Intangible Assets and Marketable Securities

Question 1

In 2017, Amazon acquired Whole Foods for $13.7 billion. The acquisition included several identifiable intangible assets such as trademarks, proprietary technology, and customer relationships. In accordance with U.S. GAAP, how should Amazon report these intangible assets, and what financial implications could arise from using the cost model for subsequent measurements?

A) Intangible assets should be reported at fair value on the acquisition date and subsequently revalued annually.
B) Identifiable intangible assets should be reported at cost on the acquisition date and amortized over their useful lives, with impairment tests conducted annually.
C) Amazon should report all intangible assets at historical cost and only test for impairment if there is an indication of impairment, with no annual revaluation.
D) Amazon must capitalize these intangible assets, use the revaluation model, and test them annually for impairment regardless of market conditions.

Answer Explanation:

Correct Answer: B) Identifiable intangible assets should be reported at cost on the acquisition date and amortized over their useful lives, with impairment tests conducted annually.
Explanation:

Under U.S. GAAP, identifiable intangible assets acquired in a business combination are initially recorded at fair value (cost) and amortized over their useful lives. Amazon must test these assets for impairment annually or when there is an indication of impairment.
Option A is incorrect because U.S. GAAP does not allow subsequent revaluation of intangible assets; it only allows the cost model.
Option C is incorrect because identifiable intangible assets must be amortized and tested for impairment.
Option D incorrectly states that revaluation is allowed under U.S. GAAP, which is not the case.

Question 2

In 2018, Alphabet Inc. (Google’s parent company) reported significant research and development (R&D) expenses related to its autonomous driving technology, Waymo. How would these costs be treated under IFRS if Google’s R&D expenses were split between the research phase and the development phase?

A) All R&D costs must be capitalized as long as the project has potential future economic benefits, regardless of the phase.
B) Costs from the research phase should be expensed, while costs from the development phase may be capitalized if technical feasibility and other criteria are met.
C) Both research and development costs can be capitalized under IFRS if the technology has the potential to disrupt the market.
D) Development costs should be expensed until commercial viability is established, then capitalized retroactively under IFRS.

Answer Explanation:

Correct Answer: B) Costs from the research phase should be expensed, while costs from the development phase may be capitalized if technical feasibility and other criteria are met.
Explanation:

Under IFRS, research costs are always expensed as incurred, but development costs can be capitalized if they meet criteria such as technical feasibility and an intent to complete the project. This approach helps reflect the economic reality of intangible asset creation.
Option A is incorrect because research costs cannot be capitalized under IFRS.
Option C is incorrect because only development costs meeting certain criteria can be capitalized, not research costs.
Option D is incorrect as IFRS does not allow retroactive capitalization once viability is established; capitalization begins only from the point the criteria are met.

Question 3

In 2015, Microsoft acquired LinkedIn for $26.2 billion. LinkedIn’s brand name, customer lists, and proprietary algorithms were identified as key intangible assets. Under IFRS, what would be the reporting treatment if Microsoft decides to use the revaluation model, and what challenges might Microsoft face?

A) Microsoft would revalue LinkedIn’s intangibles annually, recognizing any revaluation surplus in other comprehensive income; however, active market valuation challenges could lead to impairment volatility.
B) Microsoft must capitalize LinkedIn’s identifiable intangibles at fair value and report them using the cost model without any further revaluation or impairment adjustments.
C) Microsoft would revalue LinkedIn’s intangible assets annually, but revaluation losses are charged directly to the income statement, creating significant earnings volatility.
D) Microsoft can only revalue LinkedIn’s intangible assets if they are infinite-lived; finite-lived assets must remain at historical cost and amortized over time.

