Investments

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Chapter 17 Investments

QUESTIONS
1
. Distinguish between a debt security and an equity security.
2
. What purpose does the variety in bond features (types and characteristics) serve?
3
. What is the cost of a long-term investment in bonds?
4
. Identify and explain the three types of classifications for investments in debt securities.
5
. When should a debt security be classified as held-tomaturity?
6
. Explain how trading securities are accounted for and reported.
7
. At what amount should trading, available-for-sale, and held-to-maturity securities be reported on the balance sheet?
8
. On July 1, 2014, Wheeler Company purchased $4,000,000 of Duggen Company’s 8% bonds, due on July 1, 2021.
The bonds, which pay interest semiannually on January 1 and July 1, were purchased for $3,500,000 to yield 10%.
Determine the amount of interest revenue Wheeler should report on its income statement for the year ended
December 31, 2014.
9
. If the bonds in Question 8 are classified as available-forsale and they have a fair value at December 31, 2014, of $3,604,000, prepare the journal entry (if any) at December
31, 2014, to record this transaction.
1
0. Indicate how unrealized holding gains and losses should be reported for investments securities classified as trading, available-for-sale, and held-to-maturity.
1
1. (a) Assuming no Fair Value Adjustment (available-forsale) account balance at the beginning of the year, prepare the adjusting entry at the end of the year if Laura Company’s available-for-sale securities have a fair value $60,000 below cost. (b) Assume the same information as part (a), except that Laura Company has a debit balance in its Fair Value Adjustment account of $10,000 at the beginning of the year. Prepare the adjusting entry at year-end.
1
2. Identify and explain the different types of classifications for investments in equity securities.
1
3. Why are held-to-maturity investments applicable only to debt securities?
1
4. Hayes Company sold 10,000 shares of Kenyon Co. common stock for $27.50 per share, incurring $1,770 in brokerage commissions. These securities were classified as trading and originally cost $260,000. Prepare the entry to record the sale of these securities.
1
5. Distinguish between the accounting treatment for availablefor- sale equity securities and trading equity securities.
16. What constitutes “significant influence” when an investor’s financial interest is below the 50% level?
17. Explain how the investment account is affected by investee activities under the equity method.
18. Your classmate Kate believes that the equity method is applied with a strict application of the “20%” rule. Do you agree? Explain.
19. Hiram Co. uses the equity method to account for investments in common stock. What accounting should be made for dividends received from these investments subsequent to the date of investment?
20. Raleigh Corp. has an investment with a carrying value
(equity method) on its books of $170,000 representing a
30% interest in Borg Company, which suffered a $620,000 loss this year. How should Raleigh Corp. handle its proportionate share of Borg’s loss?
21. Where on the asset side of the balance sheet are trading securities, available-for-sale securities, and held-to-maturity securities reported? Explain.
22. Explain why reclassification adjustments are necessary.
23. Briefly discuss how a transfer of securities from the available- for-sale category to the trading category affects stockholders’ equity and income.
24. When is a debt security considered impaired? Explain how to account for the impairment of an available-for-sale debt security.
25. What is the GAAP definition of fair value?
26. What is the fair value option?
27. Franklin Corp. has an investment that it has held for several years. When it purchased the investment, Franklin classified and accounted for it as available-for-sale.
Can Franklin use the fair value option for this investment? Explain.
*28. What is meant by the term “underlying” as it relates to derivative financial instruments?
*29. What are the main distinctions between a traditional financial instrument and a derivative financial instrument?
*30. What is the purpose of a fair value hedge?
*31. In what situation will the unrealized holding gain or loss on an available-for-sale security be reported in income?
*32. Why might a company become involved in an interest rate swap contract to receive fixed interest payments and pay variable?
*33. What is the purpose of a cash flow hedge?
*34. Where are gains and losses related to cash flow hedges involving anticipated transactions reported?
*35. What are hybrid securities? Give an example of a hybrid security.
*36. Explain the difference between the voting-interest model and the risk-and-reward model used for consolidation.
*37. What is a variable-interest entity?


