Ch 17 Questions
variety in bond features purpose- types and characteristics
(along w variability in interest rates) permits INVESTORS to shop for exactly the investment that satisfies their safety, yield, and marketability and permits ISSUERS to create a debt instrument best suited to their needs
how is the investment acct affected vy investee activities under the EQUITY METHOD
-the investment is originally recorded at cost, then adjusted for changes in the investee's net assets. the account is increased (decreased) by the investor's proportionate share of the earnings (losses) of the investee and decreased by all dividends received by the investor from the investee
is the equity method used with a strict application of the 20% rule?
20% rule- an investment (direct or indirect) of 20% or more of the voting stock of an investee leads to the presumption that an investor has the ability to exercise significant influence over an investee and the equity method should be used. However, there are other factors, when considered, that may indicate that the ownership of 20% or more may not enable an investor to exercise significant influence. An investor w/ ownership just below 20% may be able to exercise sig influence based on representation on the BOD, participation in policy-making processes, material intracompany transactions, interchange of managerial personnel, or technological dependency. also, the extent of ownership by an investor in relation to the concentration of other shareholdings is an important consideration. factors that could lead to a conclusion of NO SIG ownership when it is above 20%: a) investee opposes the investor's acquisition of its stock b) investor and investee sign an agreement that the investor surrenders significant shareholder rights c) investor's ownership share does not result in sig influence because majority ownership of the investee is concentrated among a small group of shareholders who operate the investee without regard to the views of the investor d) the investors tries and fails to obtain representation on the investor's BOD
H Co SOLD 10k sh of K Co com stk for $27.5/sh, incurring $1,770 in brokerage commissions. They originally cost $260,000. Entry for sale?
Entry: DEBIT: Cash [(10,000 x 27.50)-1,770] 273,230 (sell price-brokerage commissions) CREDIT: Equity Investments 260,000 (original cost) Gain on sale of investments (273,230-260,000) 13,230 (diff)
R Corp has investment w/ carrying val (equity method) on its BOOKS of $170,000 representing a 30% interest in B Co, which suffered a $620,000 loss this year. how should R Co handle its proportionate share of the B Co loss?
Ordinarily, R Co should discontinue applying the equity method and not provide for additional losses beyond the carrying value of $170,000. HOWEVER, if R Co's loss is not limited to its investment (due to a guarantee of B Co's obligations or other commitment to provide further financial support or if imminent return to profitable operations by Borg appears to be assured), it is appropriate for R co to provide for its entire $186,000 ($620,000 x 30%) share of the $620,000 loss.
a) July 1 2017: W Co. purch 4 mil of D Co. 8% bonds, due on July 1, 2024. Bonds pay semiannual interest (Jan 1 and July 1) and were purchased for 3.5 mil to yield 10%. determine the amount of interest revenue W Co should report on its income statement YR END Dec 31, 2017 b) if the bonds are classified as available for sale and fair value is 3,604,000 at dec 31, 2017. prepare JE
a) Entry: DEBIT: Cash (4 mil x 8% x 1/2) 160,000 Debt Investments (175k-160k) 15,000 CREDIT: Interest Revenue (3.5 mil x 10% x 1/2) 175,000 b) Entry: DEBIT: Fair value adjustment [3,604,000 -(3,500,000 + 15,000)] 89,000 CREDIT: Unrealized Holding Gain or Loss-Equity [3,604,000 -(3,500,000 + 15,000)] 89,000
a) assuming no fair val adj acct bal @ beg of YR, prepare the adjusting entry at the end of the year is L Co available for sale debt securities have a fair val 60,000 BELOW cost. b) assume same info as part a), except that L Co has a debit balance in its fair value adjustment act of 10,000 at the beg of YR.
a) Entry: DEBIT: Unrealized Holding Gain or Loss-Equity 60,000 CREDIT: Fair Value Adjustment 60,000 b) Entry: DEBIT: Unrealized Holding Gain or Loss- Equity (60,000 + 10,000) 70,000 CREDIT: Fair value adjustment (60,000 + 10,000) 70,000
debt vs. equity security
a) debt- representing a creditor relationship w/ an enterprise. include US govt securities, municipal securities, corporate bonds, convertible debt, commercial paper and all securitized debt instruments. trade accounts receivable and loans receivable are NOT debt securities because they do not meet the definition of a security b) equity- security representing an ownership interest such such as common, preferred, or other capital stock. It also includes rights to acquire or dispose of an ownership interest at an agreed-upon or determinable price such as warrants, rights, and call/put options. convertible debt securities and redeemable pref stock are NOT treated as equity securities.
