Investments

Question 1

Cost Method- Percentage of Ownership, and what does this method imply of the investor?

Answer 1

• 0-20% ownership

- Implies that there is no influence over the investee

Question 2

Equity Method - Percentage of Ownership, and what does this method imply?

Answer 2

• 20-50%
• Implies that the investor has significant voting influence over the investee
• More consistent with accrual accounting

Question 3

Equity Method -Investment is recorded initially at:

Answer 3

Cost

Value changes every year based on earnings

Question 4

Equity Method- As investee earns money, the investor records what?

Answer 4

-Earnings based on the percentage of ownership : “Equity in Earnings” - recorded on the I/S as continuing operations

Question 5

Equity Method- Treatment of Dividends Received

Answer 5

Considered reduction of the investment account and do not show on the I/S

Question 6

Equity Method- Differences between the purchase price paid for the investee and the book value of the investee’s net assets are accounted for how?

Answer 6

FMV write up of assets

• PPE (depreciated against equity based on life of asset)
• Assets (eg. Land & Invent) -written off against reported income at the time the asset is sold
• Goodwill (amt initially recorded will later reduce reported income in periods that impaired losses recognized)

Question 7

Preferred Stock Investments - Income is equal to what?

Answer 7

Preferred Stock under the Equity Method is equal to the dividends allocated to it

For non-cumulative preferred stock, equal to annual dividend preference regardless of payments in the year

Question 8

Cost Method - Investment is recorded initially at:

Answer 8

Cost

(Value does not change as investee earns money)
- Doesn’t follow accrual accounting b/c not recog. revenue but amt is small enough generally to be ok

Question 9

Cost Method - As Investee earns money, the investor records what?

Answer 9

Nothing - the investment is kept at COST

Question 10

Cost Method - Treatment of Dividends Received

Answer 10

-Record as Dividend Income on the Income Statement

(not a reduction of the Investment)

-If dividend is more than the investor’s proportionate share of investee’s income, then it is recorded as a reduction of the investment (rare)

Question 11

Cost Method- Differences between the purchase price paid for the investee and the book value of the investee’s net assets are accounted for how?

Answer 11

Not taken into consideration

Question 12

If investee declares a stock dividend instead of cash dividend, what is the accounting treatment?

Answer 12

The CV of the investment is allocated over the increased quantity of securities

Ex: 100 shares @ $22 = $2,200
10% Stock Dividend = 110 shares
$2,200/110 = $20

Question 13

Change From Equity to Cost (40% to 10%) - Accounting Treatment:

Answer 13

If investor sells a portion of investment and loses significant influence, the remaining investment is accounted for under the cost method from that point forward

Question 14

Change From Cost to Equity (10% to 40%)

Answer 14

If investor gains significant influence - the change is made retrospectively, and requires prior period adjustments to reported income.

Question 15

Fair Value Election - Accounting Treatment for Instruments on the Equity Method

Answer 15

Securities are revalued to fair value and any gain or loss is recorded in earnings for the period

Can be elected on date investment is recognized - then it is irrevocable

Question 16

3 Types of Marketable Securities

Answer 16

Trading Securities
Available for Sale Securities
Held to Maturity Securities

Investments are categorized based on management’s intentions.

Question 17

Trading Securities (HFT- Held For Trading)

Answer 17

Investments in Equity Instruments (stocks, options, bonds) in an attempt to make profits by buying/selling in ST

Current Assets

Question 18

Available For Sale (AFS)

Answer 18

All investments in marketable debt or equity that do not meet the definition of HTM or Trading Securities

Classified as Current or Non-Current (depending on expected sale date)

Question 19

Held To Maturity (HTM)

Answer 19

Investments in bonds and other debt instruments which the investor has the ability and intent to hold until the due date for repayment.

Non-Current (unless maturity is less than a year)

Question 20

Trading Securities- Investment is initially recognized at, and carried at:

Answer 20

Initially recorded at cost, carried at FMV

Question 21

Trading Securities- Unrealized Gains and Losses recorded on the:

Answer 21

Income Statement (these are temporary differences)

Question 22

Trading Securities - Activity recorded where on the Cash Flows Statement?

Answer 22

Operating Activity, if current

Can be either operating or investing, based on the nature and purpose for which the securities were acquired.

Question 23

AFS: Initially recorded at? Carried at?

Answer 23

Initially recorded at Cost

Carried at FMV

Question 24

AFS: Debt, Equity or Both?

Answer 24

Debt and Equity

Question 25

AFS: Current or Non-Current, or both?

Answer 25

Current OR Non-Current

Question 26

AFS: Unrealized Gains/Losses recognized on:

Answer 26

Balance Sheet as Comprehensive Income

Question 27

AFS: Realized Gains/Losses recognized on:

Answer 27

Income Statement

Question 28

AFS: Activity recorded where on Cash Flows Statement?

Answer 28

Investing Activity (since the transaction is not meant for ST gains like Trading Securities)

Question 29

If any debt or equity security experiences a loss that is considered ‘other than temporary’ - accounting treatment:

Answer 29

Write down to a new cost basis and treat loss as a realized loss on the income statement

Question 30

When is an investment considered to be impaired?

Answer 30

FV < CV

Question 31

When is an impairment considered “other than temporary?”

Answer 31

Impairment should be recorded unless:

• Investor has the ability and intent to hold an investment for a reasonable period of time sufficient for a forecasted recovery of FV up to the cost of the investment
• Evidence indicating that the cost of the investment is recoverable within a reasonable period of time

Question 32

Reclassify from Trading to AFS:

Answer 32

1. Reclassify at FMV
2. Difference is treated as Realized Gain/Loss on I/S
3. Eliminate any related valuation allowance accounts

Question 33

Reclassify Between Held to Maturity and AFS

Answer 33

1. Reclassify at FMV

2. Unrealized Gains/Losses - OCI on BS

Question 34

HTM: Initially recognized at? Recorded at?

Answer 34

Initially recorded at cost

Carried at Amortized Cost (Face net of unamortized discount or premium)

Question 35

HTM: Current or Non-Current?

Answer 35

Non-Current (unless maturity date is less than a year)

Question 36

HTM: Debt (Bonds) or Equity?

Answer 36

Bonds only

Question 37

HTM: Unrealized and Realized Gains/Losses- accounting treatment

Answer 37

Since HTM are not going to be sold, fluctuations in the mkt are ignored.

Unrealized Gains/Losses - not recorded
Realized Gains/Losses - shouldn’t happen but can - record on I/S

Question 38

HTM: Activity recorded where on Cash Flows Statement?

Answer 38

Investing Activity

Question 39

Fair Value Election - Accounting Treatment for AFS unrealized gains/losses

Answer 39

Reported on the Income Statement rather than OCI

Question 40

Fair Value Election - Accounting Treatment for HTM

Answer 40

The company would no longer report the investment at amortized cost. Instead HTM would be marked to FV at the end of the period, and the resulting unrealized gains/losses would be reported on the I/S