Chapter 12: Investment
Gruen Corporation acquires a 25% interest in Blau Company for $1 million. The excess of investment cost over Gruen's share of the book value of Blau's net assets is solely attributable to goodwill. During the year, Blau reports income of $500,000 and declares dividends of $100,000. The carrying value of Gruen's investment at the end of the accounting period will be:
$1.1 million ($1,000,000 +($500,000-$100,000)*25%))
Marian Company's records show the following account balances at 2/1/18: Investment in HTM securities, $500,000; and discount on HTM investment, $20,000. On that day, the company sells the investment for $520,000. The journal entry would include CREDITS of (Select all that apply.)
$40,000 to gain from sale of investment. $500,000 to investments in HTM securities.
Ziegler Company owns 40% of Norm Company's outstanding voting stock. During the current year, Norm reported income of $2 million and declared dividends of $1 million. Ziegler should report income from its investment of:
$800,000 ($2,000,000 X 40%)
Emil Company purchases $400,000 face amount, 8% semi-annual 15-year bonds when the market rate is 7%. The number of interest periods utilized to determine interest revenue earned on the investment is
30 periods
Identify the statement that is correct regarding the purpose of additional adjustments under the equity method.
Adjustments help to approximate the effects of consolidation.
Regarding the valuation of equity investments that lack significant influence beginning in 2018, which of the following statements is correct?
Companies are required to use the fair value through net income method.
All equity investments are initially recorded at Multiple choice question.
Cost.
Other comprehensive income
Current period holding gains or losses
Winston Company has significant influence over the operating and financial policies of Xavier Company. Winston should report its investment utilizing the _______ method.
Equity
Which of the following may be a valid concern that supports recognizing unrealized gains and losses associated with AFS debt securities in other comprehensive income?
Net income may otherwise appear more volatile than it actually is.
Northern Company has bonds with an amortized cost of $600,000 and a fair value of $675,000. Northern properly classifies these bonds as trading securities. At the end of the reporting period, (Select all that apply.)
Northern will make a fair value adjustment of $75,000. Northern will report an unrealized holding gain in net income.
Net income
Realized gains and losses from the sale of AFS securities
How are equity investments that lack significant influence adjusted? (Select all that apply.)
Unrealized holding gain or loss is included in net income. A fair value adjustment is recorded at the end of every reporting period.
Von Company properly applies the equity method in accounting for its investment in Neumann Inc. Which of the following statements are correct? (Select all that apply.)
Von owns 20-50% of Neumann's voting shares. Von has significant influence over Neumann.
Andrea Company purchases 30% of Sander Company's outstanding stock for $420,000. Andrea should record this investment at cost net realizable value Sander's book value present value of expected future cash flows
a
Cash flows from buying and selling AFS debt securities are typically shown on the Statement of Cash Flows in the _____ activities section. investing operating financing
a
Cash flows related to equity investments for which the investor lacks significant influence and are held with an intent for short-term profit are shown in the _____ section of the Statement of Cash Flows. operating financing investing
a
Dividends cause the investor's investment in the investee's net assets to decrease. remain the same. increase.
a
Investments in debt securities acquired principally for the purpose of selling them in the near term are classified as ________ securities. trading available-for-sale held-to-maturity
a
When an equity method investment is sold, Multiple choice question.
a gain or loss is recognized if the sales price is more or less than the book value.
How are available-for-sale debt securities reported? (Select all that apply.) Unrealized gains and losses are reported as part of other comprehensive income when they occur. Realized gains and losses are reported in net income in the period the investment is sold. Unrealized gains and losses are reported as part of net income when they occur.
ab
January 1, 2021, Smith Co. purchased common stock of North Company for $500,000. North Company has common stock outstanding of $10 million. How should Smith Co. record the purchase of this investment? (Select all that apply.) debit investment in North Company $500,000 debit cash $500,000 credit cash $500,000 credit investment in North Company $500,000
ac
Identify critical events that companies experience with respect to equity investments that must be recognized in the accounting system. (Select all that apply.) sale of investment changes in the riskiness of investment purchase of investment changes in fair value receiving dividends
acde
Beginning in 2018, equity adjustments that lack significant influence are accounted for the same way as debt investments classified as Multiple choice question. eld-to-maturity securities trading securities available-for-sale securities
b
Consistent with the equity method, investment income is based on dividends declared by investee times ownership percentage. based on investee's income times ownership percentage. not recognized.
b
The investment account associated with Adam Corp.'s equity method investment shows a balance of $500,000. The investment is sold for $550,000. Adam should increase the investment account by $50,000. recognize a gain of $50,000. adjust other comprehensive income for $50,000.
b
True or false: If the investee reports a net loss, the equity investment account is not adjusted for additional expenses. True False Reason: If the investee reports a net loss, the investment account is decreased by the investor's share of the investee's net loss, adjusted for additional expenses.
