Investments in Debt and Equity Securities

 CHAPTER 14 
Investments in Debt
and Equity Securities
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
12 Application of the equity method to account for investments in common
stock
13 Accounting for goodwill amortization
stock
stock
18 Use of consolidated financial statements
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
533
534 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
LO2 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?
b 3. Changes in fair value of securities are reported in the stockholders' equity

LO5 section of the balance sheet for which type of securities?
d 4. Which category includes only debt securities?

LO2 a. Marketable equity securities
535
Securities
c 5. A debit balance in the account Market Adjustment--Available-for-Sale

LO5 Securities at the end of a year should be interpreted as
a. the net unrealized holding gain for that year.
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

common
LO4 stock, cash dividends received by the investor from the investee should
normally be recorded as
a. a deduction from the investment account.
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

the
LO5 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
new
LO3 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
be
LO5 recorded directly in an owners' equity account?
a. Equity method securities
c 12. The equity method of accounting for an investment in the common stock of
LO2 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
less
LO5 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.
537
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.
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
LO4 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
LO2 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. During the year the company did
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.
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

LO9 accounting standards as promulgated by IAS 39 and U.S. accounting
standards under FASB Statement No. 115 is
a. IAS 39 requires accounting for all investments in debt securities to be 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?

LO8 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.
539
Securities
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.
d 23. Poster Inc. owns 35 percent of Elliott Corporation. During the calendar year
LO4 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?
a. Understate, overstate
b. Overstate, understate
c. Overstate, overstate
d. Understate, understate
c 24. If an investment in stock is reclassified from available-for-sale securities to

LO7 trading securities, the stock should be recorded on the date it is reclassified
at the
a. market value at the date of acquisition.
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

Shaver
LO4 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. The Northwick Company
dividend revenue from Shaver Corp. in January 2002 would be
a. $0.
b. $2,500.
c. $5,000.
d. $10,000.
c 26. On January 2, 2001, Reynolds Corporation bought 15 percent of Scorpio

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?
a. $3,150
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
541
b 28. On January 1, 2002, Young Co. paid $500,000 for 20,000 shares of
Montana
LO5 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
(which includes both investments and any related market adjustments)
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.
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. Marino Corporation purchased the following portfolio of trading securities

LO6 during 2002 and reported the following balances at December 31, 2002.
No sales occurred during 2002. All declines are considered to be
temporary.
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.
c 32. In March of 2001, Moon Corp. bought 45,000 shares of McMahon Corp.’s
listed
LO7 stock for $450,000 and classified the shares as available-for-sale securities.
The market value of these shares had declined to $300,000 by December
31, 2001. Moon changed the classification of these shares to trading
securities in June of 2002 when the market value of this investment in
McMahon's stock had risen to $345,000. 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
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 $150,000 $225,000
Aggregate market value 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

LO4 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?
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

LO4 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
current market value of $800,000. 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?
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
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
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. 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

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
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
Cash...................................................................... 104,500
c. Trading Securities--10% U.S. Treasury Notes........... 100,000
Cash...................................................................... 104,500
d. Trading Securities--10% U.S. Treasury Notes........... 102,000
Cash...................................................................... 102,000
b 39. Edwards Company began business in February of 2001. During the year,
LO5 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,
LO5 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:
Market Value
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

securities
LO5 portfolio, which did not change in composition during 2002, is as follows:
December 31, 2002
Unrealized
Cost Market Gain (Loss)
Archer, Inc....................... $ 100,000 $ 100,000 $ 0
Kelly Company................ 200,000 150,000 (50,000)
Pelt Company.................. 250,000 260,000 10,000
$ 550,000 $ 510,000 $ (40,000)
December 31, 2001

Unrealized
Cost Market Gain (Loss)
Archer, Inc....................... $ 100,000 $ 135,000 $ 35,000
Kelly Company................ 200,000 210,000 10,000
Pelt Company.................. 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-
LO7 sale securities:
Market Value
D $ 96,000 $ 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

LO6 short-term investment and classified them as trading securities. The cost
and market value at December 31, 2001, were as follows:
Market Value
X 200 shares $ 8,400 $ 10,200
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. On the
sale, Barney should report a realized loss of
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. Brokerage fees for this transaction were $700. At what amount
should this acquisition of bonds be recorded?
a. $196,000
b. $196,700
c. $202,000
d. $202,700
PROBLEMS
Problem 1
In 2002, KZF Inc. purchased stock as follows:
(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. $71
Gallery Arts Corp. 41
Champion Corp. 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)...................................... 36,000
Paid-In Capital in Excess of Par (1,200 x $45)............ 54,000
Available-for-Sale Securities--Champion Corp.