identify/explain types of classifications of investments in EQUITY securities
a) holdings less than 20% FAIR VAUE METHOD- investor has PASSIVE interest b) holdings between 20%-50% EQUITY METHOD-investor has SIGNIFICANT INFLUENCE c) holdings more than 50% CONSOLIDATED STATEMENTS- investor has CONTROLLING interest if an equity investment is NOT publicly traded and is nonmarketable, a company values the investment and reports it at cost in periods subsequent to acquisition. (cost approach). companies recognize div when RECEIVED and only recognize gains and losses when SELLING the securities.
when should a debt security be classified as held to maturity?
both: a) positive intent b) the ability to hold the securities to maturity
trading debt security
debt securities bought and held primarily for sale in the near term to GENERATE income on SHORT-TERM price differences
available-for sale debt security
debt securities not classified as held to maturity or trading
held to maturity debt security
debt security the enterprise has the positive intent and ability to hold to maturity
H Co- uses EQUITY METHOD to account for investments in com stk. what accounting is made for div received from these investments subsequent to the date of investment?
div subsequent to acquisition should be accounted for as a REDUCTION in the equity investment account.
fair value option
gives companies the option to report most financial instruments at fair val w/ all gains and losses related to changes in fair value reported in the income statement. This option is applied on an instrument by instrument basis. The fair val option is generally available only at the time a company chooses to use the fair value option. it must measure this instrument at fair val until the co no longer has ownership
what amount should trading, available for sale, and held to maturity debt securities be reported on the balance sheet?
held to maturity- AMORTIZED COST trading & available for sale- FAIR VALUE
How are unrealized holding gains/losses reported for debt investments classified as held to maturity, trading, and available for sale
held-to-maturity- not recognized trading- included in net income for current period available of sale- other comprehensive income as a separate component of S E
How to account for the impairment of a held to maturity debt security
impaired- it is probable that the investor will be unable to collect all amounts due according to the contractual terms at occurrence: the security is written down to its fair value, which is also the security's new cost basis. the amount of the write down is accounted for as a realized loss
cost of a long term investment in bonds
includes: a) total consideration to acquire the investment, including brokerage fees b) other costs incidental to the purchase
why are held to maturity investments applicable only to DEBT securities?
investments in stock do not have MATURITY DATES
distinguish between accounting for marketable vs non marketable EQUITY securities
marketable- reported at FAIR VAL and any unrealized holding gain or loss is reported in NI nonmarketable- reported at COST LESS IMPAIRMENTS, encouraged to adjust for observable price changes subsequent to recording the investment at cost if it can determine prices in orderly transactions for identical investments or from similar investments of the same issuer
F co has a debt investment that it has held for several years. when it purchased the debt investment f co classified and accounted for it as available for sale. Can f co use the fair value option for this investment ?
no, fv option is generally only available at the time a company FIRST PURCHASES the financial asset or incurs a financial liability. If a co chooses to use the fair value option, it must measure this instrument at fair value until the company no longer has ownership
how are trading debt securities are accounted for and reported
reported at FAIR VALUE w/ unrealized holding gains and losses reported as part of net income. discount or premium is amortized
what constitutes SIGNIFICANT INFLUENCE when an investor's financial interest is BELOW the 50% level?
sig influence over an investee may result from representation on the BOD, participation in policy-making processes, material intracompany transactions, interchange of managerial personnel, or technological dependency. an investment (indirect or direct) of 20% or more of the voting stock of an investee constitutes significant influence unless there exists evidence to the contrary.
GAAP fair value definition
the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (market-based measure)
why are reclassification adjustments necessary?
to insure that double counting does not result when realized gains or losses are reported as part of NI but are also shown as part of other comprehensive income in the current period or in previous periods
Where on the asset side of the BS are debt investments classified as trading, available for sale, and held to maturity securities reported?
trading- FAIR VALUE as CURRENT assets. individual held to maturity & available for sale- CURRENT OR NON CURRENT depending on circumstances. held to maturity- generally classified as current or noncurrent based on maturities and expectations as to sales and redemptions in the following year.
how a transfer of securities from the available for sale category to the trading category after SE and Income.
when a security is transferred from one category to another, the transfer should be recorded at FAIR VALUE, which in this case becomes the new basis for the security. Any unrealized gain or loss at the date of the transfer increases or decreases SE. The unrealized gain or loss at the date of the transfer to the trading category is recognized in income.