BRIEF EXERCISES


BE17-1 Garfield Company purchased, as a held-to-maturity investment, $80,000 of the 9%, 5-year bonds of Chester Corporation for $74,086, which provides an 11% return. Prepare Garfield’s journal entries for
(a) the purchase of the investment, and
(b) the receipt of annual interest and discount amortization.
Assume effective-interest amortization is used.

BE17-2 Use the information from BE17-1 but assume the bonds are purchased as an available-for-sale security. Prepare Garfield’s journal entries for (a) the purchase of the investment, (b) the receipt of annual interest and discount amortization, and (c) the year-end fair value adjustment. (Assume a zero balance in the Fair Value Adjustment account.) The bonds have a year-end fair value of $75,500.

BE17-3 Carow Corporation purchased, as a held-to-maturity investment, $60,000 of the 8%, 5-year bonds of Harrison, Inc. for $65,118, which provides a 6% return. The bonds pay interest semiannually. Prepare
Carow’s journal entries for (a) the purchase of the investment, and (b) the receipt of semiannual interest and premium amortization. Assume effective-interest amortization is used.

BE17-4 Hendricks Corporation purchased trading investment bonds for $50,000 at par. At December 31,
Hendricks received annual interest of $2,000, and the fair value of the bonds was $47,400. Prepare
Hendricks’ journal entries for (a) the purchase of the investment, (b) the interest received, and (c) the fair value adjustment. (Assume a zero balance in the Fair Value Adjustment account.)

BE17-5 Fairbanks Corporation purchased 400 shares of Sherman Inc. common stock as an availablefor- sale investment for $13,200. During the year, Sherman paid a cash dividend of $3.25 per share. At yearend,
Sherman stock was selling for $34.50 per share. Prepare Fairbanks’ journal entries to record (a) the purchase of the investment, (b) the dividends received, and (c) the fair value adjustment. (Assume a zero balance in the Fair Value Adjustment account.)


BE17-6 Use the information from BE17-5 but assume the stock was purchased as a trading security. Prepare
Fairbanks’ journal entries to record (a) the purchase of the investment, (b) the dividends received, and (c) the fair value adjustment.

BE17-7 Zoop Corporation purchased for $300,000 a 30% interest in Murphy, Inc. This investment enables
Zoop to exert significant influence over Murphy. During the year, Murphy earned net income of $180,000 and paid dividends of $60,000. Prepare Zoop’s journal entries related to this investment.

BE17-8 Cleveland Company has a stock portfolio valued at $4,000 (available-for-sale). Its cost was $3,300.
If the Fair Value Adjustment account has a debit balance of $200, prepare the journal entry at year-end.

BE17-9 The following information relates to Starbucks for the year ended October 2, 2011: net income
1,245.7 million; unrealized holding loss of $10.9 million related to available-for-sale securities during the year; accumulated other comprehensive income of $57.2 million on October 3, 2010. Assuming no other changes in accumulated other comprehensive income, determine (a) other comprehensive income for 2011,
(b) comprehensive income for 2011, and (c) accumulated other comprehensive income at October 2, 2011.

BE17-10 Hillsborough Co. has an available-for-sale investment in the bonds of Schuyler Corp. with a carrying (and fair) value of $70,000. Hillsborough determined that due to poor economic prospects for
Schuyler, the bonds have decreased in value to $60,000. It is determined that this loss in value is other-than temporary.
Prepare the journal entry, if any, to record the reduction in value.



EXERCISES

E17-1 (Investment Classifications) For the following investments identify whether they are:
1. Trading Securities
2. Available-for-Sale Securities
3. Held-to-Maturity Securities
Each case is independent of the other.
(a) A bond that will mature in 4 years was bought 1 month ago when the price dropped. As soon as the value increases, which is expected next month, it will be sold.
(b) 10% of the outstanding stock of Farm-Co was purchased. The company is planning on eventually getting a total of 30% of its outstanding stock.
(c) 10-year bonds were purchased this year. The bonds mature at the first of next year.
(d) Bonds that will mature in 5 years are purchased. The company would like to hold them until they mature, but money has been tight recently and they may need to be sold.
(e) Preferred stock was purchased for its constant dividend. The company is planning to hold the preferred stock for a long time.
(f) A bond that matures in 10 years was purchased. The company is investing money set aside for an expansion project planned 10 years from now.