Stock [(800 x $70) + $800]...................................................... 56,800
Cash ...................................................................... 56,800
Market Increase/
Security Cost Value Decrease
Gallery Corp. $ 90,000 $ 82,000 $(8,000) (2,000 x $41)
Champion Corp. 56,800 57,600 800 (800 x $72)
$146,800 $139,600 $(7,200)
Unrealized Increase/Decrease in Value of Available-for-

Sale Securities................................................................. 7,200
Market Adjustment–Available-for-Sale Securities... 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..................................................... 600
Unrealized Loss on Transfer of Securities--Income........ 2,400
Market Adjustment--Available-for-Sale Securities... 600
Investment in Available-for-Sale Securities--Champion
Corp. Stock........................................................... 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:
Market Market
Cost December 31, 2001 December 31, 2002
V Company $ 50,000 $ 26,000 $ 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 ................ 20,000
Market Adjustment--Trading Securities..... 20,000
Unrealized Increase/Decrease in Value of

Available-for-Sale Securities................................. 40,000
Market Adjustment--Available-for-Sale
Securities......................................................... 40,000
2002
Dec. 31 Market Adjustment--Trading Securities................ 4,000
Unrealized Gain on Trading Securities........... 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............................................................................ $330,000

Less cash dividends paid...................................................... 160,000
Increase in retained earnings................................................ $170,000
The market value of Stone Services Inc. common stock on December 31, 2002,
was $98 per share. Alsop does not have any other noncurrent investments in
securities.
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).................... 26,000
Market Adjustment--Available-for-Sale Securities... 26,000
(2) Investment in Stone Services Inc....................................1,300,000

Cash......................................................................... 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..................................................................$150,000
Share of net income--30% of $60,000..................................... 18,000
Amortization of implied goodwill*............................................. (1,500)
Dividends received................................................................... (5,000)
Total....................................................................................$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................................................................. $28,000
July 1 - December 31............................................................... 36,000
Total.................................................................................... $64,000
Cash dividends declared and paid:

January 1 - June 30................................................................. $30,000
July 1 - December 31............................................................... 30,000
Total.................................................................................... $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
Systems’ books using the cost method.
(4) 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........................ 240,000
Cash...................................................................... 240,000
(2) Goodwill computation:

Purchase price.............................................................. $240,000
Fair market value of net assets............................. $880,000
8,000/40,000 shares............................................. x 20%
Fair market value of Mountain’s share of net assets.... 176,000
Goodwill......................................................................... $ 64,000
(3) Cost method:

Cash ($30,000 x 20%)........................................................ 6,000
Dividend Revenue................................................. 6,000
Cash dividends received (July 1 - December 31).
(4) Equity method:

Cash.............................................................................. 6,000
Investment in Precision Services Stock................ 6,000
Cash dividends received (July 1 - December 31).
Investment in Precision Services Stock ($36,000 x 20%).. 7,200

Income from Investment in Precision Stock......... 7,200
20% share of investee earnings (July 1 - December 31).
Income from Investment in Precision Stock

($64,000/40 yrs. x ½ yr.)..................................................... 800
Investment in Precision Services Stock................ 800
Amortization of goodwill for 6 months.
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. These shares were classified as trading
securities.
Mar. 31 Purchased 60,000 of the 200,000 outstanding common shares of New

Tech Corp. for $600,000. Goodwill of $160,000 was included in the
purchase price.
June 20 Received a $2.20 per share dividend on Large Auto Co. shares.
June 30 New Tech Corp. reported second quarter earnings (total) of $40,000.
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............................................ 40,225
Cash................................................................. 40,225
Mar. 31 Investment in New Tech Corp. Stock................... 600,000

Cash................................................................. 600,000
June 20 Cash (1,000 x $2.20).................................................. 2,200

Dividend Revenue........................................... 2,200
June 30 Investment in New Tech Corp. Stock................... 12,000

Income from Investment in New Tech Corp.
Stock................................................................ 12,000
To record share of New Tech Corp. earnings
($40,000 x 30% ownership).
June 30 Income from Investment in New Tech Corp. Stock 1,000

Investment in New Tech. Corp. Stock............. 1,000
To record amortization of goodwill for three
months ($160,000/40 years x 3/12).
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 ...................................................................... 8,000

Interest Revenue................................................ 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. Snyder classifies this stock as and
available-for-sale security.
(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............................125,950

Cash................................................................................. 125,950
(c) Cash........................................................................................ 3,500

Interest Revenue.............................................................. 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.............................................................. 93
($16,000 x 1.02) + ($16,000 x .035 x 1/6) = $16,413.
$16,000/$100,000 x 103,000 = $16,480.
(f) Investment in Trading Securities--Certificate of Deposit........ 12,000

Cash................................................................................. 12,000
Problem 10
Lee Company had the following portfolio of securities at the end of its first year of
operations:
Year-End
Security Classification Cost Market Value
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........................... 7,000
Unrealized Gain on Trading Securities.................... 7,000
(2) Investment in Available-for Sale Securities--Security B. . 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...................................... 660,000
Cash......................................................................... 660,000
Investment in Monroe Company...................................... 40,000

Income from Investment in Monroe Stock............... 40,000
($80,000 x 50% = 40,000)
Cash................................................................................. 9,000
Investment in Monroe Company............................. 9,000
($18,000 x 50% = 9,000)
Income from Investment in Monroe Stock....................... 3,000

