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UNIT 6 AUDIT OF INVESTMENTS, HEDGING INSTRUMENTS AND RELATED REVENUES Estimated Time: 6.

0 HOURS
*Use Louwers 4th edition

Discussion questions 6-1 Refer to Louwers 10-1, 10-3, and 10-4. Discussion questions 6-2 Refer to Louwers 10-15, 10-16, and 10-17. Discussion questions 6-3 Refer to Louwers 10-56.
JAPAN Company purchased equity securities during the year 2011 to be held as investments. The cost and market value of the investments for the year 2011 and 2012 are: December 31, 2011 Available for sale securities FVTPL December 31, 2012 Available for sale securities FVTPL Cost P2,000,000 P3,000,000 Cost P2,000,000 P3,000,000 Market 2,200,000 3,100,000 Market 2,500,000 2,900,000

Problem 6-1 Unrealized gains or losses

Prepare the entries on December 31, 2011 and December 31, 2012 to recognize the changes in market value.
On January 1, 2012, CHINA Company purchased marketable equity securities to be held as available for sale. Pertinent data are as follows: Security Alpha Bravo Charlie Cost P240,000 360,000 720,000 Market values at 12.31.2012 P260,000 330,000 650,000 Market values at 12.31.2013 P300,000 400,000

Problem 6-2 Reclassification of securities

On December 31, 2013, China reclassified its investment in security Charlie from available for sale to non-marketable security because on this date the fair value of the investment cannot be reliably measured.

Prepare all journal entries on December 31, 2012 and December 31, 2013.

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Problem 6-3 Investment in available for sale debt securities

KOREA Sauna Services purchased P800,000 7% bonds for P736,676 on May 01, 2011. Korea classified the bonds as available for sale. The bonds were purchased to yield 9% interest. Interest is payable semiannually on May 1 and November 1. The bonds mature on May 1, 2016. Korea uses the effective interest method to amortize premium or discount. On February 01, 2013, Korea sold the bonds for P777,500. Market values for the bonds are as follows: December 31, 2011 P747,674 December 31, 2012 P717,795

1. How much is the correct interest income for 2011? 2. How much is the correct interest income for 2012? 3. How much is the unrealized gain or loss on the investment as of December 31, 2012? 4. How much is the gain or loss on sale of investment on February 1, 2013?
On June 1, 2011, MALAYSIA Enterprises purchased 4,800 of the P1,000 face value, 8% bonds of the Philippine Government for P4,429,800. The bonds were purchased to yield 10% interest. Interest is payable semiannually every December 1, and June 1. The bonds mature on June 1, 2016. Malaysia uses the effective interest method of amortization. On November 1, 2012, Malaysia sold the bonds for P4,710,000 which included the appropriate interest. Market value of the bonds at each reporting date follows: December 31, 2011 98 December 31, 2012 99

Problem 6-4 Investment in trading and held to maturity debt securities

Journal entries to record the above transactions for the years 2011 and 2012, assuming the securities are classified as: 1. FVTPL 2. Held to maturity Problem 6-5 Investment in equity securities
As a member of the team engaged in auditing AUSTRALIA Company, you were tasked to take a look at the marketable securities entries made by the clients bookkeeper. During 2011 and 2012, the client made the following journal entries to account for transactions involving FVTPL and available for sale securities: 2011 (a) Nov 1 FVTPL Cash To record the purchase of P100,000 Seabiscuit Company stock. Brokerage fees were P300. Unrealized loss Marketable securities To record the decrease in market value of the current marketable securities based on the following data. 100,300 100,300

(b) Dec 31

717 717

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Cost Dreamer Company stock (AFS) Hidalgo Company stock (FVTPL) Seabiscuit Company stock (FVTPL) Total 2012 (c) Jul 1 (d) Dec 6 P 25,250 32,450 100,300 P158,000

Fair value P 23,350 33,950 99,883 P157,183 33,000

Unrealized gain/(loss) P (1,900) 1,600 (417) P (717)

(e) Dec 31

Cash FVTPL To record sale of Hidalgo Company stock. Cash Available for sale securities To record sale of half of Dreamer Company stock. Available for sale securities FVTPL Unrealized gain trading securities To record the increase in market value of FVTPL and available for sale securities. Cost

33,000 12,625 12,625 433 1,202 1,635

Fair value P 13,058 101,502 P114,560

Dreamer Company stock (AFS) Seabiscuit Company stock Total There were no other entries in 2012.

