exam 1

adjustments must be made to ______ to account for the tax effects of debt investments

-AOCI -OCI

holding bonds during periods in which the fair value of the bonds changes results in

-unrealized holding gains and losses

the "discount on bond investments" is a

contra-asset account

the interest rate for debt of similar risk and maturity is referred to as the _____ interest rate

market

On December 31, 2018, Gardner Company holds debt securities classified as HTM with a face amount of $100,000 and a carrying value of $95,000. The bonds have an effective interest rate of 6% and pay interest of $2,500 semi-annually on June 30 and December 31. The effective interest revenue recognized for the six months ended December 31, 2018 is:

$2850

Palmer Company purchases bonds with a face amount of $500,000 for $480,000 and properly classifies them as "held-to-maturity." On the maturity date of the bonds, the book value of bonds will be:

$500,000

what happens when an equity investment is sold?

-a gain or loss is recognized for the difference between its selling price and its carrying amount

on the date of acquisition, an investment in bonds should be recorded at:

-cost

Adjustments made to OCI and AOCI to account for the tax effects of unrealized holding gains and losses on available-for-sale debt securities also give rise to _________.

-deferred tax assets -deferred tax liabilities

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

On December 31, 2021, Sparrow Company has bonds with an amortized cost of $424,000 and a fair value of $452,000. These bonds are properly classified as trading debt securities. On January 12, 2022, Sparrow sells the bonds for $450,000. Just prior to recording the sale on January 12, 2022, the journal entry to update the fair value adjustment account will include

a credit to fair value adjustment $2000

Marlon Company recognizes interest revenue of $5,400 related to its bonds; its periodic bond interest payment receipts are $5,200. The bonds must have issued at:

a discount

For discounted bonds, interest revenue is ____ cash interest each interest period.

greater than

Company does not recognize unrealized holding gains and losses for its bond investments, if the company is properly applying GAAP, its investment must be classified as

held-to-maturity

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

investing

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

adjustments for additional depreciation under equity method

the investor adjusts its share of the investee's net income to reflect the revenues and expenses associated with differences between the fair value and book value of the investee's assets and liabilities that existed at the time the investment was made

over the life of an investment, amoritzation of a discount

-increases each period

investors use this interest rate to value investments in bonds

-market interest rate

Available for Sale Securities

-are not held for trading or designated as held to maturity -AFS investments are reported in balance sheet at their fair value -unrealized holding gains and losses on AFS securities are not included in net income, reported on the statement of other comprehensive income as other comprehensive income (oci) -we show unrealized gains and losses in OCI as they occur and then only include realized gains and losses in net income in the period in which the investments are actually sold

consolidation

-the financial statements of the investor and investee are combined as if they are a single company -the investor controls the investee (typically owns more than 50% of voting stock)

the critical events over the life of an investment in the equity of another company, such as shares of common stock, include the following:

1. purchasing the equity security 2. receiving dividends (for some equity securities) 3. holding the investment during periods in which the investment's fair value changes (and thus incurring unrealized holding gains and losses since the security has not been sold yet) 4. selling the investment (and thus incurring realized gains and losses, since the security has been sold and the gains or losses actually incurred

Emil Company purchases $400,000 face amount, 6% semi-annual bonds when the market rate is 8%. The rate used to determine interest received for the first 6 months on the investment is

Interest received uses the stated rate and the bonds are semi-annual so 6%/2= 3%

Greene Company purchases an investment in bonds issued by Blue Company. Greene intends to hold the bonds until they mature and did not elect the fair value option. Greene should report the investment at

amortized cost

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

an unrealized holding gain

which of the following events is of little importance if an investment in debt securities is held to maturity

-changes in fair value during the holding period

fair value option

-choosing the fair value option for HTM and AFS investments means accounting for them like trading securities -Under the FVO, HTM and AFS investments are shown in the balance sheet at their fair values, and unrealized gains and losses are recognized in net income in the period in which they occur -company decides whether to elect the FVO on the date the company purchases the investment, but the company has to explain in the notes why it made a partial election. this is irrevocable.

trading securities

-actively managed in a trading account for the purpose of profiting from short-term price changes -adjusted to their fair value in each reporting period

Archie Inc. has available-for-sale debt securities that have a fair value that exceeds their amortized cost, and Archie has been recording changes in fair value over the life of the securities. If Archie now sells those securities, it should reverse previous unrealized holding _____ included in ______.

