1. The four major activities associated with investments ...
CHAPTER 14
QUESTIONS
1. Companies make investments in the securities of another company to provide a safety cushion of available funds and to store a temporary excess of cash. Companies also invest in other companies to earn a return, to secure influence, or to gain
control.
2. Statement No. 115 applies to many debt and equity securities. All debt securities with a readily determinable fair value fall under its scope. Debt securities that do not have a readily determinable fair value are accounted for under the rules outlined in FASB Statement No. 114. Equity securities with a readily determinable fair value that are not accounted for (1) using the equity method (i.e., greater than 20% ownership) or (2) as investments in consolidated subsidiaries are accounted for using the rules outlined in Statement No. 115.
3. A security is classified as held to maturity if the business has the intent and the ability to hold the security to maturity.
4. To be classified as a trading security, the security must have a readily determinable fair value and must be purchased and held for the purpose of selling it to generate profits on short-term differences in price.
5. (a) The stated rate of interest is used to determine the amount of the annuity to be received.
(b) The market or effective rate of interest is used in the present-value computations to determine the present value of both the principal sum and the annuity.
6. The effective-interest method computes
interest revenue by multiplying the effective interest rate by the carrying value of the
investment.
7. When a company does not own more than 50% of a company, other factors may be considered to determine if control exists. Such factors include owning a large minority voting interest with no other shareholder owning a significant block of stock or having a majority voting interest in determining who is on the company’s board of directors. When these other factors exist, then control may be assumed and consolidation would be appropriate.
8. (a) Factors that may indicate the ability of a minority-interest investor to exercise significant influence over an investee’s operating and financial policies are as follows:
1. Representation on the board of
directors of the investee.
2. Participation in the policy-making process.
3. Material intercompany transactions between investee and investor.
4. Interchange of managerial personnel between investee and investor.
5. Technological dependency of investee on investor.
6. Substantial minority interest of the investor in an investee whose shares of stock are widely distributed and not concentrated for
control purposes.
(b) Factors that may indicate the inability of an investor with more than 20% of a company’s stock to exercise significant influence over an investee’s operating and financial policies are as follows:
1. Opposition by the investee, such as litigation or complaints to governmental regulatory authorities.
2. An agreement between the investor and the investee under which the investor surrenders significant rights as a shareholder.
3. Majority ownership of the investee is concentrated among a small group of shareholders who operate the investee without regard to the views of the investor.
4. The investor needs or wants more financial information to apply the equity method than is available to the investee’s other shareholders, tries to obtain the information, and fails.
5. The investor tries and fails to obtain representation on the investee’s board of directors.
9. A joint venture is accounted for using the equity method for those partners that own 20% or more and not more than 50% of the joint venture. For these joint venture partners, the liabilities of the joint venture do not show up on the balance sheet. Instead, only the net investment in the joint venture shows up on the balance sheet. Thus, the liabilities of the joint venture are “off” the balance sheet of the partners that account for the joint venture using the equity method.
10. FASB Statement No. 115 developed new rules for reporting changes in value; the disclosure varies depending on the classification of the security. For trading securities and available-for-sale securities, a market adjustment account is used on the balance sheet to report the securities at their market values. Held-to-maturity securities are
reported on the balance sheet at their
amortized cost. For trading securities, the change in fair value for the current period is reported on the income statement. The change in value for available-for-sale securities is reported in the equity section on the balance sheet.
11. Market Adjustment is a real account used in valuing investments on the balance sheet. If the fair value of a security that falls under the scope of Statement No. 115 increases, the market adjustment account will be
debited. If the value of the security
decreases, the market adjustment account will be credited. The market adjustment
account is disclosed on the balance sheet either netted against the related securities account or disclosed separately in addition to the securities account.
12. For “other-than-temporary” declines, the cost basis of the security should be reduced by crediting the investment account rather than a market adjustment account. In
addition, the write-down should be recognized as a loss and charged against current income. The new cost basis for the security may not be adjusted upward to its original cost for any subsequent increases in
market value. However, the market adjustment account may be used to record any subsequent increases.
13. The sale of trading securities during the year results in the computed unrealized gain or loss on trading securities being a combination of unrealized gains and losses for the year and reversals of cumulative
unrealized gains and losses from prior years for trading securities sold during the year. The same is true with respect to the computation of unrealized increases and decreases in value for available-for-sale securities.
14. When FASB No. 115 securities are
transferred between categories, the transfer is accounted for at the security’s current fair value. The historical cost of the security is removed from the books along with any
associated market adjustment. The difference between the security’s current fair value and its fair value on the most recent balance sheet date is accounted for differently, depending on the classifications
involved in the transfer.
