FAR 4 Flashcards
FAR 4.02 - HELD TO MATURITY AND FAIR VALUE ACCOUNTING
An investor purchased a bond classified as long-term investment between interest dates at a discount. At the purchase date, the carrying amount of the bond is more than the..
I. Cash paid to seller
II. Face amount of bond
Both I and II
Neither I nor II
II only
I only
Neither I nor II
EXPLANATION
When a bond is purchased between interest dates, the amount paid will be the fair market value of the bond, which will be the carrying value at the purchase date, plus interest accruing from the last interest date to the date of purchase.
The carrying amount excludes the interest and will be lower than the amount of cash paid.
When a bond is purchased at a discount, the carrying value will be lower than the face amount of the bond.
CV < FV = DISCOUNT
CV > FV = PREMIUM
As a result, a bond purchased between interest dates at a discount has a carrying amount that is lower than both the cash paid to the seller and the face amount of the bond.
FAR 4.02 - HELD TO MATURITY AND FAIR VALUE ACCOUNTING
Which statement(s) is (are) true about reporting debt securities held to maturity?
I. Investments in debt securities that are classified
as held to maturity are reported at amortized cost.
II. The market value of investments in debt that are classified as held to maturity must be disclosed.
III. Unrealized gains and losses on debt securities that are classified as held to maturity are recognized in income in the period of the change.
I only
I and II only
I and III only
I, II and III
I and II only
EXPLANATION:
When an entity acquires marketable debt securities that it both intends to and has the ability to hold until they mature, they are classified as held-to-maturity and initially recorded at cost.
Any difference between their face and carrying value is amortized as an adjustment to interest income and the securities are carried at amortized cost, with their fair values required to be disclosed.
Unrealized gains and losses are not reported in either net income or other comprehensive income since the investment is not adjusted to fair value.
4.01 - TYPES OF MARKETABLE SECURITIES
3 TYPES OF MARKETABLE SECURITIES
- Trading securities (HFT-Held for Trading):
- —— Instruments to make a profit -operating activity
- —— Instruments classified as Current Assets
- —— Unrealized gains/losses on Income Statement at Fair Market Value (FMV) - Available-for-sale securities:
- ——- Doesn’t fit definition of HFT or HFM
- ——- Current or Noncurrent Assets, depending on expected date of sale. If indefinite, it’s noncurrent. - Held-to-maturity securities:
- ——- Debt instruments which the investor has the ability and intent to hold until the due date for repayment
- —— Noncurrent Asset unless maturity < 1 yr
When an investment is made in securities (debt or equity) that are publicly traded , and the investment is not large enough to provide the investor with any significant influence over the investee, the accounting for the investment will depend on the classification ( ASC 320):
Trading Securities (HFT – Held For Trading) are investments in equity instruments, such as stocks, options, rights warrants or debt instruments, such as bonds, which the investor has acquired in an attempt to make profits by buying and selling within a short period of time.
Available-For-Sale (AFS/AVS) securities are all investments in marketable equity or debt instruments that do not fit the definitions of HTM or trading securities. These may be classified as current or noncurrent assets, depending on the expected date of sale. If the holding period of the securities is indefinite, they should be classified as noncurrent assets.
Held-To-Maturity (HTM) securities are investments in bonds and other debt instruments which the investor has the ability and intent to hold until the due date for repayment. These are classified as noncurrent assets (unless the maturity date is less than one year from the balance sheet date).
As a result, there are two different categories for equity securities (these cannot be HTM securities), and three categories for debt securities. They are categorized based on management’s intentions.
4.01 - TYPES OF MARKETABLE SECURITIES
On January 1 of the current year, Barton Co. paid $900,000 to purchase two-year, 8%, $1,000,000 face value bonds that were issued by another publicly-traded corporation. Barton plans to sell the bonds in the first quarter of the following year.
The fair value of the bonds at the end of the current year was $1,020,000. At what amount should Barton report the bonds in its balance sheet at the end of the current year?