- gains / OCI

which of the following are common financial instruments that are used to finance or expand a company's operations?

-common stock -preferred stock -corporate bonds

what happens after the the reclassification adjustment is made for AFS?

-fair value adjustment account has zero balance -all of the unrealized gains that are associated with the investment have been removed from the AOCI holding tank in shareholders equity -its as if no unrealized gains or losses ever took place

the discount on bond investment

-is a contra-asset account -reduces the carrying value of the bond to its cost at the date of purchase

what to do if investment is acquired mid year

-multiply income, dividends and adjustments for portion of the year (ex. 3/12)

the way an investment is accounted for affects

-net income, investment book value, and the amount of gain or loss recognized when the investment is sold

accounting for held-to-maturity, trading, and available for sale securities differs with respect to

-the year end fair value adjustment

which of the following are correct regarding the financial statement presentation of HTM securities?

-unrealized holding gains and losses are shown in the notes in the financial statements -gains and losses are shown in net income in the period in which they are sold

if a bond sells for more than its maturity value, the bond sells at a

premium

when accounting for the sale of AFS debt securities, how are unrealized gains reversed?

-debit a reclassification adjustment -credit the fair value adjustment account

debt securities that are available for sale or trading are valued at

-fair market value

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

reporting the investment under the equity method

-the carrying amount of the investment is its initial cost plus the investor's equity in the undistributed earnings of the investee -in the statement of cash flows, we report the purchase and sale of the investment as outflows and inflows of cash in the investing activities section, and the receipt of dividends is reported as an inflow of cash in the operating activites section

which of the following conditions must be present for a debt-security to be classified as "held-to-maturity"?

-the investor has the ability to hold the security until maturity -the investor intends to hold the security to maturity

two important differences between trading securities and HTM securities

1. trading securities are written up or down to their fair value, or "marked to market", in the balance sheet. (HTM securities are kept at amortized cost) 2. Unrealized holding gains and losses on trading securities are included in net income in the income statement (HTM securities do not include unrealized holding gains and losses in net income)

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

-20,000 to discounts -250,000 to cash

trading securities are typically classified in the balance sheet as

-current assets

During the current period, Muenster Company amortized $5,000 of discount relating to its investment in debt securities. The company's amortization next period should be ______ the current period.

-higher than

comparison of HTM, TS, and AFS

-to record the purchase of an investment and the receipt of interest revenue, we use identical entries in all three approaches -to record the change in fair value, the entries we use for TS and AFS securities have the same effect on the investment (via the fair value adjustment valuation allowance) and the same eventual effect on total shareholder's equity. what differs is whether the unrealized holding gain or loss is recognized in net income and then in retained earnings (TS) or recognized in OCI and then in AOCI (AFS). no fair value adjustment is reported for HTM securities -regardless of the approach, the cash flows are the same, and the same total amount of gain or loss is recognized in the income statement. question is not how much total net income is recognized, but when the amounts are recognized in net income

accounting for trade securities

-we use a valuation allowance, fair value adjustment, to increase or decrease the carrying value of the investment -we also record an unrealized gain or loss that is included in net income in the period in which fair value changes -increases in fair value adjustment produce gains on trading securities that increase net income; decreases produce losses that decrease net income

Folger Company recognizes an unrealized holding gain for debt investments that are classified as AFS. If the company had classified the investments as trading securities, its total shareholders' equity would be

the same - entries we use for TS and AFS securities have the same effect on the investment (via the fair value adjustment valuation allowance) and the same eventual effect on shareholders equity -what differs is whether the unrealized holding gain or loss is recognized in net income and then in retained earnings (TS) or recognized in OCI and then in AOCI (AFS)

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

-40,000 to gain from sale of investment -500,000 to investments in HTM 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.)

