Section 2E - Investments Flashcards
At what amount should trading, available-for-sale, and held-to-maturity debt securities be reported on the balance sheet, respectively?
Fair value, fair value, amortized cost
Fair value, fair value, fair value
Fair value, amortized cost, fair value
Fair value, amortized cost, amortized cost
Fair value, fair value, amortized cost
Trading debt securities are carried on the balance sheet at fair value, with unrealized holding gains and losses (determined at the portfolio level) reported in net income. Any discount or premium is amortized.
Available-for-sale (AFS) debt securities are carried on the balance sheet at fair value. Held-to-maturity debt securities are accounted for using the amortized cost method.
They are carried at original cost adjusted for the amortization of any discount or premium.
Held-to-maturity securities are accounted for using the __cost method. They are carried at original cost adjusted for the amortization of any ___or ___.
Trading securities are carried on the balance sheet at ___ value, with ___holding gains and losses
Available-for-sale (AFS) securities are carried on the balance sheet at fair value.
- Unrealized gains and losses from changes in fair value are reported in ___ __ income for the period.
- Unrealized gains or losses from sold securities are adjusted when the entire portfolio is evaluated for fair value at____-___
amortized,
discount,
premium
fair
unrealized
other comprehensive
year-end,
not on the date of sale.
Sun Corp. had investments in equity securities costing $650,000. The investment’s fair value was $535,000 at December 31 of the previous year, and $490,000 at December 31 of the current year.
What amount of loss from investments should Sun report in its current-year income statement?
$45,000
$85,000
$160,000
$120,000
$45,000.
The losses on the investment previous to this year have already been recognized in earnings. The losses from this year of $45,000 ($535,000 − $490,000) would be recognized in this year’s income statement.
Moss Corp. owns 20% of Dubro Corp.’s preferred stock and 80% of its common stock. Dubro’s stock outstanding on December 31, 20X1, is as follows:
10% cumulative preferred stock $100,000
Common stock 700,000
Dubro reported net income of $60,000 for the year ending December 31, 20X1. What amount should Moss record as equity in earnings of Dubro for the year ending December 31, 20X1?
$48,000
$42,000
$50,000
$48,400
$42,000
As a general rule, the ownership of __% or more of the voting stock of the investee leads to the presumption that, in the absence of evidence to the contrary, the investor has the ability to exercise ___over the investee
Examples of possible evidence to the contrary which might cause this presumption to be overcome include the following:
- . Opposition by the investee, such as __, challenges the investor’s ability to exercise sig influence.
- The investor and investee sign an __under which the investor surrenders significant rights as a shareholder.
- Majority ownership of the investee is __among a small group of shareholders
- The investor needs or wants more ___to apply the equity method
- The investor tries and fails to obtain ___on the investee’s board of directors.
20, significant influence
litigation
agreement
concentrated
financial information
representation
Dividends received from an investee reduce the ___of the investment but are not included in the income of the investor.
carrying amount
Puff Co. acquired 40% of Straw, Inc.’s, voting common stock on January 2, 20X1, for $400,000. The carrying amount of Straw’s net assets at the purchase date totaled $900,000. Fair values equaled carrying amounts for all items except equipment, for which fair values exceeded carrying amounts by $100,000. The equipment has a 5-year life. During 20X1, Straw reported net income of $150,000. What amount of income from this investment should Puff report in its 20X1 income statement?
$52,000
$60,000
$56,000
$40,000
$52,000
FASB ASC 323-10-05-5 requires the use of the equity method when a company acquires 20% or more of the outstanding stock of another company.
Significant influence is assumed. Under the equity method, Puff should report 40% of the $150,000 income of Straw, or $60,000. Because Straw’s equipment has a fair market value exceeding its carrying value,
Puff should amortize the difference over the equipment’s 5-year life. Puff should record 40% of $100,000 ($40,000) as equipment subject to amortization (depreciation). Straight-line amortization of $40,000 over five years yields an expense of $8,000. Puff has income of $60,000 less $8,000, or $52,000 for 20X1.
At the beginning of the fiscal year, Turmeric Corp. purchased 30% of Basil Co. In its balance sheet at the end of the fiscal year, Turmeric reported $482,500 as its investment in Basil. During the current year, Basil reported net income of $570,000 and declared and paid cash dividends of $190,000. Turmeric uses the equity method of accounting. How much did Turmeric pay when it purchased its investment in Basil at the beginning of the year?