$950,000
$900,000
$1,000,000
$1,020,000
$1,020,000
EXPLANATION:
Securities of a publicly-held entity (such as stocks, options warrants, or debt instruments, such as bonds) are considered marketable securities and recognized on the balance sheet at their fair market value (FMV) as of the date of the balance sheet, $1,020,000 in this case.
The fact that they were acquired for short-term gain indicates that they will be classified as trading securities and that unrealized gains and losses due to changes in FMV will be recognized in income.
4.07 - INVESTMENTS UNDER IFRS: MARKETABLE SECURITIES
On January 3, 20X1,Europa, Ltd. invested $198,000 in 6% bonds with a face value of $300,000 that mature on December 31, 20X20 and pay interest annually on December 31 each year. The bond pays interest annually on December 31.
Europa intends to hold the bond for the purpose of collecting the scheduled cash flows and expects to earn a 10% rate of return.
At December 31, 20X1, the bonds had a fair value of $205,000. Europa prepares its financial statements in accordance with IFRS and did not elect to carry the investment at fair value through profit and loss.
What amount or amounts will Europa report in its income statement for the year ended December 31, 20X1 and what will be the carrying value of the investment at December 31, 20X1?
Interest income of $19,800 and a gain of $5,200 with a carrying value of $205,000.
A gain of $7,000 with a carrying value of $205,000.
Interest income of $19,800 with a carrying value of $199,800.
Interest income of $18,000 and a gain of $7,000 with a carrying value of $205,000.
Interest income of $19,800 with a carrying value of $199,800.
EXPLANATION:
Since Europa intends to hold the bond for the purpose of collecting the scheduled cash flows, it will account for the bond at amortized cost.
Under the amortized cost approach, Europa will recognize interest income equal to the yield rate of 10% applied to the $198,000 carrying value of the bond, resulting in interest income of $19,800.
Since the amount received will be the stated rate of 6% applied to the face value of $300,000, interest received will be $18,000, resulting in the amortization of discount in the amount of $1,800.
The resulting carrying value of the bond will be ($198,000 + $1,800) $199,800.
4.02 - MARKETABLE SECURITIES: AVAILABLE FOR SALE
Data regarding Rock Corp.’s available-for-sale securities follows:
—————————-Cost Market / Value
December 31, 20X7: $80,000 / $65,000
December 31, 20X8: $80,000 / $90,000
Differences between cost and market values are considered temporary. Rock does not elect the fair value option of accounting for available-for-sale securities. By what amount should Rock increase (credit) its 20X8 other comprehensive income?
$25,000
$15,000
$10,000
$0
$25,000
EXPLANATION;
Available for sale securities are reported at their fair market values with unrealized gains and losses reported in other comprehensive income.
As of December 31, 20X7, Rock’s available for sale securities had a fair value of $65,000.
At December 31, 20X8, the securities had a fair value of $90,000, indicating an unrealized gain of $90,000 - $65,000 or $25,000, which will be reported in other comprehensive income.
4.02 - MARKETABLE SECURITIES: AVAILABLE FOR SALE
Data regarding Ball Corp.’s available-for-sale securities follow:
—————————— Cost / Market value
December 31, 20X2$150,000/ $130,000
December 31, 20X3 $150,000/ $160,000
Differences between cost and market values are considered temporary. Ball does not elect the fair value option to account for available-for-sale securities. Ball’s 20X3 other comprehensive income would be
$20,000
$30,000
$10,000
$0
$30,000
EXPLANATION:
The amount reported in other comprehensive for available for sale (AFS) investments is the increase or decrease in market value during the period.
Since the AFS were reported at their market value of $130,000 at 12/31/X2, they would be increased to their 12/31/X3 market value of $160,000 with an increase to the investment and a credit (increase) to other
comprehensive income for the difference of $30,000.
4.01 - MARKETABLE SECURITIES: TRADING
Cap Inc. has a portfolio of marketable securities that it does not intend to sell in the near future. Cap does not elect the fair value option to report these securities.
