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CHAPTER 14

 C HAPTER 14  Investments in Debt and Equity Securities M ULTIPLE C HOICE Q

Investments in Debt and Equity Securities

C HAPTER 14  Investments in Debt and Equity Securities M ULTIPLE C HOICE Q UESTIONS

MULTIPLE CHOICE QUESTIONS

Theory/Definitional Questions

1

Definition of available-for-sale securities

2

Reporting of changes in fair value of securities in the income statement

3

Reporting of changes in fair value of securities on the balance sheet

4

Definition of held-to-maturity securities

5

Accounting for available-for-sale securities

6

Application of FASB Statement No. 115

7

Accounting for investments in common stock using the cost method

8

Accounting for trading securities

9

Accounting for goodwill amortization

10

Using the fair market value of stock received as a basis for valuation

11

Accounting for available-for-sale securities

12

Application of the equity method to account for investments in common stock

13

Accounting for goodwill amortization

14

Accounting for trading securities

15

Application of the equity method to account for investments in common stock

16

Application of the equity method to account for investments in common stock

17

Accounting for available-for-sale securities

18

Use of consolidated financial statements

19

Accounting for trading securities

20

International vs. U.S. GAAP for investments in securities

21

Disclosures related to investments in securities

22

Using the cost method to account for an investment

23

Effect of using cost method when equity method was appropriate

24

Reclassification of available-for-sale securities to trading securities

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Chapter 14 Investments in Debt and Equity Securities

22 Chapter 14  Investments in Debt and Equity Securities

Computational Questions

25 Computation of dividend revenue

26 Computation of investment income on available-for-sale securities

27 Computation of investment income on available-for-sale securities

28 Computation of balance in investment account on trading securities

29 Computation of carrying value of portfolio on balance sheet

30 Computation of unrealized loss related to securities transactions

31 Determine entry to record sale of a security

32 Computation of loss transfer of securities to determine net income

33 Record corresponding charges against unrealized losses

34 Computation of carrying value of investment in common stock

35 Computation of income on long-term investment

36 Computation of investment in common stock affected by goodwill amortization

37 Computation of "Share of Net Income" of investment affected by goodwill amortization

38 Determination of journal entry for temporary investment

39 Computation of investment loss on trading securities

40 Determination of credit to "Market Adjustment--Trading Securities" account

41 Computation of unrealized loss on trading securities on income statement

42 Computation of loss on securities investment on income statement

43 Computation of realized loss on short-term investment of marketable equity securities

44 Computation of value of acquisition of bonds

PROBLEMS

1 Prepare journal entries relating to investments in common stock

2 Determine journal entries for trading and available-for-sale securities valuations

3 Prepare journal entries for investment in common stock and computation of carrying value of investment using cost and equity methods

4 Computation of amount reported for investment using equity method

5 Prepare journal entries and compute goodwill for common stock investment

6 Prepare journal entries with supporting computations for long-term investments

7 Reporting of capital stock investments on balance sheet and income statement

8

Prepare journal entries for temporary investments using asset/revenue methods

9

Accounting for the sale of securities

10

Recording the transfer of securities between categories

11

Accounting for changes from the equity method

12

Accounting for changes to the equity method

13

Explanation of “gains trading”

14

Changes from the “held-to-maturity” classification

15

Change to the equity method

16

Impairment of a loan

MULTIPLE CHOICE QUESTIONS

c

1.

Which securities are purchased with the intent of selling them in the

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near future?

a. Marketable equity securities

b. Available-for-sale securities

c. Trading securities

d. Held-to-maturity securities

c

2.

Changes in fair value of securities are reported in the income statement for

LO5

which type of securities?

a. Marketable equity securities

b. Available-for-sale securities

c. Trading securities

d. Held-to-maturity securities

b

3.

Changes in fair value of securities are reported in the stockholders' equity

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section of the balance sheet for which type of securities?

a. Marketable equity securities

b. Available-for-sale securities

c. Trading securities

d. Held-to-maturity securities

d

4.

Which category includes only debt securities?

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a. Marketable equity securities

b. Available-for-sale securities

c. Trading securities

d. Held-to-maturity securities

c

5.

A debit balance in the account Market Adjustment--Available-for-Sale

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Securities at the end of a year should be interpreted as

a. the net unrealized holding gain for that year.

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Chapter 14 Investments in Debt and Equity Securities

24 Chapter 14  Investments in Debt and Equity Securities

b. the net realized holding gain for that year.

c. the net unrealized holding gain to date.

d. the net realized holding gain to date.

a

6.

FASB Statement No. 115 generally applies when the level of ownership of

LO2

another company is at what percentage?

a. Less than 20%

b. 20%–30%

c. 30%–50%

d. More than 50%

b

7.

When an investor uses the cost method to account for investments in

a. a deduction from the investment account.

LO4

common stock, cash dividends received by the investor from the investee should

normally be recorded as

b. dividend revenue.

c. an addition to the investor’s share of the investee’s profit.

d. a deduction from the investor’s share of the investee’s profit.

b

8.

A debit balance in the account Market Adjustment—Trading Securities at

LO5

the end of a year should be interpreted as

a. the net realized holding gain to date.

b. the net unrealized holding gain to date.

c. the net realized holding gain for that year.

d. the net unrealized holding gain for that year.

d

9.

Under the cost method of accounting for unconsolidated investments in

LO4

common stock, goodwill amortization

a. reduces the investment account.

b. increases the investment account.

c. reduces both investment income and the investment account.

d. is not recorded.

c

10.

From the following, select the most appropriate basis for the valuation of a

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new investment when properties or services are exchanged for stock.

a. The par or stated value of the stock received

b. The book value of the property or services exchanged

c. The fair market value of the stock received

d. Either b or c, whichever is more clearly determinable

b

11.

For which type of investments would unrealized increases and decreases

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be recorded directly in an owners' equity account?

a. Equity method securities

b. Available-for-sale securities

c. Trading securities

d. Held-to-maturity securities

c

12.

The equity method of accounting for an investment in the common stock of

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another company should be used when the investment

a. is composed of common stock and it is the investor’s intent to vote the common stock.

b. ensures a source of supply such as raw materials.

c. enables the investor to exercise significant influence over the investee.

d. gives the investor voting control over the investee.

c

13.

Under the equity method of accounting for unconsolidated investments in

LO4

common stock, goodwill amortization

a. decreases amortization expense and reduces the investment account.

b. reduces investment income and increases the investment account.

c. reduces investment income and reduces the investment account.

d. is not recorded.

b

14. If the combined market value of trading securities at the end of the year is

LO5

less than the market value of the same portfolio of trading securities at the beginning of the year, the difference should be accounted for by

a. reporting an unrealized loss in security investments in the stockholders' equity section of the

balance sheet. b. reporting an unrealized loss in security investments in the income

statement.

c. a footnote to the financial statements.

d. a credit to Investment in Trading Securities.

a

15.

