CH 12: Investments
Margo company purchases $100,000 face amount, 6% semi - annual bonds for $110,000 when the market interest rate is 5%. Margo should recognize the following interest revenue for the first six month period:
$2,750 ($110,000 x [5% x 6/12])
On January 1, 2024, SteveCo purchased $100,000 of Clear Company bonds at a premium of $8,000. The Clear bonds pay 8% interest but were purchased when the market interest rate was 7% for bonds of similar risk and maturity. The bonds pay interest semiannually on June 30 and December 31 of each year. SteveCo accounts for the bonds as a held-to-maturity investment, and uses the effective interest method. In SteveCo's December 31, 2024, journal entry to record the second period of interest, SteveCo would record a credit to interest revenue of:
$3,772
Marion companies records show the following account balances at February 1: 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:
$500,000 to investments in HTM securities $40,000 to gain from sale of investment
Auto company purchases $200,000 face amount, 8% semi - annual bonds when the market rate is 7%. The rate used to determine interest revenue for the first six months on the investment is:
3.5%
What causes unrealized holding gains and losses for debt investments?
A change in fair value
When applying the equity method, an investor should report dividends from the investee as:
A reduction in the investment account.
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.
Consistent with the equity method, investment income is
Based on investee's income times ownership percentage
If a company chooses to apply the fair value option to investments that otherwise would be accounted for under the equity method, the election
Can be made for some investments and not others Is irrevocable
Under the equity method, the purpose of additional adjustments is to help approximate the effects of _____
Consolidation
What does investor need to do when fair value of equity investment is not readily determinable?
Continually evaluate whether fair value is readily determinable Assess annually whether the investment is impaired Fair value is estimated at cost, adjusted for previous impairments and changes in the prices of similar equity investments
At the time of acquisition, debt investments are recorded at _____
Cost
On the date of acquisition, an investment in bonds should be recorded at _____
Cost
Smith company purchased common stock of north company for $500,000. North company has common stock outstanding of $10 million. How should Smith company record the purchase of this investment?
Credit cash $500,000 Debit investment in north company $500,000
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. Two 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:
Credit to investment in bond $700,000 Debit to discount on bond investment $100,000 Debit to cash $680,000 Credit to fair value adjustment $80,000
Northern company has bonds with an amortized cost of $600,000 and a fair value of $675,000. Northern properly classifies these bonds as available for sale securities. At the end of the reporting period, the journal entry includes:
Credit to unrealized holding gain on AFS securities OCI $75,000 Debit to fair value adjustment $75,000
Smith company 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, 2024, the investment in north has a fair value of $505,000. On January 1, 2025, Smith sells the investment in North for $505,000. What journal entry is required to record the sale?
Debit cash $505,000 Credit fair value adjustment $5000 Credit investment in north stock $500,000
Silver company acquires a 30% interest and small company. The fair value of smalls inventory exceeds its carrying value by $100,000. During this a secret year, the inventory sold. As a result of the sale of inventory, investment revenue would:
Decrease by $30,000
True or false: a debt security investment classified as a current asset can be classified as held to maturity?
False
The fair value option can be applied to:
Financial assets, financial liabilities
Equity and debt securities are commonly referred to as:
Financial instruments
If an investor has the positive intent and ability to hold a debt security and tell them matures, it should be classified as a _____
Held to maturity security
Accounting for held to maturity, training, and available for sale debt securities is the same with respect to:
Interest revenue earned on investment The initial investment
On July 1, Adrian a company purchases 35% of saddle companies outstanding stock for $450,000. During the first year, saddle reports income of $200,000 and declares dividends of $50,000. Adriana should recognize income earned by debiting
Investment in saddle company for $35,000 because the stock was purchased halfway through the year
Additional adjustments under the equity method directly affect what accounts?
Investment revenue; investment
The entire amount of impairment for an available-for-sale debt investment is recognized in earnings if fair value declines below amortized cost and: The impairment is viewed as temporary. The company has incurred non-credit losses. It is more likely than not that the investor will have to sell the investment before fair value recovers. The company has incurred credit losses.
It is more likely than not that the investor will have to sell the investment before fair value recovers. (The impairment is recorded in earnings because the expectation is that the loss will be realized before fair value recovers)
Robert company properly applies the equity method to its investment in Margate corporation. At the end of the current year, the fair value of Robert companies investment increased. Should Robert company recognize a gain?