-520,000 to cash -20,000 to discounts

Trading Securities

-Actively managed in a trading account for the purpose of profiting from short-term price changes -The holding period is generally measured in hours or days rather than months or years -Typically reported among the investors current assets -Usually only banks and other financial operations invest in securities in the manner and for the purpose necessary to be categorized as trading securities -Just like HTM investments, trading securities are recorded at cost when they are purchased, and any discount or premium is amortized to interest revenue over time as periodic interest payments are received

characteristics that support classification of investments as trading securities include

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

financial statement presentation and disclosure

-trading securities, held-to-maturity securities, and AFS securities are either current or noncurrent depending on when they are expected to mature or to be sold -it is NOT necessary that a company report individual amounts for the three categories of investments on the face of the balance sheet as long as that information is presented in the disclosure notes -investors should disclose the following in the disclosure notes for each year presented: 1. aggregate fair value 2. gross realized and unrealized holding gains 3. gross realized and unrealized holding losses 4. change in net unrealized holding gains and losses 5. amortized cost basis by major security type -notes also include disclosures designed to help financial statement users understand the quality of the inputs companies use when determining fair value values and to identify parts of the financial statements that were affected by these fair value estimates

transfers between reporting categories

-when a security is reclassified between two reporting categories, the security is transferred at its fair value on the date of the transfer -any unrealized holding gain or loss should be accounted for in a manner consistent with the classification into which the security is being transferred -reclassifications are unusual but when they occur disclosure notes should describe the circumstances that resulted in the transfer

sale of trading security investments

1. adjust trading securities to fair value- unrealized holding gains and losses from fair value changes are recorded up to the date an investment is sold 2. record the sale- when a trading security is sold, all of the gain or loss already has been included in net income, so no additional gain or loss has been recognized - as with HTM, we record the receipt of cash from the sale and remove all balance sheet accounts associated with the investment -unlike HTM, TS investment has an additional balance sheet account, the fair value adjustment, that needs to be removed when we record sale -another difference is that because we carry trading securities at fair value as of the date of the sale and already have included in net income the entire gain associated with changes in the fair value of the investment, there are no gains or losses to recognize on the date of the sale -same amount of gain recognized between both approaches, with the only difference being timing. TS recognizes unrealized holding gains and losses from fair value as they occur but the HTM approach only recognizes gains and losses when they are realized upon sale

financial instrument

1. cash 2. evidence of ownership interest in an entity 3. a contract that (a) imposes on one entity an obligation to deliver cash (say accounts payable) or another financial instrument and (b) conveys to the second entity a right to receive cash (say accounts receivable) or another financial instrument 4. a contract that (a) imposes on one entity an obligation to exchange financial instruments on potentially unfavorable terms (say the issuer of a stock option) and (b) conveys to a second entity a right to exchange other financial instruments on potentially favorable terms (say the holder of a stock option) -derivatives- financial futures, interest rate swaps, forward contracts and options, these instruments derive their values from some other security or index -the FASB's ongoing financial instruments project is expected to lead a consistent framework for accounting for all financial instruments

cash flows from buying and selling debt securities as trading as a part of normal operations typically are classified as ______ activities in the statement of cash flows

operating

trading securities financial statement presentation

-income statement and statement of comprehensive income: fair value changes affect net income in the period in which they occur, do not affect other comprehensive income -balance sheet: investments in trading securities are reported at fair value, typically as current assets -cash flow statement: cash flows from buying and selling trading securities typically are classified as operating activities, because the financial institutions that routinely hold up trading securities consider them as a part of their normal operations

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?

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

other comprehensive income

-includes net income as well as other comprehensive income -OCI is closed to accumulated other comprehensive income (AOCI) at the end of each accounting period, and therefore accumulates in AOCI in the shareholders' equity section of the balance sheet -OCI relates to AOCI the same way net income relates to retained earnings

what if conditions change under the equity method?

