FAR - Cash & Equivalents 2 Flashcards
Vanity Corporation holds investments in debt securities. These investments were acquired last year and have been properly classified as available-for-sale (AFS) securities. During the current year, the company sold some of the AFS securities at a loss. At year end, the remaining portfolio of AFS securities had appreciated in total value compared with the value at the end of last year. Based on these facts, which one of the following should Vanity report in its financial statements at the end of the current year?
Income Statement:
Realized loss on sale of AFS securities
Balance Sheet:Unrealized holding gain on appreciation of AFS securities
AFS debt securities are measured at fair value at each balance sheet date. Realized losses on the sale of available-for-sale securities are included in the calculation of current period earnings. However, unrealized holding gains and losses on available-for-sale securities are excluded from earnings and are reported as components of other comprehensive income.
An investor purchased a bond as a long-term investment between interest dates at a premium. At the purchase date, the cash paid to the seller is
More than the face amount of the bond.
At the date of purchase, the cash paid to the seller is equal to interest accrued since the last interest date, plus the face amount of the bonds, plus the premium. The carrying amount of the bonds (face amount plus the premium) is equal to the present value of the cash flows associated with the bond discounted at the market rate of interest (yield).
An investor purchased a bond classified as a long-term investment between interest dates at a discount. At the purchase date, the carrying amount of the bond is more than the
Cash Paid to seller: NO
Face Amount of Bond: NO
At the date of purchase, the carrying amount of the bond equals its face amount minus the discount. The cash paid equals the initial carrying amount plus accrued interest. Hence, the initial carrying amount is less than the cash paid by the amount of the accrued interest.
In Year 5, Lee Co. acquired, at a premium, Enfield, Inc., 10-year bonds as a long-term investment. At December 31, Year 6, Enfield’s bonds were quoted at a small discount. Which of the following situations is the most likely cause of the decline in the bonds’ fair value?
Interest rates have increased since Lee purchased the bonds.
To adjust the yield on a bond investment to equal the market rate, the price of the bond must fluctuate inversely with the market rate because the nominal interest rate is fixed. Bonds selling at a premium have a nominal rate in excess of the market rate. If the market rate subsequently increases, the price of the bonds must decrease to provide a yield equal to the new market rate.
An investor purchased a bond as a long-term investment on January 2. The investor’s carrying amount at the end of the first year will be highest if the bond is purchased at a
Premium and amortized by the effective interest method.
When a bond is purchased at a premium (discount), its initial carrying amount is greater (less) than the maturity amount. The carrying amount of a bond acquired at a premium will decrease over time as the premium is amortized. Under the effective interest method, interest revenue is equal to the carrying amount of the bond at the beginning of the interest period multiplied by the yield. The amount of periodic amortization is the excess of the nominal interest received over the interest revenue. Because the carrying amount of the bond will decrease over time, the amount of interest revenue will also diminish. Subtracting the decreasing interest revenue from the constant periodic cash flow results in increasing amounts of premium amortization over the term of the bond. Under the straight-line method of amortization, equal amounts are amortized over the life of the bond. Accordingly, the least amount of premium will be amortized in the first year under the interest method, and the result will be the highest carrying amount of the bond at the end of this year.
Jent Corp. purchased bonds at a discount of $10,000. Subsequently, Jent sold these bonds at a premium of $14,000. During the period that Jent held this investment, amortization of the discount amounted to $2,000. What amount should Jent report as gain on the sale of bonds?
$22,000
The gain equals the sale price (face amount + $14,000 premium) minus the carrying amount [face amount – ($10,000 original discount – $2,000 amortization)]. Consequently, the gain is $22,000 [(face amount + $14,000) – (face amount – $8,000)].
On July 1, Year 4, Pell Co. purchased Green Corp. 10-year, 8% bonds with a face amount of $500,000 for $420,000. The bonds are classified as held-to-maturity, mature on June 30, Year 14, and pay interest semiannually on June 30 and December 31. Using the interest method, Pell recorded bond discount amortization of $1,800 for the 6 months ended December 31, Year 4. From this long-term investment, Pell should report Year 4 revenue of
$21,800
Interest income for a bond issued at a discount is equal to the sum of the periodic cash flows and the amount of bond discount amortized during the interest period. The periodic cash flows are equal to $20,000 ($500,000 face amount × 8% coupon rate × 1/2 year). The discount amortization is given as $1,800. Thus, revenue for the 6-month period from July 1 to December 31, Year 4, is $21,800 ($20,000 + $1,800).