When an investor uses the equity method to account for investments in

LO4

common stock, the investment account will be increased when the investor recognizes

a. a proportionate share of the net income of the investee.

b. a cash dividend received from the investee.

c. periodic amortization of the goodwill related to the purchase.

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Chapter 14 Investments in Debt and Equity Securities

26 Chapter 14  Investments in Debt and Equity Securities

d. depreciation related to the excess of market value over book value of the investee’s depreciable assets at the date of purchase by the investor.

b

16.

When an investor uses the equity method to account for investments in

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common stock, cash dividends received by the investor from the investee should be recorded as

a. an increase in the investment account.

b. a deduction from the investment account.

c. dividend revenue.

d. a deduction from the investor’s share of the investee’s profits.

a

17.

If the combined market value of available-for-sale securities at the end of the

LO5

year is less than the market value of the same portfolio of available-for-sale securities at the beginning of the year, the difference should be accounted for by

a. reporting an unrealized loss in security investments in the stockholders'

equity section of the balance sheet. b. reporting an unrealized loss in security investments in the income

statement.

c. a footnote to the financial statements.

d. a credit to Investment in Available-for-Sale Securities.

c

18.

Consolidated

financial

statements

are

typically

prepared

when

one

 

company

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has

a. accounted for its investment in another company by the equity method.

b. significant influence over the operating and financial policies of another company.

c. the controlling financial interest in another company.

 

d. a substantial equity interest in the net assets of another company.

 

d

19.

At the beginning of the year a company had a debit balance in the account

LO5

Market Adjustment--Trading Securities. not

buy or sell any trading securities, but at the end of the year the related market adjustment account had a credit balance. This change indicates that

a. a loss on the income statement was recognized.

b. a gain on the income statement was recognized.

During the year the company did

c. the value of the investment account increased.

d. the value of the investment account decreased.

b

20.

The only significant difference between the provisions of international

a. IAS 39 requires accounting for all investments in debt securities to be

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accounting standards as promulgated by IAS 39 and U.S. accounting

standards under FASB Statement No. 115 is

on a fair value basis while SFAS No. 115 does not.

b. IAS 39 allows all unrealized gains and losses on securities valued at fair value to be reported in net income for the period while SFAS No. 115 does not.

c. IAS 39 requires trading securities to be reported on a fair value basis but not securities available for sale.

d. IAS 39 does not permit the reporting of unrealized gains and losses on securities other than trading securities to be recorded as part of equity.

d

21.

Which of the following is true?

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a. Trading securities can be classified as current of noncurrent depending

on

management’s intent.

b. Held-to-maturity securities should not be classified as current under any circumstance.

c. Trading securities should not be classified as current under any circumstance.

d. Available-for-sale securities can be classified as current or noncurrent depending on management’s intent.

b

22. On August 1, 2001, Colorite Corp. acquired 10,000 of the outstanding shares

LO2

of Brown Co. On January 2, 2002, Colorite acquired an additional 20,000 shares of Brown Co., which brought the total ownership to 30,000 shares. Using the normal guidelines for percentages of ownership and assuming that Brown Co. had 100,000 shares outstanding during 2001 and 2002, Colorite Corp. should account for the investment in Brown Co. by

a. using the cost method in 2001 and the equity method in 2002.

b. using the cost method in 2001, retroactively adjusting the investment account to the equity method at the beginning of 2002, and using the equity method in 2002.

c. using the equity method for 2001 and 2002.

d. using the cost method in 2001 and 2002 for the 10,000 shares acquired in 2001, and using the equity method in 2002 for the 20,000 shares acquired in 2002.

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Chapter 14 Investments in Debt and Equity Securities

28 Chapter 14  Investments in Debt and Equity Securities

d

23. Poster Inc. owns 35 percent of Elliott Corporation. During the calendar

a. Understate, overstate

LO4

year 2002, Elliott had net earnings of $300,000 and paid dividends of $36,000.

Poster mistakenly accounted for the investment in Elliott using the cost method rather than the equity method of accounting. What effect would this have on the investment account and net income, respectively?

 

b. Overstate, understate

c. Overstate, overstate

d. Understate, understate

c

24.

If an investment in stock is reclassified from available-for-sale securities to

a. market value at the date of acquisition.

LO7

trading securities, the stock should be recorded on the date it is reclassified

at the

b. book value at the date of reclassification.

c. market value at the date of reclassification.

d. lower-of-cost-or-market value at the date of reclassification.

c

25.

Northwick Company acquired 10,000 shares of the common stock of

LO4

Shaver Corp. in July 2002. The following January, Shaver announced a $100,000

net income for 2002 and declared a cash dividend of $.50 per share on its

100,000 shares of outstanding common stock.

dividend revenue from Shaver Corp. in January 2002 would be

a. $0.

b. $2,500.

c. $5,000.

d. $10,000.

The Northwick Company

c

26.

On January 2, 2001, Reynolds Corporation bought 15 percent of Scorpio

a. $3,150

LO4

Corporation’s capital stock for $60,000 and classified it as available-for-

sale securities. Scorpio’s net incomes for the years ended December 31, 2001 and 2002, were $20,000 and $100,000, respectively. During 2002, Scorpio declared a dividend of $140,000. No dividends were declared in 2001. On December 31, 2002, the fair value of the Scorpio stock owned by Reynolds had increased to $90,000. How much should Reynolds show on its 2002 income statement as income from this investment?

b. $15,000

c. $21,000

d. $51,000

a

27.

On January 2, 2002, Adler Co. acquired 2,000 shares of Boxworth Co.

LO4

common stock for $8,000 and classified these shares as available-for-sale securities. During 2002, Adler received $6,000 of cash dividends. Adler’s share of Boxworth’s 2002 earnings (net income) was $5,000. The fair value of Boxworth's stock on December 31, 2002, was $7 per share. Adler should report what amount in 2002 related to Boxworth Co.?

a. Revenue of $6,000

b. Revenue of $12,000

c. A $1,000 decrease in the investment account

d. A $1,000 increase in the investment account

b

28.

On January 1, 2002, Young Co. paid $500,000 for 20,000 shares of

(which includes both investments and any related market adjustments)

LO5

Montana Co.’s common stock and classified these shares as trading securities.

Young does not have the ability to exercise significant influence over Montana. Montana declared and paid a dividend of $.50 a share to its stockholders during 2002. Montana reported net income of $260,000 for the year ended December 31, 2002. The fair value of Montana Co.'s stock at December 31, 2002, is $27 per share. What is the net asset amount

attributable to the investment in Montana that will be included on Young's balance sheet at December 31, 2002?

a. $530,000

b. $540,000

c. $569,000

d. $579,000

c

29.

Martin Co. purchased the following portfolio of trading securities during

 

2002

LO5

and reported the following balances at December 31, 2002. No sales occurred during 2002. All declines are considered to be temporary.

