FAR - Financial Instruments and Equity Method Flashcards

1
Q

What assets and liabilities are eligible for the fair value option? What is excluded?

A

it applies to financial assets (ie debt and equity securities) and financial liabilities (ie notes payable)

it does not apply to investment in subsidiaries, pension benefit assets/liabilities, assets/liabilities recognized under leases.

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2
Q

What is the impact of rising interest rates on bond investments?

A

An increase in interest rates will lead to a decrease in the bond market value

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3
Q

If an AFS investment experiences a decline due to a credit loss, does this get recorded in OCI or the earnings section of the Income Statement?

A

Earnings section of the Income Statement

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4
Q

How are unrealized gains or losses recorded in the Income Statement for:

  • Trading Securities
  • Held to Maturity
  • Available for Sale
A
  • Trading Securities - reported in earnings
  • Held to Maturity - reported at their amortized costs
  • Available for Sale - reported in OCI (net of tax)
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5
Q

The Fair Value Option is selected. Stock is originally purchased for $35K and at year end is worth $32K. The stock had $1.8K in dividends during the year. What is the income or loss reported in earnings?

A

The reported is $1.2 (loss). This is the difference between the FV and BV of investment and includes the dividend received.

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6
Q

If you have HTM debt when would you record a loss based on the CECL (current expected credit losses) model?

A

A loss is recorded when the amortized cost exceeds the PV of the Principal and Interest to be collected. Additionally the amortized cost must be between FV and PV, AND FV is greater than PV.

= the loss recorded will be amortized cost - PV of Principal/Interest

**if the fair value is higher than the amortized cost, there will be NO loss recorded)

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7
Q

A company must record an investment using the equity method if:

A

the company has less than 50% ownership in the investment AND the company has significant influence on the investment

General rule: 20 to 25% ownership in investee

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8
Q

For an equity method investment, what would be considered significant influence?

A
  1. participation in policy making processes
  2. has material intercompany transactions
  3. interchanges managerial personnel
  4. investee has technological dependency on investor
  5. investor is on the board of the investee

**investment must have voting rights…Preferred Stock or debt has no voting rights so would not be considered significant influence

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9
Q

How is a liquidating dividend recorded on the financials under the equity method?

A

it is a reduction of the investment account on the balance sheet. does not impact net income.

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10
Q

Relating to the equity method, how does the investor account for an investment where the fair value of total assets is greater than its book value?

A

when the fair value exceeds the book value of an investment, the excess is amortized over the life of the asset

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11
Q

For the equity method, if the fair value of inventory and PPE is in excess of carrying value at acquisition how does this get recorded by the investor?

A

PPE - the difference between FV and CV is depreciation over the remaining useful life and it lowers the Investor’s Net Income
Inventory - the difference between FV and CV is EXPENSED upfront and it lowers the Investor’s Net Income

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12
Q

What is the proper accounting treatment for goodwill in an equity investment?

A

There is no accounting necessary. The goodwill does not get tested for impairment annually . The WHOLE investment gets tested for impairment annually

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13
Q

How to calculate expected credit loss for debt securities?

A

Expected credit loss is PV minus amortized cost. This is used for HTM and AFS securities. Both are recorded to the income statement with an offsetting loss on the balance sheet.

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14
Q

What should be disclosed for financial instruments?

Carrying value?

Fair value?

A

carrying value and fair value should be disclosed for financial instruments…fair value is disclosed only if practical

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15
Q

SHould brokerage fees be included in the gain/loss of a financial security sale?

A

yes

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16
Q

What is the formula for an expected credit loss for a held to maturity investment?

A

expected credit loss = PV - Amortized Cost

to calculate PV you need to calculate the PV of principle and PV of new interest payments

17
Q

How to record the gain/loss for an AFS security that is impaired?

CV is $500K
New PV is $470K

  1. FV is $510K
  2. FV is $480K
  3. FV is $450K
A

Expected credit loss is $30K. to determine what gets recorded in the income statement you need to compare the FV to the CV

  1. FV - CV is $10K gain to Equity (OCI)
  2. FV - CV is $20K loss to IS
  3. FV - CV is $50K loss to $30K loss to IS and $20K loss to OCI
18
Q

For AFS securities, what is the offsetting account when recording a loss for ECL vs Unrealized Loss?

A

For ECL you record the offset to allowance for credit losses and for Unrealized loss (and gain) you record the loss to valuation account

19
Q

what is the impact of a liquidating dividend on an equity investment vs fair value investment?

A

both result in reductions to the investor’s invest account

20
Q

Greg owns 20% PS and 40% CS in Leigh. Leigh reports $60K in NI and $10K PS dividends paid. What is the reported revenue for the year?

A

$60K - $10K = $50K
$50K * 40% = $20K revenue for CS
$10K * 20% = $2K revenue for PS

$22K total revenue for Greg relating to the Leigh investment

21
Q

Greg bought 33.3% of Leigh Inc for $20 and elected the FV option. Leigh Inc net income was $10 and Dividends were $6. The investment increased to $25 by year end. What income should be attributed to the investment?

A

$5 for change in investment
$2 for dividend income

Total is $7

22
Q

When calculating goodwill for an equity method investment, do you use the book value or fair value of PPE?

A

you use the fair value when calculating PPE for goodwill

23
Q

On June 1, the Greg Inc acquired $10,000 face value, 12% 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 Greg Inc make to record the purchase of the bonds?

A

Dr Investment in Bonds $10,400
Dr Interest Receivable $100
Cr Cash $10,500