible bond into shares of common stock is a(n)embedded derivative.

True
False

Answer 10

True

a convertible bond (discussed in Chapter 16) is a hybrid instrument. It consists of two parts: (1) a debt security, referred to as the host security , combined with (2) an option to convert the bond to shares of common stock, the embedded derivative .

Question 11

In a variable-interest entity, stockholders may not absorb losses or receive the returns of a normal stockholder.

True
False

Answer 11

True

Stockholders in variable-interest entities may be shielded from losses or have their returns capped.

Question 12

In a variable-interest entity all stockholders have decision-making rights.

True
False

Answer 12

False

In some cases, stockholders do not have the influence to control the company’s destiny.

Question 13

A variable-interest entity (VIE) is an entity that has one of the following characteristics:

Answer 13

1. Insufficient equity investment at risk.

Stockholders are assumed to have sufficient capital investment to support the entity’s operations. If thinly capitalized, the entity is considered a VIE and is subject to the risk-and-reward model.

2. Stockholders lack decision-making rights.

In some cases, stockholders do not have the influence to control the company’s destiny.

3. Stockholders do not absorb the losses or receive the benefits of a normal stockholder.

In some entities, stockholders are shielded from losses related to their primary risks, or their returns are capped or must be shared with other parties.

Question 14

Which of the following is NOT a required disclosures related to financial instruments?

disclosing the fair value and related carrying value of the instruments.

combining or netting the fair value of separate financial instruments.

distinguishing between financial instruments held or issued for purposes other than trading.

displaying as a separate classification of other comprehensive income the net gain/loss on derivative instruments designated in cash flow hedges.

Answer 14

combining or netting the fair value of separate financial instruments.

Question 15

Unrealized holding gains and losses from speculation in derivatives are recognized immediately in income.

True
False

Answer 15

False

Question 16

Companies that attempt to exploit inefficiencies in various derivative markets by attempting to lock in profits by simultaneously entering into transactions in two or more markets are called

hedgers.
gamblers.
arbitrageurs.
speculators.

Answer 16

arbitrageurs

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Question 17

All of the following statements regarding accounting for derivatives are correct except that

gains and losses resulting from speculation should be deferred.

they should be recognized in the financial statements as assets and liabilities.

they should be reported at fair value.

gains and losses resulting from hedge transactions are reported in different ways, depending upon the type of hedge.

Answer 17

gains and losses resulting from speculation should be deferred.

Question 18

All of the following are characteristics of a derivative financial instrument except the instrument

has one or more underlyings and an identified payment provision.

requires or permits net settlement.

requires a large investment at the inception of the contract.

all of these are characteristics.

Answer 18

requires a large investment at the inception of the contract.

Question 19

Which of the following are considered equity securities?

Convertible debt.

Redeemable preferred stock.

Call or put options.

Answer 19

Call or put options.

Question 20

Separating the value of the host security from that of the embedded derivative is referred to as designation.

True
False

Answer 20

False

A convertible bond is a hybrid instrument. It consists of two parts: (1) a debt security, referred to as the host security, combined with (2) an option to convert the bond to shares of common stock, the embedded derivative .
To provide consistency in accounting for similar derivatives, a company must account for embedded derivatives similarly to other derivatives. Therefore, to account for an embedded derivative, a company should separate it from the host security and then account for it using the accounting for derivatives. This separation process is referred to as bifurcation .

Question 21

An option to convert a convertible bond into shares of common stock is a(n)

fair value hedge.
host security.
embedded derivative.
hybrid security.

Answer 21

embedded derivative.

Question 22

One required disclosure for financial instrument is that a separate classification of other comprehensive income the net gain/loss on derivative instruments designated in cash flow hedges must be presented.

True
False

Answer 22

True

Question 23

The fair value and related carrying value of the instrument is a required disclosures related to financial instruments.

True
False

Answer 23

True

Question 24

GAAP requires that both the cost and fair value of all financial instruments be reported in the notes to the financial statements.

True
False

Answer 24

True

Question 25

Recovery of impairment

is not permitted by IFRS for held-for-collection securities.

is permitted by US GAAP for held-to-maturity securities.

is permitted by IFRS for held-for-collection securities but prohibited by US GAAP for held-to-maturity securities.

is prohibited by both IFRS and US GAAP for any debt security.

Answer 25

is permitted by IFRS for held-for-collection securities but prohibited by US GAAP for held-to-maturity securities.

Question 26

Both IFRS and U.S. GAAP use the same test to determine whether the equity method of accounting should be used.

True
False

Answer 26

True

Both IFRS and U.S. GAAP use the same test of significant influence with a general guide of over 20 percent ownership to determine whether the equity method of accounting should be used.

Question 27

Both the FASB and the IASB believe that reporting fair values for financial assets and liabilities provides more useful and relevant information relative to historical cost.

True
False

Answer 27

True

Question 28

Rushia Company has an available-for-sale investment in the 10%, 10-year bonds of Pear Company The investment’s carrying value is $3,200,000 at December 31, 2014. On January 9, 2015, Rushia learns that Pear Company has lost its primary manufacturing facility in an uninsured fire. As a result, Rushia determines that the investment is impaired and now has a fair value of $2,300,000. In June, 2016, Pear Company has succeeded in rebuilding its manufacturing facility, and its prospects have improved as a result.

If Rushia Company determines that the fair value of the investment is now $3,900,000 and is using U.S. GAAP for its external financial reporting, which of the following is true?

Rushia may record a recovery of $900,000.

Rushia is prohibited from recording the recovery in value of the impaired investment.

Rushia may record a recovery of $700,000.

Rushia may record a recovery of $1,600,000.

Answer 28

Rushia is prohibited from recording the recovery in value of the impaired investment.

Question 29

Which of the following statements regarding accounting for derivatives is false?

they should be reported at fair value.

gains and losses resulting from speculation should be deferred.

gains and losses resulting from hedge transactions are reported in different ways, depending upon the type of hedge.

they should be recognized in the financial statements as assets and liabilities.

Answer 29

gains and losses resulting from speculation should be deferred.

Question 30

Derivatives such as fair value hedges are recorded at

carrying value.

fair value.

historical cost.

amortized cost.

Answer 30

fair value.

Question 31

Unrealized holding gains and losses on cash flow hedges are

included in net income.

reported directly in retained earnings.

not recorded or reported.

reported as a component of other comprehensive income

Answer 31

reported as a component of other comprehensive income

Question 32

A variable-interest entity has

All of the above are characteristics of a variable-interest entity.

insufficient equity investment at risk.

stockholders who have decision-making rights.

stockholders who absorb the losses or receive the benefits of a normal stockholder.

Answer 32

insufficient equity investment at risk.