-a change from the equity method to another method: say ownership changes from 22% to 15% and company has to stop using equity method. When this happens, no adjustment is made to the remaining carrying amount of the investment. the equity method is discontinued and the new method is applied from then on. the balance in the investment account when the equity is discontinued would serve as the new cost basis for writing the investment up or down to fair value in the next set of financial statements -a change from another method to the equity method: say that ownership interest is too large to qualify for accounting under the equity investment method. the previous method is discontinued and the balance in the investment account at the date of the change (including any unrealized holding gains or losses that occurred prior to the date the investment qualifies for the equity method is used as the starting balance for applying the equity method. any cost of acquiring additional shares is added to that balance, and going forward that balance is adjusted for the investor's portion of the investee earnings and dividends. a disclosure note should describe the change.

what happens when the investors expenditure to acquire an equity-method investment exceeds the book value of the underlying net assets acquired

-additional adjustments to both the investment account and investment revenue might be needed. -purpose is to approximate the effects of consolidation, without actually consolidating financial statements -both the investment account and investment revenue are adjusted for differences between net income reported by the investee and what that amount would have been if consolidation procedures had been followed

what are investments in debt securities classified as under IFRS?

-amortized cost (accounted for like HTM investments in US GAAP) -fair value through other comprehensive income (FVOCI, accounted for like AFS securities, except for different impairment recognition criteria) -fair value through profit or loss (FVPL, accounted for like trading securities) -classification depends on two criteria: (1) whether the investment's contractual cash flows consist solely of payments of principal and interest (SPPI) and (2) whether the business purpose of the investment is to hold it for purposes of collecting contractual cash flows, sell the investment at a profit, or both. -if the investment qualifies as SPPI and is held only to collect cash flows, it is classified as amortized cost -if it qualifies as SPPI and is held both to collect cash flows and potentially be sold, it is classified as FVOCI. -otherwise, it is classified as FVPL

On December 31, 2021, Gardner Company holds debt securities classified as HTM with a face amount of $100,000 and a carrying value of $95,000. The bonds have an effective interest rate of 6% and pay interest of $2,500 semi-annually on June 30 and December 31. The journal entry to record the interest payment on December 31, 2021 includes (Select all that apply.)

-credit interest revenue 2850 -debit cash 2500 -debit discount on bond investment $350

comparison of fair value and equity method

-to record the purchase of investment, we use the same basic entry for both approaches -the two approaches differ in whether we record investment revenue when dividends are received and whether we recognize unrealized holding gains and losses associated with changes in the fair value of the investment -the differences in how the two approaches account for unrealized holding gains and losses result in different carrying values for the investment at the time the investment is sold, and therefore result in different realized gains or losses when the investment is sold -regardless of approach, the same cash flows occur, and the same total amount of net income is recognized over the life of the investment -thus, the question is not how much total net income is recognized, but when that net income is recognized

fair value through net income

-similar to trading-securities approach used for debt; investment reported at fair value (with unrealized holding gains and losses included in net income) -investor does not have significant influence over the operating and financial polices of the investee (typically owns less than 20% of voting stock) -all equity investments are accounted for like trading securities -equity investments are carried at fair value in the balance sheet, with unrealized holding gains and losses recognized in net income in whatever period they occur -all equity investments are recorded at cost -dividends received for equity investments are included in income -the carrying value of equity investments must be adjusted to fair value at the end of every reporting period. as with TS, we use fair value adjustment, to increase or decrease the carrying value of the investment, and we simultaneously record an unrealized holding gain or loss that is included in net income in the period in which fair value changes -upon sale, there are two journal entries: 1. one to record in net income any gains or losses that occurred during 2022 prior to the date of the sale. 2. on the date of the sale, record the receipt of cash and remove the amounts associated with the investment from the relative balance sheet accounts -if all the unrealized holding gains and losses have been included in net income up to the time of the sale, no additional gain or loss is recognized -financial statement presentation: equity investments for which the investor does not have significant influence are classified as either current (short-term) or non-current (long-term) in the balance sheet. Those held with intent for short-term profit are normally treated as operating activities in the statement of cash flows, other current equity investments, and long-term equity investments, are classified as investing activities in the statement of cash flows -notes to the financial statements should disclose the portion of unrealized holding gains and losses for the period that relate to any equity securities still held by the company at the end of the reporting period. notes should also provide information about how the carrying value was calculated for equity investments for which fair value is not readily determinable

Margot Company purchases $100,000 face amount, 6% semi-annual bonds for $110,000 when the market interest rate is 5%. The journal entry to record the interest for the first 6-month period includes

-credit premium on bond investment -credit interest revenue 2,750 -debit cash 3,000 -the bond is a premium because the stated rate is higher than the market rate