Answer Explanation:

Correct Answer: A) Microsoft would revalue LinkedIn’s intangibles annually, recognizing any revaluation surplus in other comprehensive income; however, active market valuation challenges could lead to impairment volatility.
Explanation:

Under IFRS, the revaluation model can be used for intangible assets only if an active market exists for those assets. Revaluation gains are recognized in other comprehensive income, but frequent impairments or valuation difficulties can lead to earnings volatility.
Option B is incorrect because IFRS permits revaluation if criteria are met, unlike U.S. GAAP which only allows the cost model.
Option C misrepresents the accounting treatment as revaluation losses typically go to other comprehensive income unless they exceed the revaluation reserve.
Option D incorrectly suggests that only infinite-lived intangibles can be revalued; finite-lived intangibles can also be revalued under IFRS if an active market exists.

Question 4

In 2014, Yahoo! wrote down $4.5 billion of its Tumblr acquisition as an impairment loss. This loss reflected Tumblr’s declining market relevance. How should Yahoo! have determined the impairment, and what are the financial implications for intangible assets under U.S. GAAP?

A) Yahoo! should compare the carrying value of Tumblr’s intangible assets to their fair value, recognizing any difference as an impairment loss. Impairment must be tested only when there is evidence suggesting a decline.
B) Yahoo! should test Tumblr’s intangibles annually for impairment regardless of evidence, comparing the carrying amount to the recoverable amount and adjusting for any excess.
C) Yahoo! must apply a two-step impairment test comparing the carrying value to the sum of expected future cash flows, followed by a fair value assessment if needed.
D) Yahoo! should revalue Tumblr’s intangible assets annually, recognizing any losses in net income, and amortizing them over the new estimated useful life.

Answer Explanation:

Correct Answer: C) Yahoo! must apply a two-step impairment test comparing the carrying value to the sum of expected future cash flows, followed by a fair value assessment if needed.
Explanation:

Under U.S. GAAP, an impairment test for intangible assets involves first comparing the carrying amount to the sum of undiscounted future cash flows expected from the asset. If the carrying amount exceeds these cash flows, the impairment loss is then measured as the difference between the carrying amount and fair value.
Option A is incorrect as annual impairment tests are not required unless there is evidence of impairment.
Option B reflects IFRS treatment, not U.S. GAAP.
Option D suggests revaluation and amortization of losses, which is not allowed under U.S. GAAP.

Question 5

In 2019, Bayer faced significant goodwill impairment charges following its acquisition of Monsanto, primarily due to legal issues surrounding Roundup. What financial reporting challenges might Bayer face when testing goodwill for impairment, particularly under IFRS?

A) Bayer must conduct an annual impairment test by comparing the carrying amount of goodwill to its recoverable amount, which is the higher of fair value less costs to sell and value in use.
B) Bayer can delay goodwill impairment testing until an impairment indicator is identified, allowing them to spread potential losses over future periods.
C) Goodwill impairment should be amortized over time, with impairment charges recognized only if future cash flows from the Monsanto acquisition fall below expected levels.
D) Bayer’s impairment testing is simplified because it can recognize impairment losses directly in equity, avoiding immediate income statement impacts.

Answer Explanation:

Correct Answer: A) Bayer must conduct an annual impairment test by comparing the carrying amount of goodwill to its recoverable amount, which is the higher of fair value less costs to sell and value in use.
Explanation:

Under IFRS, goodwill is tested annually for impairment by comparing the carrying amount to the recoverable amount, defined as the higher of fair value less costs to sell and value in use (discounted cash flows). Impairment losses are recognized immediately in profit or loss.
Option B is incorrect because annual testing is mandatory even without specific impairment indicators.
Option C misrepresents IFRS treatment as goodwill cannot be amortized.
Option D incorrectly states that impairments are recognized in equity, which is not the case under IFRS.

Question 6

In 2018, Kraft Heinz reported a goodwill impairment charge of $15.4 billion, largely related to its Kraft and Oscar Mayer brands. What does this impairment suggest about Kraft Heinz’s acquisition strategy, and how should analysts interpret this in terms of financial performance?

