Investments

Solutions Manual and Test Bank of Intermediate Accounting Kieso Weygandt Warfield 15th edition

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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, 2012, Wheeler Company purchased $4,000,000 of Duggen Company’s 8% bonds, due on July 1, 2019. 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, 2012.
9.
If the bonds in question 8 are classified as available-forsale and they have a fair value at December 31, 2012, of $3,604,000, prepare the journal entry (if any) at December 31, 2012, to record this transaction.
10.
Indicate how unrealized holding gains and losses should be reported for investments securities classified as trading, available-for-sale, and held-to-maturity.
11.
(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.
12.
Identify and explain the different types of classifications for investment in equity securities.
13.
Why are held-to-maturity investments applicable only to debt securities?
14.
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.
15.
Distinguish between the accounting treatment for available-for-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.
When the equity method is applied, what disclosures should be made in the investor’s financial statements?
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.
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28. What is meant by the term underlying as it relates to derivative financial instruments?
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29. What are the main distinctions between a traditional financial instrument and a derivative financial instrument?
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30. What is the purpose of a fair value hedge?
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31. In what situation will the unrealized holding gain or loss on an available-for-sale security be reported in income?
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32. Why might a company become involved in an interest rate swap contract to receive fixed interest payments and pay variable?
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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.
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36. Explain the difference between the voting-interest model and the risk-and-reward model used for consolidation.
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37. What is a variable-interest entity? BRI E F EXERCI S E S
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. The bonds have a year-end fair value of $75,500.
2 2
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.
BE17-5
Fairbanks Corporation purchased 400 shares of Sherman Inc. common stock as an available-for-sale investment for $13,200. During the year, Sherman paid a cash dividend of $3.25 per share. At year-end, Sherman stock was selling for $34.50 per share. Prepare Fairbanks’s journal entries to record (a) the purchase of the investment, (b) the dividends received, and (c) the fair value adjustment.
BE17-6
Use the information from
BE17-5 but assume the stock was purchased as a trading security. Prepare Fairbanks’s 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. 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 September 30, 2009: net income $390.8 million; unrealized holding gain of $9.8 million related to available-for-sale securities during the year; accumulated other comprehensive income of $48.4 million on September 28, 2008. Assuming no other changes in accumulated other comprehensive income, determine (a) other comprehensive income for 2009, (b) comprehensive income for 2009, and (c) accumulated other comprehensive income at September 30, 2009.
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 otherthan- temporary. Prepare the journal entry, if any, to record the reduction in value. 2 2 3 3 4 3 7 6 EXERCI S E S
E17-1 (Investment Classifications)
For the following investments, identify whether they are: 1. Trading 2. Available-for-Sale 3. Held-to-Maturity 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) 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. (f) Preferred stock was purchased for its constant dividend. The company is planning to hold the preferred stock for a long time.
E17-2 (Entries for Held-to-Maturity Securities)
On January 1, 2012, Jennings Company purchased at par 10% bonds having a maturity value of $300,000. They are dated January 1, 2012, and mature January 1, 2017, 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 2012. (c) Prepare the journal entry to record the interest received for 2013.
E17-3 (Entries for Held-to-Maturity Securities)
On January 1, 2011, Roosevelt Company purchased 12% bonds, having a maturity value of $500,000, for $537,907.40. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2011, and mature January 1, 2016, with interest receivable December 31 of each year. Roosevelt 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 2011. (d) Prepare the journal entry to record the interest received and the amortization for 2012.
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.
2011 $534,200 2014 $517,000 2012 $515,000 2015 $500,000 2013 $513,000
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 2011. (c) Prepare the journal entry to record the recognition of fair value for 2012.
E17-5 (Effective-Interest versus Straight-Line Bond Amortization)
On January 1, 2012, Morgan Company acquires $300,000 of Nicklaus, Inc., 9% bonds at a price of $278,384. The interest is payable each December 31, and the bonds mature December 31, 2014. The investment will provide Morgan 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. (Round to nearest dollar.) (b) Prepare a 3-year schedule of interest revenue and bond discount amortization, applying the effectiveinterest method. (Round to nearest cent.) (c) Prepare the journal entry for the interest receipt of December 31, 2013, and the discount amortization under the straight-line method. (d) Prepare the journal entry for the interest receipt of December 31, 2013, 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 Kinney Company at December 31, 2012, regarding its investments. Securities Cost Fair Value 3,000 shares of Petty Corporation Common Stock $40,000 $46,000 1,000 shares of Dowe Incorporated Preferred Stock 25,000 22,000 $65,000 $68,000
Instructions
(a) Prepare the adjusting entry (if any) for 2012, assuming the securities are classified as trading. (b) Prepare the adjusting entry (if any) for 2012, assuming the securities are classified as available-for-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, 2012, Zurich Company provided you with the following information regarding its trading securities. December 31, 2012 Investments (Trading) Cost Fair Value Unrealized Gain (Loss) Stargate Corp. stock $20,000 $19,000 $(1,000) Carolina Co. stock 10,000 9,000 (1,000) Vectorman 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) 2 2 2 3 3 During 2013, Carolina Company stock was sold for $9,500. The fair value of the stock on December 31, 2013, was: Stargate Corp. stock—$19,300; Vectorman Co. stock—$20,500.
Instructions
(a) Prepare the adjusting journal entry needed on December 31, 2012. (b) Prepare the journal entry to record the sale of the Carolina Company stock during 2013. (c) Prepare the adjusting journal entry needed on December 31, 2013.
E17-8 (Available-for-Sale Securities Entries and Reporting)
Player 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 $67,000.
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, 2012, the available-for-sale equity portfolio for Wenger, Inc. is as follows. 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. 200 Fair value adjustment—Dr. $1,300 On January 20, 2013, Wenger, Inc. sold security A for $15,300. The sale proceeds are net of brokerage fees.
Instructions
(a) Prepare the adjusting entry at December 31, 2012, to report the portfolio at fair value. (b) Show the balance sheet presentation of the investment related accounts at December 31, 2012. (Ignore notes presentation.) (c) Prepare the journal entry for the 2013 sale of security A.
E17-10 (Comprehensive Income Disclosure)
Assume the same information as
E17-9 and that Wenger, Inc. reports net income in 2012 of $120,000 and in 2013 of $140,000. Total holding gains (including any realized holding gain or loss) arising during 2013 total $30,000.

Instructions
(a) Prepare a statement of comprehensive income for 2012 starting with net income. (b) Prepare a statement of comprehensive income for 2013 starting with net income.
E17-11 (Equity Securities Entries)
Capriati Corporation made the following cash purchases of securities during 2012, which is the first year in which Capriati invested in securities. 1. On January 15, purchased 9,000 shares of Gonzalez Company’s common stock at $33.50 per share plus commission $1,980. 2. On April 1, purchased 5,000 shares of Belmont Co.’s common stock at $52.00 per share plus commission $3,370. 3. On September 10, purchased 7,000 shares of Thep Co.’s preferred stock at $26.50 per share plus commission $4,910. On May 20, 2012, Capriati sold 3,000 shares of Gonzalez Company’s common stock at a market price of $35 per share less brokerage commissions, taxes, and fees of $2,850. The year-end fair values per share were: Gonzalez $30, Belmont $55, and Thep $28. In addition, the chief accountant of Capriati told you that Capriati 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 Capriati on December 31, 2012.
E17-12 (Journal Entries for Fair Value and Equity Methods)
Presented on page 1032 are two independent situations. Situation 1 Hatcher Cosmetics acquired 10% of the 200,000 shares of common stock of Ramirez Fashion at a total cost of $14 per share on March 18, 2012. On June 30, Ramirez declared and paid a $75,000 cash dividend. On December 31, Ramirez reported net income of $122,000 for the year. At December 31, the market price of Ramirez Fashion was $15 per share. The securities are classified as available-for-sale. Situation 2 Holmes, Inc. obtained significant influence over Nadal Corporation by buying 25% of Nadal’s 30,000 outstanding shares of common stock at a total cost of $9 per share on January 1, 2012. On June 15, Nadal declared and paid a cash dividend of $36,000. On December 31, Nadal reported a net income of $85,000 for the year.
Instructions
Prepare all necessary journal entries in 2012 for both situations.
E17-13 (Equity Method)
Gator Co. invested $1,000,000 in Demo Co. for 25% of its outstanding stock. Demo Co. pays out 40% of net income in dividends each year.
Instructions
Use the information in the following T-account for the investment in Demo to answer the following questions. Equity Investments (Demo Co.) 1,000,000 130,000 52,000 (a) How much was Gator Co.’s share of Demo Co.’s net income for the year? (b) How much was Gator Co.’s share of Demo Co.’s dividends for the year? (c) What was Demo Co.’s total net income for the year? (d) What was Demo Co.’s total dividends for the year?
E17-14 (Equity Investment—Trading)
Feiner Co. had purchased 300 shares of Guttman Co. for $40 each this year and classified the investment as a trading security. Feiner Co. sold 100 shares of the stock for $43 each. At year-end, the price per share of the Guttman Co. stock had dropped to $35.
Instructions
Prepare the journal entries for these transactions and any year-end adjustments.
E17-15 (Equity Investments—Trading)
Swanson Company has the following securities in its trading portfolio of securities on December 31, 2012. Investments (Trading) Cost Fair Value 1,500 shares of Parker, Inc., Common $ 71,500 $ 69,000 5,000 shares of Beilman Corp., Common 180,000 175,000 400 shares of Duncan, Inc., Preferred 60,000 61,600 $311,500 $305,600 All of the securities were purchased in 2012. In 2013, Swanson completed the following securities transactions. March 1 Sold the 1,500 shares of Parker, Inc., Common, @ $45 less fees of $1,200. April 1 Bought 700 shares of McDowell Corp., Common, @ $75 plus fees of $1,300. Swanson Company’s portfolio of trading securities appeared as follows on December 31, 2013. Investments (Trading) Cost Fair Value 5,000 shares of Beilman Corp., Common $180,000 $175,000 700 shares of McDowell Corp., Common 53,800 50,400 400 shares of Duncan, Inc., Preferred 60,000 58,000 $293,800 $283,400
Instructions
Prepare the general journal entries for Swanson Company for: (a) The 2012 adjusting entry. (b) The sale of the Parker stock. (c) The purchase of the McDowell stock. (d) The 2013 adjusting entry for the trading portfolio. 4 3 3
E17-16 (Fair Value and Equity Method Compared)
Gregory Inc. acquired 20% of the outstanding common stock of Handerson Inc. on December 31, 2012. The purchase price was $1,250,000 for 50,000 shares. Handerson Inc. declared and paid an $0.80 per share cash dividend on June 30 and on December 31, 2013. Handerson reported net income of $730,000 for 2013. The fair value of Handerson’s stock was $27 per share at December 31, 2013.
