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CHAPTER 14

Investments in Debt
and Equity Securities
MULTIPLE CHOICE QUESTIONS
Theory/Definitional Questions
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24

Definition of available-for-sale securities


Reporting of changes in fair value of securities in the income statement
Reporting of changes in fair value of securities on the balance sheet
Definition of held-to-maturity securities
Accounting for available-for-sale securities
Application of FASB Statement No. 115
Accounting for investments in common stock using the cost method
Accounting for trading securities
Accounting for goodwill amortization
Using the fair market value of stock received as a basis for valuation
Accounting for available-for-sale securities
Application of the equity method to account for investments in common
stock
Accounting for goodwill amortization
Accounting for trading securities
Application of the equity method to account for investments in common
stock
Application of the equity method to account for investments in common
stock
Accounting for available-for-sale securities
Use of consolidated financial statements
Accounting for trading securities
International vs. U.S. GAAP for investments in securities
Disclosures related to investments in securities
Using the cost method to account for an investment
Effect of using cost method when equity method was appropriate
Reclassification of available-for-sale securities to trading securities

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Chapter 14 Investments in Debt and Equity Securities

Computational Questions
25
Computation of dividend revenue
26
Computation of investment income on available-for-sale securities
27
Computation of investment income on available-for-sale securities
28
Computation of balance in investment account on trading securities
29
Computation of carrying value of portfolio on balance sheet
30
Computation of unrealized loss related to securities transactions
31
Determine entry to record sale of a security
32
Computation of loss transfer of securities to determine net income
33
Record corresponding charges against unrealized losses
34
Computation of carrying value of investment in common stock
35
Computation of income on long-term investment
36
Computation of investment in common stock affected by goodwill
amortization
37
Computation of "Share of Net Income" of investment affected by
goodwill amortization
38
Determination of journal entry for temporary investment
39
Computation of investment loss on trading securities
40
Determination of credit to "Market Adjustment--Trading Securities"
account
41
Computation of unrealized loss on trading securities on income
statement
42
Computation of loss on securities investment on income statement
43
Computation of realized loss on short-term investment of marketable
equity securities
44
Computation of value of acquisition of bonds

PROBLEMS
1
2
3
4
5
6
7

Prepare journal entries relating to investments in common stock


Determine journal entries for trading and available-for-sale securities
valuations
Prepare journal entries for investment in common stock and computation
of carrying value of investment using cost and equity methods
Computation of amount reported for investment using equity method
Prepare journal entries and compute goodwill for common stock
investment
Prepare journal entries with supporting computations for long-term
investments
Reporting of capital stock investments on balance sheet and income
statement

8
9
10
11
12
13
14
15
16

Prepare journal entries for temporary investments using asset/revenue


methods
Accounting for the sale of securities
Recording the transfer of securities between categories
Accounting for changes from the equity method
Accounting for changes to the equity method
Explanation of gains trading
Changes from the held-to-maturity classification
Change to the equity method
Impairment of a loan

MULTIPLE CHOICE QUESTIONS


c
LO2

1. Which securities are purchased with the intent of selling them in the
near future?
a. Marketable equity securities
b. Available-for-sale securities
c. Trading securities
d. Held-to-maturity securities

c
LO5

2. Changes in fair value of securities are reported in the income statement for
which type of securities?
a. Marketable equity securities
b. Available-for-sale securities
c. Trading securities
d. Held-to-maturity securities

b
LO5

3. Changes in fair value of securities are reported in the stockholders' equity


section of the balance sheet for which type of securities?
a. Marketable equity securities
b. Available-for-sale securities
c. Trading securities
d. Held-to-maturity securities

d
LO2

4. Which category includes only debt securities?


a. Marketable equity securities
b. Available-for-sale securities
c. Trading securities
d. Held-to-maturity securities

c
LO5

5. A debit balance in the account Market Adjustment--Available-for-Sale


Securities at the end of a year should be interpreted as
a. the net unrealized holding gain for that year.

23

24

Chapter 14 Investments in Debt and Equity Securities

a
LO2

b
LO4

b
LO5

d
LO4

c
LO3

b. the net realized holding gain for that year.


c. the net unrealized holding gain to date.
d. the net realized holding gain to date.
6. FASB Statement No. 115 generally applies when the level of ownership of
another company is at what percentage?
a. Less than 20%
b. 20%30%
c. 30%50%
d. More than 50%
7. When an investor uses the cost method to account for investments in
common
stock, cash dividends received by the investor from the investee should
normally be recorded as
a. a deduction from the investment account.
b. dividend revenue.
c. an addition to the investors share of the investees profit.
d. a deduction from the investors share of the investees profit.
8. A debit balance in the account Market AdjustmentTrading Securities at
the
end of a year should be interpreted as
a. the net realized holding gain to date.
b. the net unrealized holding gain to date.
c. the net realized holding gain for that year.
d. the net unrealized holding gain for that year.
9. Under the cost method of accounting for unconsolidated investments in
common stock, goodwill amortization
a. reduces the investment account.
b. increases the investment account.
c. reduces both investment income and the investment account.
d. is not recorded.
10. From the following, select the most appropriate basis for the valuation of a
new
investment when properties or services are exchanged for stock.
a. The par or stated value of the stock received
b. The book value of the property or services exchanged
c. The fair market value of the stock received
d. Either b or c, whichever is more clearly determinable

b
LO5

11. For which type of investments would unrealized increases and decreases
be
recorded directly in an owners' equity account?
a. Equity method securities
b. Available-for-sale securities
c. Trading securities
d. Held-to-maturity securities

c
LO2

12. The equity method of accounting for an investment in the common stock of
another company should be used when the investment
a. is composed of common stock and it is the investors intent to vote the
common stock.
b. ensures a source of supply such as raw materials.
c. enables the investor to exercise significant influence over the investee.
d. gives the investor voting control over the investee.

c
LO4

13. Under the equity method of accounting for unconsolidated investments in


common stock, goodwill amortization
a. decreases amortization expense and reduces the investment account.
b. reduces investment income and increases the investment account.
c. reduces investment income and reduces the investment account.
d. is not recorded.

14. If the combined market value of trading securities at the end of the year is
less
LO5
than the market value of the same portfolio of trading securities at the
beginning of the year, the difference should be accounted for by
a. reporting an unrealized loss in security investments in the stockholders'
equity section of the
balance sheet.
b. reporting an unrealized loss in security investments in the income
statement.
c. a footnote to the financial statements.
d. a credit to Investment in Trading Securities.
a
LO4

15. When an investor uses the equity method to account for investments in
common stock, the investment account will be increased when the investor
recognizes
a. a proportionate share of the net income of the investee.
b. a cash dividend received from the investee.
c. periodic amortization of the goodwill related to the purchase.

