CHAPTER 17

CHAPTER 17

Investments

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Topics

Brief

Concepts

Questions Exercises Exercises Problems for Analysis

1. Debt securities. (a) Held-to-maturity.

(b) Trading.

(c) Available-for-sale.

1, 2, 3, 13

4, 5, 7, 8, 10, 13, 21

4, 6, 7, 8, 10, 21

4, 7, 8, 9, 10, 11, 21

1, 3 4 2, 10

1

4, 7

1, 2, 3, 5 1, 7

4

1, 4

4

1, 2, 3, 4, 7 1, 4

2. Bond amortization.

8, 9

1, 2, 3 3, 4, 5

1, 2, 3

3. Equity securities. (a) Available-for-sale.

(b) Trading.

(c) Equity method.

1, 12, 13, 16

7, 10, 11,

5, 8

15, 21

6, 7, 8, 14, 6 15, 21

16, 17, 18, 7 19, 20

6, 8, 9, 11, 5, 6, 8, 9,

12, 16

10, 11, 12

6, 7, 14, 6, 8 15

12, 13,

8

16, 17

4, 7 1, 2, 3

1, 3

5, 6

4. Comprehensive income. 22

9

10

10, 12

5. Disclosures of investments. 21

8, 9

5, 9, 10,

11, 12

6. Impairments.

24

10

18

3

7. Transfers between

23

categories.

1, 3, 7

*8. Derivatives

25, 26, 27, 28, 29, 30, 31, 32

19, 20, 21, 13, 14, 15, 22, 23, 24 16, 17, 18

*9. Variable Interest Entities 33, 34

*This material is dealt with in an Appendix to the chapter.

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ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)

Learning Objectives

Brief Exercises

Exercises

Problems

1. Identify the three categories of debt

1

securities and describe the accounting

and reporting treatment for each category.

2. Understand the procedures for discount and premium amortization on bond investments.

1, 2, 3, 4

2, 3, 4, 5

1, 2, 3, 4, 7

3. Identify the categories of equity securities 5, 6, 8 and describe the accounting and reporting treatment for each category.

1, 6, 7, 8, 9, 11, 12, 14, 15, 16

3, 5, 6, 8, 9, 10, 11, 12

4. Explain the equity method of accounting 7 and compare it to the fair value method for equity securities.

12, 13, 16, 17 8

5. Describe the disclosure requirements

9

for investments in debt and equity

investments.

10

8, 9, 10, 12

6. Discuss the accounting for impairments

10

18

of debt and equity investments.

7. Describe the accounting for transfer of investment securities between categories.

*8. Explain who uses derivatives and why.

*9. Understand the basic guidelines for accounting for derivatives.

*10. Describe the accounting for derivative financial instruments.

19, 20, 21

13, 14, 15

*11. Explain how to account for a fair value hedge.

22, 23, 24

16, 18

*12. Explain how to account for a cash

17

flow hedge.

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ASSIGNMENT CHARACTERISTICS TABLE

Item

E17-1 E17-2 E17-3 E17-4 E17-5 E17-6 E17-7 E17-8 E17-9

E17-10 E17-11 E17-12 E17-13 E17-14 E17-15 E17-16 E17-17 E17-18 *E17-19 *E17-20 *E17-21 *E17-22 *E17-23 *E17-24

Description

Investment Classifications. Entries for held-to-maturity securities. Entries for held-to-maturity securities. Entries for available-for-sale securities. Effective-interest versus straight-line bond amortization. Entries for available-for-sale and trading securities. Trading securities entries. Available-for-sale securities entries and reporting. Available-for-sale securities entries and financial statement presentation. Comprehensive income disclosure. Equity securities entries. Journal entries for fair value and equity methods. Equity method. Equity investment--trading. Equity investment--trading. Fair value and equity method compared. Equity method. Impairment of debt securities. Call option. Call option. Put and call options. Cash flow hedge. Fair value hedge. Fair value hedge.

Level of Difficulty

Simple Simple Simple Simple Simple Simple Simple Simple Simple

Moderate Simple Simple

Moderate Moderate Moderate

Simple Simple Moderate Moderate Moderate Moderate Moderate Moderate Moderate

P17-1 P17-2 P17-3 P17-4 P17-5 P17-6 P17-7 P17-8 P17-9

P17-10 P17-11 P17-12 *P17-13 *P17-14 *P17-15

Debt securities. Available-for-sale debt securities. Available-for-sale investments. Available-for-sale debt securities. Equity securities entries and disclosures. Trading and available-for-sale securities entries. Available-for-sale and held-to-maturity debt securities entries. Fair value and equity methods. Financial statement presentation of available-for-sale investments. Gain on sale of securities and comprehensive income. Equity investments--available-for-sale. Available-for-sale securities--statement presentation. Call option Put option Put option

Moderate Moderate Moderate Moderate Moderate

Simple Moderate Moderate Moderate

Moderate Complex Moderate Moderate Moderate Moderate

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Time (minutes)

5?10 10?15 15?20 10?15 20?30 10?15 10?15

5?10 10?15

20?25 20?25 15?20 20?25 20?25 15?20 15?20 10?15 15?20 15?20 20?25 15?20 15?20 15?20 15?20

30?40 30?40 25?30 25?35 25?35 25?35 25?35 20?30 20?30

20?30 35?45 20?30 20?25 20?25 20?25

ASSIGNMENT CHARACTERISTICS TABLE (Continued)

Item

Description

Level of Difficulty

*P17-16 *P17-17 *P17-18

Fair value hedge interest rate swap. Cash flow hedge. Fair value hedge.