Instructions
(a) Prepare the journal entries for Gregory Inc. for 2012, and 2013, assuming that Gregory cannot exercise significant influence over Handerson. The securities should be classified as available-for-sale. (b) Prepare the journal entries for Gregory Inc. for 2012 and 2013, assuming that Gregory can exercise significant influence over Handerson. (c) At what amount is the investment in securities reported on the balance sheet under each of these methods at December 31, 2013? What is the total net income reported in 2013 under each of these methods?
E17-17 (Equity Method)
On January 1, 2012, Meredith Corporation purchased 25% of the common shares of Pirates Company for $200,000. During the year, Pirates earned net income of $80,000 and paid dividends of $20,000.
Instructions
Prepare the entries for Meredith to record the purchase and any additional entries related to this investment in Pirates Company in 2012.
E17-18 (Impairment of Debt Securities)
Cairo Corporation has municipal bonds classified as availablefor- sale at December 31, 2012. These bonds have a par value of $800,000, an amortized cost of $800,000, and a fair value of $740,000. The unrealized loss of $60,000 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. (b) What is the new cost basis of the municipal bonds? Given that the maturity value of the bonds is $800,000, should Cairo Corporation amortize the difference between the carrying amount and the maturity value over the life of the bonds? (c) At December 31, 2013, 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 2012. 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
(a) What entry would Lilly make at December 31, 2012, 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, 2012, 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, 2012, 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 2013 for $195,000. At December 31, 2013, the following information relates to its two remaining investments of common stock.
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 Net income before any security gains and losses for 2013 was $905,000.
Instructions
(a) Compute the amount of net income or net loss that Lilly should report for 2013, taking into consideration Lilly’s security transactions for 2013. (b) Prepare the journal entry to record unrealized gain or loss related to the investment in Arroyo Company stock at December 31, 2013.
E17-21 (Fair Value Option)
Presented below is selected information related to the financial instruments of Dawson Company at December 31, 2012. This is Dawson Company’s first year of operations. 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
Instructions
(a) Dawson elects to use the fair value option whenever possible. Assuming that Dawson’s net income is $100,000 in 2012 before reporting any securities gains or losses, determine Dawson’s net income for 2012. (b) Record the journal entry, if any, necessary at December 31, 2012, to record the fair value option for the bonds payable. *
E17-22 (Derivative Transaction)
On January 2, 2012, 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, 2012 (the intrinsic value is therefore $0). On March 31, 2012, 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, 2012. (b) Prepare the journal entry(ies) to recognize the change in the fair value of the call option as of March 31, 2012. (c) What was the effect on net income of entering into the derivative transaction for the period January 2 to March 31, 2012? (Ignore tax effects.) *
E17-23 (Fair Value Hedge)
On January 2, 2012, 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, 2012, 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, 2012.
Instructions
(a) Compute the net interest expense to be reported for this note and related swap transaction as of June 30, 2012. (b) Compute the net interest expense to be reported for this note and related swap transaction as of December 31, 2012. *
E17-24 (Cash Flow Hedge)
On January 2, 2012, 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, 2013.
Instructions
(a) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2012. (b) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2013. *
E17-25 (Fair Value Hedge)
Sarazan Company issues a 4-year, 7.5% fixed-rate interest only, non-prepayable $1,000,000 note payable on December 31, 2012. 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 2 3 5 11 12 13 12 payments on the debt. Assume that interest rates have declined during 2013 and that Sarazan received $13,000 as an adjustment to interest expense for the settlement at December 31, 2013. 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, 2013. (b) Prepare the journal entry to record the receipt of the swap settlement on December 31, 2013. (c) Prepare the journal entry to record the change in the fair value of the swap contract on December 31, 2013. (d) Prepare the journal entry to record the change in the fair value of the debt on December 31, 2013. *
E17-26 (Call Option)
On August 15, 2012, 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. (Market price of an Outkast share is $40.) The option expires on January 31, 2013. The following data are available with respect to the call option. Market Price of Counting Time Value of Call Date Crows Shares Option September 30, 2012 $48 per share $180 December 31, 2012 $46 per share 65 January 15, 2013 $47 per share 30
Instructions
Prepare the journal entries for Outkast for the following dates. (a) Investment in call option on Counting Crows shares on August 15, 2012. (b) September 30, 2012—Outkast prepares financial statements. (c) December 31, 2012—Outkast prepares financial statements. (d) January 15, 2013—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 October 2012, for clubs that will be shipped in the holiday shopping season. 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, 2012, Hart enters into a titanium futures contract and designates this futures contract as 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 right and the obligation to purchase titanium at a price of $500 per ounce. The price will be good until the contract expires on November 30, 2012. Assume the following data with respect to the price of the call options and the titanium inventory purchase. Spot Price for Date November Delivery May 1, 2012 $500 per ounce June 30, 2012 520 per ounce September 30, 2013 525 per ounce
Instructions
Present the journal entries for the following dates/transactions. (a) May 1, 2012—Inception of futures contract, no premium paid. (b) June 30, 2012—Hart prepares financial statements. (c) September 30, 2012—Hart prepares financial statements. (d) October 5, 2012—Hart purchases 200 ounces of titanium at $525 per ounce and settles the futures contract. (e) December 15, 2012—Hart sells clubs containing titanium purchased in October 2012 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, 2012.
P17-1 (Debt Securities)
Presented below is an amortization schedule related to Spangler Company’s 5-year, $100,000 bond with a 7% interest rate and a 5% yield, purchased on December 31, 2010, for $108,660. Cash Interest Bond Premium Carrying Amount Date Received Revenue Amortization of Bonds 12/31/10 $108,660 12/31/11 $7,000 $5,433 $1,567 107,093 12/31/12 7,000 5,354 1,646 105,447 12/31/13 7,000 5,272 1,728 103,719 12/31/14 7,000 5,186 1,814 101,905 12/31/15 7,000 5,095 1,905 100,000 The following schedule presents a comparison of the amortized cost and fair value of the bonds at year-end. 12/31/11 12/31/12 12/31/13 12/31/14 12/31/15 Amortized cost $107,093 $105,447 $103,719 $101,905 $100,000 Fair value $106,500 $107,500 $105,650 $103,000 $100,000
Instructions
(a) Prepare the journal entry to record the purchase of these bonds on December 31, 2010, assuming the bonds are classified as held-to-maturity securities. (b) Prepare the journal entry(ies) related to the held-to-maturity bonds for 2011. (c) Prepare the journal entry(ies) related to the held-to-maturity bonds for 2013. (d) Prepare the journal entry(ies) to record the purchase of these bonds, assuming they are classified as available-for-sale. (e) Prepare the journal entry(ies) related to the available-for-sale bonds for 2011. (f) Prepare the journal entry(ies) related to the available-for-sale bonds for 2013.
P17-2 (Available-for-Sale Debt Securities)
On January 1, 2012, Novotna Company purchased $400,000, 8% bonds of Aguirre Co. for $369,114. The bonds were purchased to yield 10% interest. Interest is payable semiannually on July 1 and January 1. The bonds mature on January 1, 2017. Novotna Company uses the effective-interest method to amortize discount or premium. On January 1, 2014, Novotna Company sold the bonds for $370,726 after receiving interest to meet its liquidity needs.
Instructions
(a) Prepare the journal entry to record the purchase of bonds on January 1. Assume that the bonds are classified as available-for-sale. (b) Prepare the amortization schedule for the bonds. (c) Prepare the journal entries to record the semiannual interest on July 1, 2012, and December 31, 2012. (d) If the fair value of Aguirre bonds is $372,726 on December 31, 2013, prepare the necessary adjusting entry. (Assume the fair value adjustment balance on January 1, 2013, is a debit of $3,375.) (e) Prepare the journal entry to record the sale of the bonds on January 1, 2014.
P17-3 (Available-for-Sale Investments)
Cardinal Paz Corp. carries an account in its general ledger called Investments, which contained debits for investment purchases, and no credits, with the following descriptions. Feb. 1, 2012 Sharapova Company common stock, $100 par, 200 shares $ 37,400 April 1 U.S. government bonds, 11%, due April 1, 2022, interest payable April 1 and October 1, 110 bonds of $1,000 par each 110,000 July 1 McGrath Company 12% bonds, par $50,000, dated March 1, 2012, purchased at 104 plus accrued interest, interest payable annually on March 1, due March 1, 2032 54,000
Instructions
(Round all computations to the nearest dollar.) (a) Prepare entries necessary to classify the amounts into proper accounts, assuming that all the securities are classified as available-for-sale. (b) Prepare the entry to record the accrued interest and the amortization of premium on December 31, 2012, using the straight-line method. 2 2 2 3 (c) The fair values of the investments on December 31, 2012, were: Sharapova Company common stock $ 31,800 U.S. government bonds 124,700 McGrath Company bonds 58,600 What entry or entries, if any, would you recommend be made? (d) The U.S. government bonds were sold on July 1, 2013, for $119,200 plus accrued interest. Give the proper entry.
P17-4 (Available-for-Sale Debt Investments)
Presented below is information taken from a bond investment amortization schedule with related fair values provided. These bonds are classified as available-for-sale. 12/31/12 12/31/13 12/31/14 Amortized cost $491,150 $519,442 $550,000 Fair value $497,000 $509,000 $550,000
Instructions
(a) Indicate whether the bonds were purchased at a discount or at a premium. (b) Prepare the adjusting entry to record the bonds at fair value at December 31, 2012. The Fair Value Adjustment account has a debit balance of $1,000 prior to adjustment. (c) Prepare the adjusting entry to record the bonds at fair value at December 31, 2013.
P17-5 (Equity Securities Entries and Disclosures)
Parnevik Company has the following securities in its investment portfolio on December 31, 2012 (all securities were purchased in 2012): (1) 3,000 shares of Anderson Co. common stock which cost $58,500, (2) 10,000 shares of Munter Ltd. common stock which cost $580,000, and (3) 6,000 shares of King Company preferred stock which cost $255,000. The Fair Value Adjustment account shows a credit of $10,100 at the end of 2012. In 2013, Parnevik completed the following securities transactions. 1. On January 15, sold 3,000 shares of Anderson’s common stock at $22 per share less fees of $2,150. 2. On April 17, purchased 1,000 shares of Castle’s common stock at $33.50 per share plus fees of $1,980. On December 31, 2013, the market values per share of these securities were: Munter $61, King $40, and Castle $29. In addition, the accounting supervisor of Parnevik told you that, even though all these securities have readily determinable fair values, Parnevik will not actively trade these securities because the top management intends to hold them for more than one year.