Security

Cost

Market Value at 12/31/02

X

$ 80,000

$ 82,000

Y

140,000

132,000

Z

32,000

28,000

The carrying value of the portfolio at December 31, 2002, on Martin Co.’s balance sheet would be

a. $222,000.

b. $240,000.

c. $242,000.

d. $252,000.

a

30.

Martin Co. purchased the following portfolio of available-for-sale securities

LO5

during 2002 and reported the following balances at December 31, 2002. No sales occurred during 2002. All declines are considered to be

temporary. Security

Cost

Market Value at 12/31/02

X

$ 80,000

$ 82,000

Y

140,000

132,000

Z

32,000

28,000

Martin Co. should report what amount related to the securities transactions in its 2002 income statement?

a. $0

b. $2,000 unrealized loss

c. $10,000 unrealized loss

d. $12,000 unrealized loss

a

31.

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c

32.

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Marino Corporation purchased the following portfolio of trading securities during 2002 and reported the following balances at December 31, 2002. No sales occurred during 2002. All declines are considered to be

temporary. Security

Cost

Market Value at 12/31/02

X

$ 80,000

$ 82,000

Y

140,000

132,000

Z

32,000

28,000

The only transaction in 2003 was the sale of security Z for $34,000 on December 31, 2003. The market values for the other securities at December 31, 2003 were the same as at December 31, 2002. Marino's entry to record the sale of security Z would include

a. a credit of $2,000 to Realized Gain on Sale of Trading Securities.

b. a debit of $2,000 to Realized Gain on Sale of Trading Securities.

c. a $2,000 debit to Market Adjustment-Trading Securities.

d. a $4,000 debit to Market Adjustment-Trading Securities.

In March of 2001, Moon Corp. bought 45,000 shares of McMahon Corp.’s listed

stock

securities. The market value of these shares had declined to $300,000 by

December 31, 2001.

trading securities in June of 2002 when the market value of this investment

How much should Moon

include as a loss on transfer of securities in its determination of net income for 2002?

a. $0

b. $45,000

in McMahon's stock had risen to $345,000.

Moon changed the classification of these shares to

and classified the shares as available-for-sale

for

$450,000

c. $105,000

d. $150,000

c

33.

Walsh, Inc. began business on January 1, 2002, and at December 31,

2002,

LO5

Walsh had the following investment portfolios of equity securities:

 

Trading

Available-For-Sale

 

Aggregate cost Aggregate market value

$150,000

$225,000

120,000

185,000

None of the declines is judged to be other than temporary. Unrealized losses at December 31, 2002, should be recorded with corresponding charges against Stockholders’

Income

Equity

 

a. $70,000

$

0

b. $40,000

$30,000

 

c. $30,000

$40,000

d. $

0

$70,000

c

34.

In January 2002, Henry Corporation acquired 20 percent of the outstanding common stock of Davis Company for $1,120,000. This investment gave Henry the ability to exercise significant influence over Davis. The book value of the acquired shares was $840,000. The excess of cost over book value was attributed to an identifiable intangible asset that was

undervalued on Davis’ balance sheet and that had a remaining useful life of ten years. For the year ended December 31, 2002, Davis reported net income of $252,000 and paid cash dividends of $56,000 on its common stock. What is the proper carrying value of Henry’s investment in Davis at December 31, 2002?

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a. $1,080,800

 

b. $1,092,000

c. $1,131,200

d. $1,181,600

c

35.

On January 1, 2002, Capitech Corporation acquired Logirun, Inc. as a long-term investment for $250,000 (a 30 percent common stock interest in Logirun). On that date, Logirun had net assets with a book value and

LO4

During 2002, Logirun reported net

income of $90,000 and declared and paid cash dividends of $20,000. What is the maximum amount of income that Capitech should report from this investment for 2002?

current market value of $800,000.

a. $6,000

b. $21,000

c. $26,750

d. $27,000

b

36.

On January 1, 2002, Mets Inc. purchased 30 percent of the outstanding

determined that the excess of the cost of the investment over its share of

LO4

common stock of Pirates Corporation for $516,000 cash. Mets is

accounting for this investment using the equity method. On the date of acquisition, the fair value of Pirates' net assets was $1,240,000. Mets has

Pirates' net assets is attributable to goodwill, which will be amortized over the maximum allowable period. Pirates’ net income for the year ended December 31, 2002, was $360,000. During 2002, Pirates declared and paid cash dividends of $40,000. There were no other transactions between the two companies. On December 31, 2002, the investment in Pirates should be recorded as

a. $392,400.

b. $608,400.

c. $612,000.

d. $624,000.

b

37.

On January 1, 2002, Mets Inc. purchased 30 percent of the outstanding

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common stock of Pirates Corporation for $516,000 cash. Mets is accounting for this investment using the equity method. On the date of acquisition, the fair value of Pirates' net assets was $1,240,000. Mets has

determined that the excess of the cost of the investment over its share of Pirates' net assets is attributable to goodwill, which will be amortized over the maximum allowable period. Pirates' net income for the year ended December 31, 2002, was $360,000. During 2002, Pirates declared and paid cash dividends of $40,000. There were no other transactions between the two companies. Ignoring income taxes, Mets’ statement of income for the year ended December 31, 2002, should include "Income From Investment in Pirates Corporation Stock" in the amount of

a. $68,000.

b. $104,400.

c. $108,000.

d. $111,600.

b

38.

On April 1, 2002, Ziba Inc. purchased as a temporary investment $100,000,

LO3

face amount, 10% U.S. Treasury notes; they pay interest semiannually on

January 1 and July 1.

The notes were purchased at 102.

Which of the

following entries correctly records this purchase?

a. Trading Securities--10% U.S. Treasury Notes

100,000

Interest Receivable

2,500

Premium on Trading Securities

2,000

Cash

104,500

b. Trading Securities--10% U.S. Treasury Notes

102,000

Interest Receivable

2,500

Cash

104,500

c. Trading Securities--10% U.S. Treasury Notes

100,000

Interest Receivable

4,500

Cash

104,500

d. Trading Securities--10% U.S. Treasury Notes Cash

102,000

102,000

b

39.

Edwards Company began business in February of 2001. During the year,

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Edwards purchased the three trading securities listed below. On its December 31, 2001, balance sheet, Edwards appropriately reported a

$4,000 credit balance in its Market Adjustment--Trading Securities account. There was no change during 2002 in the composition of Edward’s portfolio of trading securities. Pertinent data are as follows:

Market Value

Security

Cost

December 31, 2002

A

$120,000

$126,000

B

90,000

80,000

C

160,000

157,000

$370,000

$363,000

What amount of loss on these securities should be included in Edward’s income statement for the year ended December 31, 2002?

a. $0

b. $3,000

c. $7,000

d. $11,000

d

40.