Which of the below statements correctly describes the classification and reporting requirements for marketable securities held by Cap?
Cap should classify the marketable securities as available-for-sale securities and report unrealized gains and losses as a separate component of other comprehensive income.
Cap should classify the marketable securities as available-for-sale securities and report unrealized gains and losses as a component of income from continuing operations.
Cap should classify the marketable securities as trading securities and report unrealized gains and losses as a separate component of other comprehensive income.
Cap should classify the marketable securities as trading securities and report unrealized gains and losses as a component of income from continuing operations
Cap should classify the marketable securities as available-for-sale securities and report unrealized gains and losses as a separate component of other comprehensive income.
EXPLANATION:
A portfolio of marketable securities that an entity intends to sell in the near future is classified as trading securities with unrealized gains and losses reported in income.
When the entity does not intend to sell them in the near future, however, they are classified as available for sale securities and unrealized gains and losses are reported in other comprehensive income (OCI).
AFS ==>
- FMV reported on B/S
- Unrealized gains/loss reported as OCI gains/losses
- Closed into AOCI, component of S/E
- At disposal, realized in Net Income = Sales Proceeds - Original Cost and removed from AOCI
4.04 - SALE OF AFS AND IMPAIRMENT LOSS
Sun Corp. had investments in marketable debt securities costing $650,000 that were classied
as available-for sale. On June 30, 20X3,
Sun decided to hold the investments to maturity and accordingly reclassified them to the held-to-maturity category on that date.
The investments’ market value was $575,000 at December 31, 20X2,
$530,000 at June 30, 20X3, and $490,000 at December 31, 20X3. Sun does not elect the fair value option to account for these investments.
What amount should Sun report as net unrealized loss on marketable debt securities in its 20X3 statement of
stockholders’ equity?
$40,000
$160,000
$45,000
$120,000
$120,000
EXPLANATION:
When an investment in a debt security is reclassified from available for sale (AFS) to held to maturity (HTM), the transfer occurs at its market value on the date of transfer.
Any unrealized holding gain or loss is recognized in other comprehensive income (OCI) and amortized as an adjustment to the effective interest rate on the HTM security.
On the date of transfer, the market value of $530,000 is $120,000 lower than its $650,000 cost, which is recognized in OCI, but no portion is recognized in income.
4.02 - MARKETABLE SECURITIES: AVAILABLE FOR SALE
A corporation holds marketable securities classified
as available-for-sale securities. The following amount(s) should be included in the corporation’s net income for the current period:
I. Realized gains during the period.
II. Changes in the valuation allowance during the period.
III. Unrealized temporary gains during the period.
I and II only
I, II, and III
I only
II only
I only
EXPLANATION:
When investments are classified as available for sale, they are reported on the balance sheet at their fair market values with unrealized gains and losses reported in other comprehensive income (OCI) and closed into accumulated OCI (AOCI), a component of stockholders’ equity.
When they are disposed of, realized gains and losses, which are measured as the difference between the sales proceeds and the original cost of the securities, are recognized in net income with any previously reported unrealized gains and losses reclassified and removed from AOCI.
Changes in the valuation allowance during the period represent unrealized temporary gains and losses, which are reported in OCI.
AFS ==>
- FMV reported on B/S
- Unrealized gains/loss reported as OCI gains/losses
- Closed into AOCI, component of S/E
- At disposal, realized in Net Income = Sales Proceeds - Original Cost and removed from AOCI
4.01 - MARKETABLE SECURITIES: TRADING
Janson traded stock in Flax Co. held as trading securities during year 1 as follows:
Number of shares purchased (sold) Price per share:
February 3, year 1: 1,100 @ $11 April 15, year 1: 2,500 @ 9 May 28, year 1: (750) @ 13 July 5, year 1: 1,400 @ 12 September 30, year 1: (4,000) @ 15 No other transactions took place for Flax during the remainder of the year. At December 31, year 1, Flax is trading at $10 per share. Janson trades securities on a last in, first out basis.