Instructions
(a) Prepare the entry for the security sale on January 15, 2013. (b) Prepare the journal entry to record the security purchase on April 17, 2013. (c) Compute the unrealized gains or losses and prepare the adjusting entry for Parnevik on December 31, 2013. (d) How should the unrealized gains or losses be reported on Parnevik’s balance sheet?
P17-6 (Trading and Available-for-Sale Securities Entries)
McElroy Company has the following portfolio of investment securities at September 30, 2012, its last reporting date. Trading Securities Cost Fair Value Horton, Inc. common (5,000 shares) $215,000 $200,000 Monty, Inc. preferred (3,500 shares) 133,000 140,000 Oakwood Corp. common (1,000 shares) 180,000 179,000 On October 10, 2012, the Horton shares were sold at a price of $54 per share. In addition, 3,000 shares of Patriot common stock were acquired at $54.50 per share on November 2, 2012. The December 31, 2012, fair values were: Monty $106,000, Patriot $132,000, and the Oakwood common $193,000. All the securities are classified as trading.
Instructions
(a) Prepare the journal entries to record the sale, purchase, and adjusting entries related to the trading securities in the last quarter of 2012. (b) How would the entries in part (a) change if the securities were classified as available-for-sale?
P17-7 (Available-for-Sale and Held-to-Maturity Debt Securities Entries)
The following information relates to the debt securities investments of Wildcat Company. 1. On February 1, the company purchased 10% bonds of Gibbons Co. having a par value of $300,000 at 100 plus accrued interest. Interest is payable April 1 and October 1. 2. On April 1, semiannual interest is received. 3. On July 1, 9% bonds of Sampson, Inc. were purchased. These bonds with a par value of $200,000 were purchased at 100 plus accrued interest. Interest dates are June 1 and December 1. 4. On September 1, bonds with a par value of $60,000, purchased on February 1, are sold at 99 plus accrued interest. 5. On October 1, semiannual interest is received. 6. On December 1, semiannual interest is received. 7. On December 31, the fair value of the bonds purchased February 1 and July 1 are 95 and 93, respectively.
Instructions
(a) Prepare any journal entries you consider necessary, including year-end entries (December 31), assuming these are available-for-sale securities. (b) If Wildcat classified these as held-to-maturity investments, explain how the journal entries would differ from those in part (a).
P17-8 (Fair Value and Equity Methods)
Brooks Corp. is a medium-sized corporation specializing in quarrying stone for building construction. The company has long dominated the market, at one time achieving a 70% market penetration. During prosperous years, the company’s profits, coupled with a conservative dividend policy, resulted in funds available for outside investment. Over the years, Brooks has had a policy of investing idle cash in equity securities. In particular, Brooks has made periodic investments in the company’s principal supplier, Norton Industries. Although the firm currently owns 12% of the outstanding common stock of Norton Industries, Brooks does not have significant influence over the operations of Norton Industries. Cheryl Thomas has recently joined Brooks as assistant controller, and her first assignment is to prepare the 2012 year-end adjusting entries for the accounts that are valued by the “fair value” rule for financial reporting purposes. Thomas has gathered the following information about Brooks’s pertinent accounts. 1. Brooks has trading securities related to Delaney Motors and Patrick Electric. During this fiscal year, Brooks purchased 100,000 shares of Delaney Motors for $1,400,000; these shares currently have a market value of $1,600,000. Brooks’ investment in Patrick Electric has not been profitable; the company acquired 50,000 shares of Patrick in April 2012 at $20 per share, a purchase that currently has a value of $720,000. 2. Prior to 2012, Brooks invested $22,500,000 in Norton Industries and has not changed its holdings this year. This investment in Norton Industries was valued at $21,500,000 on December 31, 2011. Brooks’ 12% ownership of Norton Industries has a current market value of $22,225,000.
Instructions
(a) Prepare the appropriate adjusting entries for Brooks as of December 31, 2012, to reflect the application of the “fair value” rule for both classes of securities described above. (b) For both classes of securities presented above, describe how the results of the valuation adjustments made in (a) would be reflected in the body of and notes to Brooks’ 2012 financial statements. (c) Prepare the entries for the Norton investment, assuming that Brooks owns 25% of Norton’s shares. Norton reported income of $500,000 in 2012 and paid cash dividends of $100,000.
P17-9 (Financial Statement Presentation of Available-for-Sale Investments)
Kennedy Company has the following portfolio of available-for-sale securities at December 31, 2012. Percent Per Share Security Quantity Interest Cost Price Frank, Inc. 2,000 shares 8% $11 $16 Ellis Corp. 5,000 shares 14% 23 19 Mendota Company 4,000 shares 2% 31 24
Instructions
(a) What should be reported on Kennedy’s December 31, 2012, balance sheet relative to these long-term available-for-sale securities? On December 31, 2013, Kennedy’s portfolio of available-for-sale securities consisted of the following common stocks. Percent Per Share Security Quantity Interest Cost Price Ellis Corp. 5,000 shares 14% $23 $28 Mendota Company 4,000 shares 2% 31 23 Mendota Company 2,000 shares 1% 25 23 3 4 5 3 5 At the end of year 2013, Kennedy Company changed its intent relative to its investment in Frank, Inc. and reclassified the shares to trading securities status when the shares were selling for $8 per share. (b) What should be reported on the face of Kennedy’s December 31, 2013, balance sheet relative to available-for-sale securities investments? What should be reported to reflect the transactions above in Kennedy’s 2013 income statement? (c) Assuming that comparative financial statements for 2012 and 2013 are presented, draft the footnote necessary for full disclosure of Kennedy’s transactions and position in equity securities.
P17-10 (Gain on Sale of Investments and Comprehensive Income)
On January 1, 2012, Acker Inc. had the following balance sheet. ACKER INC. BALANCE SHEET AS OF JANUARY 1, 2012 Assets Equity Cash $ 50,000 Common stock $260,000 Equity investments (available-for-sale) 240,000 Accumulated other comprehensive income 30,000 Total $290,000 Total $290,000 Problems 1039 The accumulated other comprehensive income related to unrealized holding gains on available-for-sale securities. The fair value of Acker Inc.’s available-for-sale securities at December 31, 2012, was $190,000; its cost was $140,000. No securities were purchased during the year. Acker Inc.’s income statement for 2012 was as follows. (Ignore income taxes.) ACKER INC. INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 2012 Dividend revenue $ 5,000 Gain on sale of investments 30,000 Net income $35,000
Instructions
(Assume all transactions during the year were for cash.) (a) Prepare the journal entry to record the sale of the available-for-sale securities in 2012. (b) Prepare a statement of comprehensive income for 2012. (c) Prepare a balance sheet as of December 31, 2012.
P17-11 (Equity Investments—Available-for-Sale)
Castleman Holdings, Inc. had the following availablefor- sale investment portfolio at January 1, 2012. Evers Company 1,000 shares @ $15 each $15,000 Rogers Company 900 shares @ $20 each 18,000 Chance Company 500 shares @ $9 each 4,500 Equity investments (available-for-sale) @ cost 37,500 Fair value adjustment (available-for-sale) (7,500) Equity investments (available-for-sale) @ fair value $30,000 During 2012, the following transactions took place. 1. On March 1, Rogers Company paid a $2 per share dividend. 2. On April 30, Castleman Holdings, Inc. sold 300 shares of Chance Company for $11 per share. 3. On May 15, Castleman Holdings, Inc. purchased 100 more shares of Evers Co. stock at $16 per share. 4. At December 31, 2012, the stocks had the following price per share values: Evers $17, Rogers $19, and Chance $8. During 2013, the following transactions took place. 5. On February 1, Castleman Holdings, Inc. sold the remaining Chance shares for $8 per share. 6. On March 1, Rogers Company paid a $2 per share dividend. 7. On December 21, Evers Company declared a cash dividend of $3 per share to be paid in the next month. 8. At December 31, 2013, the stocks had the following price per shares values: Evers $19 and Rogers $21.
Instructions
(a) Prepare journal entries for each of the above transactions. (b) Prepare a partial balance sheet showing the investment-related amounts to be reported at December 31, 2012 and 2013.