Edwards Company began business in February 2001. During the year, Edwards purchased the three trading securities listed below. On its December 31, 2001, balance sheet, Edwards appropriately reported a $4,000 debit balance in its Market Adjustment--Trading Securities account. There was no change in 2002 in the composition of Edward’s portfolio of marketable equity securities held as a temporary investment. Pertinent data are as follows:

LO5

 

Security

Cost

Market Value December 31, 2002

 

A

$120,000

 

$126,000

B

90,000

80,000

C

160,000

157,000

 

$370,000

$363,000

 

What amount should Edwards credit to the Market Adjustment--Trading Securities account at December 31, 2002?

a. $0

b. $3,000

 

c. $7,000

d. $11,000

b

41.

Tyler

Company

began

operations

in

2001.

The

company's

trading

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securities portfolio, which did not change in composition during 2002, is as follows:

December 31, 2002

 

Unrealized

 

Cost

Market

Gain (Loss)

Archer, Inc Kelly Company Pelt Company

$ 100,000

$ 100,000

$

0

 

200,000

150,000

(50,000)

250,000

260,000

10,000

 

$

550,000

$ 510,000

$ (40,000)

 

December 31, 2001

 

Unrealized

 

Cost

Market

Gain (Loss)

Archer, Inc Kelly Company Pelt Company

$ 100,000

$ 135,000

$

35,000

 

200,000

210,000

10,000

250,000

180,000

(70,000)

 

$

550,000

$ 525,000

$ (25,000)

Ignoring income taxes, what amount should be reported as an unrealized loss on trading securities in Tyler’s 2002 income statement?

a. $0

b. $15,000

c. $25,000

d. $40,000

b

42.

On August 31, 2002, Stiggins Company purchased the following available-

 

for-

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sale securities:

 

Market Value

 

Security

Cost

D $ 96,000

December 31, 2002 $ 84,000

E 152,000

158,000

F 162,000

146,000

On December 31, 2002, Stiggins reclassified its investment in security F

from available-for-sale securities to trading securities.

What total amount

of loss on these securities should be included in Stiggins’ income statement for the year ended December 31, 2002?

a. $0

b. $16,000

c. $22,000

d. $28,000

d

43. During 2001, Barney Company purchased marketable equity securities as a short-term investment and classified them as trading securities. The cost and market value at December 31, 2001, were as follows:

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Market Value

Security

Cost

December 31, 2001 $ 10,200

X 200 shares

$

8,400

Y 2,000 shares

51,000

45,900

Z 4,000 shares

94,500

88,500

 

$153,900

$144,600

Barney sold 1,000 shares of Company Y stock on March 16, 2002, for $25

per share, incurring $1,200 in brokerage commissions and taxes. sale, Barney should report a realized loss of

On the

a. $0.

b. $500.

c. $850.

d. $1,700.

b

44.

On October 1, Dennis Company purchased $200,000 face value 12% bonds

LO3

for 98 plus accrued interest and brokerage fees and classified them as held-to-maturity securities. Interest is paid semiannually on January 1 and

July 1.

should this acquisition of bonds be recorded?

a. $196,000

b. $196,700

c. $202,000

d. $202,700

Brokerage fees for this transaction were $700.

PROBLEMS

Problem 1

In 2002, KZF Inc. purchased stock as follows:

At what amount

(a)

Acquired 2,000 shares of Gallery Arts Corp. common stock (par value $20) in

exchange for 1,200 shares of KZF Inc. preferred stock (par value $30). The preferred stock had a market value of $75 per share on the date of the exchange.

(b)

Purchased 800 shares of Champion Corp. common stock (par value $10) at $70 per share, plus a brokerage fee of $800.

At December 31, 2002, the market values of the securities were as follows:

Security

Market Value

KZF Inc. Gallery Arts Corp. Champion Corp.

$71

41

72

The investments in common stock are classified by KZF Inc. as available-for-sale securities accounted for by the cost method. The fiscal year of KZF ends on December 31.

(1)

Prepare all entries relating to the investments in common stock for 2002.

(2)

Prepare the entry to record the sale of 200 shares of Champion Corp. common stock on January 15, 2003, at $74 per share.

(3)

Prepare the entry to reclassify the remaining 600 shares of Champion Corp. common stock from available-for-sale securities to trading securities on January 31, 2003. The stock was selling at $67 per share on that date.

Solution 1 LO3, LO5, LO6 (1) Available-for-Sale Securities--Gallery Corp.

 

Stock (1,200 x $75)

90,000

Preferred Stock (1,200 x $30) Paid-In Capital in Excess of Par (1,200 x $45)

 

36,000

54,000

Available-for-Sale Securities--Champion Corp.

 

Stock [(800 x $70) + $800]

56,800

Cash

56,800

 

Market

Increase/

 

Security Gallery Corp. Champion Corp.

Cost

Value

Decrease

$ 90,000

$ 82,000

$(8,000) (2,000 x $41) 800 (800 x $72)

 

56,800

57,600

 

$146,800

$139,600

$(7,200)

 

Unrealized Increase/Decrease in Value of Available-for- Sale Securities Market Adjustment–Available-for-Sale Securities

7,200

7,200

(2)

Cash (200 x $74)

14,800

Realized Gain on Sale of Trading Securities

[($74-$71) x 200]

600

Available-for-Sale Securities--Champion Corp. Stock

 

14,200

(3) Investment in Trading Securities--Champion Corp. Stock

 
 

(600 x $67)

40,200

Unrealized Increase/Decrease in Value of Available-for- Sale Securities--Equity Unrealized Loss on Transfer of Securities--Income Market Adjustment--Available-for-Sale Securities Investment in Available-for-Sale Securities--Champion Corp. Stock

600

2,400

 

600

42,600

Problem 2 Webster Inc. carries the following marketable equity securities on its books at December 31, 2001 and 2002. All securities were purchased during 2001 and there were no beginning balances in any market adjustment accounts.

Trading Securities:

Cost

V Company $ 50,000

Market December 31, 2001 $ 26,000

Market December 31, 2002 $ 40,000

W Company

26,000

40,000

40,000

X

Company 70,000

60,000

50,000

 

Total

$146,000

$126,000

$130,000

Available-for-Sale Securities:

 

Y Company $420,000

$360,000

$100,000

Z Company

100,000

120,000

140,000

 

Total

$520,000

$480,000

$240,000

The cost method is used in accounting for all investments in securities.

(1) Give the entries necessary to record the valuations for both trading and available-for-sale securities at December 31, 2001 and 2002. (2) What net effect would these valuations have on 2001 and 2002 net income?