$368,500
$254,500
$482,500
$539,500
$368,500
When a company owns 20% or more of another company’s voting stock but does not control the other company (<= 50% ownership), the company is said to have significant influence over the investee and the equity method of accounting for the investment in the other company applies. Under the equity method, the investment (in the owned company) account is initially measured at the original investment. It is subsequently increased by the percentage share of the owned company’s income and decreased by the dividends received by the investor.
Since the information given is the ending balance and not the beginning balance, one way to solve for the beginning balance is to use the following equation:
- Beginning balance + (0.30 × $570,000) – (0.30 × $190,000) = $482,500
- Beginning balance = $482,500 – $171,000 + $57,000
- Beginning balance = $368,500
__method: The investor initially records the investment at cost. Subsequent to acquisition, the investor adjusts the carrying amount of the investment to recognize the investor’s share of the earnings or losses of the investee after the date of acquisition.
The amount of the adjustment is included in the ___of the investor
The types of adjustments include those necessary to:
- recognize the investor’s share of the investee’s reported __ or __,
- eliminate ___gains and losses, and
- ___any difference between cost of the investment and the investor’s equity in the net assets of the investee.
Equity
net income
earnings or losses
intercompany
amortize
Bort Co. purchased 2,000 shares of Crel Co. common stock on March 5, Year 1, for $72,000. Bort received a $1,000 cash dividend on the Crel stock on July 15, Year 1. Crel declared a 10% stock dividend on December 15, Year 1, to stockholders of record as of December 31, Year 1. The dividend was distributed on January 15, Year 2. The market price of the stock was $38 on December 15, Year 1, $40 on December 31, Year 1, and $42 on January 15, Year 2. What amount should Bort record as dividend revenue for the year ended December 31, Year 1?
$9,000
$1,000
$9,400
$8,600
$1,000
Cash dividends ($1,000) are recorded as income (revenue) when the dividend is declared for investments in equity securities not accounted for under the equity method. Stock dividends are not reflected in earnings (i.e., income statement).
Disclosure of information about significant concentrations of credit risk is required for:
financial instruments with off-balance sheet risk of accounting loss only.
all financial instruments.
financial instruments with off-balance sheet credit risk only.
financial instruments with off-balance sheet market risk only.
all financial instruments.
FASB ASC 815-10-20 defines credit risk as the risk of changes in the hedged item’s fair value attributable to both of the following:
- Changes in the obligor’s creditworthiness
- Changes in the spread over the benchmark interest rate with respect to the hedged item’s credit sector at inception of the hedge
As for disclosure of credit risk, an entity shall disclose all significant concentrations of credit risk arising from all financial instruments, whether from an individual counterparty or groups of counterparties. An entity must also recognize all of its derivatives as an asset or liability.
In short, credit risk for all financial instruments should be disclosed.
FASB ASC 815-10-20 defines credit risk as the risk of changes in the hedged item’s fair value attributable to both of the following:
Changes in the obligor’s____
Changes in the spread over the benchmark ____ rate with respect to the hedged item’s credit sector at inception of the hedge
As for disclosure of credit risk, an entity shall disclose all significant concentrations of credit risk arising from ___financial instruments, whether from an individual counterparty or groups of counterparties. An entity must also recognize all of its ___as an asset or liability.
In short, credit risk for all financial instruments should be disclosed.
creditworthiness
interest rate
all
derivatives
FASB ASC 815-10-20 defines credit risk as the risk of changes in the hedged item’s fair value attributable to both of the following:
- Changes in the obligor’s creditworthiness
- Changes in the spread over the ____ ___rate with respect to the hedged item’s credit sector at inception of the hedge
creditworthiness
benchmark interest
IIn 20X1, Lee Co. acquired Enfield, Inc., 10-year bonds at a premium as a long-term investment. On December 31, 20X2, 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’ market value?
Interest rates have increased since Lee purchased the bonds.
Interest rates have declined since Lee purchased the bonds.
Enfield is expected to call the bonds at a premium, which is less than Lee’s carrying amount.
Enfield issued a stock dividend.
Interest rates have increased since Lee purchased the bonds.
Bonds sell at a premium when the stated rate of interest paid by the bonds exceeds the market rate. The opposite is true if bonds sell at a discount.
In the Lee Co. situation, Lee paid a premium price in 20X1 because Enfield, Inc.’s, interest rate was greater than the market rate. By December 31, 20X2, the situation had changed. The market rate was higher than Enfield’s rate.
Since Enfield’s stated bond interest rate did not change during this period, the only explanation for the change in bond price from premium to discount was that market interest rates increased since Lee purchased the bonds.
Bonds sell at a ___when the stated rate of interest paid by the bonds exceeds the market rate.