P17-12 (Available-for-Sale Securities—Statement Presentation)
Fernandez Corp. invested its excess cash in available-for-sale securities during 2012. As of December 31, 2012, the portfolio of available-for-sale securities consisted of the following common stocks. Security Quantity Cost Fair Value Lindsay Jones, Inc. 1,000 shares $ 15,000 $ 21,000 Poley Corp. 2,000 shares 40,000 42,000 Arnold Aircraft 2,000 shares 72,000 60,000 Totals $127,000 $123,000
Instructions
(a) What should be reported on Fernandez’s December 31, 2012, balance sheet relative to these securities? What should be reported on Fernandez’s 2012 income statement? On December 31, 2013, Fernandez’s portfolio of available-for-sale securities consisted of the following common stocks. Security Quantity Cost Fair Value Lindsay Jones, Inc. 1,000 shares $ 15,000 $20,000 Lindsay Jones, Inc. 2,000 shares 33,000 40,000 Duff Company 1,000 shares 16,000 12,000 Arnold Aircraft 2,000 shares 72,000 22,000 Totals $136,000 $94,000 During the year 2013, Fernandez Corp. sold 2,000 shares of Poley Corp. for $38,200 and purchased 2,000 more shares of Lindsay Jones, Inc. and 1,000 shares of Duff Company. (b) What should be reported on Fernandez’s December 31, 2013, balance sheet? What should be reported on Fernandez’s 2013 income statement? On December 31, 2014, Fernandez’s portfolio of available-for-sale securities consisted of the following common stocks. Security Quantity Cost Fair Value Arnold Aircraft 2,000 shares $72,000 $82,000 Duff Company 500 shares 8,000 6,000 Totals $80,000 $88,000 During the year 2014, Fernandez Corp. sold 3,000 shares of Lindsay Jones, Inc. for $39,900 and 500 shares of Duff Company at a loss of $2,700. (c) What should be reported on the face of Fernandez’s December 31, 2014, balance sheet? What should be reported on Fernandez’s 2014 income statement? (d) What would be reported in a statement of comprehensive income at (1) December 31, 2012, and (2) December 31, 2013? *P 17-13 (Derivative Financial Instrument) The treasurer of Miller Co. has read on the Internet that the stock price of Wade Inc. is about to take off. In order to profit from this potential development, Miller Co. purchased a call option on Wade common shares on July 7, 2012, for $240. The call option is for 200 shares (notional value), and the strike price is $70. (The market price of a share of Wade stock on that date is $70.) The option expires on January 31, 2013. The following data are available with respect to the call option. 3 5 11 Date Market Price of Wade Shares Time Value of Call Option September 30, 2012 $77 per share $180 December 31, 2012 75 per share 65 January 4, 2013 76 per share 30
Instructions
Prepare the journal entries for Miller Co. for the following dates. (a) July 7, 2012—Investment in call option on Wade shares. (b) September 30, 2012—Miller prepares financial statements. (c) December 31, 2012—Miller prepares financial statements. (d) January 4, 2013—Miller settles the call option on the Wade shares. *
P17-14 (Derivative Financial Instrument)
Johnstone Co. purchased a put option on Ewing common shares on July 7, 2012, for $240. The put option is for 200 shares, and the strike price is $70. (The market price of a share of Ewing stock on that date is $70.) The option expires on January 31, 2013. The following data are available with respect to the put option. Date Market Price of Ewing Shares Time Value of Put Option September 30, 2012 $77 per share $125 December 31, 2012 75 per share 50 January 31, 2013 78 per share 0
Instructions
Prepare the journal entries for Johnstone Co. for the following dates. (a) July 7, 2012—Investment in put option on Ewing shares. (b) September 30, 2012—Johnstone prepares financial statements. (c) December 31, 2012—Johnstone prepares financial statements. (d) January 31, 2013—Put option expires. *
P17-15 (Free-Standing Derivative)
Warren Co. purchased a put option on Echo common shares on January 7, 2012, for $360. The put option is for 400 shares, and the strike price is $85 (which equals the price of an Echo share on the purchase date). The option expires on July 31, 2012. The following data are available with respect to the put option. Date Market Price of Echo Shares Time Value of Put Option March 31, 2012 $80 per share $200 June 30, 2012 82 per share 90 July 6, 2012 77 per share 25
Instructions
Prepare the journal entries for Warren Co. for the following dates. (a) January 7, 2012—Investment in put option on Echo shares. (b) March 31, 2012—Warren prepares financial statements. (c) June 30, 2012—Warren prepares financial statements. (d) July 6, 2012—Warren settles the put option on the Echo shares. *P 17-16 (Fair Value Hedge Interest Rate Swap) On December 31, 2012, Mercantile Corp. had a $10,000,000, 8% fixed-rate note outstanding, payable in 2 years. It decides to enter into a 2-year swap with Chicago First Bank to convert the fixed-rate debt to variable-rate debt. The terms of the swap indicate that Mercantile will receive interest at a fixed rate of 8.0% and will pay a variable rate equal to the 6-month LIBOR rate, based on the $10,000,000 amount. The LIBOR rate on December 31, 2012, is 7%. The LIBOR rate will be reset every 6 months and will be used to determine the variable rate to be paid for the following 6-month period. Mercantile Corp. designates the swap as a fair value hedge. Assume that the hedging relationship meets all the conditions necessary for hedge accounting. The 6-month LIBOR rate and the swap and debt fair values are as follows. Date 6-Month LIBOR Rate Swap Fair Value Debt Fair Value December 31, 2012 7.0% — $10,000,000 June 30, 2013 7.5% (200,000) 9,800,000 December 31, 2013 6.0% 60,000 10,060,000
Instructions
(a) Present the journal entries to record the following transactions. (1) The entry, if any, to record the swap on December 31, 2012. (2) The entry to record the semiannual debt interest payment on June 30, 2013.  (3) The entry to record the settlement of the semiannual swap amount receivables at 8%, less amount payable at LIBOR, 7%. (4) The entry to record the change in the fair value of the debt on June 30, 2013. (5) The entry to record the change in the fair value of the swap at June 30, 2013. (b) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2012. (c) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on June 30, 2013. (d) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2013. *
P17-17 (Cash Flow Hedge)
LEW Jewelry Co. uses gold in the manufacture of its products. LEW anticipates that it will need to purchase 500 ounces of gold in October 2012, for jewelry that will be shipped for the holiday shopping season. However, if the price of gold increases, LEW’s cost to produce its jewelry will increase, which would reduce its profit margins. To hedge the risk of increased gold prices, on April 1, 2012, LEW enters into a gold futures contract and designates this futures contract as a cash flow hedge of the anticipated gold purchase. The notional amount of the contract is 500 ounces, and the terms of the contract give LEW the right and the obligation to purchase gold at a price of $300 per ounce. The price will be good until the contract expires on October 31, 2012. Assume the following data with respect to the price of the call options and the gold inventory purchase. Date Spot Price for October Delivery April 1, 2012 $300 per ounce June 30, 2012 310 per ounce September 30, 2012 315 per ounce
Instructions
Prepare the journal entries for the following transactions. (a) April 1, 2012—Inception of the futures contract, no premium paid. (b) June 30, 2012—LEW Co. prepares financial statements. (c) September 30, 2012—LEW Co. prepares financial statements. (d) October 10, 2012—LEW Co. purchases 500 ounces of gold at $315 per ounce and settles the futures contract. (e) December 20, 2012—LEW sells jewelry containing gold purchased in October 2012 for $350,000. The cost of the finished goods inventory is $200,000. (f) Indicate the amount(s) reported on the balance sheet and income statement related to the futures contract on June 30, 2012. (g) Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions on December 31, 2012. *
P17-18 (Fair Value Hedge)
On November 3, 2012, Sprinkle Co. invested $200,000 in 4,000 shares of the common stock of Pratt Co. Sprinkle classified this investment as available-for-sale. Sprinkle Co. is considering making a more significant investment in Pratt Co. at some point in the future but has decided to wait and see how the stock does over the next several quarters. To hedge against potential declines in the value of Pratt stock during this period, Sprinkle also purchased a put option on the Pratt stock. Sprinkle paid an option premium of $600 for the put option, which gives Sprinkle the option to sell 4,000 Pratt shares at a strike price of $50 per share. The option expires on July 31, 2013. The following data are available with respect to the values of the Pratt stock and the put option. Date Market Price of Pratt Shares Time Value of Put Option December 31, 2012 $50 per share $375 March 31, 2013 45 per share 175 June 30, 2013 43 per share 40
Instructions
(a) Prepare the journal entries for Sprinkle Co. for the following dates. (1) November 3, 2012—Investment in Pratt stock and the put option on Pratt shares. (2) December 31, 2012—Sprinkle Co. prepares financial statements. (3) March 31, 2013—Sprinkle prepares financial statements. (4) June 30, 2013—Sprinkle prepares financial statements. (5) July 1, 2013—Sprinkle settles the put option and sells the Pratt shares for $43 per share. (b) Indicate the amount(s) reported on the balance sheet and income statement related to the Pratt investment and the put option on December 31, 2012. (c) Indicate the amount(s) reported on the balance sheet and income statement related to the Pratt investment and the put option on June 30, 2013. 12 13 CONCEPTS FOR ANALYS I S
CA17-1 (Issues Raised about Investment Securities)
You have just started work for Warren Co. as part of the controller’s group involved in current financial reporting problems. Jane Henshaw, controller for Warren, is interested in your accounting background because the company has experienced a series of financial reporting surprises over the last few years. Recently, the controller has learned from the company’s auditors that there is authoritative literature that may apply to its investment in securities. She assumes that you are familiar with this pronouncement and asks how the following situations should be reported in the financial statements. Situation 1 Trading securities in the current assets section have a fair value that is $4,200 lower than cost. Situation 2 A trading security whose fair value is currently less than cost is transferred to the available-for-sale category. Situation 3 An available-for-sale security whose fair value is currently less than cost is classified as noncurrent but is to be reclassified as current. Situation 4 A company’s portfolio of available-for-sale securities consists of the common stock of one company. At the end of the prior year, the fair value of the security was 50% of original cost, and this reduction in fair value was reported as an other than temporary impairment. However, at the end of the current year the fair value of the security had appreciated to twice the original cost. Situation 5 The company has purchased some convertible debentures that it plans to hold for less than a year. The fair value of the convertible debentures is $7,700 below its cost.
Instructions
What is the effect upon carrying value and earnings for each of the situations above? Assume that these situations are unrelated.
CA17-2 (Equity Securities)
Lexington Co. has the following available-for-sale securities outstanding on December 31, 2012 (its first year of operations). Cost Fair Value Greenspan Corp. Stock $20,000 $19,000 Summerset Company Stock 9,500 8,800 Tinkers Company Stock 20,000 20,600 $49,500 $48,400 During 2013, Summerset Company stock was sold for $9,200, the difference between the $9,200 and the “fair value” of $8,800 being recorded as a “Gain on Sale of Investments.” The market price of the stock on December 31, 2013, was: Greenspan Corp. stock $19,900; Tinkers Company stock $20,500.
Instructions
(a) What justification is there for valuing available-for-sale securities at fair value and reporting the unrealized gain or loss as part of stockholders’ equity? (b) How should Lexington Company apply this rule on December 31, 2012? Explain. (c) Did Lexington Company properly account for the sale of the Summerset Company stock? Explain. (d) Are there any additional entries necessary for Lexington Company at December 31, 2013, to reflect the facts on the financial statements in accordance with generally accepted accounting principles? Explain. (AICPA adapted)
CA17-3 (Financial Statement Effect of Equity Securities)
Presented below are three unrelated situations involving equity securities. Situation 1 An equity security, whose fair value is currently less than cost, is classified as available-for-sale but is to be reclassified as trading. Situation 2 A noncurrent portfolio with an aggregate fair value in excess of cost includes one particular security whose fair value has declined to less than one-half of the original cost. The decline in value is considered to be other than temporary. Situation 3 The portfolio of trading securities has a cost in excess of fair value of $13,500. The available-forsale portfolio has a fair value in excess of cost of $28,600.
Instructions
What is the effect upon carrying value and earnings for each of the situations above?
CA17-4 (Equity Securities)
The Financial Accounting Standards Board issued accounting guidance to clarify accounting methods and procedures with respect to certain debt and all equity securities. An important part of the statement concerns the distinction between held-to-maturity, available-for-sale, and trading securities.
Instructions
(a) Why does a company maintain an investment portfolio of held-to-maturity, available-for-sale, and trading securities? (b) What factors should be considered in determining whether investments in securities should be classified as held-to-maturity, available-for-sale, and trading? How do these factors affect the accounting treatment for unrealized losses?
CA17-5 (Investment Accounted for under the Equity Method)
On July 1, 2013, Fontaine Company purchased for cash 40% of the outstanding capital stock of Knoblett Company. Both Fontaine Company and Knoblett Company have a December 31 year-end. Knoblett Company, whose common stock is actively traded in the over-the-counter market, reported its total net income for the year to Fontaine Company and also paid cash dividends on November 15, 2013, to Fontaine Company and its other stockholders.