Solution 2

LO5

(1) 2001

Dec. 31

Unrealized Loss on Trading Securities Market Adjustment--Trading Securities

20,000

20,000

Unrealized Increase/Decrease in Value of Available-for-Sale Securities Market Adjustment--Available-for-Sale Securities

40,000

40,000

2002

Dec. 31

Market Adjustment--Trading Securities Unrealized Gain on Trading Securities

4,000

4,000

Dec. 31

Unrealized Increase/Decrease in Value of Available-for-Sale Securities

240,000

Market Adjustment–Available-for-Sale Securities

240,000

(2) Effect of valuation entries on 2001 net income:

Recognized decline in value of trading securities

$(20,000)

Effect of valuation entries on 2002 net income:

Recognized increase in value of trading securities

$4,000

Problem 3 On January 1, 2002, Alsop Corp. acquired 30 percent (13,000 shares) of Stone Services Inc. common stock for $1,300,000 as a long-term investment. Data from Stone’s 2002 financial statements include the following:

Net income Less cash dividends paid Increase in retained earnings

$330,000

160,000

$170,000

The market value of Stone Services Inc. common stock on December 31, 2002,

was $98 per share. securities.

Alsop does not have any other noncurrent investments in

Prepare the necessary journal entries for Alsop’s investment in Stone Services Inc. common stock under (1) the cost method classified as available-for-sale securities. (2) the equity method.

Solution 3

LO4, LO5

(1)

Investment in Available-for-Sale Securities--Stone Services Stock

1,300,000

Cash

1,300,000

Cash ($160,000 x 30%)

48,000

Dividend Revenue

48,000

Unrealized Increase/Decrease in Value of Available- for-Sale Securities--Equity (13,000 shares x $2) Market Adjustment--Available-for-Sale Securities

26,000

26,000

(2)

Investment in Stone Services Inc Cash

1,300,000

1,300,000

Cash

48,000

Investment in Stone Services Inc. Stock

48,000

Investment in Stone Services Inc. Stock

($330,000 x 30%)

99,000

Income from Investment in Stone Services Inc. Stock

99,000

Problem 4 On January 1, 2002, Gardner Associates purchased 30 percent of the outstanding shares of stock of Gillen Corp. for $150,000 cash. The investment will be accounted for by the equity method. On that date, Gillen’s net assets (book and fair value) were $300,000. Gardner has determined that the excess of the cost of its investment in Gillen over its share of Gillen’s net assets is attributable to goodwill, which will be amortized over the maximum allowable period.

Gillen’s net income for the year ended December 31, 2002, was $60,000. During 2002, Gardner received $5,000 cash dividends from Gillen. There were no other transactions between the two companies.

Compute the amount that would be reported on Gardner Associates’ books for the investment in Gillen Corp. at December 31, 2002.

Solution 4

LO4

Investment in Gillen Corp. stock:

Original investment Share of net income--30% of $60,000 Amortization of implied goodwill* Dividends received Total

$150,000

18,000

(1,500)

(5,000)

$161,500

* Implied value of Gillen Corp.:

Implied value: $150,000/.30 = $500,000 Implied goodwill: $500,000 - $300,000 = $200,000 Gardner's share of goodwill: $200,000 x .3 = $60,000 Amortization of implied goodwill: $60,000/40-year life = $1,500

Problem 5 On July 1, 2002, Mountain Systems acquired 8,000 shares of Precision Services’ 40,000 outstanding common shares at a cost of $240,000. The book value and fair market value of Precision's net assets on that date was $880,000. The following data pertain to Precision Services for 2002.

Net income reported in 2002:

January 1 - June 30 July 1 - December 31 Total

Cash dividends declared and paid:

January 1 - June 30 July 1 - December 31 Total

$28,000

36,000

$64,000

$30,000

30,000

$60,000

(1)

Prepare the entry to record the original investment on July 1.

(2)

Compute the goodwill (if any) on the purchase.

(3)

Prepare the necessary entries (other than acquisition) for 2002 on Mountain

(4)

Systems’ books using the cost method. Prepare the necessary entries (other than acquisition) for 2002 on Mountain Systems’ books using the equity method.

Solution 5

LO4, LO5

(1)

Investment in Precision Services Stock Cash

240,000

240,000

(2) Goodwill computation:

 
 

Purchase price Fair market value of net assets 8,000/40,000 shares Fair market value of Mountain’s share of net assets Goodwill

 

$240,000

$880,000

x

20%

 

176,000

$ 64,000

(3) Cost method:

 
 

Cash ($30,000 x 20%)

6,000

Dividend Revenue Cash dividends received (July 1 - December 31).

 

6,000

(4) Equity method:

 
 

Cash

6,000

Investment in Precision Services Stock Cash dividends received (July 1 - December 31).

 

6,000

Investment in Precision Services Stock ($36,000 x 20%)

7,200

Income from Investment in Precision Stock 20% share of investee earnings (July 1 - December 31).

7,200

Income from Investment in Precision Stock

($64,000/40 yrs. x ½ yr.)

800

Investment in Precision Services Stock Amortization of goodwill for 6 months.

800

Problem 6 Joseph Co. executed the following long-term investment transactions during the current year.

Feb. 6

Purchased 1,000 shares of Large Auto Co. for $40 per share plus

brokerage costs of $225. securities.

These shares were classified as trading

Mar. 31

Purchased 60,000 of the 200,000 outstanding common shares of New

Tech Corp. for $600,000. purchase price.

Goodwill of $160,000 was included in the

June 20

Received a $2.20 per share dividend on Large Auto Co. shares.

Sept. 4

Acquired 4,000 shares of Mega Conglomerate’s stock for $30 per share plus $600 transaction costs. These shares were classified as available- for-sale securities.

Dec. 31

Market values of Large Auto Co. and Mega Conglomerate stock were $45 and $28 per share, respectively.

Prepare journal entries with appropriate supporting computations for the year’s transactions.

Solution 6

 

LO4, LO5

Feb. 6

Investment in Trading Securities--

Large Auto Co. Stock Cash

40,225

40,225

Mar. 31

Investment in New Tech Corp. Stock Cash

600,000

600,000

June

20

Cash (1,000 x $2.20)

2,200

 

Dividend Revenue

2,200

June 30

Investment in New Tech Corp. Stock Income from Investment in New Tech Corp. Stock

($40,000 x 30% ownership).

12,000

12,000

To record share of New Tech Corp. earnings

June 30

Income from Investment in New Tech Corp. Stock

months ($160,000/40 years x 3/12).

1,000

Investment in New Tech. Corp. Stock To record amortization of goodwill for three

1,000

Sept. 4

Investment in Available-for-Sale Securities--Mega

Conglomerate Stock [(4,000 x $30) + $600]

120,600

Cash

120,600

Dec. 31

Market Adjustment–Trading Securities

4,775

Unrealized Gain on Trading Securities

4,775

Unrealized Increase/Decrease in Value of Available-for-Sale Securities

8,600

Market Adjustment--Available-for-Sale Securities

8,600

 

Cost

Market

Large Auto Co

$ 40,225

$ 45,000

Mega Conglomerate

120,600

112,000

Problem 7 On July 1, 2002, The Woodward Group purchased for cash 35 percent of the outstanding capital stock of Massey Studios. Both The Woodward Group and Massey Studios have a December 31 year-end. Massey Studios, whose common stock is actively traded in the over-the-counter market, reported its total net income for the year to The Woodward Group and also paid cash dividends on November 15, 2002, to The Woodward Group and its other stockholders.