E17-2 (Entries for Held-to-Maturity Securities) On January 1, 2013, Dagwood Company purchased at par 12% bonds having a maturity value of $300,000. They are dated January 1, 2013, and mature January 1,
2018, with interest receivable December 31 of each year. The bonds are classified in the held-to-maturity category.
Instructions

(a) Prepare the journal entry at the date of the bond purchase.
(b) Prepare the journal entry to record the interest received for 2013.
(c) Prepare the journal entry to record the interest received for 2014.

E17-3 (Entries for Held-to-Maturity Securities) On January 1, 2013, Hi and Lois Company purchased
12% bonds having a maturity value of $300,000 for $322,744.44. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2013, and mature January 1, 2018, with interest receivable December
31 of each year. Hi and Lois Company uses the effective-interest method to allocate unamortized discount or premium. The bonds are classified in the held-to-maturity category.
Instructions

(a) Prepare the journal entry at the date of the bond purchase.
(b) Prepare a bond amortization schedule.
(c) Prepare the journal entry to record the interest received and the amortization for 2013.
(d) Prepare the journal entry to record the interest received and the amortization for 2014.

E17-4 (Entries for Available-for-Sale Securities) Assume the same information as in E17-3 except that the securities are classified as available-for-sale. The fair value of the bonds at December 31 of each year-end is as follows.
2013 $320,500 2016 $310,000
2014 $309,000 2017 $300,000
2015 $308,000
Instructions

(a) Prepare the adjusting entry (if any) for 2014, assuming the securities are classified as trading.
(b) Prepare the adjusting entry (if any) for 2014, assuming the securities are classified as availablefor- sale.
(c) Discuss how the amounts reported in the financial statements are affected by the entries in (a) and (b).

E17-7 (Trading Securities Entries) On December 21, 2013, Bucky Katt Company provided you with the following information regarding its trading securities.
During 2014, Colorado Company stock was sold for $9,400. The fair value of the stock on December 31,
2014, was Clemson Corp. stock—$19,100; Buffaloes Co. stock—$20,500.
Instructions

(a) Prepare the journal entry at the date of the bond purchase.
(b) Prepare the journal entries to record the interest received and recognition of fair value for 2013.
(c) Prepare the journal entry to record the recognition of fair value for 2014.

E17-5 (Effective-Interest versus Straight-Line Bond Amortization) On January 1, 2013, Phantom Company acquires $200,000 of Spiderman Products, Inc., 9% bonds at a price of $185,589. The interest is payable each
December 31, and the bonds mature December 31, 2015. The investment will provide Phantom Company a 12% yield. The bonds are classified as held-to-maturity.
Instructions

(a) Prepare a 3-year schedule of interest revenue and bond discount amortization, applying the straightline method.
(b) Prepare a 3-year schedule of interest revenue and bond discount amortization, applying the effective-interest method.
(c) Prepare the journal entry for the interest receipt of December 31, 2014, and the discount amortization under the straight-line method.
(d) Prepare the journal entry for the interest receipt of December 31, 2014, and the discount amortization under the effective-interest method.

E17-6 (Entries for Available-for-Sale and Trading Securities) The following information is available for
Barkley Company at December 31, 2014, regarding its investments.
Securities Cost Fair Value
3,000 shares of Myers Corporation Common Stock $40,000 $48,000
1,000 shares of Cole Incorporated Preferred Stock 25,000 22,000 $65,000 $70,000
December 31, 2013
Investments (Trading) Cost Fair Value Unrealized Gain (Loss)
Clemson Corp. stock $20,000 $19,000 $(1,000)
Colorado Co. stock 10,000 9,000 (1,000)
Buffaloes Co. stock 20,000 20,600 600
Total of portfolio $50,000 $48,600 (1,400)
Previous fair value adjustment balance –0–
Fair value adjustment—Cr. $(1,400)
Instructions
(a) Prepare the adjusting journal entry needed on December 31, 2013.
(b) Prepare the journal entry to record the sale of the Colorado Company stock during 2014.
(c) Prepare the adjusting journal entry needed on December 31, 2014.