Instructions
How should Fontaine Company report the above facts in its December 31, 2013, balance sheet and its income statement for the year then ended? Discuss the rationale for your answer. (AICPA adapted)
CA17-6 (Equity Investment)
On July 1, 2012, Selig Company purchased for cash 40% of the outstanding capital stock of Spoor Corporation. Both Selig and Spoor have a December 31 year-end. Spoor Corporation, whose common stock is actively traded on the American Stock Exchange, paid a cash dividend on November 15, 2012, to Selig Company and its other stockholders. It also reported its total net income for the year of $920,000 to Selig Company.
Instructions
Prepare a one-page memorandum of
Instructions
on how Selig Company should report the above facts in its December 31, 2012, balance sheet and its 2012 income statement. In your memo, identify and describe the method of valuation you recommend. Provide rationale where you can. Address your memo to the chief accountant at Selig Company.
CA17-7 (Fair Value)
Addison Manufacturing holds a large portfolio of debt and equity securities as an investment. The fair value of the portfolio is greater than its original cost, even though some securities have decreased in value. Sam Beresford, the financial vice president, and Angie Nielson, the controller, are near year-end in the process of classifying for the first time this securities portfolio in accordance with GAAP. Beresford wants to classify those securities that have increased in value during the period as trading securities in order to increase net income this year. He wants to classify all the securities that have decreased in value as available-for-sale (the equity securities) and as held-to-maturity (the debt securities). Nielson disagrees. She wants to classify those securities that have decreased in value as trading securities and those that have increased in value as available-for-sale (equity) and held-to-maturity (debt). She contends that the company is having a good earnings year and that recognizing the losses will help to smooth the income this year. As a result, the company will have built-in gains for future periods when the company may not be as profitable.
Instructions
Answer the following questions. (a) Will classifying the portfolio as each proposes actually have the effect on earnings that each says it will? (b) Is there anything unethical in what each of them proposes? Who are the stakeholders affected by their proposals? (c) Assume that Beresford and Nielson properly classify the entire portfolio into trading, available-for-sale, and held-to-maturity categories. But then each proposes to sell just before year-end the securities with gains or with losses, as the case may be, to accomplish their effect on earnings. Is this unethical? USING YOUR JUDGMENT
FINANCIAL REPORTING

Financial Reporting Problem
The Procter & Gamble Company (P&G) The financial statements of P&G are presented in Appendix 5B or can be accessed at the book’s companion website, www.wiley.com/college/kieso.
Instructions
Refer to P&G’s financial statements and the accompanying notes to answer the following questions. (a) What investments does P&G report in 2009, and how are these investments accounted for in its financial statements? (b) How are P&G’s investments valued? How does P&G determine fair value? (c) How does P&G use derivative financial instruments? Comparative Analysis Case The Coca-Cola Company and PepsiCo, Inc.
Instructions
Go to the book’s companion website and use information found there to answer the following questions related to The Coca-Cola Company and PepsiCo, Inc. (a) Based on the information contained in these financial statements, determine each of the following for each company. (1) Cash used in (for) investing activities during 2009 (from the statement of cash flows). (2) Cash used for acquisitions and investments in unconsolidated affiliates (or principally bottling companies) during 2009. (3) Total investment in unconsolidated affiliates (or investments and other assets) at the end of 2009. (4) What conclusions concerning the management of investments can be drawn from these data? (b) (1) Briefly identify from Coca-Cola’s December 31, 2009, balance sheet the investments it reported as being accounted for under the equity method. (2) What is the amount of investments that Coca-Cola reported in its 2009 balance sheet as “cost method investments,” and what is the nature of these investments? (c) In its Note 2 on Investments, what total amounts did Coca-Cola report at December 31, 2009, as: (1) trading securities, (2) available-for-sale securities, and (3) held-to-maturity securities?
Financial Statement Analysis Case
Union Planters Union Planters is a Tennessee bank holding company (that is, a corporation that owns banks). (Union Planters is now part of Regions Bank.) Union Planters manages $32 billion in assets, the largest of which is its loan portfolio of $19 billion. In addition to its loan portfolio, however, like other banks it has significant debt investments. The nature of these investments varies from short-term in nature to long-term in nature. As a consequence, consistent with the requirements of accounting rules, Union Planters reports its investments in two different categories—trading and available-for-sale. The following facts were found in a recent Union Planters’ annual report. Gross Gross Amortized Unrealized Unrealized Fair (all dollars in millions) Cost Gains Losses Value Trading account assets $ 275 — — $ 275 Securities available for sale 8,209 $108 $15 8,302 Net income 224 Net securities gains (losses) (9)
Instructions
(a) Why do you suppose Union Planters purchases investments, rather than simply making loans? Why does it purchase investments that vary in nature both in terms of their maturities and in type (debt versus stock)? (b) How must Union Planters account for its investments in each of the two categories? (c) In what ways does classifying investments into two different categories assist investors in evaluating the profitability of a company like Union Planters? (d) Suppose that the management of Union Planters was not happy with its net income for the year. What step could it have taken with its investment portfolio that would have definitely increased reported profit? How much could it have increased reported profit? Why do you suppose it chose not to do this? Accounting, Analysis, and Principles Instar Company has several investments in the securities of other companies. The following information regarding these investments is available at December 31, 2012. 1. Instar holds bonds issued by Dorsel Corp. The bonds have an amortized cost of $320,000 and their fair value at December 31, 2012, is $400,000. Instar intends to hold the bonds until they mature on December 31, 2020. 2. Instar has invested idle cash in the equity securities of several publicly traded companies. Instar intends to sell these securities during the first quarter of 2013, when it will need the cash to acquire seasonal inventory. These equity securities have a cost basis of $800,000 and a fair value of $920,000 at December 31, 2012. 3. Instar has a significant ownership stake in one of the companies that supplies Instar with various components Instar uses in its products. Instar owns 6% of the common stock of the supplier, does not have any representation on the supplier’s board of directors, does not exchange any personnel with the supplier, and does not consult with the supplier on any of the supplier’s operating, financial, or strategic decisions. The cost basis of the investment in the supplier is $1,200,000 and the fair value of the investment at December 31, 2012, is $1,550,000. Instar does not intend to sell the investment in the foreseeable future. The supplier reported net income of $80,000 for 2012 and paid no dividends. 4. Instar owns some common stock of Forter Corp. The cost basis of the investment in Forter is $200,000 and the fair value at December 31, 2012, is $50,000. Instar believes the decline in the value of its investment in Forter is other than temporary, but Instar does not intend to sell its investment in Forter in the foreseeable future. 5. Instar purchased 25% of the stock of Slobbaer Co. for $900,000. Instar has significant influence over the operating activities of Slobbaer Co. During 2012, Slobbaer Co. reported net income of $300,000 and paid a dividend of $100,000. Accounting (a) Determine whether each of the investments described above should be classified as available- for-sale, held-to-maturity, trading, or equity method. (b) Prepare any December 31, 2012, journal entries needed for Instar relating to Instar’s various investments in other companies. Assume 2012 is Instar’s first year of operations. Analysis What is the effect on Instar’s 2012 net income (as reported on Instar’s income statement) of Instar’s investments in other companies? Principles Briefly explain the different rationales for the different accounting and reporting rules for different types of investments in the securities of other companies.
BRIDGE TO THE PROFESSION

Professional Research: FASB Codifi cation
Your client, Cascade Company, is planning to invest some of its excess cash in 5-year revenue bonds issued by the county and in the stock of one of its suppliers, Teton Co. Teton’s shares trade on the over-the-counter market. Cascade plans to classify these investments as available-forsale. They would like you to conduct some research on the accounting for these investments.
Instructions
If your school has a subscription to the FASB Codification, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses. (a) Since the Teton shares do not trade on one of the large stock markets, Cascade argues that the fair value of this investment is not readily available. According to the authoritative literature, when is the fair value of a security “readily determinable”? (b) How is an impairment of a security accounted for? (c) To avoid volatility in their fi nancial statements due to fair value adjustments, Cascade debated whether the bond investment could be classifi ed as held-to-maturity; Cascade is pretty sure it will hold the bonds for 5 years. How close to maturity could Cascade sell an investment and still classify it as held-to-maturity? (d) What disclosures must be made for any sale or transfer from securities classifi ed as heldto- maturity? Using Your Judgment 1047
Professional Simulation
In this simulation, you are asked to address questions related to investments. Prepare responses to all parts. The fair values of the investments on December 31, 2012, were: Blossom Company common stock $ 33,800 (1% interest) U.S. Government bonds 124,700 Buttercup Company bonds 58,600 Use a computer spreadsheet to prepare a schedule indicating any fair value adjustment needed at December 31, 2012. (a) Assuming that all the investments are classified as available-for-sale, prepare the journal entries necessary to classify the amounts into the proper accounts. (b) Prepare the entry to record the accrued interest on December 31, 2012. Now assume Powerpuff’s investment in Blossom Company represents 30% of Blossom’s shares. In 2012, Blossom declared and paid dividends of $9,000 (on September 30) and reported net income of $30,000. Prepare a brief memorandum explaining how the accounting for the Blossom investment will change, and discuss the impact on the financial statements of Powerpuff Corp. Directions Situation Journal Entries Measurement Explanation Resources Directions Situation Journal Entries Measurement Explanation Resources Directions Situation Journal Entries Measurement Explanation Resources Directions Situation Journal Entries Measurement Explanation Resources Powerpuff Corp. carries an account in its general ledger called investments, which contained the following debits for investment purchases and no credits. Feb. 1, 2012 Blossom Company common stock, $100 par, 200 shares $ 37,400 April 1 U.S. Government bonds, 11%, due April 1, 2012, interest payable April 1 and October 1, 100 bonds of $1,000 par each 100,000 July 1 Buttercup Company 12% bonds, par $50,000, dated March 1, 2012, purchased at par plus accrued interest, interest payable annually on March 1, due March 1, 2032 52,000 1 2 3 45 A B C + KWW_Professional_Simulation Investments Time Remaining 3 hours 20 minutes Unsplit Split Horiz Split Vertical Spreadsheet Calculator Exit The accounting for investments is discussed in IAS 27 (“Consolidated and Separate Financial Statements”), IAS 28 (“Accounting for Investments in Associates”), IAS 39 (“Financial Instruments: Recognition and Measurement”), and IFRS 9 (“Financial Instruments”). Until recently, when the IASB issued IFRS 9, the accounting and reporting for investments under IFRS and GAAP were for the most part very similar. However, IFRS 9 introduces new investment classifi cations and increases the situations when investments are accounted for at fair value, with gains and losses recorded in income. IFRS Insights RELEVANT FACTS • GAAP classifi es investments as trading, available-for-sale (both debt and equity investments), and held-to-maturity (only for debt investments). IFRS uses heldfor- collection (debt investments), trading (both debt and equity investments), and non-trading equity investment classifi cations. The accounting for trading investments is the same between GAAP and IFRS. Held-tomaturity (GAAP) and held-for-collection investments are accounted for at amortized cost. Gains and losses related to available-for-sale securities (GAAP) and non-trading equity investments (IFRS) are reported in other comprehensive income. Both GAAP and IFRS use the same test to determine whether the equity method of accounting should be used—that is, signifi cant infl uence with a general guide of over 20 percent ownership. The basis for consolidation under IFRS is control. Under GAAP, a bipolar approach is used, which is a risk-and-reward model (often referred to as a variable-entity approach) and a voting-interest approach. However, under both systems, for consolidation to occur, the investor company must generally own 50 percent of another company. GAAP and IFRS are similar in the accounting for the fair value option. That is, the option to use the fair value method must be made at initial recognition, the selection is irrevocable, and gains and losses are reported as part of income. One difference is that GAAP permits the fair value option for equity method investments. While measurement of impairments is similar, GAAP does not permit the reversal of an impairment charge related to available-for-sale debt and equity investments. IFRS allows reversals of impairments of held-for-collection investments.