15. Realized gains on trading securities are subtracted from net income in computing cash from operating activities (when the
indirect method is used). Realized losses are added back to net income. The same is true for unrealized items; unrealized gains on trading securities are subtracted and
unrealized losses on trading securities are added back to net income.
16. Because trading securities, by their very definition, are held to take advantage of short-term differences in price, these
securities are always classified as current. Held-to-maturity securities are always
classified as long-term unless the security is maturing in the current period. The major classification problem arises with available-for-sale securities. These securities can be classified as either current or long-term, depending on the intention and assessments of management.
17. For all securities not classified as trading, the cash flow effects of purchases and sales are disclosed in the Investing section of the statement of cash flows. For securities classified as trading, the purchase and sale of securities are disclosed in the Operating section.
18. FASB Statement No. 115 requires the
following additional disclosures for the
different classifications of securities:
Trading securities—the change in the net unrealized holding gain or loss that is
included in the income statement.
Available-for-sale securities—the aggregate fair value, gross unrealized holding gains and gross unrealized holding losses, and amortized cost basis by major security type. In addition, for debt securities the company should disclose information about contractual maturities. Companies need to also disclose the proceeds from sales of
available-for-sale securities, the gross
unrealized gains and losses on those sales, and the basis on which cost was determined in computing unrealized gains and losses. Finally, companies should disclose the change in net unrealized holding gain or loss on available-for-sale securities that has been included in stockholders’ equity during the period.
Held-to-maturity securities—the aggregate fair value, gross unrealized holding gains and gross unrealized holding losses, and amortized cost basis by major security type. In addition, the company should disclose
information about contractual maturities.
19. The only significant difference between the provisions of IAS 39 and those of SFAS No. 115 is in the reporting of unrealized gains and losses. Under IAS 39, a company can elect to recognize all unrealized gains and losses—both for trading and available-for-sale securities—in net income for the
period.
20.‡ FASB Statement No. 115 applies to all debt securities for which there is a readily
determinable fair value. Thus, most debt securities would fall under the scope of this pronouncement. Loans often do not have a readily determinable fair value because they are not traded on an exchange as are most debt securities. Thus, the provisions of Statement No. 115 are not applicable to impaired loans. FASB Statement No. 114 addresses the accounting for the impairment of a loan.
‡Relates to Expanded Material.
PRACTICE EXERCISES
PRACTICE 14–1 PURCHASING DEBT SECURITIES
1. Asset approach
Feb. 1
Investment in Trading Securities 50,000
Interest Receivable 333
Cash 50,333
Interest Receivable: $50,000 ( 0.08 ( (1/12) = $333
June 30
Cash 2,000
Interest Receivable 333
Interest Revenue 1,667
Cash: $50,000 ( 0.08 ( (6/12) = $2,000
2. Revenue approach
Feb. 1
Investment in Trading Securities 50,000
Interest Revenue 333
Cash 50,333
Interest Revenue: $50,000 ( 0.08 ( (1/12) = $333
June 30
Cash 2,000
Interest Revenue 2,000
Cash: $50,000 ( 0.08 ( (6/12) = $2,000
PRACTICE 14–2 PURCHASING EQUITY SECURITIES
Investment in Available-for-Sale Securities 32,020
Cash 32,020
Investment: (1,000 shares ( $32) + $20 = $32,020
PRACTICE 14–3 COMPUTING THE VALUE OF DEBT SECURITIES
N = 7 years ( 2 = 14
I = 12/2 = 6
PMT = $100,000 ( 0.08 ( (6/12) = $4,000
FV = $100,000 (the face value is paid at the end of 7 years)
PV = $81,410
PRACTICE 14–4 INTEREST REVENUE FOR HELD-TO-MATURITY SECURITIES
1. Investment in Held-to-Maturity Securities 25,518
Cash 25,518
2. Cash [$20,000 ( 0.10 ( (6/12)] 1,000
Investment in Held-to-Maturity Securities 107
Interest Revenue 893
Interest Revenue: $25,518 ( 0.07 ( (6/12) = $893
3. Cash 1,000
Investment in Held-to-Maturity Securities 111
Interest Revenue 889
Interest Revenue: ($25,518 – $107) ( 0.07 ( (6/12) = $889
PRACTICE 14–5 COST METHOD, EQUITY METHOD, AND CONSOLIDATION
Number of Total Shares
Shares Owned of Investee Company Percentage Accounting
by Investor Company Outstanding Ownership Classification
1. 1,200 10,000 12% Trading or
available for sale
2. 6,000 8,000 75 Consolidation
3. 20,000 55,000 36 Equity method
PRACTICE 14–6 REVENUE FOR TRADING AND AVAILABLE-FOR-SALE SECURITIES
Dividends received on trading and available-for-sale securities are both classified as dividend revenue.