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Chapter 14 Investments in Debt and Equity Securities

d. depreciation related to the excess of market value over book value of


the investees depreciable assets at the date of purchase by the
investor.
b
LO4

16. When an investor uses the equity method to account for investments in
common stock, cash dividends received by the investor from the investee
should be recorded as
a. an increase in the investment account.
b. a deduction from the investment account.
c. dividend revenue.
d. a deduction from the investors share of the investees profits.

17. If the combined market value of available-for-sale securities at the end of


the
LO5
year is less than the market value of the same portfolio of available-for-sale
securities at the beginning of the year, the difference should be accounted
for by
a. reporting an unrealized loss in security investments in the stockholders'
equity section of the balance sheet.
b. reporting an unrealized loss in security investments in the income
statement.
c. a footnote to the financial statements.
d. a credit to Investment in Available-for-Sale Securities.
c
LO2

18. Consolidated financial statements are typically prepared when one


company
has
a. accounted for its investment in another company by the equity method.
b. significant influence over the operating and financial policies of another
company.
c. the controlling financial interest in another company.
d. a substantial equity interest in the net assets of another company.

d 19. At the beginning of the year a company had a debit balance in the account
LO5
Market Adjustment--Trading Securities. During the year the company did
not
buy or sell any trading securities, but at the end of the year the related
market
adjustment account had a credit balance. This change indicates that
a. a loss on the income statement was recognized.
b. a gain on the income statement was recognized.

c. the value of the investment account increased.


d. the value of the investment account decreased.
b
LO9

20. The only significant difference between the provisions of international


accounting standards as promulgated by IAS 39 and U.S. accounting
standards under FASB Statement No. 115 is
a. IAS 39 requires accounting for all investments in debt securities to be
on a fair value basis while SFAS No. 115 does not.
b. IAS 39 allows all unrealized gains and losses on securities valued at fair
value to be reported in net income for the period while SFAS No. 115
does not.
c. IAS 39 requires trading securities to be reported on a fair value basis
but not securities available for sale.
d. IAS 39 does not permit the reporting of unrealized gains and losses on
securities other than trading securities to be recorded as part of equity.

d
LO8
on

21. Which of the following is true?


a. Trading securities can be classified as current of noncurrent depending
managements intent.
b. Held-to-maturity securities should not be classified as current under any
circumstance.
c. Trading securities should not be classified as current under any
circumstance.
d. Available-for-sale securities can be classified as current or noncurrent
depending on managements intent.

22. On August 1, 2001, Colorite Corp. acquired 10,000 of the outstanding


shares
of Brown Co. On January 2, 2002, Colorite acquired an additional 20,000
shares of Brown Co., which brought the total ownership to 30,000 shares.
Using the normal guidelines for percentages of ownership and assuming
that Brown Co. had 100,000 shares outstanding during 2001 and 2002,
Colorite Corp. should account for the investment in Brown Co. by
a. using the cost method in 2001 and the equity method in 2002.
b. using the cost method in 2001, retroactively adjusting the investment
account to the equity method at the beginning of 2002, and using the
equity method in 2002.
c. using the equity method for 2001 and 2002.
d. using the cost method in 2001 and 2002 for the 10,000 shares acquired
in 2001, and using the equity method in 2002 for the 20,000 shares
acquired in 2002.

LO2

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Chapter 14 Investments in Debt and Equity Securities

d
LO4

23. Poster Inc. owns 35 percent of Elliott Corporation. During the calendar
year
2002, Elliott had net earnings of $300,000 and paid dividends of $36,000.
Poster mistakenly accounted for the investment in Elliott using the cost
method rather than the equity method of accounting. What effect would this
have on the investment account and net income, respectively?
a. Understate, overstate
b. Overstate, understate
c. Overstate, overstate
d. Understate, understate

c
LO7

24. If an investment in stock is reclassified from available-for-sale securities to


trading securities, the stock should be recorded on the date it is reclassified
at the
a. market value at the date of acquisition.
b. book value at the date of reclassification.
c. market value at the date of reclassification.
d. lower-of-cost-or-market value at the date of reclassification.

25. Northwick Company acquired 10,000 shares of the common stock of


Shaver
Corp. in July 2002. The following January, Shaver announced a $100,000
net income for 2002 and declared a cash dividend of $.50 per share on its
100,000 shares of outstanding common stock. The Northwick Company
dividend revenue from Shaver Corp. in January 2002 would be
a. $0.
b. $2,500.
c. $5,000.
d. $10,000.

LO4

c
LO4

26. On January 2, 2001, Reynolds Corporation bought 15 percent of Scorpio


Corporations capital stock for $60,000 and classified it as available-forsale securities. Scorpios net incomes for the years ended December 31,
2001 and 2002, were $20,000 and $100,000, respectively. During 2002,
Scorpio declared a dividend of $140,000. No dividends were declared in
2001. On December 31, 2002, the fair value of the Scorpio stock owned by
Reynolds had increased to $90,000. How much should Reynolds show on
its 2002 income statement as income from this investment?
a. $3,150
b. $15,000
c. $21,000
d. $51,000

a
LO4

27. On January 2, 2002, Adler Co. acquired 2,000 shares of Boxworth Co.
common stock for $8,000 and classified these shares as available-for-sale
securities. During 2002, Adler received $6,000 of cash dividends. Adlers
share of Boxworths 2002 earnings (net income) was $5,000. The fair value
of Boxworth's stock on December 31, 2002, was $7 per share. Adler should
report what amount in 2002 related to Boxworth Co.?
a. Revenue of $6,000
b. Revenue of $12,000
c. A $1,000 decrease in the investment account
d. A $1,000 increase in the investment account

29

b
LO5

c
LO5

28. On January 1, 2002, Young Co. paid $500,000 for 20,000 shares of
Montana
Co.s common stock and classified these shares as trading securities.
Young does not have the ability to exercise significant influence over
Montana. Montana declared and paid a dividend of $.50 a share to its
stockholders during 2002. Montana reported net income of $260,000 for
the year ended December 31, 2002. The fair value of Montana Co.'s stock
at December 31, 2002, is $27 per share. What is the net asset amount
(which includes both investments and any related market adjustments)
attributable to the investment in Montana that will be included on Young's
balance sheet at December 31, 2002?
a. $530,000
b. $540,000
c. $569,000
d. $579,000
29. Martin Co. purchased the following portfolio of trading securities during
2002
and reported the following balances at December 31, 2002. No sales
occurred during 2002. All declines are considered to be temporary.
Security
Cost
Market Value at 12/31/02
X
$ 80,000
$ 82,000
Y
140,000
132,000
Z
32,000
28,000
The carrying value of the portfolio at December 31, 2002, on Martin Co.s
balance sheet would be
a. $222,000.
b. $240,000.
c. $242,000.
d. $252,000.

a
LO5

30. Martin Co. purchased the following portfolio of available-for-sale securities


during 2002 and reported the following balances at December 31, 2002.
No sales occurred during 2002. All declines are considered to be
temporary.
Security
Cost
Market Value at 12/31/02
X
$ 80,000
$ 82,000
Y
140,000
132,000
Z
32,000
28,000