No
Under the equity method, the fair value of the investment shares at the end of the reporting period is
Not reported
The price of a bond is equal to the:
Present value of future cash receipts
Which of the following is NOT a reason why an investor might record at least some amount of credit loss for an available-for-sale investment in net income? The investor determines that a credit loss exists on the investment. The investor intends to sell the investment. The investor believes it is "more likely than not" that the investor will be required to sell the investment prior to recovering the amortized cost of the investment less any credit losses arising in the current year. The investor believes it is "more likely than not" that there is a non-credit loss on the investment.
The investor believes it is "more likely than not" that there is a non-credit loss on the investment. (There is no "more likely than not" non-credit loss criterion)
The equity method is used when an investor can't control, but can exercise significant influence over the operating and financial policies of the investee. We presume, in the absence of evidence to the contrary, that this is so if: The investor owns between 20% and 50% of the investee's voting shares. The investor classifies the investment as held-to-maturity. The investor owns between 51% or more of the investee's voting shares. The investor classifies the investment as available-for-sale.
The investor owns between 20% and 50% of the investee's voting shares (Between 20% and 50% ownership, significant influence is presumed)
If the investors share of an investees net loss exceeds the investment account balance, the equity method is not applied until
The subsequent income is equal to the unrecognized loss
Western Manufacturing Company owns 40% of the outstanding common stock of Eastern Supply Company. During 2024, Western received a $50 million cash dividend from Eastern. What effect did this dividend have on Western's 2024 financial statements?
Total assets are unchanged (dividend increases cash but decreases the investment asset)
Level Company owns bonds of Leader Company classified as held-to-maturity. During 2024, the fair value of those bonds increased by $4 million. Interest was received of $3 million. What effect did the investment have on Level's 2024 financial statements?
Total assets increased by $3 million (Receipt of interest would increase cash by $3 million)
Investments in debt securities acquired principally for the purpose of selling them in the near term are classified as _____ securities
Trading
Beginning in 2018, equity adjustments that lacks significant influence are accounted for in the same way as debt investments classified as:
Trading securities
The accounting for unrealized holding gains and losses will be different if the fair value option is elected for all of the following types of investments except: Available-for-sale. Trading security. Equity method. Held-to-maturity.
Trading security (Trading securities are already accounted for at fair value)
True or false: Changes in fair value are a critical event that investors experience over the life of an investment
True
True or false: Goodwill arising from an investment accounted for under the equity method is not amortized.
True
True or false: held to maturity debt investments do not recognize unrealized holding gains and losses
True
How are available for sale debt securities reported?
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
How are equity investments that lacks significant influence adjusted?
Unrealized holding gain or loss is included in net income A fair value adjustment is recorded at the end of every reporting period
Are unrealized holding gains and losses are included in an investor's earnings for both trading securities and securities available-for-sale?
Yes for trading securities, no for securities available-for-sale. (Unrealized holding gains and losses are recognized in earnings for trading securities but not for available-for-sale securities)
All equity investments are originally recorded at _____
cost
Unrealized holding gains and losses for securities available-for-sale are: not reported in the income statement nor the balance sheet. reported as extraordinary items. included in accumulated other comprehensive income in the shareholders' equity section of the balance sheet. included in the determination of income from operations in the period of the change.
included in accumulated other comprehensive income in the shareholders' equity section of the balance sheet.
Fair value is used as the basis for valuation of a firm's debt investments when: the investment is classified as held-to-maturity. the investment is not classified as held-to-maturity. management's intention is to dispose of the investment within one year. the market value is less than cost for the investment.
the investment is not classified as held-to-maturity.
Under the equity method, dividends received from the investment
Decrease the investment account balance
The fair value option Can be traded on exchanges, similar to other options. For debt is available only if anticipated to not be held to maturity. Is not available for equity-method investments. Must be elected when a security is purchased, and is irrevocable.
Must be elected when a security is purchased, and is irrevocable.
True or false: sale of investment and receipt of dividends are critical events that companies experience with respect to equity investments that must be recognized in the accounting system
True
True or false: the fair value of a fixed rate investment moves in the opposite direction of market interest rates
True
True or false: when an equity method investment is sold, a gain or loss is recognized if the sales price is more or less than the book value
True
Holding bonds during periods in which the fair value of the bonds changes results in:
Unrealized holding gains and losses
The choice to classify debt securities as current or noncurrent depends on:
When they are expected to mature or be sold
Are investment securities reported on a balance sheet at fair value for both trading securities and securities available-for-sale?
Yes
Ziglar company owns 40% of norm companies outstanding voting stock. During the current year, norm reported income of $2 million in declared dividends of $1 million. Ziegler should report income from its investment of
$800,000
Unrealized holding gains and losses for trading securities are: Reported as extraordinary items. Reported as a separate component of the shareholders' equity section of the balance sheet. Included in the determination of income from operations in the period of the change. Not reported in the income statement nor the balance sheet.