A) The impairment suggests that the economic value of the acquired brands exceeded their accounting value, enhancing future cash flow prospects.
B) The impairment indicates that Kraft Heinz overestimated the future benefits of the acquisition, and the acquired brands are generating less than anticipated.
C) Goodwill impairment is purely an accounting adjustment and has no real impact on an analyst’s assessment of Kraft Heinz’s acquisition strategy.
D) The impairment suggests Kraft Heinz managed to improve its economic goodwill by reducing book goodwill, enhancing its long-term valuation.

Answer Explanation:

Correct Answer: B) The impairment indicates that Kraft Heinz overestimated the future benefits of the acquisition, and the acquired brands are generating less than anticipated.
Explanation:

A goodwill impairment suggests that the value of the acquired brands has deteriorated significantly since the acquisition, often because the future expected cash flows from these brands are not being realized.
Option A is incorrect because the impairment reflects a decline in the economic value, not an enhancement.
Option C is incorrect as the impairment reflects poor acquisition decisions that impact the company’s financial performance and investor perception.
Option D is incorrect because goodwill impairment reduces reported asset values and is not indicative of improved economic goodwill.

Question 7

When Microsoft acquired LinkedIn in 2016 for $26.2 billion, it recorded significant goodwill on its balance sheet. What are the key risks associated with this goodwill in Microsoft’s financial statements, particularly during economic downturns?

A) Microsoft must amortize the goodwill annually, which could lead to decreased net income during periods of economic instability.
B) Goodwill must be tested for impairment annually, and during downturns, Microsoft could face significant impairment losses that reduce net income.
C) Goodwill will be automatically written off during economic downturns, creating opportunities to enhance reported earnings in future periods.
D) Microsoft’s goodwill is protected from impairment charges during downturns if it can demonstrate potential synergies from the LinkedIn acquisition.

Answer Explanation:

Correct Answer: B) Goodwill must be tested for impairment annually, and during downturns, Microsoft could face significant impairment losses that reduce net income.
Explanation:

Under accounting standards, goodwill is not amortized but must be tested for impairment at least annually or more frequently if events suggest impairment. During economic downturns, the fair value of the acquired business may decline, increasing the risk of impairment losses.
Option A is incorrect because goodwill is not amortized.
Option C is incorrect because goodwill is not automatically written off; impairment must be specifically identified and reported.
Option D is incorrect as impairment charges are based on actual valuation declines, not potential future synergies.

Question 8

In 2017, General Electric (GE) wrote down $22 billion in goodwill related to its power business, one of the largest goodwill impairments in history. How should analysts adjust their financial models to reflect the implications of this impairment, and what does it suggest about GE’s past acquisition strategy?

A) Analysts should treat the impairment as a one-time charge and add it back to net income to better assess GE’s ongoing performance.
B) Analysts should eliminate the impact of the impairment from future financial forecasts but retain goodwill on the balance sheet as a measure of potential economic value.
C) Analysts should remove the goodwill impairment charge and evaluate GE’s acquisitions in terms of overpayment and the underperformance of acquired assets.
D) Analysts should ignore the impairment charge, as it is a non-cash item that does not affect GE’s future operating cash flow.

Answer Explanation:

Correct Answer: C) Analysts should remove the goodwill impairment charge and evaluate GE’s acquisitions in terms of overpayment and the underperformance of acquired assets.
Explanation:

The massive impairment suggests that GE significantly overpaid for its acquisitions, and the acquired businesses did not generate the expected economic returns. Analysts should critically assess these acquisitions to understand the extent of overpayment and potential management misjudgments.
Option A is incorrect because the impairment reflects real economic losses that should not be simply added back.
Option B is incorrect because retaining the impaired goodwill does not improve comparability or provide accurate insights.
Option D is incorrect because although the impairment is non-cash, it reflects economic realities that affect GE’s valuation.

Question 9

In 2020, Pfizer and Mylan completed a merger to form Viatris, resulting in the creation of substantial goodwill on Viatris’s balance sheet. How should Viatris approach goodwill testing, and what impact could failing to appropriately test for impairment have on its financial statements and investor confidence?

