ACCTG 472 Chap 12

How are equity investments that lack significant influence adjusted?

A fair value adjustment is recorded at the end of every reporting period. Unrealized holding gain or loss is included in net income.

Barber Company acquires 35% of the outstanding shares of Carter Company. Which of the following is correct?

Barber may choose to apply the fair value option.

At the end of the accounting period, trading debt securities must be adjusted to _______ value.

Blank 1: fair or market

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

Blank 1: fair or market Blank 2: value

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.

Blank 1: income Blank 2: statement

Under the fair value option, unrealized gains and losses on HTM and AFS debt securities are recognized in ____ ______ in the period they occur.

Blank 1: net Blank 2: 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.

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

Corporate bonds Preferred stock Common stock

Other Comprehensive Income (OCI)

Current period holding gains or losses

Which reporting method should be used if the investor can exert significant influence over the investee?

Equity method

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

False

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:

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

Holding gain or loss in other comprehensive income matches

Investment in available-for-sale debt securities

holding gain or loss in other comprehensive income

Investment in available-for-sale debt securities

no holding gain or loss is recognized

Investment in held-to-maturity debt securities

Holding gain or loss in income

Investment in trading debt securities

holding gain or loss in income

Investment in trading debt securities

Accumulated Other Comprehensive Income

Net fair value adjustments to date - net holding gains and losses to date

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.

How are available-for-sale debt securities reported?

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 other comprehensive income when they occur.

Net Income

Realized gains and losses from the sale of AFS securities

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.

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

Characteristics that support classification of investments as trading securities include

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

Under the fair value option, unrealized gains and losses on debt securities are

recognized in net income.

Gruen Corporation aquires 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

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

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. $520,000 to cash.

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.

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.

No holding gain or loss is recognized

Investment in held-to-maturity debt securities

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,

Northern will report an unrealized holding gain in net income. Northern will make a fair value adjustment of $75,000.

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?

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.

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

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.

Von Company properly applies the equity method in accounting for its investment in Neumann Inc. Which of the following statements are correct?

Von owns 20-50% of Neumann's voting shares. Von has significant influence over Neumann.

Porter Company classified its debt investment in Bailey Company as an available-for-sale security. Subsequent to the purchase, the fair value of the investment increased by $5,000. The result of this increase in value will be

an increase in other comprehensive income.

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

an unrealized holding gain

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.

All equity investments are initially recorded at

cost

Adrianna Company purchases 35% of Saddle Company's outstanding stock for $450,000. Adrianna should record this investment with

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

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?

credit investment in North stock $500,000 credit fair value adjustment $5,000 debit cash $505,000

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

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

Trading securities typically are classified in the balance sheet as

current assets.

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 _____.

decrease; $1,200

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

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

Equity and debt securities are commonly referred to as ______ instruments.

financial

The fair value option can be applied to:

financial liabilities financial assets

If an investor has the positive intent and ability to hold a debt security until it matures, it should be classified as a(n)

held-to-maturity security.

Accounting for held-to-maturity, trading, and available-for-sale debt securities is the same with respect to

interest revenue earned on investment. the initial investment.

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

investing

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

investing

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

not amortized.

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.

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

Identify critical events that companies experience with respect to equity investments that must be recognized in the accounting system.

receiving dividends changes in fair value purchase of investment sale of investment

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.

If an investment accounted for under the equity method is acquired during the year, income and other adjustments are

recognized for the portion of the year the investment was owned.

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.

From an accounting perspective, critical events that investors experience over the life of an investment include

changes in fair value receiving dividends sale of investment

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

unrealized holding gains and losses

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.

Under the equity method, dividends received from the investment

decrease the investment account balance

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

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.

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

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.

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?

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

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

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

decrease by the investor's proportionate share of the investee's net loss

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

decrease.

Equity investments for which the investor does not have significant influence are classified as _____ in the balance sheet.

noncurrent assets current assets

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.

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.

When fair value of equity investments is not readily determinable

the investor needs to assess annually whether the investment is impaired. 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 carrying value of an equity method investment consists of its initial cost plus

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

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.

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?

debit investment in North Company $500,000 credit cash $500,000

Additional adjustments under the equity method directly affect which of the following accounts?

investment investment revenue

If a company holds bonds that are not actively traded, it can estimate the fair value of those bonds by using _______ _________ techniques.

Blank 1: present Blank 2: value

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?

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

The choice to classify debt securities as current or noncurrent depends on

when they are expected to mature or be sold.