Martin Co. should report what amount related to the securities transactions
in its 2002 income statement?
a. $0
b. $2,000 unrealized loss
c. $10,000 unrealized loss
d. $12,000 unrealized loss
a
LO6

31. Marino Corporation purchased the following portfolio of trading securities


during 2002 and reported the following balances at December 31, 2002.
No sales occurred during 2002. All declines are considered to be
temporary.
Security
Cost
Market Value at 12/31/02
X
$ 80,000
$ 82,000
Y
140,000
132,000
Z
32,000
28,000
The only transaction in 2003 was the sale of security Z for $34,000 on
December 31, 2003. The market values for the other securities at
December 31, 2003 were the same as at December 31, 2002. Marino's
entry to record the sale of security Z would include
a. a credit of $2,000 to Realized Gain on Sale of Trading Securities.
b. a debit of $2,000 to Realized Gain on Sale of Trading Securities.
c. a $2,000 debit to Market Adjustment-Trading Securities.
d. a $4,000 debit to Market Adjustment-Trading Securities.

c
LO7

32. In March of 2001, Moon Corp. bought 45,000 shares of McMahon Corp.s
listed
stock for $450,000 and classified the shares as available-for-sale
securities. The market value of these shares had declined to $300,000 by
December 31, 2001. Moon changed the classification of these shares to
trading securities in June of 2002 when the market value of this investment
in McMahon's stock had risen to $345,000. How much should Moon
include as a loss on transfer of securities in its determination of net income
for 2002?
a. $0
b. $45,000
c. $105,000
d. $150,000

c
LO5

33. Walsh, Inc. began business on January 1, 2002, and at December 31,
2002,
Walsh had the following investment portfolios of equity securities:
Trading
Available-For-Sale
Aggregate cost
$150,000
$225,000
Aggregate market value
120,000
185,000
None of the declines is judged to be other than temporary. Unrealized
losses at December 31, 2002, should be recorded with corresponding
charges against
Stockholders
Income
Equity
a. $70,000
$ 0
b. $40,000
$30,000
c. $30,000
$40,000
d. $ 0
$70,000

c
LO4

34. In January 2002, Henry Corporation acquired 20 percent of the outstanding


common stock of Davis Company for $1,120,000. This investment gave
Henry the ability to exercise significant influence over Davis. The book
value of the acquired shares was $840,000. The excess of cost over book
value was attributed to an identifiable intangible asset that was
undervalued on Davis balance sheet and that had a remaining useful life of
ten years. For the year ended December 31, 2002, Davis reported net
income of $252,000 and paid cash dividends of $56,000 on its common
stock. What is the proper carrying value of Henrys investment in Davis at
December 31, 2002?
a. $1,080,800
b. $1,092,000
c. $1,131,200
d. $1,181,600

c
LO4

35. On January 1, 2002, Capitech Corporation acquired Logirun, Inc. as a


long-term investment for $250,000 (a 30 percent common stock interest in
Logirun). On that date, Logirun had net assets with a book value and
current market value of $800,000. During 2002, Logirun reported net
income of $90,000 and declared and paid cash dividends of $20,000.
What is the maximum amount of income that Capitech should report from
this investment for 2002?
a. $6,000
b. $21,000
c. $26,750
d. $27,000

b
LO4

36. On January 1, 2002, Mets Inc. purchased 30 percent of the outstanding


common stock of Pirates Corporation for $516,000 cash.
Mets is
accounting for this investment using the equity method. On the date of
acquisition, the fair value of Pirates' net assets was $1,240,000. Mets has
determined that the excess of the cost of the investment over its share of
Pirates' net assets is attributable to goodwill, which will be amortized over
the maximum allowable period. Pirates net income for the year ended
December 31, 2002, was $360,000. During 2002, Pirates declared and
paid cash dividends of $40,000. There were no other transactions between
the two companies. On December 31, 2002, the investment in Pirates
should be recorded as
a. $392,400.
b. $608,400.
c. $612,000.
d. $624,000.

b
LO4

37. On January 1, 2002, Mets Inc. purchased 30 percent of the outstanding


common stock of Pirates Corporation for $516,000 cash.
Mets is
accounting for this investment using the equity method. On the date of
acquisition, the fair value of Pirates' net assets was $1,240,000. Mets has
determined that the excess of the cost of the investment over its share of
Pirates' net assets is attributable to goodwill, which will be amortized over
the maximum allowable period. Pirates' net income for the year ended
December 31, 2002, was $360,000. During 2002, Pirates declared and
paid cash dividends of $40,000. There were no other transactions between
the two companies. Ignoring income taxes, Mets statement of income for
the year ended December 31, 2002, should include "Income From
Investment in Pirates Corporation Stock" in the amount of
a. $68,000.
b. $104,400.
c. $108,000.
d. $111,600.

b
LO3

38. On April 1, 2002, Ziba Inc. purchased as a temporary investment $100,000,


face amount, 10% U.S. Treasury notes; they pay interest semiannually on
January 1 and July 1. The notes were purchased at 102. Which of the
following entries correctly records this purchase?
a. Trading Securities--10% U.S. Treasury Notes........... 100,000
Interest Receivable.....................................................
2,500
Premium on Trading Securities..................................
2,000
Cash......................................................................
104,500
b. Trading Securities--10% U.S. Treasury Notes........... 102,000
Interest Receivable.....................................................
2,500
Cash......................................................................
104,500
c. Trading Securities--10% U.S. Treasury Notes........... 100,000
Interest Receivable.....................................................
4,500
Cash......................................................................
104,500
d. Trading Securities--10% U.S. Treasury Notes........... 102,000
Cash......................................................................
102,000

b
LO5

39. Edwards Company began business in February of 2001. During the year,
Edwards purchased the three trading securities listed below. On its
December 31, 2001, balance sheet, Edwards appropriately reported a
$4,000 credit balance in its Market Adjustment--Trading Securities account.
There was no change during 2002 in the composition of Edwards portfolio
of trading securities. Pertinent data are as follows:
Market Value
Security
Cost
December 31, 2002
A
$120,000
$126,000
B
90,000
80,000
C
160,000
157,000
$370,000
$363,000
What amount of loss on these securities should be included in Edwards
income statement for the year ended December 31, 2002?
a. $0
b. $3,000
c. $7,000
d. $11,000

d
LO5

40. Edwards Company began business in February 2001. During the year,
Edwards purchased the three trading securities listed below. On its
December 31, 2001, balance sheet, Edwards appropriately reported a
$4,000 debit balance in its Market Adjustment--Trading Securities account.
There was no change in 2002 in the composition of Edwards portfolio of
marketable equity securities held as a temporary investment. Pertinent
data are as follows:
Market Value
Security
Cost
December 31, 2002
A
$120,000
$126,000
B
90,000
80,000
C
160,000
157,000
$370,000
$363,000
What amount should Edwards credit to the Market Adjustment--Trading
Securities account at December 31, 2002?
a. $0
b. $3,000
c. $7,000
d. $11,000

b
LO5

41. Tyler Company began operations in 2001.


The company's trading
securities
portfolio, which did not change in composition during 2002, is as follows:
December 31, 2002
Unrealized
Cost
Market
Gain (Loss)
Archer, Inc.......................
$ 100,000
$ 100,000
$
0
Kelly Company................
200,000
150,000
(50,000)
Pelt Company..................
250,000
260,000
10,000
$ 550,000
$ 510,000
$ (40,000)
December 31, 2001
Archer, Inc.......................
Kelly Company................
Pelt Company..................