Cash 7,600
Dividend Revenue 7,600
Cash: (2,000 shares ( $2.50) + (4,000 shares ( $0.65) = $7,600
PRACTICE 14–7 REVENUE FOR EQUITY METHOD SECURITIES
Because Burton owns more than 20% of Company A stock (2,000/8,000 = 25%), the investment is accounted for using the equity method. Because the purchase price was equal to Burton’s share of the book value of Company A’s equity, there is no excess of purchase price over cost basis.
Year 1
Investment in Company A Stock 27,000
Cash 27,000
Investment in Company A Stock 5,000
Income from Company A Stock 5,000
Income from Company A Stock: $20,000 ( (2,000 shares/8,000 shares) = $5,000
Cash 1,600
Investment in Company A Stock 1,600
Cash: $0.80 ( 2,000 shares = $1,600
Year 2
Investment in Company A Stock 6,250
Income from Company A Stock 6,250
Income from Company A Stock: $25,000 ( (2,000 shares/8,000 shares) = $6,250
Cash 2,000
Investment in Company A Stock 2,000
Cash: $1.00 ( 2,000 shares = $2,000
PRACTICE 14–8 EQUITY METHOD: EXCESS DEPRECIATION
1. Underlying market value of net assets ($65,000/0.40) $ 162,500
Book value of net assets 120,000
Implied amount of excess value of building $ 42,500
Investor’s interest in net assets 0.40
Amount of excess building value to be depreciated $ 17,000
Depreciation period ÷ 20 years
Annual extra depreciation $ 850
PRACTICE 14–8 (Concluded)
Year 1
Investment in Company B Stock 65,000
Cash 65,000
Investment in Company B Stock 16,000
Income from Company B Stock 16,000
Income from Company B Stock: $40,000 ( (4,000 shares/10,000 shares) = $16,000
Cash 4,400
Investment in Company B Stock 4,400
Cash: 4,000 shares ( $1.10 = $4,400
Income from Company B Stock 850
Investment in Company B Stock 850
2. Investment in Company B
Purchase 65,000
Income 16,000 4,400 Dividends
Extra
850 Depreciation
Ending 75,750
PRACTICE 14–9 EQUITY METHOD: COST GREATER THAN BOOK VALUE
1. Underlying market value of net assets ($100,000/0.25) $ 400,000
Book value of net assets 300,000
Implied amount of excess of market over book value $ 100,000
Excess market value identified with:
Inventory $ 10,000
Building 50,000
Goodwill 40,000
Total $ 100,000
Investor’s interest in net assets 0.25
Amount of excess inventory cost this year $ 2,500
Amount of excess building value to be depreciated $ 12,500
Depreciation period ÷ 10 years
Annual extra depreciation $ 1,250
No extra expense is associated with the goodwill, assuming that it is not impaired during the year.
PRACTICE 14–9 (Concluded)
Year 1
Investment in Company C Stock 100,000
Cash 100,000
Investment in Company C Stock 17,500
Income from Company C Stock 17,500
Income from Company C Stock: $70,000 ( (2,500 shares/10,000 shares) = $17,500
Cash 5,000
Investment in Company C Stock 5,000
Cash: 2,500 shares ( $2.00 = $5,000
Income from Company C Stock 3,750
Investment in Company C Stock 3,750
Extra inventory cost $2,500 + Extra depreciation $1,250 = $3,750
2. Investment in Company C
Purchase 100,000
Income 17,500 5,000 Dividends
Extra
3,750 Expense
Ending 108,750
PRACTICE 14–10 CHANGES IN VALUE: TRADING SECURITIES
(a) Market Adjustment—Trading Securities 200
Unrealized Gain on Trading Securities 200
(b) Unrealized Loss on Trading Securities 150
Market Adjustment—Trading Securities 150
(c) $1,500 + $200 = $1,700
(d) $1,500 ( $150 = $1,350
PRACTICE 14–11 CHANGES IN VALUE: AVAILABLE-FOR-SALE SECURITIES
(a) Market Adjustment—Available-for-Sale Securities 200
Unrealized Increase in Available-for-Sale Securities 200
(b) Unrealized Decrease in Available-for-Sale Securities 150
Market Adjustment—Available-for-Sale Securities 150
(c) $1,500 + No income impact = $1,500
(d) $1,500 – No income impact = $1,500
PRACTICE 14–12 CHANGES IN VALUE: HELD-TO-MATURiTY SECURITIES
(a) No adjusting entry
(b) No adjusting entry
(c) $1,500 + No income impact = $1,500
(d) $1,500 – No income impact = $1,500
PRACTICE 14–13 CHANGES IN VALUE: EQUITY METHOD
(a) No adjusting entry