How should The Woodward Group report the above facts in its December 31, 2002, balance sheet and its income statement for the year then ended? Discuss the rationale for your answer.

Solution 7

LO4

The Woodward Group should follow the equity method of accounting for its investment in Massey Studios because The Woodward Group is presumed, because of the size of its investment, to be able to exercise significant influence over the operating and financial policies of Massey Studios.

In 2002, The Woodward Group should report its interest in Massey Studios’ outstanding capital stock as a long-term investment. Following the equity method of accounting, The Woodward Group should record the cash purchase of 35 percent of Massey Studios at cost, which is the amount paid.

Thirty-five percent of Massey Studios’ total net income from July 1, 2002, to December 31, 2002, should be added to the carrying amount of the investment in The Woodward Group’s balance sheet and shown as revenue in its income statement to recognize The Woodward Group’s share of the net income of Massey Studios after the date of acquisition. This amount should reflect adjustments similar to those made in preparing consolidated statements, including adjustments to eliminate intercompany gains and losses, and to amortize, if appropriate, any difference between The Woodward Group’s cost and the underlying equity in net assets of Massey Studios on July 1, 2002.

The cash dividends paid by Massey Studios to The Woodward Group should reduce the carrying amount of the investment in The Woodward Group’s balance sheet and have no effect on The Woodward Group’s income statement.

Problem 8 On February 1, 2002, Pyle Inc. had excess cash on hand. The controller suggested to management that the company buy $200,000 of U.S. Treasury bonds selling at 102 and paying 8 percent interest. Interest payments on these bonds are made semiannually on January 1 and July 1.

(1) Prepare entries to record the February purchase of U.S. Treasury bonds and the subsequent collection of interest on July 1, using

(a)

the asset approach.

(b)

the revenue approach.

(2) Assuming that

these

bonds

were

acquired

as

an

investment in

trading

securities, explain whether the premium or discount should be amortized.

Solution 8

LO2, LO4

(1)

(a)

Investment--Trading Securities

204,000

 

Interest Receivable (200,000 x 8% x 1/12)

1,333

Cash

205,333

Cash

8,000

Interest Receivable

1,333

Interest Revenue

6,667

 

(b)

Investment--Trading Securities

204,000

 

Interest Revenue

1,333

Cash

205,333

Cash Interest Revenue

8,000

8,000

(2) Periodic amortization of the premium or discount is used when bonds are acquired at a higher or lower price than their maturity value and it is expected that they will be held until maturity. However, when bonds are acquired as a temporary investment and it is not likely that the bonds will be held until maturity, such procedures are normally not applied. Problem 9 The following transactions of the Snyder Company were completed during the fiscal year just ended:

 

(a)

Purchased $100,000 of U.S. Treasury 7% bonds, paying 102.5 plus accrued interest of $1,750. In addition, the company paid brokerage fees of $500. Snyder Company uses the revenue approach to record accrued interest. Snyder classified these bonds as a trading security.

(b)

Purchased 1,000 shares of Ferris Company common stock at $125 per

 

share plus brokerage fees of $950. available-for-sale security.

Snyder classifies this stock as and

 

(c)

Received semiannual interest on the U.S. Treasury Bonds.

(d)

Sold 150 shares of Ferris at $132 per share.

(e)

Sold $16,000 of U.S. Treasury 7% bonds at 102 plus accrued interest of

$93.

 

(f)

Purchased a $12,000, 6-month certificate of deposit. The certificate is classified as a trading security.

Prepare the entries necessary to record the above transactions.

Solution 9

 

LO6

(a)

Investment in Trading Securities--Treasury Bonds

103,000

Interest Revenue

1,750

Cash

104,750

1.025 x 100,000 = $102,500; $102,500 + 500 brokerage fee = $103,000

(b)

Investment in Available-for-Sale Securities Cash

125,950

125,950

(c)

Cash Interest Revenue

3,500

3,500

(d)

Cash

19,800

Investment in Available-for-Sale Securities

18,893

Gain on Sale

907

$132 x 150 shares = $19,800; 150/1,000 x $125,950 = $18,893; $19,800 - $18,893 = $907.

(e)

Cash

16,413

Realized Loss on Sale of Securities

160

Investment in Trading Securities--Treasury Bonds

16,480

Interest Revenue ($16,000 x 1.02) + ($16,000 x .035 x 1/6) = $16,413.

93

$16,000/$100,000 x 103,000 = $16,480.

(f) Investment in Trading Securities--Certificate of Deposit Cash

12,000

12,000

Problem 10 Lee Company had the following portfolio of securities at the end of its first year of operations:

Year-End

Market Value

Security

Classification

Cost

A Trading

$18,000

$23,000

B Trading

$25,000

$27,000

(1) Provide the entry necessary to adjust the portfolio of securities to market value.

(2) After adjusting the securities to market, Lee elects to reclassify Security B as an available-for-sale security. On the date of the transfer, Security B’s market value is $26,500. Provide the journal entry to reclassify Security B.

Solution 10

 

LO7

(1)

Market Adjustment--Trading Securities Unrealized Gain on Trading Securities

7,000

7,000

(2)

Investment in Available-for Sale Securities--Security

26,500

Unrealized Loss on Transfer of Securities

500

Market Adjustment--Trading Securities

2,000

Investment in Trading Securities--Security B

25,000

Entry reclassifies security as available-for-sale at current fair value of $26,500 and removes historical cost of trading security of $25,000. Unrealized loss represents the difference between fair value at the beginning

of

the period and fair value on date of transfer.

Problem 11 On January 1, 2001, Paxman Company purchased 50% of Monroe Company for cash of $660,000. On that date the net assets of Monroe Company had a book value of $1,200,000. The difference between fair value and book value is attributed to goodwill and is amortized over 20 years. On January 1, 2002, Paxman sold 70% of its ownership in Monroe for $525,000 and reclassified the remaining stock as available- for-sale. Net income and dividends for 2001 and 2002 for Monroe are given below:

 

2001

2002

Net income

$80,000 $90,000

Dividends

18,000

25,000

Prepare the required journal entries made by Paxman Company relating to its investment in Monroe for the years 2001 and 2002 assuming no change in market value during the 2-year period.

Solution 11

LO10

2001

Investment in Monroe Company Cash

660,000

660,000

Investment in Monroe Company Income from Investment in Monroe Stock ($80,000 x 50% = 40,000)

40,000

40,000

Cash

9,000

Investment in Monroe Company ($18,000 x 50% = 9,000)

9,000

Income from Investment in Monroe Stock Investment in Monroe Company [$660,000 - ($1,200,000 x 50%) = $60,000] ($60,000 20 = $3,000]

3,000

3,000

2002

Cash

525,000

Investment in Monroe Company

481,600

Gain on Sale of Monroe Stock

43,400

Book value at end of 2001 = $660,000 + $40,000 - $9,000 - $3,000 =

$688,000.