P 12,625 100,300 P112,925

Unrealized gain/(loss) P 433 1,202 P 1,635

1. Adjusting entries at December 31, 2012. 2. Unrealized gain/(loss) to be reported on the December 31, 2012 income statement. 3. Adjusted balance of FVTPL and available for sale securities accounts at December

31, 2012.

Problem 6-6 Acquisition, disposal and measurement of available for sale equity securities

The ENGLAND Trench Exploration had acquired interest in a promising local company, the Trench Gold Corp. During your audit of the companys accounts for the past calendar year of 2012, which was a first audit, you found the following two accounts in the general ledger.
Investment in Trench Gold Corp. 2010 Shares January 2 30,000 2011 July 2 90,000 2012 March 2 30,000 2012 July 15 Shares 50,000

P1,050,000 5,400,000 2,100,000

P2,000,000

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Investment in Trench Iron Corp. 2012 August 10 Dividend Income

P10,000 2012 January 2 April 1 August 10 December 20

P120,000 150,000 10,000 100,000

The investments are classified as available for sale. Prior to 2012, the fair value of the Investment in Trench Gold Company cannot be reliably measured. The transactions of the audit year 2012 may be described as follows: Jan. Mar. Apr. 2 2 1 Received a cash dividend (declared on Dec. 1) of P1.00 per share. Bought 30,000 shares at P70. Received a cash dividend (declared on March 1 to stockholders of record, March 10) of P1.00 per share. Sold 50,000 shares at P40. Received an extra dividend in stock of one share of Trench Iron Corp. for each ten shares of Trench Gold Corp. The dividend stock had a market value of P3.00 per share and its carrying value on the ledger of the Trench Gold Corp. was P1.00 per share. Received cash dividend of P1.00 per share, declared Dec. 1 out of the Trench Golds reserve for depletion funds. Sold 10,000 Trench Gold Company shares at P70. Cash was received on January 5, 2013.

July 15 Aug. 10

Dec. 20 Dec. 29

Market prices per share of the securities as of December 31, 2012 are P70 for Trench Gold and P2.50 for Trench Iron.

1. Compute the loss on sale of 50,000 Trench Gold Company shares on July 15, 2012. 2. Compute the gain on sale of 10,000 Trench Gold Company shares on December 29, 2012. 3. Compute the dividend income for the year ended December 31, 2012. 4. Compute the carrying value of available for sale securities as of December 31, 2012. 5. Compute the net unrealized gain to be recognized in equity as of December 31, 2012.

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Problem 6-7 Change in accounting estimate

On January 1, 2012, NORWAY Company purchased 30% of the outstanding common stock of Thailand Company for P5,160,000 cash. On the date of acquisition, the fair value of Thailands net assets was P12,400,000. Norway has determined that the excess of the total cost of the investment over its share of Thailands net assets is attributable to an undervalued depreciable asset with a remaining useful life of 10 years. Thailands net income for the year ended December 31, 2012 was P3,600,000 while the market value of the Thailand stock is P200 per share. During 2012, Thailand declared and paid cash dividends of P400,000. On July 1, 2013, one-fifth of Norways investment in Thailand stocks were sold for P1,500,000. Brokerage fees amounting to P3,000 were paid by Norway. At the end of 2013, Thailand earned a net income of P4,000,000 (which was earned evenly during the year) while the market value of the income of Thailand stock is P205 per share. Norway received cash dividends of P80,000 from Thailand on December 31, 2013.

1. Balance of Norways investment in Thailand Companys stocks at December 2012. 2. Amount of income Norway should report from its Investment in Thailand Co. for year ended December 31, 2012. 3. Amount of gain/loss from the July 1 sale. 4. Balance of Norways Investment in Thailand Companys stocks at December 2013. 5. Amount of income Norway should report from its Investment in Thailand Co. for year ended December 31, 2013 (exclude the gain or loss on sale from July 1). Problem 6-8 Change in accounting policy

31, the 31, the

SSS Corporation acquired stocks for EEE, Inc. over the three-year period 2010-2012. Purchased, dividend, and income information for these years are as follows: Purchased were made on the first day of each year. Net Income, EEE % of Acquired Purchased Dividends Ownership Paid, EEE, Inc. Inc, Dec.31 Price Dec 31 2010 10% P500,000 P1,000,000 P2,000,000 2011 5% 300,000 1,200,000 3,000,000 2012 15% 1,170,000 1,800,000 4,000,000 All purchase prices are equal to the underlying book values at the date of purchase. SSS Corp. recorded all of the transactions from 2010 to 2012 under the cost method. Year

1. Prepare the adjusting journal entries as at December 31, 2012. 2. Compute for the correct carrying value of the Investment in EEE, Inc. common stocks as of December 31, 2012.