Cost
$ 100,000
200,000
250,000
$ 550,000

Market
$ 135,000
210,000
180,000
$ 525,000

Unrealized
Gain (Loss)
$ 35,000
10,000
(70,000)
$ (25,000)

Ignoring income taxes, what amount should be reported as an unrealized


loss on trading securities in Tylers 2002 income statement?
a. $0
b. $15,000
c. $25,000
d. $40,000
b
LO7

42. On August 31, 2002, Stiggins Company purchased the following availableforsale securities:
Market Value
Security
Cost
December 31, 2002
D
$ 96,000
$ 84,000
E
152,000
158,000
F
162,000
146,000
On December 31, 2002, Stiggins reclassified its investment in security F
from available-for-sale securities to trading securities. What total amount
of loss on these securities should be included in Stiggins income statement
for the year ended December 31, 2002?
a. $0
b. $16,000
c. $22,000
d. $28,000

d
LO6

43. During 2001, Barney Company purchased marketable equity securities as a


short-term investment and classified them as trading securities. The cost
and market value at December 31, 2001, were as follows:
Market Value
Security
Cost
December 31, 2001
X 200 shares
$ 8,400
$ 10,200
Y 2,000 shares
51,000
45,900
Z 4,000 shares
94,500
88,500
$153,900
$144,600
Barney sold 1,000 shares of Company Y stock on March 16, 2002, for $25
per share, incurring $1,200 in brokerage commissions and taxes. On the
sale, Barney should report a realized loss of
a. $0.
b. $500.
c. $850.
d. $1,700.

b
LO3

44. On October 1, Dennis Company purchased $200,000 face value 12%


bonds
for 98 plus accrued interest and brokerage fees and classified them as
held-to-maturity securities. Interest is paid semiannually on January 1 and
July 1. Brokerage fees for this transaction were $700. At what amount
should this acquisition of bonds be recorded?
a. $196,000
b. $196,700
c. $202,000
d. $202,700

PROBLEMS
Problem 1
In 2002, KZF Inc. purchased stock as follows:
(a) Acquired 2,000 shares of Gallery Arts Corp. common stock (par value $20) in
exchange for 1,200 shares of KZF Inc. preferred stock (par value $30). The
preferred stock had a market value of $75 per share on the date of the
exchange.
(b) Purchased 800 shares of Champion Corp. common stock (par value $10) at
$70 per share, plus a brokerage fee of $800.
At December 31, 2002, the market values of the securities were as follows:
Security
KZF Inc.
Gallery Arts Corp.
Champion Corp.

Market Value
$71
41
72

The investments in common stock are classified by KZF Inc. as available-for-sale


securities accounted for by the cost method. The fiscal year of KZF ends on
December 31.
(1) Prepare all entries relating to the investments in common stock for 2002.
(2) Prepare the entry to record the sale of 200 shares of Champion Corp. common
stock on January 15, 2003, at $74 per share.
(3) Prepare the entry to reclassify the remaining 600 shares of Champion Corp.
common stock from available-for-sale securities to trading securities on
January 31, 2003. The stock was selling at $67 per share on that date.

Solution 1
LO3, LO5, LO6
(1) Available-for-Sale Securities--Gallery Corp.
Stock (1,200 x $75)...............................................................
Preferred Stock (1,200 x $30)......................................
Paid-In Capital in Excess of Par (1,200 x $45)............
Available-for-Sale Securities--Champion Corp.
Stock [(800 x $70) + $800]......................................................
Cash ......................................................................
Security
Gallery Corp.
Champion Corp.

Cost
$ 90,000
56,800
$146,800

Market
Value
$ 82,000
57,600
$139,600

90,000
36,000
54,000
56,800
56,800

Increase/
Decrease
$(8,000) (2,000 x $41)
800 (800 x $72)
$(7,200)

Unrealized Increase/Decrease in Value of Available-forSale Securities.................................................................


Market AdjustmentAvailable-for-Sale Securities. . .

7,200

(2) Cash (200 x $74).................................................................. 14,800


Realized Gain on Sale of Trading Securities
[($74-$71) x 200]............................................................
Available-for-Sale Securities--Champion Corp. Stock
(3) Investment in Trading Securities--Champion Corp. Stock
(600 x $67).........................................................................
40,200
Unrealized Increase/Decrease in Value of Available-forSale Securities--Equity....................................................
600
Unrealized Loss on Transfer of Securities--Income........
2,400
Market Adjustment--Available-for-Sale Securities...
Investment in Available-for-Sale Securities--Champion
Corp. Stock...........................................................

7,200

600
14,200

600
42,600

Problem 2
Webster Inc. carries the following marketable equity securities on its books at
December 31, 2001 and 2002. All securities were purchased during 2001 and
there were no beginning balances in any market adjustment accounts.
Trading Securities:
Cost
V Company $ 50,000
W Company 26,000
X Company 70,000
Total $146,000

Market
December 31, 2001
$ 26,000
40,000
60,000
$126,000

Market
December 31, 2002
$ 40,000
40,000
50,000
$130,000

$360,000
120,000
$480,000

$100,000
140,000
$240,000

Available-for-Sale Securities:
Y Company $420,000
Z Company 100,000
Total $520,000

The cost method is used in accounting for all investments in securities.


(1) Give the entries necessary to record the valuations for both trading and
available-for-sale securities at December 31, 2001 and 2002.
(2) What net effect would these valuations have on 2001 and 2002 net income?
Solution 2
LO5
(1) 2001
Dec. 31

Unrealized Loss on Trading Securities ................ 20,000


Market Adjustment--Trading Securities......
20,000
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities................................ 40,000
Market Adjustment--Available-for-Sale
Securities.........................................................
40,000

2002
Dec. 31
Dec. 31

Market Adjustment--Trading Securities.................


Unrealized Gain on Trading Securities...........

4,000
4,000

Unrealized Increase/Decrease in Value of


Available-for-Sale Securities...............................240,000
Market AdjustmentAvailable-for-Sale
Securities.......................................................
240,000

(2) Effect of valuation entries on 2001 net income:


Recognized decline in value of trading securities........
Effect of valuation entries on 2002 net income:
Recognized increase in value of trading securities......

$(20,000)
$4,000

Problem 3
On January 1, 2002, Alsop Corp. acquired 30 percent (13,000 shares) of Stone
Services Inc. common stock for $1,300,000 as a long-term investment. Data from
Stones 2002 financial statements include the following:
Net income.............................................................................
Less cash dividends paid......................................................
Increase in retained earnings................................................