A) Viatris should amortize goodwill over 20 years to gradually recognize any overpayment and reduce the risk of sudden financial statement shocks.
B) Viatris must test goodwill for impairment annually and report any loss directly in other comprehensive income, maintaining net income stability.
C) Viatris should conduct regular impairment tests, especially if market conditions deteriorate, to prevent overstating asset values and misleading investors.
D) Failing to test goodwill for impairment is acceptable as long as Viatris can demonstrate expected future synergies from the merger.

Answer Explanation:

Correct Answer: C) Viatris should conduct regular impairment tests, especially if market conditions deteriorate, to prevent overstating asset values and misleading investors.
Explanation:

Goodwill must be tested annually for impairment, and more frequently if indicators of impairment exist. Proper testing ensures that the financial statements accurately reflect the value of acquired assets and maintain investor trust.
Option A is incorrect as goodwill is not amortized under current accounting standards.
Option B is incorrect because impairment losses must be recognized in the income statement, not other comprehensive income.
Option D is incorrect as failing to test for impairment violates accounting standards and could lead to financial misstatements.

Question 10

When Dell acquired EMC in 2016 for $67 billion, it recorded over $20 billion in goodwill. What are the key considerations for analysts when assessing the sustainability of such high levels of goodwill on Dell’s balance sheet?

A) Analysts should consider the potential for future synergies to justify the goodwill, treating it as an offset to liabilities.
B) Analysts should focus on Dell’s cash flow generation to determine if the future expected benefits justify the high goodwill valuation.
C) Analysts should prioritize Dell’s reported net income, as goodwill does not impact cash flow and has minimal relevance to financial health.
D) Analysts should ignore goodwill entirely, as its value is purely subjective and not indicative of actual company performance.

Answer Explanation:

Correct Answer: B) Analysts should focus on Dell’s cash flow generation to determine if the future expected benefits justify the high goodwill valuation.
Explanation:

The key to justifying high levels of goodwill is whether the acquired business generates sufficient cash flows to support the premium paid. Analysts must assess whether the economic benefits align with the recorded goodwill value.
Option A is incorrect as goodwill cannot be treated as an offset to liabilities.
Option C downplays the importance of goodwill, which can significantly impact financial stability if impairments occur.
Option D is incorrect because goodwill’s value, although subjective, can reflect real economic implications and management decisions.

Question 11

In 2022, Netflix Inc. reported $1.2 billion in unrealized gains on its investment portfolio. If Netflix classifies these investments as available-for-sale under U.S. GAAP, how should these unrealized gains be reported, and what implications might this have for Netflix’s financial statements?

A) The unrealized gains should be reported in the income statement, increasing net income and improving key profitability ratios.
B) The unrealized gains should be reported in other comprehensive income, increasing shareholders’ equity but not affecting net income directly.
C) The unrealized gains should be reported as a deferred tax asset on the balance sheet, anticipating future tax benefits.
D) The unrealized gains should be included in retained earnings, increasing Netflix’s distributable profits and enhancing dividend capacity.

Answer Explanation:

Correct Answer: B) The unrealized gains should be reported in other comprehensive income, increasing shareholders’ equity but not affecting net income directly.
Explanation:

Available-for-sale securities are measured at fair value with unrealized gains and losses reported in other comprehensive income, impacting equity but not net income.
Option A is incorrect because only trading securities recognize unrealized gains and losses in the income statement.
Option C is incorrect as the gains are not directly related to tax effects; any tax impact would be separately recognized.
Option D is incorrect as unrealized gains do not flow into retained earnings until realized.

Question 12

In 2021, Tesla Inc. disclosed significant holdings in cryptocurrency, classifying them as trading securities. During the year, the market value of these holdings fluctuated dramatically. How does the classification of these financial assets affect Tesla’s income statement and balance sheet?

A) Tesla must report these assets at historical cost, shielding its net income from any unrealized volatility in market prices.
B) Tesla must report these holdings at amortized cost, recognizing changes only if the value drops below the cost basis.
C) Tesla must report these holdings at fair value, with unrealized gains and losses directly impacting net income, leading to increased earnings volatility.
D) Tesla must report these assets in other comprehensive income, minimizing the impact on reported net income while affecting equity.