[$660,000 - ($1,200,000 x 50%) = $60,000]
($60,000  20 = $3,000]
2002
Cash................................................................................. 525,000
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................................................................................. 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

564 Chapter 14  Investments in Debt and Equity Securities
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
Test Bank, Intermediate Accounting, 14th ed. 565
fair value but unrealized changes in fair value are excluded from earnings. 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.
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)................................................... $45,000
Test Bank, Intermediate Accounting, 14th ed. 567
Income for 2002:

First half (200,000 x .15)…………………..……………………. $30,000
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) = $75,000  20]...........................$ 3,750 $ 3,750
Goodwill on 2002 acquisition:
[$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) Compute the present value of the expected future cash flows as of December 31,
2003.
(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 Table Value Present Value at 8%

Jan. 1, 2004 $40,000 now 1.000 $ 40,000
Jan. 1, 2005 $40,000 1 year .9259 37,036
Jan. 1, 2006 $40,000 2 years .8573 34,292
Present value at December 31, 2003 $111,328
(2) Journal entry to record impairment:
12/31/2003 Bad Debt Expense………………………………… 8,672

Allowance for Loan Impairment..................... 8,672
(3) Journal entries made during 2004:
1/01/2004 Cash………………………………………………… 40,000

Loan Receivable………………….…………… 40,000
12/31/2004 Allowance for Loan Impairment.......................... 5,706

Interest Revenue……………………………… 5,706
[($111,328 - $40,000) x .08 = 5,706]
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.
569
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.
570
CHAPTER 14 -- QUIZ C
Name _________________________
Section ________________________
A. Cost method H. Equity method

B. Significant influence I. Merger
C. Parent company J. Consolidation
D. Long-term investments K. Nonconvertible investments
E. Subsidiary company L. Executory contract
F. Market method M. Available-for-sale securities
G. Control 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.
571
____ 10. Securities purchased without the intent of selling them in the near future.
572
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

Investments in Debt and Equity Securities

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 CHAPTER 14 

1 Definition of available-for-sale securities

1 Prepare journal entries relating to investments in common stock

MULTIPLE CHOICE QUESTIONS

b 3. Changes in fair value of securities are reported in the stockholders' equity

d 4. Which category includes only debt securities?

c 5. A debit balance in the account Market Adjustment--Available-for-Sale

b 7. When an investor uses the cost method to account for investments in

b 8. A debit balance in the account Market Adjustment—Trading Securities at

d 9. Under the cost method of accounting for unconsolidated investments in

c 13. Under the equity method of accounting for unconsolidated investments in

a 17. If the combined market value of available-for-sale securities at the end of

b 20. The only significant difference between the provisions of international

d 21. Which of the following is true?

d. Available-for-sale securities can be classified as current or noncurrent

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

c 24. If an investment in stock is reclassified from available-for-sale securities to

c 25. Northwick Company acquired 10,000 shares of the common stock of

c 26. On January 2, 2001, Reynolds Corporation bought 15 percent of Scorpio

a 30. Martin Co. purchased the following portfolio of available-for-sale securities

a 31. Marino Corporation purchased the following portfolio of trading securities

None of the declines is judged to be other than temporary. Unrealized

c 34. In January 2002, Henry Corporation acquired 20 percent of the outstanding

c 35. On January 1, 2002, Capitech Corporation acquired Logirun, Inc. as a

b 37. On January 1, 2002, Mets Inc. purchased 30 percent of the outstanding

What amount of loss on these securities should be included in Edward’s

What amount should Edwards credit to the Market Adjustment--Trading

b 41. Tyler Company began operations in 2001. The company's trading

December 31, 2001

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

d 43. During 2001, Barney Company purchased marketable equity securities as a

Security Market Value

The investments in common stock are classified by KZF Inc. as available-for-sale

Available-for-Sale Securities--Champion Corp.

Unrealized Increase/Decrease in Value of Available-for-

(2) Cash (200 x $74)................................................................. 14,800

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

Y Company $420,000 $360,000 $100,000

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

Unrealized Increase/Decrease in Value of

Dec. 31 Unrealized Increase/Decrease in Value of

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

Effect of valuation entries on 2002 net income:

Net income............................................................................ $330,000

Cash ($160,000 x 30%)......................................................... 48,000

Unrealized Increase/Decrease in Value of Available-

(2) Investment in Stone Services Inc....................................1,300,000

Investment in Stone Services Inc. Stock

* Implied value of Gillen Corp.:

Net income reported in 2002:

Cash dividends declared and paid:

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

(2) Goodwill computation:

(3) Cost method:

(4) Equity method:

Investment in Precision Services Stock ($36,000 x 20%).. 7,200

Income from Investment in Precision Stock

Mar. 31 Purchased 60,000 of the 200,000 outstanding common shares of New

Mar. 31 Investment in New Tech Corp. Stock................... 600,000

June 20 Cash (1,000 x $2.20).................................................. 2,200

June 30 Investment in New Tech Corp. Stock................... 12,000

June 30 Income from Investment in New Tech Corp. Stock 1,000