Chapter 12

Select all that apply 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.

Winston Company has significant influence over the operating and financial policies of Xavier Company. Winston should report its investment utilizing the (1) method. (Enter only one word.)

1. equity

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.

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 is a common special purpose fund?

Petty cash

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.

All equity investments are initially recorded at

cost

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

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

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.

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

Select all that apply 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.

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

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

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

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.

Select all that apply 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.

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.

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

recognized as other comprehensive income.

Gains and losses relating to debt securities classified as trading are presented in the (1) (2) in the periods in which fair value changes, regardless of whether they are realized or unrealized. (Enter one word per blank.)

1. income 2. statement

Under the fair value option, unrealized gains and losses on HTM and AFS debt securities are recognized in (1) (2) in the period they occur. (Enter one word per blank.)

1. net 2. income

Consistent with IFRS No. 9, impairments of debt investments will be accounted for using a

expected credit loss model.

Select all that apply 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.

Select all that apply 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

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

not amortized.

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

Otto Company purchases $200,000 face amount, 8% semi-annual 10-year bonds when the market rate is 7%. The number of interest periods utilized to determine interest revenue earned on the investment is

20 periods.

Emil Company purchases $400,000 face amount, 8% semi-annual 15-year bonds when the market rate is 7%. The number of interest periods utilized to determine interest revenue earned on the investment is

30 periods.

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.

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

Equity method

Select all that apply 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.

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

trading securities

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

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.

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.

Credit losses are due to

an expected decrease in future cash flows due to defaults on interest or principal payments.

Select all that apply The premium payments of life insurance policies with cash surrender value include (Select all that apply.)

an investment portion an insurance expense portion

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

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

cost

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

Select all that apply 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.)

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

Dividends earned on an equity investment, when there is a lack of significant influence, are credited to

dividend revenue.

Under IFRS, the entire impairment of debt investments are recognized in ______; under U.S. GAAP, if a portion of an impairment is due to noncredit losses, it is recorded in _______.

earnings; OCI

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

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

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

investing

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

Unrealized gains and losses for equity method investments that are carried at fair value are:

reported as part of earnings

Credit losses are calculated as the difference between the amortized cost of the debt and

the present value of future cash flows expected to be collected.

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

the year-end fair value adjustment.

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

Select all that apply 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.

At the end of the accounting period, trading debt securities must be adjusted to (1) value. (Enter only one word.)

1. fair

Investments in debt securities classified as trading are reported on the balance sheet at (1) (2). (Enter one word per blank.)

1. fair 2. value

Cash flows from buying and selling debt securities classified as trading as a part of normal operations typically are classified as (1) activities in the statement of cash flows. (Enter only one word.)

1. operating

If a company holds bonds that are not actively traded, it can estimate the fair value of those bonds by using (1) (2) techniques.

1. present 2. value

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

False

Select all that apply 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.)

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

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.

Select all that apply 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.

Select all that apply 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 has the ability to hold the security until maturity. The investor intends to hold the security until maturity.

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.

Consistent with the equity method, investment income is

based on investee's income times ownership percentage.

Select all that apply 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? (Select all that apply.)

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

Select all that apply Equity investments for which the investor does not have significant influence are classified as _____ in the balance sheet. (Select all that apply).

current assets noncurrent assets

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.

Select all that apply 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.)

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

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

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

Select all that apply 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.)

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

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

Under the equity method, dividends received from the investment

decrease the investment account balance

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

The appropriateness of the classification of debt investments must be reassessed

each reporting date

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.

The premium payments of life insurance policies with cash surrender value include an insurance expense portion and a(n)

investment portion.

Select all that apply Additional adjustments under the equity method directly affect which of the following accounts? (Select all that apply.)

investment revenue investment

Noncurrent special purpose funds set aside for a future specific use, are typically classified as

investments on the balance sheet.

Losses arising from credit losses on available-for-sale debt securities are recognized in _____; noncredit losses are recognized in _____.

net income; OCI

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 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.

Select all that apply From an accounting perspective, critical events that investors experience over the life of an investment include (Select all that apply.)

receiving dividends sale of investment changes in fair value

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.

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

recognized in net income.

Kendrick Company elected the fair value option for its equity method investments. During the current period, the fair value of the investments increased. Kendrick Company should

report the increase as part of net income.

Select all that apply 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 changes in fair value purchase of investment receiving dividends

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.

Select all that apply 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.

Select all that apply 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.

Impairments of available-for-sale debt instruments are recognized in other comprehensive income

to the extent that they arise from noncredit losses

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.