Included in the determination of income from operations in the period of the change.
Cash flows from buying and selling AFS debt securities are typically shown on the statement of cash flows in the _____ activities section
Investing
On January 2, 2024, Garner, Incorporated bought 30% of the outstanding common stock of Moody, Incorporated for $60 million cash. At the date of acquisition of the stock, Moody's net assets had a book value and fair value of $180 million. Moody's net income for the year ended December 31, 2024, was $30 million. During 2024, Moody declared and paid cash dividends of $6 million. On December 31, 2024, the fair value of 100% of Moody's stock was $650 million. On December 31, 2024, Garner's investment account should be reported at:
$67.2 million
Cash flows from buying and selling it held to maturity securities are typically classified as _____ activities on the statement of cash flows
Investing
Marcus company sells 1000 bonds of its debt investment for $20,000. The original cost of the bonds was $18,000. During the prior year, the bonds were reported on the balance sheet at a fair value of $19,000. The investment is available for sale, the journal entry to record the sale of the bond should include these credits:
Investment in AFS $18,000 Gain on sale of investment $2000
Under the fair value option, unrealized gains and losses on HTM & AFS debt securities are recognized in _____ _____
Net income
If Reibach Incorporated concluded that an investment originally classified as a trading security would now more appropriately be classified as held-to-maturity, Reibach would: Reclassify the investment as held-to-maturity and immediately recognize in net income all unrealized holding gains and losses that have not already been recognized as of the reclassification date. Reclassify the investment as held-to-maturity, but there would be no income effect. Not reclassify the investment, as original classifications are irrevocable. Reclassify the investment as held-to-maturity and treat the fair value as of the date of reclassification as the investment's amortized cost basis for future amortization.
Reclassify the investment as held-to-maturity and immediately recognize in net income all unrealized holding gains and losses that have not already been recognized as of the reclassification date. (That approach catches up the accounting for the trading security classification to the point in time at which the transfer occurs.)
Level Company owns bonds of Leader Company classified as available-for-sale. During 2024, the fair value of those bonds increased by $4 million. Interest was received of $3 million. What effect would the investment have on Level's 2024 financial statements?
Total assets increased by $7 million (Receipt of interest would increase cash by $3 million, and the increase in fair value of the bonds would increase the bond investment by $4 million)
True or false: if the investee reports a net loss, the investment account is decreased by the investor share of the investees net loss, adjusted for additional expenses
True
The appropriateness of the classification of debt Investments must be reassessed
Each reporting date
Interest revenue is calculated based on the _____ interest rate
Effective
If Arleo Company concluded that an investment originally classified as held-to-maturity would now more appropriately be classified as available-for-sale, Arleo would:
Reclassify the investment as available-for-sale and immediately recognize in accumulated other comprehensive income any unrealized holding gain or loss on the reclassification date. (The unrealized holding gain or loss at reclassification should be accounted for in a manner consistent with the classification into which the security is being transferred)
On January 2, 2024, Garner, Incorporated bought 10% of the outstanding common stock of Moody, Incorporated for $60 million cash. Garner does not exercise significant influence over Moody. At the date of acquisition of the stock, Moody's net assets had a book value and fair value of $180 million. Moody's net income for the year ended December 31, 2024, was $30 million. During 2024, Moody declared and paid cash dividends of $6 million. On December 31, 2024, the fair value of 100% of Moody's stock was $650 million. On December 31, 2024, Garner's investment should be reported at:
$65.0 million (Garner own's 10% of a company valued at a total of $650,000 as of December 31, 2024, so it should carry the investment at 10% × $650,000 = $65,000)
On January 2, 2024, Garner, Incorporated bought 10% of the outstanding common stock of Moody, Incorporated for $60 million cash. Garner does not exercise significant influence over Moody. At the date of acquisition of the stock, Moody's net assets had a book value and fair value of $180 million. Moody's net income for the year ended December 31, 2024, was $30 million. During 2024, Moody declared and paid cash dividends of $6 million. On December 31, 2024, the fair value of 100% of Moody's stock was $650 million. On December 31, 2024, Garner's investment should be reported at:
$65.0 million (
On January 2, 2024, Germane, Incorporated bought 30% of the outstanding common stock of Quality, Incorporated for $56 million cash. At the date of acquisition of the stock, Quality's net assets had a book value and fair value of $120 million. Quality's net income for the year ended December 31, 2024, was $30 million. During 2024, Quality declared and paid cash dividends of $10 million. On December 31, 2024, Germane's should report investment revenue of:
$9 million (30% × $30 million = $9 million)
On January 12, Henderson Corporation purchased bonds of Honeycutt Corporation for $73 million and classified the securities as available-for-sale. At the close of the same year, the fair value of the securities is $81 million. Henderson Corporation should report: A gain of $8 million on the income statement. An increase in shareholders' equity of $8 million. An investment of $73 million. None of the choices are correct.