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. Northern properly classifies these bonds as AFS securities. Prior to recording the sale, the journal entry to adjust the bonds to fair value includes

-debit to fair value adjustment 5,000 -credit to unrealized holding gain on AFS securities- OCI 5,000

Lucky Company invested in debt securities and classified them as HTM. At the end of the accounting period, the value of the investment appreciated by $10,500. The company should:

-disclose the fair market value in the notes

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:

-gain on sale of investment - $2000 - investment in AFS - $18,000

for each year presented, investors should disclose the following in the disclosure notes related to investments

-gross realized and unrealized holding gains and losses -aggregate fair value description of the valuation techniques used in the fair value measurement process

equity method

-if company acquires more than 50% of the voting stock of another company, it's said to have control, because by voting those shares, the investor actually can control the company acquired -investor is called the parent, the investee is called the subsidiary. both companies continue to operate as separate legal entities, and the subsidiary reports separate financial statements -the parent company reports consolidated financial statements, which treat the parent company and the subsidiary as if they were only one company -even if effective control is absent, the investor still may be able to exercise significant influence over the operating and financial policies of the investee, must own at 20& of the investee's voting shares -other indications that an investor may be unable to exercise significant influence: 1. the investee challenges the investor's ability to exercise significant influence (through litigation or complaints to regulators) 2. the investor surrenders significant shareholder rights in a signed agreement 3. the investor is unable to acquire sufficient information about the investee to apply the equity method 4. the investor tries and fails to obtain representation on the board of directors of the investee -when significant influence exists but the investor does not have effective control, the investment should be accounted for by the equity method -the investor recognizes on its own income statement its proportionate share of the investee's income with the reasoning that as the investee's net assets increase, the value of the investor's share of those net assets also increases, so the investor increases its investment by the amount of income recognized -as the investee distributes net assets as dividends, the investor does not recognize revenue. Rather, the investor's investment in the investee's net assets is reduced -under the equity method, the investment is initially recorded at cost. After that, the investment balance is: 1. increased by the investor's percentage share of the investee's net income (or decreased by its share of a loss) 2. decreased by the investor's percentage share of the investee's dividends paid -if investee reports a net loss instead, the investment account would be decreased by the investor's share of the investee's net loss (adjusted for additional expenses) -impairment of equity method investments: if a decline is viewed as other than temporary, the investor would recognize an impairment loss in net income and reduce the carrying value of the investment to fair value in the balance sheet

fair value option under the equity method

-if the fair value option is chosen for investments otherwise accounted for by the equity method, the amount is reported at fair value is clearly indicated -the company carries the investment at fair value in the balance sheet and includes unrealized gains and losses in net income -these investments are shown on their own line in the balance sheet or are combined with equity method investments with the amount at fair value shown paranthetically -all the disclosures that are required when reporting fair values as well as some of those that would be required under the equity method must still be provided

how do AFS securities appear in the financial statements?

-income statement and statement of comprehensive income: gains and losses are shown in OCI in the periods in which changes in fair value occur. these amounts are reclassified out of OCI and recognized in net income in the periods in which securities are sold -balance sheet: investments in AFS securities are reported at fair value. Unrealized holding gains and losses become part of AOCI in shareholder's equity and are reclassified out of AOCI in the periods in which securities are sold -cash flow statement: cash flows from buying and selling AFS securities typically are classified as investing activities

why are there no adjustments for land or goodwill?

-land is not an asset we depreciate, as a result the difference between the fair value and book value of the land would not cause higher expenses and we habe no need to adjust investment revenue or the investment in stock for the land -we also have no need to adjust investment revenue or stock for goodwill

decision makers perspective on accounting methods

-managers may structure equity investments to qualifiy for their preferred accounting approach -fair value accounting prevents managers from timing the sale of investments to recognize gains or losses in particular reporting periods -a concern with fair value accounting is that management has too much discretion over fair values and may not be able to estimate fair values acurately

two cash sources that bonds typically provide

-principal -interest

holding gains and losses associated with investments properly classified as trading securities are

-recognized as a part of income

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

-recognized as other comprehensive income

Which of the following is the most important concept or principle that explains the differences in reporting holding gains or losses?

-relevance