Answer Explanation:

Correct Answer: C) Tesla must report these holdings at fair value, with unrealized gains and losses directly impacting net income, leading to increased earnings volatility.
Explanation:

Trading securities, including cryptocurrency classified this way, are reported at fair value with changes reflected in the income statement, thereby impacting earnings volatility.
Option A is incorrect as trading securities are not measured at historical cost.
Option B is incorrect as amortized cost applies to held-to-maturity securities, not trading securities.
Option D is incorrect because only available-for-sale securities recognize gains and losses in other comprehensive income, not trading securities.

Question 13

In 2020, ExxonMobil classified $500 million in debt securities as held-to-maturity. During the year, interest rates dropped sharply, significantly increasing the market value of these securities. How should ExxonMobil reflect this change in its financial statements under U.S. GAAP?

A) Recognize the increase in market value as an unrealized gain in the income statement, improving reported earnings.
B) Report the securities at fair value on the balance sheet, with unrealized gains flowing into other comprehensive income.
C) Continue reporting the securities at amortized cost, with no impact on the income statement or equity until the securities are sold.
D) Reclassify the securities as available-for-sale to capture the increased market value in shareholders’ equity.

Answer Explanation:

Correct Answer: C) Continue reporting the securities at amortized cost, with no impact on the income statement or equity until the securities are sold.
Explanation:

Held-to-maturity securities are measured at amortized cost, ignoring changes in market value unless there is evidence of impairment.
Option A is incorrect because unrealized gains are not recognized in the income statement for held-to-maturity securities.
Option B is incorrect as this treatment applies to available-for-sale securities.
Option D is incorrect because reclassification is not typically allowed unless there is a change in the intent or ability to hold the security.

Question 14

Apple Inc. holds a portfolio of derivatives for hedging purposes, classified as trading securities. In 2023, Apple reported a significant unrealized loss on these derivatives due to market volatility. What are the financial reporting implications, and how should analysts interpret this loss?

A) The unrealized loss must be reported in other comprehensive income, preserving net income but reducing shareholders’ equity.
B) The unrealized loss should be recognized immediately in the income statement, impacting Apple’s profitability and potentially signaling increased financial risk.
C) Apple can defer recognition of the unrealized loss until the derivatives are settled, smoothing earnings over multiple periods.
D) The loss is not reported as it is offset by anticipated future gains from the underlying hedged positions.

Answer Explanation:

Correct Answer: B) The unrealized loss should be recognized immediately in the income statement, impacting Apple’s profitability and potentially signaling increased financial risk.
Explanation:

Trading securities, including derivatives held for trading, must be reported at fair value, with unrealized gains and losses reflected in the income statement, affecting profitability directly.
Option A is incorrect because this treatment applies to available-for-sale securities, not trading derivatives.
Option C is incorrect as there is no deferral for trading derivatives.
Option D is incorrect because any offsetting gains must be reported separately and cannot net off against losses in financial reporting.

Question 15

In 2019, Amazon acquired a significant number of unlisted equity investments, classified at historical cost due to the absence of a reliable fair market value. What impact does this classification have on Amazon’s financial statements and risk assessment by analysts?

A) The classification allows Amazon to avoid recognizing volatility in net income, potentially masking the actual economic risk of these investments.
B) Historical cost valuation forces Amazon to recognize unrealized gains and losses periodically, aligning financial statements with market value.
C) This classification is advantageous as it inflates Amazon’s net income by recognizing gains from appreciation over time.
D) The classification requires Amazon to regularly revalue the investments and adjust the balance sheet accordingly, increasing earnings volatility.

Answer Explanation:

Correct Answer: A) The classification allows Amazon to avoid recognizing volatility in net income, potentially masking the actual economic risk of these investments.
Explanation:

Unlisted equity investments at historical cost do not reflect changes in market value, leading to potentially outdated financial statement figures that can obscure the actual risk and performance of these assets.
Option B is incorrect as historical cost does not require revaluation.
Option C is incorrect because historical cost does not recognize unrealized gains.
Option D is incorrect because revaluation is not required under historical cost accounting.