$688,000 x 70% = $481,600. $525,000 - $481,600 = $43,400.

Cash

Dividend Revenue

3,750

3,750

Problem 12 Park Company purchased 18% of the outstanding common stock of Ray Company on January 1, 2001, when the net assets of Ray Company had a book value and fair value of $400,000. Park Company paid $72,000 for this investment. On January 1, 2002, Park purchased an additional 10% of the outstanding stock of Ray Company, paying another $41,000. (Assume the book and fair values of the net assets is $410,000). Ray Company reported income and dividends for 2001 and 2002 are given below:

 

2001

2002

Net income

$40,000 $50,000

Dividends

30,000

30,000

Prepare the journal entries made by Park during 2001 and 2002 related to its investment in Ray Company, including the adjusting entries needed to reflect the change from an available-for-sale security to the equity method.

Solution 12

 

LO10

2001

Jan. 1

Investment in Available-for-Sale Securities Ray Company

72,000

Cash

72,000

Dec. 31 Cash (.18 x $30,000)

5,400

 

Dividend Revenue

5,400

Test Bank, Intermediate Accounting, 14 th ed.

51

Test Bank, Intermediate Accounting , 14 t h ed. 51

2002

Jan. 1

Investment in Ray Company

114,800

Cash

 

41,000

Retained Earnings

1,800

Investment in Available-for-Sale Securities-- Ray Company

72,000

Computation of adjustment to retained earnings:

 

Equity in Ray Co. earnings

(18% x $40,000)

$7,200

Dividends received

(5,400)

Retroactive adjustment to change from cost to equity method

$1,800

Dec. 31 Investment

in Ray Company (.28 x $50,000)

14,000

 

Income from Investment in Ray Company

 

14,000

Cash

8,400

Investment in Ray Company

8,400

Problem 13 The Financial Accounting Standards Board had several goals in issuing Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and changing the accounting for certain debt and equity securities from a lower-of-cost-or-market basis to a fair value basis. Among these goals was the elimination of what is termed “gains trading.”

Explain the meaning of the term “gains trading.”

Solution 13

LO5

The term “gains trading” refers to the practice of management of selectively selling securities the prices of which have appreciated and including the realized gains in earnings. Gains trading results from the use of amortized cost accounting and the available-for-sale classification.

The use of amortized cost permits recognition of holding gains through selected sales of appreciated securities and the inclusion of these realized holding gains in earnings. At the same time, use of amortized cost does not provide for the recognition of unrealized losses. Managers thus can selectively manage earnings by choosing to sell those securities that have appreciated while selectively excluding unrealized losses from earnings. Debt and equity securities classified as available-for-sale are reported at fair value but unrealized changes in fair value are excluded from earnings.

52

Chapter 14 Investments in Debt and Equity Securities

52 Chapter 14  Investments in Debt and Equity Securities

Managers again can selectively sell securities the prices of which have appreciated and include the realized gains in earnings. Securities for which prices have dropped are held. The available-for-sale treatment thus permits unrealized gains and losses to be excluded from earnings since these unrealized gains and losses are reported in a separate component of stockholders’ equity.

Problem 14 Investments in debt securities currently are permitted to be classified as held-to- maturity and accounted for at amortized cost if an enterprise has the positive intent and ability to hold these securities to maturity. The held-to-maturity classification is the most restrictive of the three classifications specified in accounting standards. Despite the restrictiveness of the held-to-maturity classification, certain changes in circumstances may occur that would necessitate transferring an investment in a debt security from the held-to-maturity classification without calling into question the investor’s general intention to hold other similarly classified investments to maturity.

What types of circumstances would cause an investor in debt securities classified as held-to-maturity to change that classification without calling into question the intent of the investor to hold other similarly classified investments to maturity?

Solution 14

LO2

The following changes in circumstances may cause an investor to change its intent to hold a certain security to maturity without calling into question its intent to hold other debt securities to maturity in the future:

1. Evidence of a significant deterioration in the issuer’s creditworthiness.

The

deterioration must be actual and not based on speculation.

2. A change in tax law eliminates or reduces the tax-exempt status of interest

on the debt security. This provision does not include a change in tax law

that

revises the marginal tax rates applicable to interest income.

3. A major business combination or major disposition (such as the sale of a

segment) necessitates the sale or transfer of held-to-maturity securities to maintain the enterprise’s existing interest rate risk position or credit risk policy.

4. A change in statutory or regulatory requirements significantly modifying

either what constitutes a permissible investment or the maximum level of investments in certain kinds of securities, thereby causing an enterprise to

dispose of a

held-to-maturity security.

Test Bank, Intermediate Accounting, 14 th ed.

53

Test Bank, Intermediate Accounting , 14 t h ed. 53

5. A significant increase by the regulator in the industry’s capital requirements that causes the enterprise to downsize by selling held-to-maturity securities.

6.

A significant increase in the risk weights of debt securities used for

regulatory

risk-based capital purposes.

Problem 15 On January 1, 2001, Arthur Company paid $450,000 for 10,000 shares of DW Company voting common stock, which represented a 15% interest in DW. At this date, the net assets of DW Company totaled $2.5 million. The fair values of DW Company’s identifiable assets and liabilities were equal to their book values. Arthur did not have the ability to exercise significant influence over the operating and financial policies of DW as a result of this investment. Arthur received dividends of $0.80 per share from DW on October 1, 2001. DW reported net income of $300,000 for the year ended December 31, 2001. The stock was classified as available-for-sale. Market prices for the 10,000 shares was $450,000.

On July 1, 2002, Arthur paid $1,550,000 for 30,000 shares of DW Company’s voting common stock, which represents a 25% interest in DW. The fair value of the identifiable assets, net of liabilities of DW was equal to their book values of $4,650,000. As a result of this transaction, Arthur acquired the ability to exercise significant influence over the operating and financial policies of DW. Arthur received a dividend of $0.85 per share from DW on April 1, 2002, and $1.40 per share on October 1, 2002. DW reported net income of $350,000 for the year ended December 31, 2002, and $150,000 for the six months ended December 31, 2002. Arthur amortizes goodwill over 20 years.

Determine the amount of income from the investment in DW common stock that should be reported on Arthur’s income statement for the year ended December 31, 2002, and December 31, 2001 (restated).

Solution 15

LO10

2002

2001

Income from investment in DW Company

$90,000

$45,000

Less: Goodwill amortization

13,438

3,750

Income from investment

76,562

$41,250

Arthur’s share of DW income:

2002

2001

Income for 2001 (300,000 x .15) Income for 2002:

First half (200,000 x .15)…………………

…………………….