$330,000
160,000
$170,000

The market value of Stone Services Inc. common stock on December 31, 2002,
was $98 per share. Alsop does not have any other noncurrent investments in
securities.
Prepare the necessary journal entries for Alsops investment in Stone Services Inc.
common stock under
(1) the cost method classified as available-for-sale securities.
(2) the equity method.

Solution 3
LO4, LO5
(1) Investment in Available-for-Sale Securities--Stone
Services Stock.................................................................1,300,000
Cash.........................................................................
Cash ($160,000 x 30%).........................................................
Dividend Revenue...................................................
Unrealized Increase/Decrease in Value of Availablefor-Sale Securities--Equity (13,000 shares x $2)....................
Market Adjustment--Available-for-Sale Securities...

48,000
48,000
26,000
26,000

(2) Investment in Stone Services Inc....................................1,300,000


Cash.........................................................................
Cash.................................................................................
Investment in Stone Services Inc. Stock.................
Investment in Stone Services Inc. Stock
($330,000 x 30%)...................................................................
Income from Investment in Stone Services
Inc. Stock.................................................................

1,300,000

1,300,000

48,000
48,000
99,000
99,000

Problem 4
On January 1, 2002, Gardner Associates purchased 30 percent of the outstanding
shares of stock of Gillen Corp. for $150,000 cash. The investment will be
accounted for by the equity method. On that date, Gillens net assets (book and
fair value) were $300,000. Gardner has determined that the excess of the cost of
its investment in Gillen over its share of Gillens net assets is attributable to
goodwill, which will be amortized over the maximum allowable period.
Gillens net income for the year ended December 31, 2002, was $60,000. During
2002, Gardner received $5,000 cash dividends from Gillen. There were no other
transactions between the two companies.
Compute the amount that would be reported on Gardner Associates books for the
investment in Gillen Corp. at December 31, 2002.

Solution 4
LO4
Investment in Gillen Corp. stock:
Original investment..................................................................$150,000
Share of net income--30% of $60,000..................................... 18,000
Amortization of implied goodwill*............................................. (1,500)
Dividends received................................................................... (5,000)
Total....................................................................................$161,500
* Implied value of Gillen Corp.:
Implied value: $150,000/.30 = $500,000
Implied goodwill: $500,000 - $300,000 = $200,000
Gardner's share of goodwill: $200,000 x .3 = $60,000
Amortization of implied goodwill: $60,000/40-year life = $1,500
Problem 5
On July 1, 2002, Mountain Systems acquired 8,000 shares of Precision Services
40,000 outstanding common shares at a cost of $240,000. The book value and fair
market value of Precision's net assets on that date was $880,000. The following
data pertain to Precision Services for 2002.
Net income reported in 2002:
January 1 - June 30................................................................. $28,000
July 1 - December 31............................................................... 36,000
Total.................................................................................... $64,000
Cash dividends declared and paid:
January 1 - June 30................................................................. $30,000
July 1 - December 31............................................................... 30,000
Total.................................................................................... $60,000
(1)
(2)
(3)
(4)

Prepare the entry to record the original investment on July 1.


Compute the goodwill (if any) on the purchase.
Prepare the necessary entries (other than acquisition) for 2002 on Mountain
Systems books using the cost method.
Prepare the necessary entries (other than acquisition) for 2002 on Mountain
Systems books using the equity method.

Solution 5
LO4, LO5
(1) Investment in Precision Services Stock........................
Cash......................................................................
(2) Goodwill computation:
Purchase price..............................................................
Fair market value of net assets.............................
8,000/40,000 shares.............................................
Fair market value of Mountains share of net assets....
Goodwill.........................................................................

240,000
240,000
$240,000
$880,000
x
20%

(3) Cost method:


Cash ($30,000 x 20%)........................................................
Dividend Revenue.................................................
Cash dividends received (July 1 - December 31).
(4) Equity method:
Cash..............................................................................
Investment in Precision Services Stock................
Cash dividends received (July 1 - December 31).

176,000
$ 64,000
6,000
6,000

6,000
6,000

Investment in Precision Services Stock ($36,000 x 20%)..


7,200
Income from Investment in Precision Stock..........
20% share of investee earnings (July 1 - December 31).
Income from Investment in Precision Stock
($64,000/40 yrs. x yr.).....................................................
Investment in Precision Services Stock................
Amortization of goodwill for 6 months.

7,200

800
800

Problem 6
Joseph Co. executed the following long-term investment transactions during the
current year.
Feb. 6

Purchased 1,000 shares of Large Auto Co. for $40 per share plus
brokerage costs of $225. These shares were classified as trading
securities.

Mar. 31

Purchased 60,000 of the 200,000 outstanding common shares of New


Tech Corp. for $600,000. Goodwill of $160,000 was included in the
purchase price.

June 20

Received a $2.20 per share dividend on Large Auto Co. shares.

June 30

New Tech Corp. reported second quarter earnings (total) of $40,000.

Sept. 4

Acquired 4,000 shares of Mega Conglomerates stock for $30 per share
plus $600 transaction costs. These shares were classified as availablefor-sale securities.

Dec. 31

Market values of Large Auto Co. and Mega Conglomerate stock were
$45 and $28 per share, respectively.

Prepare journal entries with appropriate supporting computations for the years
transactions.
Solution 6
LO4, LO5
Feb. 6
Investment in Trading Securities-Large Auto Co. Stock............................................
Cash.................................................................
Mar. 31
June 20
June 30

June 30

Sept. 4

40,225
40,225

Investment in New Tech Corp. Stock.................... 600,000


Cash.................................................................
Cash (1,000 x $2.20)..................................................
Dividend Revenue...........................................

2,200

Investment in New Tech Corp. Stock....................


Income from Investment in New Tech Corp.
Stock................................................................
To record share of New Tech Corp. earnings
($40,000 x 30% ownership).

12,000

Income from Investment in New Tech Corp. Stock


Investment in New Tech. Corp. Stock..............
To record amortization of goodwill for three
months ($160,000/40 years x 3/12).

1,000

600,000
2,200

12,000

Investment in Available-for-Sale Securities--Mega


Conglomerate Stock [(4,000 x $30) + $600]................ 120,600
Cash.................................................................

1,000

120,600

Dec. 31

Market AdjustmentTrading Securities.................