b
Which of the following is a common special purpose fund? Inventory Petty cash Bonds payable
b
The carrying value of an equity method investment consists of its initial cost plus the investee's undistributed income changes in the fair value of the investee's common shares held by the investor the investor's equity in the investee's undistributed income changes in the fair value of the investee's common shares
c
Under U.S. GAAP, which of the following statements regarding the classification of debt investments is correct? The classification of investments must be reassessed with each change in fair value. The classification of investments is permanent. The classification of investments must be reassessed each reporting period.
c
Which of the following scenarios may require additional adjustments under the equity method? The investor's acquisition cost exceeds market value of the underlying net assets. The acquisition takes place during the middle of the fiscal period. The investor's acquisition cost exceeds the book value of the underlying net assets.
c
Which reporting method should be used if the investor can exert significant influence over the investee? Consolidation method Cost method Equity method Fair value method
c
The premium payments of life insurance policies with cash surrender value include an insurance expense portion and a(n) a risk adjustment portion a cancellation fee an insurance expense portion an investment portion
cd
James Company is paid $6,000 in dividends from Mark Corp. on its equity investment. James lacks significant influence over Mark Corp. James Company should
credit dividend revenue
An investor who purchased corporate bonds that are not publicly traded may estimate the bonds' fair value by determining the expected future earnings potential of the investee an appraised value original cost of the investment present value of the future cash flows
d
Consistent with IFRS No. 9, impairments of debt investments will be accounted for using a expected cash flow model. present value model. fair value model. expected credit loss model.
d
If the market rate of interest DECREASES after a bond is purchased, the bond incurs a realized gain a realized loss an unrealized holding loss an unrealized holding gain
d
January 1, 2021, Smith Co. purchased common stock of North Company for $500,000. North Company has common stock outstanding of $10 million. Smith owns 5% of the outstanding stock of North. On December 31, 2021, the investment in North Company has a fair value of $505,000. On January 1, 2022, Smith sells the investment in North Company for $505,000. What journal entry is required to record the sale?
debit cash $505,000 credit fair value adjustment $5,000 credit investment in North stock $500,000
Adrianna Company purchases 35% of Saddle Company's outstanding stock for $450,000. Adrianna should record this investment with (Select all that apply.)
debit investment in Saddle $450,000 credit cash $450,000
Silvia Company acquires a 30% interest in Small Company. The fair value of Small's inventory exceeds its carrying value by $100,000. During the subsequent year, the inventory is sold. As a result of the sale of inventory, investment revenue would:
decrease by $30,000
Under the equity method, if the investee company reports a net loss, the investment balance will Multiple choice question.
decrease by the investor's proportionate share of the investee's net loss
Under the equity method, dividends received from the investment Multiple choice question.
decrease the investment account balance
Abbott Inc. owns 30% of the outstanding voting shares of Berta Inc. On the date of acquisition, the fair value of Berta's equipment with a remaining useful life of five years and no residual value exceeded its carrying value by $20,000. During the year after the acquisition, the undervalued equipment will _____ Abbott's investment revenue by _____. Multiple choice question.
decrease; $1,200 (($20,000 X 30%)/5 years)
Dividends earned on an equity investment, when there is a lack of significant influence, are credited to
dividend revenue.
The appropriateness of the classification of debt investments must be reassessed
each reporting date
Under IFRS, the entire impairment of debt investments are recognized in ______; under U.S. GAAP, if a portion of an impairment is due to noncredit losses, it is recorded in _______.
earnings; OCI
Investments in debt securities classified as trading are reported on the balance sheet at ____ ____.
fair value
At the end of the accounting period, trading debt securities must be adjusted to _________ value.
fair/market
The fair value option can be applied to: (Select all that apply.) Multiple select question.
financial assets financial liabilities
Gains and losses relating to debt securities classified as trading are presented in the ____________ ____________ in the periods in which fair value changes, regardless of whether they are realized or unrealized. (Enter one word per blank.)
income statement
Noncurrent special purpose funds set aside for a future specific use, are typically classified as
investments on the balance sheet.
Accumulated other comprehensive income
net fair value adjustments to date - net holding gains and losses to date
Under the fair value option, unrealized gains and losses on HTM and AFS debt securities are recognized in ______ ______ in the period they occur.
net income
Losses arising from credit losses on available-for-sale debt securities are recognized in _____; noncredit losses are recognized in _____.
net income; OCI
Equity investments for which the investor does not have significant influence are classified as _____ in the balance sheet. (Select all that apply).
noncurrent assets current assets
Cash flows from buying and selling debt securities classified as trading as a part of normal operations typically are classified as ______ activities in the statement of cash flows.
operating
When equity investments that lack significant influence are sold and a fair value adjustment account has been used to increase or decrease the carrying value of the investment, the investment account is credited for the
original cost of the investment.