Bonds sell at a___ when the stated rate of interest paid by the bonds is less than the market rate
premium
discount
Any discount or premium should be amortized by using the ___interest method
Buying and selling trading debt securities is designed to generate profits from the short-term differences in price; these investments are typically held less than ___months.
effective
three
At year-end, Rim Co. held several investments with the intent of selling them in the near term. The investments consisted of $100,000, 8%, 5-year bonds purchased for $92,000, and equity securities purchased for $35,000. At year-end, the bonds were selling on the open market for $105,000 and the equity securities had a fair value of $50,000. What amount should Rim report as securities in its year-end balance sheet?
$142,000
$50,000
$155,000
$127,000
$155,000
Investment in debt securities (other than those intended to be held until maturity) and investment in equity securities are reported at fair value in the balance sheet.
The exceptions are marketable debt securities that a company plans to hold to maturity (reported at amortized cost) and marketable equity securities that provide the company the ability to significantly influence the investee (equity method required) or to control the investee (consolidation required). Therefore, Rim should report both at fair value of $155,000.
Pear Co.’s income statement for the year ended December 31, 20X1, as prepared by Pear’s controller, reported income before taxes of $125,000. The auditor questioned the following amounts that had been included in income before taxes:
Equity in earnings of Cinn Co $40,000
Dividends received from Cinn 8,000
Adjustments to profits of prior years
for arithmetical errors in depreciation (35,000)
Pear owns 40% of Cinn’s common stock. Pear’s December 31, 20X1, income statement should report income before taxes of what amount?
$85,000
$152,000
$117,000
$120,000
$152,000
On February 28, 20X5, Obligato Limited purchased 35% of the outstanding shares of Glissando Corporation. The book values of Glissando’s assets and liabilities were approximately equal to their fair values at that date. This level of ownership allows Obligato to exercise significant influence over Glissando. During 20X5, Glissando reported net income of $245,000 and declared and paid dividends of $115,000. If the ending balance in Obligato’s “Investment in Glissando” account at December 31, 20X5, was $520,500, how much did Obligato pay for its investment in Glissando Corporation on February 28, 20X5?
$475,000
$429,500
$560,750
$520,500
$475,000
When a company owns 20% or more of another company’s voting stock but does not control the other company (<= 50% ownership), the company is said to have significant influence over the investee and the equity method of accounting for the investment in the other company applies.
Obligato owns 35% of Glissando, implying the equity method of accounting for the investment will be used.
The ending balance of $520,500 results from the beginning balance plus Obligato’s share of Glissando’s net income and minus Obligato’s share of Glissando’s dividends.
Obligato’s share of Glissando’s net income is $85,750 ($245,000 × 0.35) and their share of the dividends is $40,250 ($115,000 × 0.35).
The formula to compute the answer is Beginning balance + $85,750 – $40,250 = $520,500. Solving this equation results in the beginning balance of $475,000.
Which of the following factors would not be an indicator of an investor’s ability to exercise significant influence over the operating and financial policies of an investee?
Dependence by the investee on the investor’s proprietary technology
Investor recommendation for the investee to hire a specific executive
Investor representation on the investee board of directors
Interchange of managerial personnel between investor and investee
Investor recommendation for the investee to hire a specific executive
As a general rule, ownership of less than 20% (direct or indirect) of the voting stock of the investee leads to the presumption that an investor does not have the ability to exercise significant influence. This presumption can be overcome, however, if the ability to exercise significant influence can be demonstrated in other ways. Examples of such circumstances include the following:
- Representation on the investee’s board of directors
- Participation in the investee’s policy-making processes
- Material intercompany transactions with the investee
- Interchange of managerial personnel
- Technological dependency of the investee on the investor
Investor recommendation for the investee to hire a specific executive is not one of the listed circumstances.
As a general rule, ownership of less than 20% (direct or indirect) of the voting stock of the investee leads to the presumption that an investor does not have the ability to exercise significant influence. This presumption can be overcome, however, if the ability to exercise significant influence can be demonstrated in other ways. Examples of such circumstances include the following:
Representation on the investee’s____
Participation in the investee’s ____processes
Material ___transactions with the investee
Interchange of ___personnel
Technological ____of the investee on the investor
Adjustments of PY depreciation should be ___ from current period income and recorded directly to ____
board of directors
Policy-making
intercompany
mangerial
dependency
excluded, beginning retained earnings
Grant, Inc., acquired 30% of South Co.’s voting stock for $200,000 on January 2, 20X1. Grant’s 30% interest in South gave Grant the ability to exercise significant influence over South’s operating and financial policies. During 20X1, South earned $80,000 and paid dividends of $50,000. South reported earnings of $100,000 for the six months ended June 30, 20X2, and $200,000 for the year ended December 31, 20X2. On July 1, 20X2, Grant sold half of its stock in South for $150,000 cash. South paid dividends of $60,000 on October 1, 20X2.