4,775
Unrealized Gain on Trading Securities...........
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities................................
8,600
Market Adjustment--Available-for-Sale Securities

Cost
Large Auto Co.................................................................. $ 40,225
Mega Conglomerate........................................................ 120,600

4,775
8,600
Market
$ 45,000
112,000

Problem 7
On July 1, 2002, The Woodward Group purchased for cash 35 percent of the
outstanding capital stock of Massey Studios. Both The Woodward Group and
Massey Studios have a December 31 year-end. Massey Studios, whose common
stock is actively traded in the over-the-counter market, reported its total net income
for the year to The Woodward Group and also paid cash dividends on November
15, 2002, to The Woodward Group and its other stockholders.
How should The Woodward Group report the above facts in its December 31,
2002, balance sheet and its income statement for the year then ended? Discuss
the rationale for your answer.
Solution 7
LO4
The Woodward Group should follow the equity method of accounting for its
investment in Massey Studios because The Woodward Group is presumed,
because of the size of its investment, to be able to exercise significant influence
over the operating and financial policies of Massey Studios.
In 2002, The Woodward Group should report its interest in Massey Studios
outstanding capital stock as a long-term investment. Following the equity method
of accounting, The Woodward Group should record the cash purchase of 35
percent of Massey Studios at cost, which is the amount paid.
Thirty-five percent of Massey Studios total net income from July 1, 2002, to
December 31, 2002, should be added to the carrying amount of the investment in
The Woodward Groups balance sheet and shown as revenue in its income
statement to recognize The Woodward Groups share of the net income of Massey
Studios after the date of acquisition. This amount should reflect adjustments
similar to those made in preparing consolidated statements, including adjustments
to eliminate intercompany gains and losses, and to amortize, if appropriate, any
difference between The Woodward Groups cost and the underlying equity in net
assets of Massey Studios on July 1, 2002.

The cash dividends paid by Massey Studios to The Woodward Group should
reduce the carrying amount of the investment in The Woodward Groups balance
sheet and have no effect on The Woodward Groups income statement.
Problem 8
On February 1, 2002, Pyle Inc. had excess cash on hand. The controller
suggested to management that the company buy $200,000 of U.S. Treasury bonds
selling at 102 and paying 8 percent interest. Interest payments on these bonds are
made semiannually on January 1 and July 1.
(1) Prepare entries to record the February purchase of U.S. Treasury bonds and
the subsequent collection of interest on July 1, using
(a) the asset approach.
(b) the revenue approach.
(2) Assuming that these bonds were acquired as an investment in trading
securities, explain whether the premium or discount should be amortized.
Solution 8
LO2, LO4
(1) (a) Investment--Trading Securities................................ 204,000
Interest Receivable (200,000 x 8% x 1/12).....................
1,333
Cash...................................................................
Cash ......................................................................
Interest Receivable............................................
Interest Revenue................................................
(b)

8,000
1,333
6,667

Investment--Trading Securities................................ 204,000


Interest Revenue.....................................................
1,333
Cash...................................................................
Cash ......................................................................
Interest Revenue................................................

205,333

205,333

8,000
8,000

(2) Periodic amortization of the premium or discount is used when bonds are
acquired at a higher or lower price than their maturity value and it is expected
that they will be held until maturity. However, when bonds are acquired as a
temporary investment and it is not likely that the bonds will be held until
maturity, such procedures are normally not applied.
Problem 9
The following transactions of the Snyder Company were completed during the fiscal
year just ended:

(a)

Purchased $100,000 of U.S. Treasury 7% bonds, paying 102.5 plus


accrued interest of $1,750. In addition, the company paid brokerage fees
of $500.
Snyder Company uses the revenue approach to record accrued interest.
Snyder classified these bonds as a trading security.

(b)

Purchased 1,000 shares of Ferris Company common stock at $125 per


share plus brokerage fees of $950. Snyder classifies this stock as and
available-for-sale security.

(c)

Received semiannual interest on the U.S. Treasury Bonds.

(d)

Sold 150 shares of Ferris at $132 per share.

(e)

Sold $16,000 of U.S. Treasury 7% bonds at 102 plus accrued interest of

(f)

Purchased a $12,000, 6-month certificate of deposit. The certificate is


classified as a trading security.

$93.

Prepare the entries necessary to record the above transactions.


Solution 9
LO6
(a) Investment in Trading Securities--Treasury Bonds................103,000
Interest Revenue.................................................................... 1,750
Cash.................................................................................
104,750
1.025 x 100,000 = $102,500; $102,500 + 500 brokerage fee = $103,000
(b) Investment in Available-for-Sale Securities............................125,950
Cash.................................................................................
125,950
(c) Cash........................................................................................ 3,500
Interest Revenue..............................................................
(d) Cash........................................................................................19,800
Investment in Available-for-Sale Securities.....................
Gain on Sale....................................................................
$132 x 150 shares = $19,800; 150/1,000 x $125,950 = $18,893;
$19,800 - $18,893 = $907.
(e) Cash........................................................................................ 16,413
Realized Loss on Sale of Securities.......................................
160
Investment in Trading Securities--Treasury Bonds.........
Interest Revenue..............................................................
($16,000 x 1.02) + ($16,000 x .035 x 1/6) = $16,413.

3,500
18,893
907

16,480
93

$16,000/$100,000 x 103,000 = $16,480.


(f) Investment in Trading Securities--Certificate of Deposit........ 12,000
Cash.................................................................................

12,000

Problem 10
Lee Company had the following portfolio of securities at the end of its first year of
operations:
Year-End
Security Classification
Cost
Market Value
A
Trading
$18,000
$23,000
B
Trading
$25,000
$27,000
(1) Provide the entry necessary to adjust the portfolio of securities to market value.
(2) After adjusting the securities to market, Lee elects to reclassify Security B as an
available-for-sale security. On the date of the transfer, Security Bs market value is
$26,500. Provide the journal entry to reclassify Security B.
Solution 10
LO7
(1)
Market Adjustment--Trading Securities............................
Unrealized Gain on Trading Securities...................
(2)

Investment in Available-for Sale Securities--Security B. .


Unrealized Loss on Transfer of Securities......................
Market Adjustment--Trading Securities...................
Investment in Trading Securities--Security B..........

7,000
7,000
26,500
500
2,000
25,000

Entry reclassifies security as available-for-sale at current fair value of $26,500


and removes historical cost of trading security of $25,000.
Unrealized loss represents the difference between fair value at the beginning
of
the period and fair value on date of transfer.

Problem 11
On January 1, 2001, Paxman Company purchased 50% of Monroe Company for cash
of $660,000. On that date the net assets of Monroe Company had a book value of
$1,200,000. The difference between fair value and book value is attributed to goodwill
and is amortized over 20 years. On January 1, 2002, Paxman sold 70% of its
ownership in Monroe for $525,000 and reclassified the remaining stock as availablefor-sale. Net income and dividends for 2001 and 2002 for Monroe are given below:
2001
2002
Net income ...................................................................... $80,000 $90,000
Dividends......................................................................... 18,000 25,000
Prepare the required journal entries made by Paxman Company relating to its
investment in Monroe for the years 2001 and 2002 assuming no change in market
value during the 2-year period.
Solution 11
LO10
2001
Investment in Monroe Company...................................... 660,000
Cash.........................................................................
660,000
Investment in Monroe Company...................................... 40,000
Income from Investment in Monroe Stock...............
($80,000 x 50% = 40,000)
Cash.................................................................................
Investment in Monroe Company..............................
($18,000 x 50% = 9,000)

9,000

Income from Investment in Monroe Stock.......................