Question 16

In 2023, Alphabet Inc. acquired a $2 million bond classified under IFRS as measured at fair value through other comprehensive income (FVOCI). During the year, the market value of the bond declined by $150,000 due to rising interest rates, while generating $120,000 in interest income. How will Alphabet report these effects on its financial statements?

A) The bond will be reported at $1,850,000 on the balance sheet, with a $150,000 loss recognized in the income statement, and $120,000 of interest income recognized in other comprehensive income.
B) The bond will be reported at $2,000,000 on the balance sheet, with $120,000 of interest income and no recognition of market value changes.
C) The bond will be reported at $1,850,000 on the balance sheet, with the $150,000 loss reported in other comprehensive income and $120,000 of interest income recognized in the income statement.
D) The bond will be reported at $1,850,000 on the balance sheet, with both the $150,000 loss and $120,000 interest income recognized in the income statement.

Answer Explanation:

Correct Answer: C) The bond will be reported at $1,850,000 on the balance sheet, with the $150,000 loss reported in other comprehensive income and $120,000 of interest income recognized in the income statement.
Explanation:

Under IFRS, FVOCI securities report changes in market value in other comprehensive income, not the income statement, while interest income is recognized in the income statement.
Option A is incorrect because the loss is not recognized in the income statement but rather in OCI.
Option B is incorrect because the bond must be revalued to fair value, not kept at historical cost.
Option D is incorrect as both the loss and interest income should not be recognized entirely in the income statement.

Question 17

In 2022, Microsoft purchased an equity security for $5 million, classifying it under IFRS as measured at fair value through profit and loss (FVTPL). By year-end, the market value of the security dropped to $4.2 million. How should Microsoft report this investment and its changes in value under IFRS?

A) The security should be reported at $5 million, with no adjustments to income or OCI since it was purchased with the intent to hold long-term.
B) The security should be reported at $4.2 million on the balance sheet, with an $800,000 loss reported in the income statement as unrealized loss.
C) The security should be reported at $4.2 million on the balance sheet, with the $800,000 loss reported in other comprehensive income.
D) The security should be reported at $5 million on the balance sheet, with the loss recognized only upon disposal.

Answer Explanation:

Correct Answer: B) The security should be reported at $4.2 million on the balance sheet, with an $800,000 loss reported in the income statement as unrealized loss.
Explanation:

FVTPL requires the security to be marked to market with unrealized gains and losses recognized in the income statement.
Option A is incorrect because IFRS requires fair value adjustments for FVTPL securities.
Option C is incorrect as OCI treatment applies to FVOCI, not FVTPL.
Option D is incorrect as FVTPL requires ongoing fair value adjustments to the income statement.

Question 18

In 2021, Berkshire Hathaway classified $10 million of unlisted equity investments under U.S. GAAP as measured at historical cost due to the absence of reliable fair value measures. Midway through 2022, a reliable market value was established at $12 million. How should Berkshire adjust its financial statements according to U.S. GAAP?

A) Reclassify the equity investment to trading securities and recognize the $2 million gain in the income statement immediately.
B) Recognize the $2 million gain directly in other comprehensive income, reflecting the new fair value.
C) No adjustment is necessary; the investment remains at historical cost, with gains recognized only upon sale.
D) Reclassify the investment as available-for-sale, recognizing the gain in other comprehensive income.

Answer Explanation:

Correct Answer: C) No adjustment is necessary; the investment remains at historical cost, with gains recognized only upon sale.
Explanation:

Under U.S. GAAP, unlisted securities measured at historical cost do not revalue to market prices unless reclassification is necessary, which is not permitted without substantial justification.
Option A is incorrect because reclassification requires specific criteria that are not met here.
Option B is incorrect as historical cost securities do not adjust for fair value unless reclassified.
Option D is incorrect because available-for-sale classification does not apply retroactively.

