Chapter 12: Part A: Accounting for Debt 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%))

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.)

$2,000

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

$22,000.

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%)

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.

Identify the statement that is correct regarding the purpose of additional adjustments under the equity method.

Adjustments help to approximate the effects of consolidation.

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 other comprehensive income.

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.

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

Current.

Winston Company has significant influence over the operating and financial policies of Xavier Company. Winston should report its investment utilizing the _______ method.

Equity

True or false: If the investee reports a net loss, the equity investment account is not adjusted for additional expenses.

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.

Match the correct accounting treatment with the correct transaction.

Holding gain or loss in other comprehensive income-- Investment in available-for-sale debt securities Holding gain or loss in income-- Investment in trading debt securities No holding gain or loss is recognized-- Investment in held-to-maturity debt securities

Cash flows from buying and selling AFS debt securities are typically shown on the Statement of Cash Flows in the _____ activities section. Multiple choice question.

Investing

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.)

Investment in AFS - $18,000 Gain on sale of investment - $2,000

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.

Under U.S. GAAP, which of the following statements regarding the classification of debt investments is correct?

The classification of investments must be reassessed each reporting period.

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 intends to hold the security until maturity. The investor has the ability to hold the security until maturity.

Which of the following scenarios may require additional adjustments under the equity method?

The investor's acquisition cost exceeds the book value of the underlying net assets.

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.

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.

If the market rate of interest rises after a bond is purchased, the bond incurs

an unrealized holding loss

Consistent with the equity method, investment income is

based on investee's income times ownership percentage.

Andrea Company purchases 30% of Sander Company's outstanding stock for $420,000. Andrea should record this investment at Multiple choice question.

cost

Adrianna Company purchases 35% of Saddle Company's outstanding stock for $450,000. Adrianna should record this investment with (Select all that apply.)

credit cash $450,000 debit investment in Saddle $450,000

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

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.)

credit dividend revenue $5,000 debit cash $5,000

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. 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.)

credit to investment in bonds $700,000 debit to discount on bond investment $100,000 debit to cash $680,000 credit to fair value adjustment $80,000.

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

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 credit cash $500,000

Dividends cause the investor's investment in the investee's net assets to

decrease

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:

decrease by $10,000 ($40,000 X 25%)

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

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

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

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)

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; $1,500 (($50,000 X 30%) /10 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

Investments in debt securities classified as trading are reported on the balance sheet at ____ ____.

fair value

The fair value option can be applied to: (Select all that apply.) Multiple select question.

financial assets financial liabilities

Characteristics that support classification of investments as trading securities include (Select all that apply.)

frequent and active trading. motivation to realize short-term profits.

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.

Cash flows from buying and selling held-to-maturity securities are typically classified as _____ activities on the Statement of Cash Flows.

investing

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 $35,000. ($200,000 X 35% X 6/12)--Purchased in July 1

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

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

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.

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 Multiple choice question.

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

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

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.

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

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 receiving dividends changes in fair value purchase of investment

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.

Accounting for held-to-maturity, trading, and available-for-sale debt securities is the same with respect to (Select all that apply.)

the initial investment. interest revenue earned on investment.

Beginning in 2018, equity adjustments that lack significant influence are accounted for the same way as debt investments classified as Multiple choice question.

trading securities

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.)

$20,000 to discounts. $520,000 to cash.

Which of the following are correct regarding the financial statement presentation of HTM securities? (Select all that apply.)

Gains and losses are shown in net income in the period in which the securities are sold. Unrealized holding gains and losses are disclosed in the notes to the financial statements.

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. Multiple choice question.

Operating

Correctly match the account balances related to AFS debt securities with the correct financial statement presentation.

Other comprehensive income ---Current period holding gains or losses Net income ---Realized gains and losses from the sale of AFS securities Accumulated other comprehensive income ---Net fair value adjustments to date - net holding gains and losses to date

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.

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.)

credit to fair value adjustment $1,000 credit investment in bonds $100,000 debit to cash $99,000 debit to discount $2,000

Under the equity method, dividends received from the investment Multiple choice question.

decrease the investment account balance

Goodwill arising from an investment accounted for under the equity method is

not amortized.

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

recognize a gain of $50,000.

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.

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.

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.

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

Unrealized holding gains and losses associated with debt investments properly classified as "available for sale" are

recognized as other comprehensive income.

The carrying value of an equity method investment consists of its initial cost plus

the investor's equity in the investee's undistributed income