Investment in Monroe Company..............................
[$660,000 - ($1,200,000 x 50%) = $60,000]
($60,000 20 = $3,000]

3,000

40,000

9,000

3,000

2002
Cash................................................................................. 525,000
Investment in Monroe Company..............................
Gain on Sale of Monroe Stock.................................

481,600
43,400

Book value at end of 2001 = $660,000 + $40,000 - $9,000 - $3,000 =


$688,000.
$688,000 x 70% = $481,600.
$525,000 - $481,600 = $43,400.
Cash................................................................................. 3,750
Dividend Revenue...................................................

3,750

Problem 12
Park Company purchased 18% of the outstanding common stock of Ray Company on
January 1, 2001, when the net assets of Ray Company had a book value and fair value
of $400,000. Park Company paid $72,000 for this investment. On January 1, 2002,
Park purchased an additional 10% of the outstanding stock of Ray Company, paying
another $41,000. (Assume the book and fair values of the net assets is $410,000).
Ray Company reported income and dividends for 2001 and 2002 are given below:
2001
2002
Net income ...................................................................... $40,000 $50,000
Dividends......................................................................... 30,000 30,000
Prepare the journal entries made by Park during 2001 and 2002 related to its
investment in Ray Company, including the adjusting entries needed to reflect the
change from an available-for-sale security to the equity method.
Solution 12
LO10
2001
Jan. 1 Investment in Available-for-Sale Securities
Ray Company................................................................... 72,000
Cash.........................................................................
Dec. 31 Cash (.18 x $30,000).............................................................
Dividend Revenue...................................................

72,000

5,400
5,400

51

Test Bank, Intermediate Accounting, 14th ed.

2002
Jan. 1

Investment in Ray Company............................................ 114,800


Cash.........................................................................
Retained Earnings...................................................
Investment in Available-for-Sale Securities-Ray Company..........................................................

41,000
1,800
72,000

Computation of adjustment to retained earnings:


Equity in Ray Co. earnings (18% x $40,000)................. $7,200
Dividends received.................................................. (5,400)
Retroactive adjustment to change from cost to
equity method.......................................................... $1,800
Dec. 31 Investment in Ray Company (.28 x $50,000)........................ 14,000
Income from Investment in Ray Company...............

14,000

Cash.................................................................................
Investment in Ray Company....................................

8,400

8,400

Problem 13
The Financial Accounting Standards Board had several goals in issuing Statement of
Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt
and Equity Securities, and changing the accounting for certain debt and equity
securities from a lower-of-cost-or-market basis to a fair value basis. Among these
goals was the elimination of what is termed gains trading.
Explain the meaning of the term gains trading.
Solution 13
LO5
The term gains trading refers to the practice of management of selectively selling
securities the prices of which have appreciated and including the realized gains in
earnings. Gains trading results from the use of amortized cost accounting and the
available-for-sale classification.
The use of amortized cost permits recognition of holding gains through selected sales
of appreciated securities and the inclusion of these realized holding gains in earnings.
At the same time, use of amortized cost does not provide for the recognition of
unrealized losses. Managers thus can selectively manage earnings by choosing to sell
those securities that have appreciated while selectively excluding unrealized losses
from earnings. Debt and equity securities classified as available-for-sale are reported
at fair value but unrealized changes in fair value are excluded from earnings.

52

Chapter 14 Investments in Debt and Equity Securities

Managers again can selectively sell securities the prices of which have appreciated
and include the realized gains in earnings. Securities for which prices have dropped
are held. The available-for-sale treatment thus permits unrealized gains and losses to
be excluded from earnings since these unrealized gains and losses are reported in a
separate component of stockholders equity.
Problem 14
Investments in debt securities currently are permitted to be classified as held-tomaturity and accounted for at amortized cost if an enterprise has the positive intent and
ability to hold these securities to maturity. The held-to-maturity classification is the
most restrictive of the three classifications specified in accounting standards. Despite
the restrictiveness of the held-to-maturity classification, certain changes in
circumstances may occur that would necessitate transferring an investment in a debt
security from the held-to-maturity classification without calling into question the
investors general intention to hold other similarly classified investments to maturity.
What types of circumstances would cause an investor in debt securities classified as
held-to-maturity to change that classification without calling into question the intent of
the investor to hold other similarly classified investments to maturity?
Solution 14
LO2
The following changes in circumstances may cause an investor to change its intent to
hold a certain security to maturity without calling into question its intent to hold other
debt securities to maturity in the future:
1. Evidence of a significant deterioration in the issuers creditworthiness. The
deterioration must be actual and not based on speculation.
on
that

2. A change in tax law eliminates or reduces the tax-exempt status of interest


the debt security. This provision does not include a change in tax law
revises the marginal tax rates applicable to interest income.

3. A major business combination or major disposition (such as the sale of a


segment) necessitates the sale or transfer of held-to-maturity securities to
maintain the enterprises existing interest rate risk position or credit risk policy.
4. A change in statutory or regulatory requirements significantly modifying
either
what constitutes a permissible investment or the maximum level of
investments
in certain kinds of securities, thereby causing an enterprise to
dispose of a
held-to-maturity security.

Test Bank, Intermediate Accounting, 14th ed.

53

5. A significant increase by the regulator in the industrys capital requirements


that causes the enterprise to downsize by selling held-to-maturity securities.
6.
regulatory

A significant increase in the risk weights of debt securities used for


risk-based capital purposes.

Problem 15
On January 1, 2001, Arthur Company paid $450,000 for 10,000 shares of DW
Company voting common stock, which represented a 15% interest in DW. At this date,
the net assets of DW Company totaled $2.5 million. The fair values of DW Companys
identifiable assets and liabilities were equal to their book values. Arthur did not have
the ability to exercise significant influence over the operating and financial policies of
DW as a result of this investment. Arthur received dividends of $0.80 per share from
DW on October 1, 2001. DW reported net income of $300,000 for the year ended
December 31, 2001. The stock was classified as available-for-sale. Market prices for
the 10,000 shares was $450,000.
On July 1, 2002, Arthur paid $1,550,000 for 30,000 shares of DW Companys voting
common stock, which represents a 25% interest in DW. The fair value of the
identifiable assets, net of liabilities of DW was equal to their book values of $4,650,000.
As a result of this transaction, Arthur acquired the ability to exercise significant
influence over the operating and financial policies of DW. Arthur received a dividend of
$0.85 per share from DW on April 1, 2002, and $1.40 per share on October 1, 2002.
DW reported net income of $350,000 for the year ended December 31, 2002, and
$150,000 for the six months ended December 31, 2002. Arthur amortizes goodwill over
20 years.
Determine the amount of income from the investment in DW common stock that should
be reported on Arthurs income statement for the year ended December 31, 2002, and
December 31, 2001 (restated).
Solution 15
LO10
2002
Income from investment in DW Company.....................................
$45,000
Less: Goodwill amortization.........................................................
3,750
Income from investment............................................................... 76,562
Arthurs share of DW income:
2002
Income for 2001 (300,000 x .15)...................................................
Income for 2002:
First half (200,000 x .15)... $30,000