If a company holds bonds that are not actively traded, it can estimate the fair value of those bonds by using ____ _____ techniques.
present value
The price of a bond is equal to the
present value of future cash receipts.
The price of a bond is equal to
present value of future interest payments plus present value of principal
Unrealized holding gains and losses associated with debt investments properly classified as "available for sale" are
recognized as other comprehensive income.
If an investment accounted for under the equity method is acquired during the year, income and other adjustments are Multiple choice question.
recognized for the portion of the year the investment was owned.
Under the fair value option, unrealized gains and losses on debt securities are
recognized in net income.
Kendrick Company elected the fair value option for its equity method investments. During the current period, the fair value of the investments increased. Kendrick Company should
report the increase as part of net income.
From an accounting perspective, critical events that investors experience over the life of an investment include (Select all that apply.)
sale of investment changes in fair value receiving dividends
When fair value of equity investments is not readily determinable (select all that apply)
the investor needs to continually evaluate whether fair value is readily determinable. the fair value is estimated as cost, adjusted for previous impairments and changes in the prices of similar equity investments. the investor needs to assess annually whether the investment is impaired.
Jones Financial Institution buys and sells debt securities frequently to maximize short-term gains in market value. Jones should classify its portfolio as
trading securities.
The choice to classify debt securities as current or noncurrent depends on
when they are expected to mature or be sold.
If an investor has the positive intent and ability to hold a debt security until it matures, it should be classified as a(n) Multiple choice question. held-to-maturity security. available-for-sale security. trading security.
a
Unrealized gains and losses for equity method investments that are carried at fair value are: reported as part of earnings reported as other comprehensive income ignored
a
When fair value of equity investments is not readily determinable, the fair value is estimated as cost, less previously recognized impairments, then adjusted based on similar equity. the fair value is estimated as the present value of the future cash flows of the equity investments. the fair value method is prohibited.
a
Characteristics that support classification of investments as trading securities include (Select all that apply.) frequent and active trading. long-term appreciation of value. motivation to realize short-term profits. long-term reduction in investment risk.
ac
Which of the following conditions must be present for a debt security to be classified as "held-to-maturity?" (Select all that apply.) The investor has the ability to hold the security until maturity. The maturity date is less than 90 days from the date of purchase. The investment can be classified as a current asset. The investor intends to hold the security until maturity.
ad
When equity investments that lack significant influence are sold and a fair value adjustment account has been used to increase or decrease the carrying value of the investment, the investment account is credited for the the sale price of the investment. original cost of the investment. the carrying value of the investment.
b
Lerner Inc. owns 30% of the outstanding voting shares of Koerner Inc. On the date of acquisition, the fair value of Koerner's equipment with a remaining useful life of ten years and no residual value exceeded its carrying value by $50,000. During the year after the acquisition, the undervalued equipment will _____ Lerner's investment revenue by _____. decrease; $5,000 increase; $1,500 increase; $5,000 decrease; $1,500
d
Northern Company has bonds with an amortized cost of $600,000. At the end of the first reporting period, the bonds had a fair value of $675,000. 2 days after the end of the first reporting period, the bonds have a fair value of $680,000 and Northern decides to sell the bonds. The initial investment in the bonds was $700,000 and the discount on bond account has a $100,000 balance. Northern properly classifies these bonds as trading securities. The journal entry to record the sale of the bonds includes (Select all that apply.)
debit to cash $680,000 debit to discount on bond investment $100,000 credit to investment in bonds $700,000 credit to fair value adjustment $80,000.
Cash flows from buying and selling held-to-maturity securities are typically classified as _____ activities on the Statement of Cash Flows. financing operating investing
c
Which of the following are correct regarding the financial statement presentation of HTM securities? (Select all that apply.) Unrealized holding gains and losses are disclosed in the notes to the financial statements. Gains and losses are shown in net income in the period in which the securities are sold. Unrealized holding gains and losses are shown in other comprehensive income. Unrealized holding gains and losses are shown in net income.
ab
Marian Company's records show the following account balances at 2/1/18: Investment in HTM securities, $500,000; and discount on HTM investment, $20,000. On that day, the company sells the investment for $520,000. The journal entry would include DEBITS of (Select all that apply.) $520,000 to cash. $20,000 to gain. $20,000 to loss. $20,000 to discounts.