E17-8 (Available-for-Sale Securities Entries and Reporting) Satchel Corporation purchases equity securities costing $73,000 and classifies them as available-for-sale securities. At December 31, the fair value of the portfolio is $65,000.
Instructions

Prepare the adjusting entry to report the securities properly. Indicate the statement presentation of the accounts in your entry.

E17-9 (Available-for-Sale Securities Entries and Financial Statement Presentation) At December 31,
2013, the available-for-sale equity portfolio for Steffi Graf, Inc. is as follows.
On January 20, 2014, Steffi Graf, Inc. sold security A for $15,100. The sale proceeds are net of brokerage fees.
Instructions

(a) Prepare the adjusting entry at December 31, 2013, to report the portfolio at fair value.
(b) Show the balance sheet presentation of the investment-related accounts at December 31, 2013.
(Ignore notes presentation.)
(c) Prepare the journal entry for the 2014 sale of security A.

E17-10 (Comprehensive Income Disclosure) Assume the same information as E17-9 and that Steffi Graf
Inc. reports net income in 2013 of $120,000 and in 2014 of $140,000. Total holding gains (including any realized holding gain or loss) total $40,000.
Instructions

(a) Prepare a statement of comprehensive income for 2013 starting with net income.
(b) Prepare a statement of comprehensive income for 2014 starting with net income.

E17-11 (Equity Securities Entries) Arantxa Corporation made the following cash purchases of securities during 2014, which is the first year in which Arantxa invested in securities.
1. On January 15, purchased 10,000 shares of Sanchez Company’s common stock at $33.50 per share plus commission $1,980.
2. On April 1, purchased 5,000 shares of Vicario Co.’s common stock at $52.00 per share plus commission $3,370.
3. On September 10, purchased 7,000 shares of WTA Co.’s preferred stock at $26.50 per share plus commission $4,910.
On May 20, 2014, Arantxa sold 4,000 shares of Sanchez Company’s common stock at a market price of $35 per share less brokerage commissions, taxes, and fees of $3,850. The year-end fair values per share were
Sanchez $30, Vicario $55, and WTA $28. In addition, the chief accountant of Arantxa told you that Arantxa
Corporation plans to hold these securities for the long term but may sell them in order to earn profits from appreciation in prices.
Instructions

(a) Prepare the journal entries to record the above three security purchases.
(b) Prepare the journal entry for the security sale on May 20.
(c) Compute the unrealized gains or losses and prepare the adjusting entries for Arantxa on December 31, 2014.

E17-12 (Journal Entries for Fair Value and Equity Methods) The following are two independent situations.
Security Cost Fair Value Unrealized Gain (Loss)
A $17,500 $15,000 ($2,500)
B 12,500 14,000 1,500
C 23,000 25,500 2,500
Total $53,000 $54,500 1,500
Previous fair value adjustment balance—Dr. 400
Fair value adjustment—Dr. $1,100
Situation 1: Conchita Cosmetics acquired 10% of the 200,000 shares of common stock of Martinez Fashion at a total cost of $13 per share on March 18, 2014. On June 30, Martinez declared and paid a $75,000 cash dividend. On December 31, Martinez reported net income of $122,000 for the year. At December 31, the market price of Martinez Fashion was $15 per share. The securities are classified as available-for-sale.
Situation 2: Monica, Inc. obtained significant influence over Seles Corporation by buying 30% of Seles’s
30,000 outstanding shares of common stock at a total cost of $9 per share on January 1, 2014. On June 15,
Seles declared and paid a cash dividend of $36,000. On December 31, Seles reported a net income of $85,000 for the year.
Instructions

Prepare all necessary journal entries in 2014 for both situations.