What amount is the net value of the investment in Flax at year end?
$2,750
$2,500
($250)
$3,750
$2,500
EXPLANATION:
The net value of Janson’s investment in Flax at year end is the year end fair value of $10 per share multiplied by the number of shares held at year end.
With 5,000 shares purchased and 4,750 sold during the year, Janson’s ending number of Flax shares at year end is 250.
Multiplied by a fair value of $10 per share, the value of the investment at year end is 250 x $10, or $2,500.
4.01 - MARKETABLE SECURITIES: TRADING
When the market value of an investment in debt securities exceeds its amortized cost, how should each of the following assets be reported at the end of the year?
Trading securities: Market value
Debt securities held to maturity: Market value
Trading securities: Amortized cost
Debt securities held to maturity: Market value
Trading securities: Amortized cost
Debt securities held to maturity: Amortized cost
Trading securities: Market value
Debt securities held to maturity: Amortized cost
Trading securities: Market value
Debt securities held to maturity: Amortized cost
EXPLANATION:
Investments in marketable debt or equity securities that are classified as trading securities are reported at market value with any gains or losses recognized in income in the period of change.
Investments in debt securities that are classified as held to maturity are reported at amortized cost with disclosure of the market value.
4.02 - MARKETABLE SECURITIES: AVAILABLE FOR SALE
A marketable equity security is transferred from trading securities to securities available for sale. At the transfer date, the security’s cost exceeds its market value.
What amount is used at the transfer date to record the security in securities available for sale?
Market value, only if the decline in market value below cost is considered permanent.
Market value, regardless of whether the decline in market value below cost is considered permanent or
temporary.
Cost, regardless of whether the decline in market value below cost is considered permanent or
temporary.
Cost, if the decline in market value below cost is considered temporary
Market value, regardless of whether the decline in market value below cost is considered permanent or temporary.
EXPLANATION:
When investments in marketable securities are transferred between the trading and available for sale categories, the transfer is always recorded at the fair market value of the securities on the date of the transfer.
4.02 - MARKETABLE SECURITIES: AVAILABLE FOR SALE
The following information pertains to Smoke, Inc.’s investment in marketable equity securities:
On December 31, 20X1, Smoke reclassied
a security with a $70,000 cost and a $50,000 market value from trading to available for sale.
A marketable equity security available for sale costing $75,000, written down to $30,000 in 20X0, had a
$60,000 market value on December 31, 20X1.
What is the net effect of the above items on Smoke’s valuation allowance for marketable equity securities
available for sale as of December 31, 20X1?
No effect.
$30,000 decrease.
$20,000 increase.
$10,000 decrease
$30,000 decrease.
EXPLANATION:
When a security is reclassified from trading to available for sale, the amount reported as an available for sale is the market value on the date of transfer.
Smoke would report the reclassified security at $50,000 with no effect on the allowance.
The increase in value of the other security from $30,000 to $60,000 would be recognized as OCI and a reduction to the allowance of $30,000.
4.02 - MARKETABLE SECURITIES: AVAILABLE FOR SALE
The following information pertains to Lark Corp.’s long-term marketable equity securities portfolio classified as available for sale:
B/S DATE———–12/31/20X1 / 12/31/20X0
Cost—————- $200,000 / $200,000
Market value—- $240,000 / $180,000
Differences between cost and market values are considered to be temporary. The decline in market value was properly accounted for at December 31, 20X0.
By what amount should the valuation account related to the marketable equity securities available for sale change from December 31, 20X0, to December 31, 20X1?
$60,000
$0
$40,000
$20,000
$60,000
EXPLANATION:
Marketable securities classified as available for sale are reported at their fair market values with the difference between that and the cost reported in a valuation account.
At 12/31/X0, market was lower than cost by $20,000.
At 12/31/X1, market was higher than cost by $40,000.
As a result, the valuation allowance would change by $60,000 from a credit balance of $20,000 to a debit balance of $40,000.