ad
January 1, 2018, Smith Co. purchased common stock of North Company for $500,000. North Company has common stock outstanding of $10 million. Smith owns 5% of the outstanding stock of North. On December 31, 2018, North Company has $250,000 in net income and pays Smith Co. $5,000 in dividends. What should Smith Co. record on December 31, 2018? (Select all that apply.) debit cash $5,000 debit cash $17,500 debit dividend revenue $5,000 debit investment in North Company stock $12,500 credit investment revenue $12,500 credit dividend revenue $5,000
af
Accounting for held-to-maturity, trading, and available-for-sale debt securities is the same with respect to (Select all that apply.) the reclassification of unrealized holding gains and losses. interest revenue earned on investment. the initial investment. year-end fair value adjustment.
bc
Goodwill arising from an investment accounted for under the equity method is amortized over 10 years. amortized over 40 years. not amortized.
c
Silvia Company acquires a 30% interest in Small Company. The fair value of Small's inventory exceeds its carrying value by $100,000. During the subsequent year, the inventory is sold. As a result of the sale of inventory, investment revenue would: Multiple choice question.
decrease by $30,000
Adrianna Company purchases 35% of Saddle Company's outstanding stock for $450,000. At the time of acquisition, book value of the company's net assets is $1 million and the fair value of the company's net assets is $1.2 million. The difference between the book value and fair value of the net assets is attributed to undervalued land. Adrianna should
not amortize the difference between fair value and book value attributable to land.
Markus Company sells 1,000 bonds of its debt investment in Berta Inc. for $20,000. The original cost of the 1,000 bonds was $18,000. During the prior year, the bonds were reported on the balance sheet at a fair value of $19,000. Assume the investment was accounted for as available-for-sale and all unrealized holding gains and losses have been reversed. The journal entry to record the sale of the bonds should include these credits: (Select all that apply.) Fair value adjustment AFS - $1,000 Gain on sale of investment - $2,000 Investment in AFS - $18,000 Gain on sale of investment - $1,000 Investment in AFS - $19,000
bc
Action Company sells bond investments classified as trading securities for $99,000. The face amount is $100,000; unamortized discount is $2,000. What must be included in the journal entry to record the sale? (Select all that apply.) debit to loss on sale for $1,000 debit to cash $99,000 debit to discount $2,000 credit investment in bonds $100,000 credit to fair value adjustment $1,000 credit to gain on sale for $1,000
bcde
Credit losses are calculated as the difference between the amortized cost of the debt and the principal and interest still due on the debt instrument. the market value of the debt. the present value of future cash flows expected to be collected.
c
Gunter Company acquires a 25% interest in Hunter Company. The fair value of Hunter's inventory exceeds its book value by $40,000. During the subsequent year, the inventory is sold. As a result of the sale of inventory, investment revenue would: not change increase by $40,000 decrease by $10,000 increase by $10,000 decrease by $40,000
c
Holding bonds during periods in which the fair value of the bonds changes results in realized gains and losses a change in the amount of interest received unrealized holding gains and losses
c
If the market rate of interest INCREASES after a bond is purchased, the bond incurs a realized gain a realized loss an unrealized holding loss an unrealized holding gain
c
Impairments of available-for-sale debt instruments are recognized in other comprehensive income for the entire impairment amount to the extent of the credit losses to the extent that they arise from noncredit losses
c
How is an equity investment that lacks significant influence adjusted to fair value at the end of each reporting period? A valuation allowance account is increased or decreased. A realized gain or loss is recorded. The equity investment account is directly adjusted to fair value.
a
Rosa Company purchases debt securities and classifies them as "available-for-sale" securities. How should Rosa recognize changes in the value of the investment? As unrealized holding gain or loss in income. As unrealized holding gain or loss in other comprehensive income. Rosa should not recognize changes in value.
b
Bella Company purchased debt securities with a face amount of $500,000 for $480,000 and classifies them as trading securities. During the first year, the company amortized $2,000 of the associated discount. At the end of the period, the fair value is $504,000. Bella should recognize a fair value adjustment of $18,000. $20,000. $22,000.
c
Global Company holds a portfolio of equity securities. The company intends to sell the securities during the next accounting period. The company should classify the investment as noncurrent. current. either current or noncurrent.
a
Markus Company sells 1,000 bonds of its debt investment in Berta Inc. for $20,000. The original cost of the 1,000 bonds was $18,000. During the prior year, the bonds were reported on the balance sheet at a fair value of $19,000. On the date of sale, Markus should recognize a realized gain of _____ in net income. (Assume the debt investment was accounted for as available-for-sale and all unrealized holding gains and losses have been reversed.) $0 $1,000 $2,000
c
On July 1, Adrianna Company purchases 35% of Saddle Company's outstanding stock for $450,000. During the first year, Saddle reports income of $200,000 and declares dividends of 50,000. Adrianna should recognize income earned by debiting investment in Saddle Company for $15,000. investment in Saddle Company for $70,000. investment in Saddle Company for $35,000. dividends revenue for $15,000.
c