E17-13 (Equity Method) Parent Co. invested $1,000,000 in Sub Co. for 25% of its outstanding stock. Sub
Co. pays out 40% of net income in dividends each year.
Instructions

Use the information in the following T-account for the investment in Sub to answer the following questions.
Investment in Sub Co.
1,000,000 110,000 44,000
(a) How much was Parent Co.’s share of Sub Co.’s net income for the year?
(b) How much was Parent Co.’s share of Sub Co.’s dividends for the year?
(c) What was Sub Co.’s total net income for the year?
(d) What was Sub Co.’s total dividends for the year?

E17-14 (Equity Investment—Trading) Oregon Co. had purchased 200 shares of Washington Co. for $40 each this year and classified the investment as a trading security. Oregon Co. sold 100 shares of the stock for $45 each. At year-end, the price per share of the Washington Co. stock had dropped to $35.
Instructions

Prepare the journal entries for these transactions and any year-end adjustments.

E17-15 (Equity Investments—Trading) Kenseth Company has the following securities in its trading portfolio of securities on December 31, 2013.
All of the securities were purchased in 2013.
In 2014, Kenseth completed the following securities transactions.
March 1 Sold the 1,500 shares of Gordon, Inc., Common, @ $45 less fees of $1,200
April 1 Bought 700 shares of Earnhart Corp., Common, @ $75 plus fees of $1,300
Kenseth Company’s portfolio of trading securities appeared as follows on December 31, 2014.
Instructions

Prepare the general journal entries for Kenseth Company for:
(a) The 2013 adjusting entry.
(b) The sale of the Gordon stock.
(c) The purchase of the Earnhart stock.
(d) The 2014 adjusting entry for the trading portfolio.
Investments (Trading) Cost Fair Value
5,000 shares of Wallace Corp., Common $180,000 $175,000
700 shares of Earnhart Corp., Common 53,800 50,400
400 shares of Martin, Inc., Preferred 60,000 58,000 $293,800 $283,400
Investments (Trading) Cost Fair Value
1,500 shares of Gordon, Inc., Common $ 73,500 $ 69,000
5,000 shares of Wallace Corp., Common 180,000 175,000
400 shares of Martin, Inc., Preferred 60,000 61,600 $313,500 $305,600

E17-16 (Fair Value and Equity Method Compared) Jaycie Phelps Inc. acquired 20% of the outstanding common stock of Theresa Kulikowski Inc. on December 31, 2013. The purchase price was $1,200,000 for
50,000 shares. Kulikowski Inc. declared and paid an $0.85 per share cash dividend on June 30 and on
December 31, 2014. Kulikowski reported net income of $730,000 for 2014. The fair value of Kulikowski’s stock was $27 per share at December 31, 2014.
Instructions

(a) Prepare the journal entries for Jaycie Phelps Inc. for 2013 and 2014, assuming that Phelps cannot exercise significant influence over Kulikowski. The securities should be classified as availablefor- sale.
(b) Prepare the journal entries for Jaycie Phelps Inc. for 2013 and 2014, assuming that Phelps can exercise significant influence over Kulikowski.
(c) At what amount is the investment in securities reported on the balance sheet under each of these methods at December 31, 2014? What is the total net income reported in 2014 under each of these methods?

E17-17 (Equity Method) On January 1, 2014, Pennington Corporation purchased 30% of the common shares of Edwards Company for $180,000. During the year, Edwards earned net income of $80,000 and paid dividends of $20,000.
Instructions

Prepare the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in 2014.

E17-18 (Impairment of Debt Securities) Hagar Corporation has municipal bonds classified as availablefor- sale at December 31, 2013. These bonds have a par value of $800,000, an amortized cost of $800,000, and a fair value of $720,000. The unrealized loss of $80,000 previously recognized as other comprehensive income and as a separate component of stockholders’ equity is now determined to be other than temporary. That is, the company believes that impairment accounting is now appropriate for these bonds.
Instructions

(a) Prepare the journal entry to recognize the impairment. No entry is needed to adjust accumulated other comprehensive income.
(b) What is the new cost basis of the municipal bonds? Given that the maturity value of the bonds is $800,000, should Hagar Corporation amortize the difference between the carrying amount and the maturity value over the life of the bonds?
(c) At December 31, 2014, the fair value of the municipal bonds is $760,000. Prepare the entry (if any) to record this information.