2001
$90,000
13,438
$41,250
2001
$45,000

54

Chapter 14 Investments in Debt and Equity Securities

Second half (150,000 x .40)................................................... 60,000


$90,000
Goodwill amortization:
Goodwill on 2001 acquisition:
[$450,000 (.15 x $2,500,000) = $75,000 20]...........................$ 3,750
Goodwill on 2002 acquisition:
[$1,550,000 (.25 x $4,650,000) = $387,500 20 x ]............... 9,688
$13,438

$45,000

$ 3,750

$ 3,750

Problem 16
EMD Corp. loaned $200,000 to Alco Corp. on January 1, 2001. The terms of the loan
require principal payments of $40,000 each year for five years plus interest at 8%. The
first principal and interest payment is due on January 1, 2002. Alco made the required
payments during 2002 and 2003. Alco began to experience financial difficulties in
2003, however, which made it necessary for EMD to reassess the likelihood of the loan
being collected. On December 31, 2003, EMD determines that the principal payments
will be collected, but that the collection of interest is unlikely.
(1) Compute the present value of the expected future cash flows as of December 31,
2003.
(2) Provide the journal entry to record the loan impairment as of December 31, 2003.
(3) Provide the journal entries for 2004 to record receipt of the principal payment on
January 1 and the recognition of interest revenue as of December 31, assuming that
EMDs assessment of the likelihood of collecting the loan has not changed.
Solution 16
LO11
(1) Present value of expected future cash flows:
Date
Payment Time of Discount
Jan. 1, 2004
$40,000
now
Jan. 1, 2005
$40,000
1 year
Jan. 1, 2006
$40,000
2 years
Present value at December 31, 2003

Table Value
1.000
.9259
.8573

Present Value at 8%
$ 40,000
37,036
34,292
$111,328

55

Test Bank, Intermediate Accounting, 14th ed.

(2) Journal entry to record impairment:


12/31/2003 Bad Debt Expense
Allowance for Loan Impairment.....................

8,672
8,672

(3) Journal entries made during 2004:


1/01/2004 Cash
Loan Receivable.

40,000

12/31/2004 Allowance for Loan Impairment...........................


Interest Revenue
[($111,328 - $40,000) x .08 = 5,706]

5,706

40,000
5,706

56

Chapter 14 Investments in Debt and Equity Securities

CHAPTER 14 -- QUIZ A
Name _________________________
Section ________________________
T F 1. An investment in stock is initially recorded at cost and all commissions, taxes,
and other fees are expensed as incurred, under both the cost and equity
methods.
T F 2. Under some circumstances, consolidated financial statements are appropriate
even though the parent company owns less than 50 percent of the voting
stock of the subsidiary.
T F 3. Accounting practice allows companies not to consolidate certain
majority-owned subsidiaries if these subsidiaries have nonhomogeneous
operations, a large minority interest, or a foreign location.
T F 4. The cost method of accounting should always be used when the investor does
not exercise significant influence over the investee.
T F 5. The equity method may not be appropriate in some cases even though the
investor owns more than 20 percent of the voting stock of the investee.
T F 6. As a general rule, consolidated financial statements should be prepared only
when the parent corporation owns 80 percent or more of the outstanding
common stock of the subsidiary.
T F 7. Under the cost method, the investment account is periodically adjusted to
reflect changes in the underlying net assets of the investee.
T F 8. When an investment in equity securities has been accounted for under the
equity method, but circumstances dictate a change to the cost method,
retroactive application of the cost method is required.
T F 9. When the purchase price of stock is greater or less than the underlying book
value of the investees net assets, an adjustment is made by the investor to
the income reported by the investee in applying the equity method.
T F 10. No adjustment is made to the investment account when changing from the
equity method to the cost method.

CHAPTER 14 -- QUIZ B
Name _________________________
Section ________________________
T F 1. Unrealized holding gains and losses on investments in trading securities are
recognized on the income statement.
T F 2. Unrealized gains and losses on investments in available-for-sale securities
are recognized on the income statement.
T F 3. A debit balance in the account Market AdjustmentAvailable-for-Sale
Securities implies a corresponding owners' equity account with a credit
balance of the same amount.
T F 4. For balance sheet classification, securities are classified as short -term or
long-term investments based on managements intended holding period.
T F 5. The net reported balance in the available-for-sale securities investment
account is the original cost plus a credit balance in the market adjustment
account or minus a debit balance in the market adjustment account.
T F 6. When investments in trading securities are sold, the realized gain or loss is
the difference in the market value since acquisition.
T F 7. Unrealized holding gains on investments in held-to-maturity securities are
recognized as a direct increase to owners' equity.
T F 8. Increases in the market value of trading securities and available-for-sale
securities investments cause the related market adjustment account to
decrease.
T F 9. Investments in trading securities may be classified as current or long-term.
T F 10. If an investor does not have a controlling interest in another company, the
investor may choose to use either the cost method or the equity method to
account for that investment in equity securities.

57

CHAPTER 14 -- QUIZ C

A.
B.
C.
D.
E.
F.
G.

Name _________________________
Section ________________________

Cost method
Significant influence
Parent company
Long-term investments
Subsidiary company
Market method
Control

H.
I.
J.
K.
L.
M.
N.

Equity method
Merger
Consolidation
Nonconvertible investments
Executory contract
Available-for-sale securities
Trading securities

Select the term that best fits each of the following definitions and descriptions. Indicate
your answer by placing the appropriate letter in the space provided.
____ 1.

A company that is owned or controlled by another company.

____ 2.

The ability of an investor to impact the operating, investing, and financing


decisions of an investee but not absolutely determine those decisions.

____ 3.

The ability of an investor to decisively influence the operating, investing,


and financial decisions made by an investee.

____ 4.

An accounting method under which the initial investment is recorded and


maintained at cost with dividends being recognized as revenue when
received.

____ 5.

An accounting method that combines the financial statement balances of


the parent and subsidiary companies as if they were one total economic
unit.

____ 6.

A company that exercises control over other companies through majority


ownership of voting stock.

____ 7.

An accounting method under which the initial investment is recorded at


cost and subsequently is increased by a proportionate share of earnings
and decreased by dividends.

____ 8.

Investments that are either not readily marketable or not expected to be


converted to cash within a year.

____ 9.

Securities purchased with the intent of selling them in the near future.

____ 10.

Securities purchased without the intent of selling them in the near future.
58

CHAPTER 14 -- QUIZ SOLUTIONS


Quiz A
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

F
F
F
T
T
F
F
F
T
T

Quiz B
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

T
F
T
T
F
F
F
F
F
F

Quiz C
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

E
B
G
A
J
C
H
D
N
M