ABOUT THE NUMBERS

Accounting for Financial Assets
A fi nancial asset is cash, an equity investment of another company (e.g., ordinary or preference shares), or a contractual right to receive cash from another party (e.g., loans, receivables, and bonds). The accounting for cash is relatively straightforward and is discussed in Chapter 7. The accounting and reporting for equity and debt investments, as discussed in the opening story, is extremely contentious, particularly in light of the credit crisis in the latter part of 2008. IFRS requires that companies determine how to measure their financial assets based on two criteria: The company’s business model for managing its fi nancial assets; and The contractual cash fl ow characteristics of the fi nancial asset. If a company has (1) a business model whose objective is to hold assets in order to collect contractual cash fl ows and (2) the contractual terms of the fi nancial asset provides specifi ed dates to cash fl ows that are solely payments of principal and interest on the principal amount outstanding, then the company should use amortized cost. For example, assume that Mitsubishi purchases a bond investment that it intends to hold to maturity. Its business model for this type of investment is to collect interest and then principal at maturity. The payment dates for the interest rate and principal are stated on the bond. In this case, Mitsubishi accounts for the investment at amortized cost. If, on the other hand, Mitsubishi purchased the bonds as part of a trading strategy to speculate on interest rate changes (a trading investment), then the debt investment is reported at fair value. As a result, only debt investments such as receivables, loans, and bond investments that meet the two criteria above are recorded at amortized cost. All other debt investments are recorded and reported at fair value. IFRS Insights 1049 Debt Investments Debt Investments—Amortized Cost Only debt investments can be measured at amortized cost. If a company like Carrefour makes an investment in the bonds of Nokia, it will receive contractual cash fl ows of interest over the life of the bonds and repayment of the principal at maturity. If it is Carrefour’s strategy to hold this investment in order to receive these cash fl ows over the life of the bond, it has a held-for-collection strategy and it will measure the investment at amortized cost.42 Example: Debt Investment at Amortized Cost. To illustrate the accounting for a debt investment at amortized cost, assume that Robinson Company purchased $100,000 of 8 percent bonds of Evermaster Corporation on January 1, 2012, at a discount, paying $92,278. The bonds mature January 1, 2017, and yield 10 percent; interest is payable each July 1 and January 1. Robinson records the investment as follows. January 1, 2012 Debt Investments 92,278 Cash 92,278 As indicated in Chapter 14, companies must amortize premiums or discounts using the effective-interest method. They apply the effective-interest method to bond investments in a way similar to that for bonds payable. To compute interest revenue, companies compute the effective-interest rate or yield at the time of investment and apply that rate to the beginning carrying amount (book value) for each interest period. The investment carrying amount is increased by the amortized discount or decreased by the amortized premium in each period. Illustration
IFRS17-2 shows the effect of the discount amortization on the interest revenue that Robinson records each period for its investment in Evermaster bonds.
42Classification as held-for-collection does not mean the security must be held to maturity. For example, a company may sell an investment before maturity if (1) the security does not meet the company’s investment strategy (e.g., the company has a policy to invest in only AAA-rated bonds but the bond investment has a decline in its credit rating), (2) a company changes its strategy to invest only in securities within a certain maturity range, or (3) the company needs to sell a security to fund certain capital expenditures. However, if a company begins trading heldfor- collection investments on a regular basis, it should assess whether such trading is consistent with the held-for-collection classification. ILLUSTRATION
IFRS17-1
Summary of Investment Accounting Approaches Type of Investment Assessment of Accounting Criteria Valuation Approach Meets business model (held-for-collection) and Amortized cost Debt (Section 1) contractual cash fl ow tests. Does not meet the business model test Fair value (not held-for-collection). Equity (Section 2) Does not meet contractual cash fl ow test. Fair value Exercises some control. Equity method Equity investments are generally recorded and reported at fair value. Equity investments do not have a fixed interest or principal payment schedule and therefore cannot be accounted for at amortized cost. In summary, companies account for investments based on the type of security, as indicated in Illustration
IFRS17-1. Robinson records the receipt of the first semiannual interest payment on July 1, 2012 (using the data in Illustration
IFRS17-2), as follows.
July 1, 2012 Cash 4,000 Debt Investments 614 Interest Revenue 4,614 Because Robinson is on a calendar-year basis, it accrues interest and amortizes the discount at December 31, 2012, as follows. December 31, 2012 Interest Receivable 4,000 Debt Investments 645 Interest Revenue 4,645 Again, Illustration
IFRS17-2 shows the interest and amortization amounts. Thus, the accounting for held-for-collection investments in IFRS is the same as held-to-maturity investments under GAAP.
Debt Investments—Fair Value In some cases, companies both manage and evaluate investment performance on a fair value basis. In these situations, these investments are managed and evaluated based on a documented risk-management or investment strategy based on fair value information. For example, some companies often hold debt investments with the intention of selling them in a short period of time. These debt investments are often referred to as trading investments because companies frequently buy and sell these investments to generate profi ts in short-term differences in price. Companies that account for and report debt investments at fair value follow the same accounting entries as debt investments held-for-collection during the reporting period. That is, they are recorded at amortized cost. However, at each reporting date, companies adjust the amortized cost to fair value, with any unrealized holding gain or loss reported as part of net income (fair value method). An unrealized holding gain or loss is the net change in the fair value of a debt investment from one period to another. IFRS Insights 1051 ILLUSTRATION
IFRS17-2
Schedule of Interest Revenue and Bond Discount Amortization— Effective-Interest Method 8% BONDS PURCHASED TO YIELD 10% Bond Carrying Cash Interest Discount Amount Date Received Revenue Amortization of Bonds 1/1/12 $ 92,278 7/1/12 $ 4,000a $ 4,614b $ 614c 92,892d 1/1/13 4,000 4,645 645 93,537 7/1/13 4,000 4,677 677 94,214 1/1/14 4,000 4,711 711 94,925 7/1/14 4,000 4,746 746 95,671 1/1/15 4,000 4,783 783 96,454 7/1/15 4,000 4,823 823 97,277 1/1/16 4,000 4,864 864 98,141 7/1/16 4,000 4,907 907 99,048 1/1/17 4,000 4,952 952 100,000 $40,000 $47,722 $7,722 a$4,000 5 $100,000 3 08 3 6y12 b$4,614 5 $92,278 3 .10 3 6y12 c$614 5 $4,614 2 $4,000 d$92,892 5 $92,278 1 $614 Example: Debt Investment at Fair Value. To illustrate the accounting for debt investments using the fair value approach, assume the same information as in our previous illustration for Robinson Company. Recall that Robinson Company purchased $100,000 of 8 percent bonds of Evermaster Corporation on January 1, 2012, at a discount, paying $92,278.43 The bonds mature January 1, 2017, and yield 10 percent; interest is payable each July 1 and January 1. The journal entries in 2012 are exactly the same as those for amortized cost. These entries are as follows. January 1, 2012 Debt Investments 92,278 Cash 92,278 July 1, 2012 Cash 4,000 Debt Investments 614 Interest Revenue 4,614 December 31, 2012 Interest Receivable 4,000 Debt Investments 645 Interest Revenue 4,645 Again, Illustration
IFRS17-2 shows the interest and amortization amounts. If the debt investment is held-for-collection, no further entries are necessary. To apply the fair value approach, Robinson determines that, due to a decrease in interest rates, the fair value of the debt investment increased to $95,000 at December 31, 2012. Comparing the fair value with the carrying amount of these bonds at December 31, 2012, Robinson has an unrealized holding gain of $1,463, as shown in Illustration
IFRS17-3.
43Companies may incur brokerage and transaction costs in purchasing securities. For investments accounted for at fair value (both debt and equity), IFRS requires that these costs be recorded in net income as other income and expense and not as an adjustment to the carrying value of the investment. ILLUSTRATION
IFRS17-3
Computation of Unrealized Gain on Fair Value Debt Investment (2012) Fair value at December 31, 2012 $95,000 Amortized cost at December 31, 2012 (per Illustration
IFRS17-2) 93,537
Unrealized holding gain or (loss) $ 1,463 Robinson therefore makes the following entry to record the adjustment of the debt investment to fair value at December 31, 2012. Fair Value Adjustment 1,463 Unrealized Holding Gain or Loss—Income 1,463 Robinson uses a valuation account (Fair Value Adjustment) instead of debiting Debt Investments to record the investment at fair value. The use of the Fair Value Adjustment account enables Robinson to maintain a record at amortized cost in the accounts. Because the valuation account has a debit balance, in this case the fair value of Robinson’s debt investment is higher than its amortized cost. The Unrealized Holding Gain or Loss—Income account is reported in the other income and expense section of the income statement as part of net income. This account is closed to net income each period. The Fair Value Adjustment account is not closed each period and is simply adjusted each period to its proper valuation. The Fair Value Adjustment balance is not shown on the statement of financial position but is simply used to restate the debt investment account to fair value. Robinson reports its investment in Evermaster bonds in its December 31, 2012, financial statements as shown in Illustration
IFRS17-4.
ILLUSTRATION
IFRS17-4
Financial Statement Presentation of Debt Investments at Fair Value Statement of Financial Position Current assets Interest receivable $ 4,000 Debt investments (trading) 95,000 Income Statement Other income and expense Interest revenue ($4,614 1 $4,645) $ 9,259 Unrealized holding gain or (loss) 1,463 As you can see from this example, the accounting for trading debt investments under IFRS is the same as GAAP. Equity Investments As in GAAP, under IFRS, the degree to which one corporation (investor) acquires an interest in the shares of another corporation (investee) generally determines the accounting treatment for the investment subsequent to acquisition. To review, the classifi cation of such investments depends on the percentage of the investee voting shares that is held by the investor: 1. Holdings of less than 20 percent (fair value method)—investor has passive interest. 2. Holdings between 20 percent and 50 percent (equity method)—investor has signifi cant infl uence. 3. Holdings of more than 50 percent (consolidated statements)—investor has controlling interest. The accounting and reporting for equity investments therefore depend on the level of influence and the type of security involved, as shown in Illustration
IFRS17-5.