E17-19 (Fair Value Measurement) Presented below is information related to the purchases of common stock by Lilly Company during 2014.
Cost Fair Value
(at purchase date) (at December 31)
Investment in Arroyo Company stock $100,000 $ 80,000
Investment in Lee Corporation stock 250,000 300,000
Investment in Woods Inc. stock 180,000 190,000
Total $530,000 $570,000
Instructions
(Assume a zero balance for any Fair Value Adjustment account.)
(a) What entry would Lilly make at December 31, 2014, to record the investment in Arroyo Company stock if it chooses to report this security using the fair value option?
(b) What entry would Lilly make at December 31, 2014, to record the investment in Lee Corporation, assuming that Lilly wants to classify this security as available-for-sale? This security is the only available-for-sale security that Lilly presently owns.
(c) What entry would Lilly make at December 31, 2014, to record the investment in Woods Inc., assuming that Lilly wants to classify this investment as a trading security?

E17-20 (Fair Value Measurement Issues) Assume the same information as in E17-19 for Lilly Company.
In addition, assume that the investment in the Woods Inc. stock was sold during 2015 for $195,000.
Cost Fair Value
(at purchase date) (at December 31)
Investment in Arroyo Company stock $100,000 $140,000
Investment in Lee Corporation stock 250,000 310,000
Total $350,000 $450,000
Carrying Fair Value
Amount (at December 31)
Investment in debt securities (intent is to hold to maturity) $ 40,000 $ 41,000
Investment in Chen Company stock 800,000 910,000
Bonds payable 220,000 195,000
At December 31, 2015, the following information relates to its two remaining investments of common stock.
Net income before any security gains and losses for 2015 was $905,000.
Instructions

(a) Compute the amount of net income or net loss that Lilly should report for 2015, taking into consideration
Lilly’s security transactions for 2015.
(b) Prepare the journal entry to record unrealized gain or loss related to the investment in Arroyo
Company stock at December 31, 2015.

E17-21 (Fair Value Option) Presented below is selected information related to the financial instruments of
Dawson Company at December 31, 2014. This is Dawson Company’s first year of operations.
Instructions
(a) Dawson elects to use the fair value option whenever possible. Assuming that Dawson’s net income is $100,000 in 2014 before reporting any securities gains or losses, determine Dawson’s net income for 2014.
(b) Record the journal entry, if any, necessary at December 31, 2014, to record the fair value option for the bonds payable.

*E17-22 (Derivative Transaction) On January 2, 2014, Jones Company purchases a call option for $300 on
Merchant common stock. The call option gives Jones the option to buy 1,000 shares of Merchant at a strike price of $50 per share. The market price of a Merchant share is $50 on January 2, 2014 (the intrinsic value is therefore $0). On March 31, 2014, the market price for Merchant stock is $53 per share, and the time value of the option is $200.
Instructions

(a) Prepare the journal entry to record the purchase of the call option on January 2, 2014.
(b) Prepare the journal entry(ies) to recognize the change in the fair value of the call option as of
March 31, 2014.
(c) What was the effect on net income of entering into the derivative transaction for the period January 2 to March 31, 2014?

*E17-23 (Fair Value Hedge) On January 2, 2014, MacCloud Co. issued a 4-year, $100,000 note at 6% fixed interest, interest payable semiannually. MacCloud now wants to change the note to a variable-rate note.
As a result, on January 2, 2014, MacCloud Co. enters into an interest rate swap where it agrees to receive 6% fixed and pay LIBOR of 5.7% for the first 6 months on $100,000. At each 6-month period, the variable rate will be reset. The variable rate is reset to 6.7% on June 30, 2014.
Instructions

(a) Compute the net interest expense to be reported for this note and related swap transaction as of
June 30, 2014.
(b) Compute the net interest expense to be reported for this note and related swap transaction as of December 31, 2014.