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Problem 6-9 Investment in bonds

In your audit of CLUB Corp., you were informed that on June 01, 2012, Club purchased as a long term investment 6,000 of the P1,000 face value, 8% bonds of Smart Corporation. Club intends to hold the bonds until they mature. The bonds were purchased to yield 10% interest which is payable semiannually every December1 and June 1. The bonds will mature on June 1, 2018 and the company uses the effective interest method of amortization. On November 01, 2013, Club sold the bonds for P5,887,500.

1. 2. 3. 4.

Purchase price of the bonds. Interest income for 2012 and 2013. Carrying value of the investment on December 31, 2012. Gain on sale of the investment.

On September 1, 2012, MMM Company purchased equipment from BBB for $50,000 to be paid on March 1, 2013. The exchange rate on September 1, 2012 is P40 to $1. On the same date, MMM entered into a foreign currency forward contract and agreed to pay P2,000,000 at the rate of P40 to $1. This forward contract is designated as a fair value hedge of the payable that is denominated in foreign currency. The peso exchange rate to the dollar is P41 on December 31, 2012 and P43 on March 1, 2013.

Problem 6-10 Forward contract

Prepare all indicated entries for 2012 and 2013 to record the forward contract and the purchase of the equipment. Problem 6-11 Futures contract
BABY Herbal Medicines produces bottled virgin coconut oil. Virgin coconut meat is typically bought and sold by the kilo, and Baby uses 100,000 kilos of coco meat each month. On December 1, 2012, Baby entered into a coco meat futures contract to buy 100,000 kilos of coco meat on January 1 at a price of P0.85 per kilo, which is also the market price of coco meat on December 1. Baby designates the futures contract as a hedge of the forecasted purchase of coco meat in January.

Prepare all journal entries on Babys books on December 1, 2012, December 31, 2012, and January 1, 2013, to record this futures contract. On December 31, 2012, and on January 1, 2013, the market price of coco meat is P0.75 per kilo.

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Problem 6-12 Call option

PURE Fitness Plant uses soybeans to make one of their nutritional supplement products. Pure anticipates a need of 500,000 pounds of soybeans in January of 2012. On November 1, 2012, Pure purchased a call option for 500,000 pounds of soybeans on January 1, 2013, at a price of P0.40 per pound, which is the market price on November 1. Pure paid P1,200 for the call option and designated this option as a hedge against price fluctuations for their January purchase of soybeans. On December 31, 2012, and January 1, 2013, the prevailing market price for soybeans is P0.45 per pound. On January 1, 2013, Pure purchased 500,000 pounds of soybeans.

Make the necessary entries on Pures books at 1. November 1, 2012 2. December 31, 2012 3. January 1, 2013 Problem 6-13 Put option
ANGEL Cottons sells approximately 500,000 kilos of cotton each month. On January 1, 2012, Angel purchased an option to sell 500,000 kilos of cotton on January 1, 2014, at a price of P1.75 per kilo. The market price on January 1, 2012 is P1.75 per kilo. Angel had to pay P100,000 to purchase this cotton put option, which it designated as a hedge against price decreases for its January 2014 sales of cotton. On December 31, 2012, the price of cotton is P2.00 per kilo. Because there is still time for the price of cotton to potentially fall below P1.75 per kilo before the option expires (thus making it advantageous to exercise the put option), the option has a value on December 31, 2012, of P30,000. On December 31, 2013, the price of cotton is P1.80 per kilo. 1. How much is the option price? 2. Make all journal entries necessary on Angels books in 2012, 2013, and 2014 to

record this option and the sale of 500,000 kilos of cotton in January 2014.

Problem 6-14 Interest rate swap

On January 1, 2011, CHERUBS Company borrowed P5 million from Bank One at a variable rate of interest for four years. Interest will be paid annually to the bank on December 31 and the principal is due on December 31, 2014. Under the agreement, the market rate of interest every January 1 resets the variable rate for that period and the amount of interest to be paid on December 31. In conjunction with the loan, Cherubs entered into a receive variable, pay fixed interest rate swap agreement with Bank Two (a speculator). The interest rate swap agreement was designated as a cash flow hedge. The market rates of interest are 10%, 14%, 12%, and 11% for January 1, 2011, January 1, 2012, January 1, 2013, and January 1, 2014, respectively.

Prepare all entries from 2011 to 2014 to recognize all transactions relating to the contract of loan and the derivative contract.

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