On January 1, Year 1, Purl Corp. purchased as a long-term investment $500,000 face amount of Shaw, Inc.’s 8% bonds for $456,200. The bonds were purchased to yield 10% interest. The bonds mature on January 1, Year 6, and pay interest annually on January 1. Purl uses the effective interest method of amortization. What amount (rounded to nearest $100) should Purl report on its December 31, Year 2, balance sheet for these held-to-maturity bonds?
Under the effective interest method, interest income is equal to the carrying amount of an investment at the beginning of an interest period multiplied by the effective (yield) rate of interest. The carrying amount of the bonds was $456,200 at January 1, Year 1. Hence, interest income for Year 1 was $45,620. The $5,620 difference between interest income and the $40,000 periodic cash flow was the discount to be amortized for Year 1. Accordingly, the carrying amount of the bond investment was $461,820 ($456,200 + $5,620) at the beginning of Year 2. For Year 2, interest income was $46,180, periodic cash flow was $40,000, and the discount amortization was $6,180. The carrying amount of the bonds at December 31, Year 2, thus equals $468,000 ($461,820 + $6,180).
Year 1 interest income $456,200 × 10% = $ 45,620 Year 1 cash interest received $500,000 × 8% = (40,000) Year 1 discount amortized $ 5,620
Year 1 carrying amount $456,200 Year 1 discount amortized 5,620 12/31/Yr 1 carrying amount $461,820
Year 2 interest income $461,820 × 10% = $ 46,180 Year 2 interest received $500,000 × 8% = (40,000) Year 2 discount amortized $ 6,180
Year 2 carrying amount $461,820 Year 2 discount amortized 6,180 12/31/Yr 2 carrying amount $468,000
On October 1, Year 1, Park Co. purchased 200 of the $1,000 face amount, 10% bonds of Ott, Inc., for $220,000, including accrued interest of $5,000. The bonds, which mature on January 1, Year 8, pay interest semiannually on January 1 and July 1. Park used the straight-line method of amortization and appropriately recorded the bonds as a long-term investment. On Park’s December 31, Year 2, balance sheet, the bonds should be reported at
$212,000
The carrying amount of a bond investment does not include the amount of accrued interest paid. Thus, these bonds were initially recorded at $215,000 ($220,000 – $5,000). Under the straight-line method, the $15,000 premium should be amortized over the 75-month period extending from October 1, Year 1, to January 1, Year 8. For the 15 months from October 1, Year 1, through December 31, Year 2, $3,000 of the premium [$15,000 × (15 months ÷ 75 months)] should be amortized. The unamortized premium of $12,000 ($15,000 – $3,000) plus the $200,000 (200 bonds × $1,000 face amount) maturity amount of the bonds equals a carrying amount at December 31, Year 2, of $212,000.
On July 1, Year 2, York Co. purchased as a long-term investment $1 million of Park, Inc.’s 8% bonds for $946,000, including accrued interest of $40,000. The bonds were purchased to yield 10% interest. The bonds mature on January 1, Year 8, and pay interest annually on January 1. York uses the effective interest method of amortization. In its December 31, Year 2, balance sheet, what amount should York report as investment in bonds?
$911,300
The bond investment’s original balance was $906,000 ($946,000 price – $40,000 accrued interest) because the carrying amount does not include accrued interest paid. Under the effective interest method, interest income equals the yield or effective interest rate times the carrying amount of the bonds at the beginning of the interest period. The amortization of premium or discount is the difference between this interest income and the periodic cash payments. For Year 2, interest income is $45,300 [$906,000 × 10% × (6 ÷ 12)], and the actual interest is $40,000 [$1,000,000 × 8% × (6 ÷ 12)]. Hence, the carrying amount at year-end is $911,300 [$906,000 + ($45,300 – $40,000)].
On September 1, the Consul Company acquired $10,000 face value, 8% bonds of Envoy Corporation at 104. The bonds were dated May 1 and mature in 5 years on April 30, with interest payable each October 31 and April 30. What entry should Consul make to record the purchase of the bonds?