$30,000

$45,000

54

Chapter 14 Investments in Debt and Equity Securities

54 Chapter 14  Investments in Debt and Equity Securities

Second half (150,000 x .40)

60,000

$90,000

$45,000

Goodwill amortization:

Goodwill on 2001 acquisition:

[$450,000 – (.15 x $2,500,000) = $75,000 20] Goodwill on 2002 acquisition:

$

3,750

$ 3,750

[$1,550,000 – (.25 x $4,650,000) = $387,500 20 x ½]

9,688

 

$13,438

$ 3,750

Problem 16 EMD Corp. loaned $200,000 to Alco Corp. on January 1, 2001. The terms of the loan require principal payments of $40,000 each year for five years plus interest at 8%. The first principal and interest payment is due on January 1, 2002. Alco made the required payments during 2002 and 2003. Alco began to experience financial difficulties in 2003, however, which made it necessary for EMD to reassess the likelihood of the loan being collected. On December 31, 2003, EMD determines that the principal payments will be collected, but that the collection of interest is unlikely.

(1)

2003.

Compute the present value of the expected future cash flows as of December 31,

(2) Provide the journal entry to record the loan impairment as of December 31, 2003.

(3) Provide the journal entries for 2004 to record receipt of the principal payment on January 1 and the recognition of interest revenue as of December 31, assuming that EMD’s assessment of the likelihood of collecting the loan has not changed.

Solution 16

LO11

(1) Present value of expected future cash flows:

Date

Payment

Time of Discount now 1 year 2 years

Table Value

Present Value at 8% $ 40,000

Jan. 1, 2004 Jan. 1, 2005 Jan. 1, 2006

$40,000

1.000

$40,000

.9259

37,036

$40,000

.8573

34,292

Present value at December 31, 2003

$111,328

Test Bank, Intermediate Accounting, 14 th ed.

55

Test Bank, Intermediate Accounting , 14 t h ed. 55

(2) Journal entry to record impairment:

12/31/2003 Bad Debt Expense………………………………… Allowance for Loan Impairment

8,672

8,672

(3) Journal entries made during 2004:

 

1/01/2004 Cash………………………………………………… Loan Receivable………………….……………

40,000

40,000

12/31/2004

Allowance for Loan Impairment Interest Revenue……………………………… [($111,328 - $40,000) x .08 = 5,706]

5,706

5,706

56

Chapter 14 Investments in Debt and Equity Securities

56 Chapter 14  Investments in Debt and Equity Securities

CHAPTER 14 -- QUIZ A

Name

Section

T

F 1. An investment in stock is initially recorded at cost and all commissions, taxes, and other fees are expensed as incurred, under both the cost and equity methods.

T

F 2. Under some circumstances, consolidated financial statements are appropriate even though the parent company owns less than 50 percent of the voting stock of the subsidiary.

T

F 3. Accounting practice allows companies not to consolidate certain majority-owned subsidiaries if these subsidiaries have “nonhomogeneous” operations, a large minority interest, or a foreign location.

T

F

4.

The cost method of accounting should always be used when the investor does not exercise significant influence over the investee.

T

F

5.

The equity method may not be appropriate in some cases even though the investor owns more than 20 percent of the voting stock of the investee.

T

F 6. As a general rule, consolidated financial statements should be prepared only when the parent corporation owns 80 percent or more of the outstanding common stock of the subsidiary.

T

F

7.

Under the cost method, the investment account is periodically adjusted to reflect changes in the underlying net assets of the investee.

T

F 8. When an investment in equity securities has been accounted for under the equity method, but circumstances dictate a change to the cost method, retroactive application of the cost method is required.

T

F

9.

When the purchase price of stock is greater or less than the underlying book value of the investee’s net assets, an adjustment is made by the investor to the income reported by the investee in applying the equity method.

T

F 10.

No adjustment is made to the investment account when changing from the equity method to the cost method.

CHAPTER 14 -- QUIZ B

Name

Section

T

F

1.

Unrealized holding gains and losses on investments in trading securities are recognized on the income statement.

T

F

2.

Unrealized gains and losses on investments in available-for-sale securities are recognized on the income statement.

T

F

3.

A debit

balance in the account Market Adjustment—Available-for-Sale

 

Securities implies a corresponding owners' equity account with a credit balance of the same amount.

T

F

4.

For balance sheet classification, securities are classified as short -term or long-term investments based on management’s intended holding period.

T

F 5. The net reported balance in the available-for-sale securities investment account is the original cost plus a credit balance in the market adjustment account or minus a debit balance in the market adjustment account.

T

F

6.

When investments in trading securities are sold, the realized gain or loss is the difference in the market value since acquisition.

T

F

7.

Unrealized holding gains on investments in held-to-maturity securities are recognized as a direct increase to owners' equity.

T

F 8. Increases in the market value of trading securities and available-for-sale securities investments cause the related market adjustment account to decrease.

T

F

9.

Investments in trading securities may be classified as current or long-term.

T

F 10.

If an investor does not have a controlling interest in another company, the investor may choose to use either the cost method or the equity method to account for that investment in equity securities.

57

CHAPTER 14 -- QUIZ C

A. Cost method

B. Significant influence

C. Parent company

D. Long-term investments

E. Subsidiary company

F. Market method

G. Control

Name

Section

H. Equity method

I. Merger

J. Consolidation

K. Nonconvertible investments

L. Executory contract

M. Available-for-sale securities

N. Trading securities

Select the term that best fits each of the following definitions and descriptions. Indicate your answer by placing the appropriate letter in the space provided.

1.

A company that is owned or controlled by another company.

2.

The ability of an investor to impact the operating, investing, and financing decisions of an investee but not absolutely determine those decisions.

3.

The ability of an investor to decisively influence the operating, investing, and financial decisions made by an investee.

4. An accounting method under which the initial investment is recorded and maintained at cost with dividends being recognized as revenue when received.

5.

An accounting method that combines the financial statement balances of the parent and subsidiary companies as if they were one total economic unit.

6.

A company that exercises control over other companies through majority ownership of voting stock.

7.

An accounting method under which the initial investment is recorded at cost and subsequently is increased by a proportionate share of earnings and decreased by dividends.

8.

Investments that are either not readily marketable or not expected to be converted to cash within a year.

9.

Securities purchased with the intent of selling them in the near future.

10.

Securities purchased without the intent of selling them in the near future.

58

CHAPTER 14 -- QUIZ SOLUTIONS

Quiz A

Quiz B

Quiz C

1.

F

1.

T

1. E

2.

F

2.

F

2. B

3.

F

3.

T

3. G

4.

T

4.

T

4. A

5.

T

5.

F

5. J

6.

F

6.

F

6. C

7.

F

7.

F

7. H

8.

F

8.

F

8. D

9.

T

9.

F

9. N

10.

T

10.

F

10. M