An increase in shareholders' equity of $8 million (Henderson has an unrealized holding gain of $81 million − $73 million = $8 million, which would be included in shareholders' equity given that the investment is accounted for as an available-for-sale investment)
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 investments as:
Current
Equity investments for which the investor does not have significant influence are classified as either _____ or _____ assets in the balance sheet
Current, noncurrent
Smith company purchased a common stock of north company for $500,000. North company has common stock outstanding of $10 million. Smith company owns 5% of the outstanding stock of north company. On December 31, north company has $250,000 in net income and pays Smith Company $5000 in dividends. What should smith company record on December 31?
Debit cash $5000 Credit dividend revenue $5000
Action company sells bond investments classified as trading securities for $99,000. The face amount is $100,000; unamortized discount is $2000. What must be included in the journal entry to record the sale?
Debit to cash $99,000 Debit to discount $2000 Credit to fair value adjustment $1000 Credit investment in bonds $100,000
Abbott 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 _____ Abbotts investment revenue by _____
Decrease; $1200
Interest revenue on bonds is recorded using the _____ _____ method
Effective interest
When significant influence exists but the investor does not have effective control, the investment should be accounted for by the _____ method
Equity
Credit losses would correctly be calculated as the difference between the amortized cost of debt and: Expected future cash flows multiplied by the effective interest rate that existed when the investment was acquired. Current cash flows multiplied by the expected future discount rate. Current cash flows multiplied by the effective interest rate that existed when the investment was acquired. Expected future cash flows multiplied by the expected future discount rate.
Expected future cash flows multiplied by the effective interest rate that existed when the investment was acquired.
At the end of the accounting period, trading debt securities must be adjusted to _____ value
Fair
Which of the following statements is not true regarding investments in equity securities? If the investor owns more than 50 percent of the outstanding voting common stock, the financial statements are consolidated. If the investor owns less than 20 percent of outstanding voting common stock, the equity method usually is not used. If the investor owns less than 20 percent of outstanding voting common stock, the securities generally are reported at their fair value. If the investor owns 20-50 percent of the outstanding voting common stock, the equity method always is required.
If the investor owns 20-50 percent of the outstanding voting common stock, the equity method always is required. (The key for the equity method is whether the investor exercises significant influence over the investee. The 20% threshold is only a guideline to determine whether significant influence is the case)
Evans Company owns 450 bonds of Frazier Company classified as available-for-sale. During 2024, the fair value of those bonds increased by $9 million. What effect did this increase have on Evans' 2024 financial statements? Net assets increased Shareholders' equity decreased Net income increased Total assets decreased
Net assets increased (The investment would be carried at fair value on the balance sheet, so the asset would increase by $9 million)
Where do trading securities debt investments report unrealized holding gains and losses?
Net income
What is a valid concern that supports recognizing unrealized gains and losses associated with AFS debt securities and other comprehensive income?
Net income may otherwise appear more volatile than it actually is
On January 1, 2024, Normal Plastics bought 15% of Model Inc outstanding bonds for $900,000. On October 1, 2025, the bonds were valued at $1,026,000 and Normal sold half of the amount it purchased. On December 31, 2025, the remaining bonds were valued at $580,000. How much should Normal show on its 2025 income statement from this investment, assuming that it accounts for it as an available-for-sale investment?
Normal would recognize income of ($1,026,000 − $900,000) / 2 = $63,000. The remainder of the unrealized holding gain in 2025 would affect OCI as no other sale took place.
Adriana company purchases 35% of saddle companies outstanding stock for $450,000. At the time of acquisition, book value of the company's net assets is $1 million in 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. Adriana should
Not amortize the difference between fair value and book value attributable to land
Unrealized holding gains and losses for securities to be held-to-maturity are: Reported as extraordinary items. Not reported in the income statement nor the balance sheet. Included in the determination of income from operations in the period of the change. Reported as a separate component of the shareholders' equity section of the balance sheet.
Not reported in the income statement nor the balance sheet.
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
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
When equity investments that lacks significant influence are sold in 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
Where do available for sale securities recognize unrealized holding gains and losses?
Other comprehensive income
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:
Present value of future interest payments plus present value of principal
An investor who purchased corporate bonds that are not publicly traded may estimate the bonds fair value by determining the:
Present value of the future cash flows