Equity Investments at Fair Value When an investor has an interest of less than 20 percent, it is presumed that the investor has little or no infl uence over the investee. As indicated in Illustration
IFRS17-5, there are two classifi cations for holdings less than 20 percent. Under IFRS, the presumption is
IFRS Insights 1053 ILLUSTRATION
IFRS17-5
Accounting and Reporting for Equity Investments by Category Unrealized Holding Category Valuation Gains or Losses Other Income Effects Holdings less than 20% 1. Trading Fair value Recognized in net Dividends declared; income gains and losses from sale. 2. Non- Fair value Recognized in “Other Dividends declared; Trading comprehensive gains and losses income” and as from sale. separate component of equity Holdings between Equity Not recognized Proportionate share 20% and 50% of investee’s net income. Holdings more Consolidation Not recognized Not applicable. than 50% that equity investments are held-for-trading. That is, companies hold these securities to profi t from price changes. As with debt investments that are held-for trading, the general accounting and reporting rule for these investments is to value the securities at fair value and record unrealized gains and losses in net income (fair value method).44 However, some equity investments are held for purposes other than trading. For example, a company may be required to hold an equity investment in order to sell its products in a particular area. In this situation, the recording of unrealized gains and losses in income, as is required for trading investments, is not indicative of the company’s performance with respect to this investment. As a result, IFRS allows companies to classify some equity investments as non-trading. Non-trading equity investments are recorded at fair value on the statement of financial position, with unrealized gains and losses reported in other comprehensive income. Example: Equity Investment (Income). Upon acquisition, companies record equity investments at fair value. To illustrate, assume that on November 3, 2012, Republic Corporation purchased ordinary shares of three companies, each investment representing less than a 20 percent interest. 44Fair value at initial recognition is the transaction price (exclusive of brokerage and other transaction costs). Subsequent fair value measurements should be based on market prices, if available. For non-traded investments, a valuation technique based on discounted expected cash flows can be used to develop a fair value estimate. While IFRS requires that all equity investments be measured at fair value, in certain limited cases, cost may be an appropriate estimate of fair value for an equity investment. Cost Burberry $259,700 Nestlé 317,500 St. Regis Pulp Co. 141,350 Total cost $718,550 Republic records these investments as follows. November 3, 2012 Equity Investments 718,550 Cash 718,550 On December 6, 2012, Republic receives a cash dividend of $4,200 on its investment in the ordinary shares of Nestlé. It records the cash dividend as follows. December 6, 2012 Cash 4,200 Dividend Revenue 4,200 All three of the investee companies reported net income for the year, but only Nestlé declared and paid a dividend to Republic. But, recall that when an investor owns less than 20 percent of the shares of another corporation, it is presumed that the investor has relatively little influence on the investee. As a result, net income earned by the investee is not a proper basis for recognizing income from the investment by the investor. Why? Because the increased net assets resulting from profitable operations may be permanently retained for use in the investee’s business. Therefore, the investor earns net income only when the investee declares cash dividends. At December 31, 2012, Republic’s equity investment portfolio has the carrying value and fair value shown in Illustration
IFRS17-6. For Republic’s equity investment portfolio, the gross unrealized gains are $15,300, and the gross unrealized losses are $50,850 ($13,500
1 $37,350), resulting in a net unrealized loss of $35,550. The fair value of the equity investment portfolio is below cost by $35,550. As with debt investments, Republic records the net unrealized gains and losses related to changes in the fair value of equity investments in an Unrealized Holding Gain or Loss—Income account. Republic reports this amount as other income and expense. In this case, Republic prepares an adjusting entry debiting the Unrealized Holding Gain or Loss—Income account and crediting the Fair Value Adjustment account to record the decrease in fair value and to record the loss as follows. December 31, 2012 Unrealized Holding Gain or Loss—Income 35,550 Fair Value Adjustment 35,550 On January 23, 2013, Republic sold all of its Burberry ordinary shares, receiving $287,220. Illustration
IFRS17-7 shows the computation of the realized gain on the sale.
ILLUSTRATION
IFRS17-6
Computation of Fair Value Adjustment— Equity Investment Portfolio (2012) EQUITY INVESTMENT PORTFOLIO DECEMBER 31, 2012 Carrying Investments Value Fair Value Unrealized Gain (Loss) Burberry $259,700 $275,000 $ 15,300 Nestlé 317,500 304,000 (13,500) St. Regis Pulp Co. 141,350 104,000 (37,350) Total of portfolio $718,550 $683,000 (35,550) Previous fair value adjustment balance –0– Fair value adjustment—Cr. $(35,550) ILLUSTRATION
IFRS17-7
Computation of Gain on Sale of Burberry Shares Net proceeds from sale $287,220 Cost of Burberry shares 259,700 Gain on sale of shares $ 27,520 IFRS Insights 1055 Republic records the sale as follows. January 23, 2013 Cash 287,220 Equity Investments 259,700 Gain on Sale of Equity Investment 27,520 As indicated in this example, the fair value method accounting for trading equity investments under IFRS is the same as GAAP for trading equity investments. As shown in the next section the accounting for non-trading equity investments under IFRS is similar to the accounting for available-for-sale equity investments under GAAP. Example: Equity Investments (OCI). The accounting entries to record non-trading equity investments are the same as for trading equity investments, except for recording the unrealized holding gain or loss. For non-trading equity investments, companies report the unrealized holding gain or loss as other comprehensive income (OCI). Thus, the account titled Unrealized Holding Gain or Loss—Equity is used. To illustrate, assume that on December 10, 2012, Republic Corporation purchased $20,750 of 1,000 ordinary shares of Hawthorne Company for $20.75 per share (which represents less than a 20 percent interest). Hawthorne is a distributor for Republic products in certain locales, the laws of which require a minimum level of share ownership of a company in that region. The investment in Hawthorne meets this regulatory requirement. As a result, Republic accounts for this investment at fair value, with unrealized gains and losses recorded in OCI.45 Republic records this investment as follows. December 10, 2012 Equity Investments 20,750 Cash 20,750 On December 27, 2012, Republic receives a cash dividend of $450 on its investment in the ordinary shares of Hawthorne Company. It records the cash dividend as follows. December 27, 2012 Cash 450 Dividend Revenue 450 Similar to the accounting for trading investments, when an investor owns less than 20 percent of the ordinary shares of another corporation, it is presumed that the investor has relatively little influence on the investee. Therefore, the investor earns income when the investee declares cash dividends. At December 31, 2012, Republic’s investment in Hawthorne has the carrying value and fair value shown in Illustration
IFRS17-8.
45The classification of an equity investment as non-trading is irrevocable. This approach is designed to provide some discipline to the application of the non-trading classification, which allows unrealized gains and losses to bypass net income. ILLUSTRATION
IFRS17-8
Computation of Fair Value Adjustment— Non-Trading Equity Investment (2012) Unrealized Non-Trading Equity Investment Carrying Value Fair Value Gain (Loss) Hawthorne Company $20,750 $24,000 $3,250 Previous fair value adjustment balance 0 Fair value adjustment (Dr.) $3,250 For Republic’s non-trading investment, the unrealized gain is $3,250. That is, the fair value of the Hawthorne investment exceeds cost by $3,250. Because Republic has classified this investment as non-trading, Republic records the unrealized gains and losses related to changes in the fair value of this non-trading equity investment in an Unrealized Holding Gain or Loss—Equity account. Republic reports this amount as a part of other comprehensive income and as a component of other accumulated comprehensive income (reported in equity) until realized. In this case, Republic prepares an adjusting entry crediting the Unrealized Holding Gain or Loss—Equity account and debiting the Fair Value Adjustment account to record the decrease in fair value and to record the loss as follows. December 31, 2012 Fair Value Adjustment 3,250 Unrealized Holding Gain or Loss—Equity 3,250 Republic reports its equity investments in its December 31, 2012, financial statements as shown in Illustration
IFRS17-9. During 2013, sales of Republic products through Hawthorne as a distributor did not meet management’s goals. As a result, Republic withdrew from these markets and on December 20, 2013, Republic sold all of its Hawthorne Company ordinary shares, receiving net proceeds of $22,500. Illustration
IFRS17-10 shows the computation of the realized gain on the sale.
IFRS Insights 1057 ILLUSTRATION
IFRS17-9
Financial Statement Presentation of Equity Investments at Fair Value (2012) Statement of Financial Position Investments Equity investments (non-trading) $24,000 Equity Accumulated other comprehensive gain $ 3,250 Statement of Comprehensive Income Other income and expense Dividend revenue $ 450 Other comprehensive income Unrealized holding gain $ 3,250 ILLUSTRATION
IFRS17-10
Computation of Gain on Sale of Shares Net proceeds from sale $22,500 Cost of Hawthorne shares 20,750 Gain on sale of shares $ 1,750 Republic records the sale as follows. December 20, 2013 Cash 22,500 Equity Investments 20,750 Gain on Sale of Equity Investment 1,750 Because Republic no longer holds any equity investments, it makes the following entry to eliminate the Fair Value Adjustment account. Unrealized Holding Gain or Loss—Equity 3,250 Fair Value Adjustment 3,250 In summary, the accounting for non-trading equity investments deviates from the general provisions for equity investments. The IASB noted that while fair value provides the most useful information about investments in equity investments, recording unrealized gains or losses in other comprehensive income is more representative for non-trading equity investments. Impairments A company should evaluate every held-for-collection investment, at each reporting date, to determine if it has suffered impairment—a loss in value such that the fair value of the investment is below its carrying value.46 For example, if an investee experiences a bankruptcy or a signifi cant liquidity crisis, the investor may suffer a permanent loss. If the company determines that an investment is impaired, it writes down the amortized cost basis of the individual security to refl ect this loss in value. The company accounts for the write-down as a realized loss, and it includes the amount in net income. For debt investments, a company uses the impairment test to determine whether “it is probable that the investor will be unable to collect all amounts due according to the contractual terms.” If an investment is impaired, the company should measure the loss due to the impairment. This impairment loss is calculated as the difference between the 46Note that impairments tests are conducted only for debt investments that are held-forcollection (which are accounted for at amortized cost). Other debt and equity investments are measured at fair value each period; thus, an impairment test is not needed. carrying amount plus accrued interest and the expected future cash flows discounted at the investment’s historical effective-interest rate. Example: Impairment Loss At December 31, 2011, Mayhew Company has a debt investment in Bellovary Inc., purchased at par for $200,000. The investment has a term of four years, with annual interest payments at 10 percent, paid at the end of each year (the historical effective-interest rate is 10 percent). This debt investment is classifi ed as held-for-collection. Unfortunately, Bellovary is experiencing signifi cant fi nancial diffi culty and indicates that it will be unable to make all payments according to the contractual terms. Mayhew uses the present value method for measuring the required impairment loss. Illustration
IFRS17-11 shows the cash fl ow schedule prepared for this analysis.