Moderate Moderate Moderate

CA17-1 CA17-2 CA17-3 CA17-4 CA17-5 CA17-6 CA17-7

Issues raised about investment securities. Equity securities. Financial statement effect of equity securities. Equity securities. Investment accounted for under the equity method. Equity method. Fair value--ethics.

Moderate Moderate

Simple Moderate

Simple Moderate Moderate

Time (minutes)

30?40 25?35 25?35

25?30 25?30 20?30 20?25 15?25 25?35 25?35

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ANSWERS TO QUESTIONS

1. A debt security is an instrument representing a creditor relationship with an enterprise. Debt securities include U.S. government securities, municipal securities, corporate bonds, convertible debt, and commercial paper. Trade accounts receivable and loans receivable are not debt securities because they do not meet the definition of a security.

An equity security is described as a security representing an ownership interest such as common, preferred, or other capital stock. It also includes rights to acquire or dispose of an ownership interest at an agreed-upon or determinable price such as warrants, rights, and call options or put options. Convertible debt securities and redeemable preferred stocks are not treated as equity securities.

2. The variety in bond features along with the variability in interest rates permits investors to shop for exactly the investment that satisfies their risk, yield, and marketability desires, and permits issuers to create a debt instrument best suited to their needs.

3. Cost includes the total consideration to acquire the investment, including brokerage fees and other costs incidental to the purchase.

4. The three types of classifications are:

Held-to-maturity:

Debt securities that the enterprise has the positive intent and ability to hold

to maturity.

Trading:

Debt securities bought and held primarily for sale in the near term to

generate income on short-term price differences.

Available-for-sale: Debt securities not classified as held-to-maturity or trading securities.

5. A debt security should be classified as held-to-maturity only if the company has both: (1) the positive intent and (2) the ability to hold those securities to maturity.

6. Trading securities are reported at fair value, with unrealized holding gains and losses reported as part of net income. Since trading securities are held primarily for sale in the near term, any discount or premium is not amortized.

7. Trading and available-for-sale securities should be reported at fair value, whereas held-tomaturity securities should be reported at amortized cost.

8. $1,750,000 X 10% = $175,000; $175,000 ? 2 = $87,500.

9. Securities Fair Value Adjustment (Available-for-Sale) ................................ Unrealized Holding Gain or Loss--Equity ........................................... [$1,802,000 ? ($1,750,000 + $7,500)]

44,500

44,500

10. Unrealized holding gains and losses for trading securities should be included in net income for the current period. Unrealized holding gains and losses for available-for-sale securities should be reported as other comprehensive income and as a separate component of stockholders' equity. Unrealized holding gains and losses are not recognized for held-to-maturity securities.

11. (a) Unrealized Holding Gain or Loss--Equity ........................................... Securities Fair Value Adjustment (Available-for-Sale).................

70,000

70,000

(b) Unrealized Holding Gain or Loss--Equity ........................................... Securities Fair Value Adjustment (Available-for-Sale).................

80,000

80,000

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Questions Chapter 17 (Continued)

12. Investments in equity securities can be classified as follows: 1. Holdings of less than 20% (fair value method)--investor has passive interest. 2. Holdings between 20% and 50% (equity method)--investor has significant influence. 3. Holdings of more than 50% (consolidated statements)--investor has controlling interest.

Holdings of less than 20% are then classified into trading and available-for-sale, assuming determinable fair values.

13. Investments in stock do not have a maturity date and therefore cannot be classified as held-tomaturity securities.

14. Gross selling price of 10,000 shares at $27.50 Less: Brokerage commissions Proceeds from sale Cost of 10,000 shares Gain on sale of stock

$275,000 (1,770)

273,230 (250,000) $ 23,230

Cash ...................................................................................................... Trading Securities .......................................................................... Gain on Sale of Stock ....................................................................

273,230

250,000 23,230

15. Both trading and available-for-sale equity securities are reported at fair value. However, any unrealized holding gain or loss is reported in net income for trading securities but as other comprehensive income and as a separate component of stockholders' equity for available-forsale securities.

16. Significant influence over an investee may result from representation on the board of directors, participation in policy-making processes, material intercompany transactions, interchange of managerial personnel, or technological dependency. An investment (direct or indirect) of 20% or more of the voting stock of an investee constitutes significant influence unless there exists evidence to the contrary.

17. Under the equity method, the investment is originally recorded at cost, but is adjusted for changes in the investee's net assets. The investment account is increased (decreased) by the investor's proportionate share of the earnings (losses) of the investee and decreased by all dividends received by the investor from the investee.

18. The following disclosures in the investor's financial statements are generally applicable to the equity method: (1) The name of each investee and the percentage of ownership of common stock. (2) The accounting policies of the investor with respect to investments in common stock. (3) The difference, if any, between the amount in the investment account and the amount of underlying equity in the net assets of the investee. (4) The aggregate value of each identified investment based on quoted market price (if available). (5) When investments of 20% or more interest are, in the aggregate, material in relation to the financial position and operating results of an investor, it may be necessary to present summarized information concerning assets, liabilities, and results of operations of the investees, either individually or in groups, as appropriate.

19. Dividends in excess of earnings subsequent to acquisition should be accounted for as a reduction in the investment in common stock account.

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