Investment in bonds $10,400
Interest receivable $266
Cash $10,666
At 104, the price paid for the bonds is $10,400 in the absence of any accrued interest. Because the bonds were purchased between interest dates, cash interest accrued for the 4 months from May 1 to September 1 (date of purchase) must be computed and included in the purchase price. The interest for 4 months at 8% is $266.67 [$10,000 × 8% × (4 months ÷ 12 months)], which is recorded as interest receivable and added to the $10,400 purchase price, for a total amount paid of $10,666. When interest is received on October 31, the $266 in interest receivable will be credited.
On July 1, Year 1, Cody Co. paid $1,198,000 for 10%, 20-year bonds with a face amount of $1 million. Interest is paid on December 31 and June 30. The bonds were purchased to yield 8%. Cody uses the effective interest rate method to recognize interest income from this investment. The bonds are properly classified as held-to-maturity. What should be reported as the carrying amount of the bonds in Cody’s December 31, Year 1, balance sheet?
$1,195,920
Under the effective interest method, interest income equals the yield or effective interest rate times the carrying amount of the bonds at the beginning of the interest period. The amortization of premium or discount is the difference between this interest income and the periodic cash payments. For Year 1, interest income is $47,920 [$1,198,000 × 8% × (6 months ÷ 12 months)], and interest received is $50,000 [$1,000,000 × 10% × (6 months ÷ 12 months)]. Hence, the carrying amount at year end is $1,195,920 [$1,198,000 – ($50,000 – $47,920)].
The following pertains to Smoke, Inc.’s investment in debt securities:
On December 31, Year 3, Smoke reclassified a security acquired during the year for $70,000. It had a $50,000 fair value when it was reclassified from trading to available-for-sale.
An available-for-sale security costing $75,000, written down to $30,000 in Year 2 because of an other-than-temporary impairment of fair value, had a $60,000 fair value on December 31, Year 3.
What is the net effect of the above items on Smoke’s net income for the year ended December 31, Year 3?
$20,000 decrease.
Unrealized holding gains and losses on trading debt securities are included in net income, and reclassification is at fair value. Furthermore, if a security is transferred from the trading category, the unrealized holding gain or loss at the date of transfer already has been recognized in net income and is not reversed. Smoke therefore should include a $20,000 ($70,000 cost – $50,000 fair value at 12/31/Yr 3) unrealized holding loss in the determination of net income. After an available-for-sale debt security has been written down to reflect an other-than-temporary decline in fair value, with the loss included in net income, subsequent increases in its fair value are included in OCI. Thus, the appreciation of this security has no effect on Year 3 net income.
Sun Corp. had investments in trading debt securities costing $650,000. On June 30, Year 2, Sun decided to hold the investments indefinitely and accordingly reclassified them as available-for-sale debt securities on that date. The investments’ fair value was $575,000 at December 31, Year 1, $530,000 at June 30, Year 2, and $490,000 at December 31, Year 2. What amount should Sun report as net unrealized loss on available-for-sale securities in its Year 2 other comprehensive income?
$40,000
The securities were available-for-sale securities after the reclassification, which was at fair value ($530,000 at 6/30/Yr 2). Subsequent unrealized holding gains and losses are excluded from net income and reported in other comprehensive income until realized. Accordingly, the amount reported as net unrealized loss on available-for-sale securities is $40,000 ($530,000 – $490,000 fair value at 12/31/Yr 2).
On both December 31, Year 1, and December 31, Year 2, Kopp Co.’s only available-for-sale debt security had the same fair value, which was below amortized cost. Kopp considered the decline in value to be temporary in Year 1 but other than temporary in Year 2. At the end of both years the security was classified as a noncurrent asset. What should be the effects of the determination that the decline was other than temporary on Kopp’s Year 2 net noncurrent assets and net income?
No effect on net noncurrent assets and decrease in net income.
Unrealized holding gains and losses on available-for-sale debt securities, including those classified as current assets, are not included in earnings but are reported in other comprehensive income until realized, net of tax effect. Thus, the unrealized holding loss would have been reflected in the measurement of the asset at the end of Year 1 but not in Year 1 earnings. The other-than-temporary decline identified in Year 2 should be included in earnings. Given that the decline in fair value below amortized cost judged to be temporary in Year 1 equaled the impairment recognized in Year 2, the measurement of the asset and of net noncurrent assets does not change.