*E17-24 (Cash Flow Hedge) On January 2, 2014, Parton Company issues a 5-year, $10,000,000 note at
LIBOR, with interest paid annually. The variable rate is reset at the end of each year. The LIBOR rate for the first year is 5.8%.
Parton Company decides it prefers fixed-rate financing and wants to lock in a rate of 6%. As a result,
Parton enters into an interest rate swap to pay 6% fixed and receive LIBOR based on $10 million. The variable rate is reset to 6.6% on January 2, 2015.
Instructions
(a) Compute the net interest expense to be reported for this note and related swap transactions as of
December 31, 2014.
(b) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2015.

*E 17-25 (Fair Value Hedge) Sarazan Company issues a 4-year, 7.5% fixed-rate interest only, nonprepayable $1,000,000 note payable on December 31, 2013. It decides to change the interest rate from a fixed rate to variable rate and enters into a swap agreement with M&S Corp. The swap agreement specifies that Sarazan will receive a fixed rate at 7.5% and pay variable with settlement dates that match the interest payments on the debt. Assume that interest rates have declined during 2014 and that Sarazan received $13,000 as an adjustment to interest expense for the settlement at December 31, 2014. The loss related to the debt (due to interest rate changes) was $48,000. The value of the swap contract increased $48,000.
Instructions

(a) Prepare the journal entry to record the payment of interest expense on December 31, 2014.
(b) Prepare the journal entry to record the receipt of the swap settlement on December 31, 2014.
(c) Prepare the journal entry to record the change in the fair value of the swap contract on December 31,
2014.
(d) Prepare the journal entry to record the change in the fair value of the debt on December 31, 2014.

*E17-26 (Call Option) On August 15, 2013, Outkast Co. invested idle cash by purchasing a call option on
Counting Crows Inc. common shares for $360. The notional value of the call option is 400 shares, and the option price is $40. The option expires on January 31, 2014. The following data are available with respect to the call option.
Instructions
Prepare the journal entries for Outkast for the following dates.
(a) Investment in call option on Counting Crows shares on August 15, 2013.
(b) September 30, 2013—Outkast prepares financial statements.
(c) December 31, 2013—Outkast prepares financial statements.
(d) January 15, 2014—Outkast settles the call option on the Counting Crows shares.

*E17-27 (Cash Flow Hedge) Hart Golf Co. uses titanium in the production of its specialty drivers. Hart anticipates that it will need to purchase 200 ounces of titanium in November 2014, for clubs that will be shipped in the spring and summer of 2015. However, if the price of titanium increases, this will increase the cost to produce the clubs, which will result in lower profit margins.
To hedge the risk of increased titanium prices, on May 1, 2014, Hart enters into a titanium futures contract and designates this futures contract as a cash flow hedge of the anticipated titanium purchase. The notional amount of the contract is 200 ounces, and the terms of the contract give Hart the option to purchase titanium at a price of $500 per ounce. The price will be good until the contract expires on November 30, 2014.
Assume the following data with respect to the price of the call options and the titanium inventory purchase.
Instructions

Present the journal entries for the following dates/transactions.
(a) May 1, 2014—Inception of futures contract, no premium paid.
(b) June 30, 2014—Hart prepares financial statements.
(c) September 30, 2014—Hart prepares financial statements.
(d) October 5, 2014—Hart purchases 200 ounces of titanium at $525 per ounce and settles the futures contract.
Market Price of Counting Time Value of Call
Date Crows Shares Option
September 30, 2013 $48 per share $180
December 31, 2013 $46 per share 65
January 15, 2014 $47 per share 30
Spot Price for
Date November Delivery
May 1, 2014 $500 per ounce
June 30, 2014 520 per ounce
September 30, 2014 525 per ounce
(e) December 15, 2014—Hart sells clubs containing titanium purchased in October 2014 for $250,000.
The cost of the finished goods inventory is $140,000.
(f) Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions on December 31, 2014.


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