ILLUSTRATION
IFRS17-11
Investment Cash Flows Contractual Expected Loss of Dec. 31 Cash Flows Cash Flows Cash Flows 2012 $ 20,000 $ 16,000 $ 4,000 2013 20,000 16,000 4,000 2014 20,000 16,000 4,000 2015 220,000 216,000 4,000 Total cash flows $280,000 $264,000 $16,000 As indicated, the expected cash flows of $264,000 are less than the contractual cash flows of $280,000. The amount of the impairment to be recorded equals the difference between the recorded investment of $200,000 and the present value of the expected cash flows, as shown in Illustration
IFRS17-12.
ILLUSTRATION
IFRS17-12
Computation of Impairment Loss Recorded investment $200,000 Less: Present value of $200,000 due in 4 years at 10% (Table 6-2); FV(PVF4,10%); ($200,000 3 .68301) $136,602 Present value of $16,000 interest receivable annually for 4 years at 10% (Table 6-4); R(PVF-OA4,10%); ($16,000 3 3.16986) 50,718 187,320 Loss on impairment $ 12,680 The loss due to the impairment is $12,680. Why isn’t it $16,000 ($280,000 2 $264,000)? A loss of $12,680 is recorded because Mayhew must measure the loss at a present value amount, not at an undiscounted amount. Mayhew recognizes an impairment loss of $12,680 by debiting Loss on Impairment for the expected loss. At the same time, it reduces the overall value of the investment. The journal entry to record the loss is therefore as follows. Loss on Impairment 12,680 Debt Investments 12,680 Recovery of Impairment Loss Subsequent to recording an impairment, events or economic conditions may change such that the extent of the impairment loss decreases (e.g., due to an improvement in the debtor’s credit rating). In this situation, some or all of the previously recognized impairment loss shall be reversed with a debit to the Debt Investments account and a credit to Recovery of Impairment Loss. Similar to the accounting for impairments of receivables shown in Chapter 7, the reversal of impairment losses shall not result in a carrying amount of the investment that exceeds the amortized cost that would have been reported had the impairment not been recognized. ON THE HORIZON At one time, both the FASB and IASB have indicated that they believe that all fi nancial instruments should be reported at fair value and that changes in fair value should be reported as part of net income. However, the recently issued IFRS indicates that the IASB believes that certain debt investments should not be reported at fair value. The IASB’s decision to issue new rules on investments, prior to the FASB’s completion of its deliberations on fi nancial instrument accounting, could create obstacles for the Boards in converging the accounting in this area. IFRS SELF-TEST QUESTIONS 1. All of the following are key similarities between GAAP and IFRS with respect to accounting for investments except: (a) IFRS and GAAP have a held-to-maturity investment classifi cation. (b) IFRS and GAAP apply the equity method to signifi cant infl uence equity investments. (c) IFRS and GAAP have a fair value option for fi nancial instruments. (d) the accounting for impairment of investments is similar, although IFRS allows recovery of impairment losses. 2. Which of the following statements is correct? (a) GAAP has a held-for-collection investment classifi cation. (b) GAAP permits recovery of impairment losses. (c) Under IFRS, non-trading equity investments are accounted for at amortized cost (d) IFRS and GAAP both have a trading investment classifi cation. 3. IFRS requires companies to measure their fi nancial assets at fair value based on: (a) the company’s business model for managing its fi nancial assets. (b) whether the fi nancial asset is a debt investment. (c) whether the fi nancial asset is an equity investment. (d) All of the choices are IFRS requirements. 4. Select the investment accounting approach with the correct valuation approach: Not Held-for-Collection Held-for-Collection (a) Amortized cost Amortized cost (b) Fair value Fair value (c) Fair value Amortized cost (d) Amortized cost Fair value 5. Under IFRS, a company: (a) should evaluate only equity investments for impairment. (b) accounts for an impairment as an unrealized loss, and includes it as a part of other comprehensive income and as a component of other accumulated comprehensive income until realized. (c) calculates the impairment loss on debt investments as the difference between the carrying amount plus accrued interest and the expected future cash fl ows discounted at the investment’s historical effective-interest rate. (d) All of the above. IFRS Insights 1059 IFRS CONCEPTS AND APPLICATION
IFRS17-1
Where can authoritative IFRS be found related to investments?
IFRS17-2
Briefl y describe some of the similarities and differences between GAAP and IFRS with respect to the accounting for investments.
IFRS17-3
Describe the two criteria for determining the valuation of fi nancial assets.
IFRS17-4
Which types of investments are valued at amortized cost? Explain the rationale for this accounting.
IFRS17-5
Lady Gaga Co. recently made an investment in the bonds issued by Chili Peppers Inc. Lady Gaga’s business model for this investment is to profi t from trading in response to changes in market interest rates. How should this investment be classifi ed by Lady Gaga? Explain.
IFRS17-6
Consider the bond investment by Lady Gaga in
IFRS17-5. Discuss the accounting for this investment if Lady Gaga’s business model is to hold the investment to collect interest while outstanding and to receive the principal at maturity.

IFRS17-7
Indicate how unrealized holding gains and losses should be reported for investments classifi ed as trading and held for-collection.
IFRS17-8
Ramirez Company has a held-for-collection investment in the 6%, 20-year bonds of Soto Company. The investment was originally purchased for $1,200,000 in 2011. Early in 2012, Ramirez recorded an impairment of $300,000 on the Soto investment, due to Soto’s fi nancial distress. In 2013, Soto returned to profi tability and the Soto investment was no longer impaired. What entry does Ramirez make in 2013 under (a) GAAP and (b) IFRS?
IFRS17-9
Carow Corporation purchased, as a held-for-collection 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.
IFRS17-10
Fairbanks Corporation purchased 400 ordinary shares of Sherman Inc. as a trading investment for $13,200. During the year, Sherman paid a cash dividend of $3.25 per share. At year-end, Sherman shares were selling for $34.50 per share. Prepare Fairbanks’s journal entries to record (a) the purchase of the investment, (b) the dividends received, and (c) the fair value adjustment.
IFRS17-11
Use the information from
IFRS17-10 but assume the shares were purchased to meet a non-trading regulatory requirement. Prepare Fairbanks’s journal entries to record (a) the purchase of the investment, (b) the dividends received, and (c) the fair value adjustment.

IFRS17-12
On January 1, 2012, Roosevelt Company purchased 12% bonds, having a maturity value of $500,000, for $537,907.40. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2012, and mature January 1, 2017, with interest receivable December 31 of each year. Roosevelt’s business model is to hold these bonds to collect contractual cash fl ows.
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 2012. (d) Prepare the journal entry to record the interest received and the amortization for 2013.
IFRS17-13
Assume the same information as in
IFRS17-12 except that Roosevelt has an active trading strategy for these bonds. The fair value of the bonds at December 31 of each year-end is as follows.
2012 $534,200 2015 $517,000 2013 $515,000 2016 $500,000 2014 $513,000
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 2012. (c) Prepare the journal entry to record the recognition of fair value for 2013.
IFRS17-14
On December 21, 2012, Zurich Company provided you with the following information regarding its trading investments. December 31, 2012 Investments (Trading) Cost Fair Value Unrealized Gain (Loss) Stargate Corp. shares $20,000 $19,000 $(1,000) Carolina Co. shares 10,000 9,000 (1,000) Vectorman Co. shares 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) During 2013, Carolina Company shares were sold for $9,500. The fair value of the shares on December 31, 2013, was Stargate Corp. shares—$19,300; Vectorman Co. shares—$20,500.
Instructions
(a) Prepare the adjusting journal entry needed on December 31, 2012. (b) Prepare the journal entry to record the sale of the Carolina Company shares during 2013. (c) Prepare the adjusting journal entry needed on December 31, 2013.
IFRS17-15
Komissarov Company has a debt investment in the bonds issued by Keune Inc. The bonds were purchased at par for $400,000 and, at the end of 2012, have a remaining life of 3 years with annual interest payments at 10%, paid at the end of each year. This debt investment is classified as held-for-collection. Keune is facing a tough economic environment and informs all of its investors that it will be unable to make all payments according to the contractual terms. The controller of Komissarov has prepared the following revised expected cash flow forecast for this bond investment. Expected Dec. 31 Cash Flows 2013 $ 35,000 2014 35,000 2015 385,000 Total cash flows $455,000
Instructions
(a) Determine the impairment loss for Komissarov at December 31, 2012. (b) Prepare the entry to record the impairment loss for Komissarov at December 31, 2012. (c) On January 15, 2013, Keune receives a major capital infusion from a private equity investor. It informs Komissarov that the bonds now will be paid according to the contractual terms. Briefl y describe how Komissarov would account for the bond investment in light of this new information. IFRS Insights 1061
Professional Research

IFRS17-16
Your client, Cascade Company, is planning to invest some of its excess cash in 5-year revenue bonds issued by the county and in the shares of one of its suppliers, Teton Co. Teton’s shares trade on the over-the-counter market. Cascade plans to classify these investments as trading. They would like you to conduct some research on the accounting for these investments.
Instructions
Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/). When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.) (a) Since the Teton shares do not trade on one of the large securities exchanges, Cascade argues that the fair value of this investment is not readily available. According to the authoritative literature, when is the fair value of a security “readily determinable”? (b) How is an impairment of a debt investment accounted for? (c) To avoid volatility in their fi nancial statements due to fair value adjustments, Cascade debated whether the bond investment could be classifi ed as held-forcollection; Cascade is pretty sure it will hold the bonds for 5 years. What criteria must be met for Cascade to classify it as held-for-collection?
International Financial Reporting Problem:
Marks and Spencer plc
IFRS17-17
The fi nancial statements of Marks and Spencer plc (M&S) are available at the book’s companion website or can be accessed at http://corporate. marksandspencer. com/documents/publications/2010/Annual_Report_2010.
Instructions
Refer to M&S’s financial statements and the accompanying notes to answer the following questions. (a) What investments does M&S report in 2010, and where are these investments reported in its fi nancial statements? (b) How are M&S’s investments valued? How does M&S determine fair value? (c) How does M&S use derivative fi nancial instruments?
ANSWERS TO IFRS SELF-TEST QUESTIONS
1. a 2. d 3. a 4. c 5. c  




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