Question 19

In 2020, Goldman Sachs reported a $3 million unrealized gain on its derivative portfolio classified as held-for-trading under U.S. GAAP. How will this gain impact Goldman’s financial statements?

A) The gain will be reported on the balance sheet as a direct increase to asset value, with no impact on the income statement.
B) The gain will be recognized in other comprehensive income, boosting shareholders’ equity without impacting net income.
C) The gain will be recognized in the income statement, directly boosting net income and potentially altering key profitability ratios.
D) The gain will be reported only upon the actual settlement of the derivatives, deferring recognition to avoid earnings volatility.

Answer Explanation:

Correct Answer: C) The gain will be recognized in the income statement, directly boosting net income and potentially altering key profitability ratios.
Explanation:

Trading securities, including derivatives classified as held-for-trading, are marked to market with gains and losses recognized in the income statement.
Option A is incorrect because gains impact the income statement, not just asset values.
Option B is incorrect as OCI treatment does not apply to trading securities.
Option D is incorrect because trading securities do not defer recognition of unrealized gains and losses.

Question 20

In 2022, JP Morgan acquired a debt security classified as held-to-maturity under U.S. GAAP for $5 million, at par value. Rising interest rates have since caused the market value of the security to decline to $4.7 million. How should JP Morgan reflect this security on its financial statements, and what are the implications for financial analysis?

A) Report the security at $4.7 million, with a $300,000 unrealized loss in the income statement affecting profitability.
B) Report the security at $5 million amortized cost, ignoring market fluctuations until maturity, reflecting stability in reported values.
C) Reclassify the security as available-for-sale to reflect current market value and recognize losses in OCI.
D) Recognize the loss only if the security is impaired, otherwise report the security at historical cost with adjustments deferred until sale.

Answer Explanation:

Correct Answer: B) Report the security at $5 million amortized cost, ignoring market fluctuations until maturity, reflecting stability in reported values.
Explanation:

Held-to-maturity securities are reported at amortized cost with no recognition of changes in market value, preserving stability in reported financials but potentially masking market risk.
Option A is incorrect as market value adjustments are not recorded for held-to-maturity securities.
Option C is incorrect because reclassification requires a change in intent or ability, which is not routine.
Option D is incorrect because held-to-maturity securities do not adjust unless impaired, and impairment is not indicated by the scenario.

Question 21

In 2021, IBM issued $1 billion in 10-year bonds at a discount, receiving proceeds of $950 million. By 2023, IBM reported the bonds at an amortized cost of $960 million. How will IBM’s bond liability appear on the balance sheet by the end of 2023, and what is the impact on interest expense?

A) The bonds will be reported at $960 million on the balance sheet, with an interest expense lower than the coupon rate due to the discount.
B) The bonds will be reported at $960 million on the balance sheet, with interest expense higher than the coupon rate because of the discount amortization.
C) The bonds will be reported at $1 billion, with no effect on interest expense because only the coupon payments matter.
D) The bonds will be reported at face value, with interest expense adjusted annually to match market conditions.

Answer Explanation:

Correct Answer: B) The bonds will be reported at $960 million on the balance sheet, with interest expense higher than the coupon rate because of the discount amortization.
Explanation:

The bond’s amortized cost increases over time as the discount is amortized, increasing interest expense above the coupon rate.
Option A is incorrect because amortizing the discount raises interest expense, not lowers it.
Option C is incorrect as the bonds are not reported at face value until maturity.
Option D is incorrect because bonds issued at a discount are not adjusted annually for market conditions.

Question 22

In 2022, Tesla held a short position in Rivian stock as part of its trading strategy, classified under held-for-trading liabilities. By the year-end, the market price of Rivian stock rose significantly, resulting in a $50 million increase in the liability. How should Tesla report this liability, and what are the financial implications?

A) Report the liability at fair value with the $50 million loss recognized in the income statement, increasing reported liabilities and reducing net income.
B) Report the liability at the original transaction price, with the increase deferred until the position is closed.
C) Report the liability at amortized cost with losses recognized in other comprehensive income, reflecting minimal impact on net income.
D) Report the liability at face value with adjustments only recognized at settlement.