In its 20X2 income statement, what amount should Grant report as gain from the sale of half of its investment?
$45,500
$24,500
$30,500
$35,000
$30,500
When purchasing a bond, the present value of the bond’s expected net future cash inflows discounted at the market rate of interest provides what information about the bond?
Price
A bond has a face amount of principal, which is the amount repaid to the owner of the bond at the end of its term. A bond has a coupon rate, which, when multiplied by the face (principal) amount, states the amount of (actual cash) interest paid to the bond owner annually.
The value of owning the bond is the (present) value of these two rights, to be repaid the principal at the end of the bond’s term, and to be paid the coupon rate of interest every year until then.
The present value of these rights is the value of the bonds, hence the rational price.
The present value is based on the market rate of interest, since this is the (rational) rate to charge, and discount based on what the market would require of the debtor.
“Yield” is a synonym for market rate, and “par” is another term for face amount.
A company should report investment in debt securities that it has classified as trading at:
fair value, with holding gains and losses included in earnings.
lower of cost or market, with holding gains and losses included in earnings.
lower of cost or market, with holding gains included in earnings only to the extent of previously recognized holding losses.
fair value, with holding gains included in earnings only to the extent of previously recognized holding losses.
fair value, with holding gains and losses included in earnings.
Investment in debt securities are carried at fair value with holding gains and losses included in earnings.
a
$0
Available-for-sale (AFS) debt securities are carried on the balance sheet at fair value. Unrealized gains and losses from changes in fair value are reported in Other Comprehensive Income (OCI) for the period. OCI is then added to (subtracted from) Accumulated Other Comprehensive Income (AOCI), which is shown as a separate component of stockholders’ equity until realized. Therefore, $0 would be reflected on the income statement.
Debit to Net Unrealized Holding Loss of $400
a
Debit to Net Unrealized Holding Loss of $400
Equity investments in unconsolidated entities with readily determinable fair values are measured at fair value with any changes in fair value recognized through net income (FV-NI). Since the previous fair value adjustment of $150 was an increase to the equity securities, the previous fair value balance must have been $6,150 for December 31, 20X1. Although the net unrealized holding loss for 20X2 is ($250), the adjustment to reduce the carrying balance to $5,750 is a debit to Net Unrealized Holding Loss of $400.
Income from continuing operations
The holding gain or loss on investment in equity securities is always included in income from continuing operations.
Grant, Inc., acquired 30% of South Co.’s voting stock for $200,000 on January 2, 20X1. Grant’s 30% interest in South gave Grant the ability to exercise significant influence over South’s operating and financial policies. During 20X1, South earned $80,000 and paid dividends of $50,000. South reported earnings of $100,000 for the six months ended June 30, 20X2, and $200,000 for the year ended December 31, 20X2. On July 1, 20X2, Grant sold half of its stock in South for $150,000 cash. South paid dividends of $60,000 on October 1, 20X2.
Before income taxes, what amount should Grant include in its 20X1 income statement as a result of the investment?
$15,000
$24,000
$80,000
$50,000
$24,000
Peel Co. received a cash dividend from a common stock investment. Peel should report an increase in the investment account if it uses which method of accounting?
The equity method
None of the answer choices are correct.
The cost method
Either the cost method or the equity method
None of the answer choices are correct.
Income from continuing operations
The unrealized holding gain or loss on investment in equity securities is always included in income from continuing operations.
On January 2 of the current year, Otto Co. purchased 40% of Penn Co.’s outstanding common stock. The carrying amount of Penn’s depreciable assets was $1,000,000 on January 2. Penn’s depreciable assets had an original useful life of 10 years, and a remaining useful life of 5 years. Otto recognized $8,000 amortization for the current year ending December 31 related to its investment in Penn due to the excess of fair value over book value on these assets. What was the fair value of Penn’s depreciable assets on January 2 of the current year?
$100,000
$1,100,000
$900,000
$1,000,000
$1,100,000
Debit to Unrealized Holding Loss of $800
Equity investments in unconsolidated entities with readily determinable fair values are measured at fair value with any changes in fair value recognized through net income (FV-NI).
Since the previous fair value adjustment of $300 was an increase to the equity securities, the previous fair value balance must have been $12,300 for December 31, 20X7.
Although the net unrealized holding loss for 20X8 is ($500), the adjustment to reduce the carrying balance to $11,500 is a debit to Unrealized Holding Loss of $800.