Answer Explanation:

Correct Answer: A) Report the liability at fair value with the $50 million loss recognized in the income statement, increasing reported liabilities and reducing net income.
Explanation:

Held-for-trading liabilities are marked to market, and any changes in fair value are recognized in the income statement.
Option B is incorrect because held-for-trading liabilities are adjusted continuously, not deferred.
Option C is incorrect because OCI does not apply to trading liabilities.
Option D is incorrect because adjustments are made continuously, not deferred until settlement.

Question 23

In 2023, Meta Platforms Inc. utilized an accelerated depreciation method for tax purposes and straight-line depreciation for financial reporting, creating a deferred tax liability of $200 million. What does this deferred tax liability represent, and how should it be reported?

A) The deferred tax liability reflects taxes that are due immediately and should be reported as a current liability on the balance sheet.
B) The deferred tax liability represents future taxes payable resulting from timing differences in depreciation methods, reported as a non-current liability.
C) The deferred tax liability is an estimate of future tax refunds and should be recorded in other comprehensive income.
D) The deferred tax liability must be amortized over time to match the reversal of depreciation differences.

Answer Explanation:

Correct Answer: B) The deferred tax liability represents future taxes payable resulting from timing differences in depreciation methods, reported as a non-current liability.
Explanation:

Deferred tax liabilities arise when tax depreciation exceeds financial statement depreciation, creating future tax obligations.
Option A is incorrect as deferred tax liabilities are not due immediately.
Option C is incorrect as deferred tax liabilities are not linked to tax refunds or OCI.
Option D is incorrect because deferred tax liabilities are not amortized but reversed as timing differences even out.

Question 24

Amazon issued convertible bonds at a premium in 2021, receiving proceeds of $1.1 billion for bonds with a $1 billion face value. By 2025, the amortized premium is $50 million. How should Amazon account for the bonds on its 2025 balance sheet, and what impact does this have on interest expense?

A) Report the bonds at the original proceeds of $1.1 billion, with interest expense adjusted to reflect the premium.
B) Report the bonds at $1 billion, with no impact on interest expense because the premium is a one-time adjustment.
C) Report the bonds at $1.05 billion, with interest expense lower than the coupon rate due to the premium amortization.
D) Report the bonds at $1.05 billion, with no impact on interest expense until the bonds are converted.

Answer Explanation:

Correct Answer: C) Report the bonds at $1.05 billion, with interest expense lower than the coupon rate due to the premium amortization.
Explanation:

The premium amortization reduces interest expense below the coupon rate as the premium is spread over the bond’s life.
Option A is incorrect because the bonds are not carried at the original proceeds but at the amortized value.
Option B is incorrect because the bonds reflect ongoing premium amortization, not a one-time adjustment.
Option D is incorrect as amortization affects interest expense continuously, not just at conversion.

Question 25

In 2024, Netflix classified a $500 million derivative liability under fair value accounting. During the year, the derivative’s fair value decreased by $80 million due to market changes. How will Netflix report this change on its financial statements?

A) Report the derivative at $580 million, recognizing the $80 million gain in the income statement, which improves net income.
B) Report the derivative at $420 million, recognizing the $80 million reduction in the liability as other comprehensive income.
C) Report the derivative at $420 million on the balance sheet, with the gain recognized in the income statement, reducing liabilities and increasing income.
D) Report the derivative at its initial value of $500 million, with adjustments recognized only upon maturity.

Answer Explanation:

Correct Answer: C) Report the derivative at $420 million on the balance sheet, with the gain recognized in the income statement, reducing liabilities and increasing income.
Explanation:

Fair value accounting requires the derivative to be marked to market, and changes in value are recognized in the income statement.
Option A is incorrect as it misstates the effect direction and impact on income.
Option B is incorrect because gains and losses on derivatives are not reported in OCI.
Option D is incorrect as fair value accounting adjusts continuously, not just at maturity.