(b) No adjusting entry
(c) $1,500 + No income impact = $1,500
(d) $1,500 – No income impact = $1,500
PRACTICE 14–14 SALE OF SECURITIES
1. Cash (400 ( $27) 10,800
Realized Gain on Trading Securities 1,600
Investment Securities(Trading (400 ( $23) 9,200
2. Cash (400 ( $20) 8,000
Realized Loss on Trading Securities 1,200
Investment Securities(Trading (400 ( $23) 9,200
PRACTICE 14–15 SALE OF SECURITIES AND THE MARKET ADJUSTMENT ACCOUNT
1. Cash proceeds $ 9,500
– Cost 10,000
Realized loss $ (500)
2. Cumulative unrealized loss, end of year ($5,800 – $9,000) $ (3,200)
Cumulative unrealized gain, beginning of year ($26,000 – $19,000) 7,000
Unrealized loss for the year $ (10,200)
PRACTICE 14–16 TRANSFER BETWEEN CATEGORIES: TO AND FROM TRADING
Security A
Investment Securities—Available for Sale 5,500
Market Adjustment—Trading 1,000
Unrealized Gain on Transfer of Securities 1,500
Investment Securities—Trading 5,000
Security B
Investment Securities—Trading 4,100
Unrealized Loss on Transfer of Securities 3,900
Market Adjustment—Available for Sale 2,000
Investment Securities—Available for Sale 6,000
PRACTICE 14–17 TRANSFER BETWEEN CATEGORIES: AVAILABLE FOR SALE
Security A
Investment Securities—Held to Maturity 8,000
Market Adjustment—Available for Sale 1,500
Unrealized Increase in Available-for-Sale Securities 2,000
Investment Securities—Available for Sale 7,500
Security B
Investment Securities—Available for Sale 7,100
Unrealized Decrease in Available-for-Sale Securities 1,900
Investment Securities—Held to Maturity 9,000
PRACTICE 14–18 CASH FLOW AND AVAILABLE-FOR-SALE SECURITIES
Realized gain: $470 sales proceeds – $350 cost = $120 realized gain
Unrealized increase: $65 market value – $50 cost ($400 – $350) = $15 unrealized
increase
Net Income: $880 + $120 realized gain = $1,000
1. Operating activities:
Net income $1,000
Less: Realized gain on sale of securities (120) $880
2. Investing activities:
Purchase of available-for-sale securities $ (400)
Sale of available-for-sale securities 470 $70
PRACTICE 14–19 CASH FLOW AND TRADING SECURITIES
Realized gain: $470 sales proceeds – $350 cost = $120 realized gain
Unrealized gain: $65 market value – $50 cost ($400 – $350) = $15 unrealized gain
Net Income: $880 + $120 realized gain + $15 unrealized gain = $1,015
1. Operating activities:
Net income $1,015
Purchase of trading securities (400)
Sale of trading securities 470
Less: Realized gain on sale of securities (120)
Less: Unrealized gain on sale of securities (15) $950
2. Investing activities:
None
PRACTICE 14–20 DISCLOSURE: COMPUTATION OF TOTAL ECONOMIC GAIN
1.
Mar. 23 Cash (8,000 ( $47) 376,000
Realized Gain on Available-for-Sale Securities 136,000
Investment Securities—Available for Sale 240,000
(8,000 ( $30)
Dec. 31 Unrealized Decrease in Available-for-Sale Securities 75,000
Market Adjustment—Available for Sale 75,000
The key with the market adjustment is to get the ending balance in the market adjustment account equal to a $25,000 debit [5,000 shares ( ($55 ( $50)]. This requires a credit of $75,000 since the balance at the end of last year was a $100,000 debit.
PRACTICE 14–20 (Concluded)
2. The easy way to get the answer is Realized gain $136,000 – Unrealized “loss” $75,000 = $61,000 economic gain. In this case, it doesn’t matter that the unrealized decrease is not recognized in the income statement; it is still an economic loss.
To prove this, look at the economic value of the portfolio at the beginning of the year compared to the value of the portfolio plus cash at the end of the year:
Beginning: Cost of $490,000 ($240,000 + $250,000) + $100,000 market
adjustment = $590,000
Ending: $275,000 in stock (5,000 ( $55) + $376,000 cash = $651,000
The increase is $61,000 ($651,000 ( $590,000)
PRACTICE 14–21 LOAN IMPAIRMENT: INITIAL MEASUREMENT
Sum of payments to be received:
Maturity value $5,000
Annual interest payments (5 ( $800) 4,000
Total $9,000
The entire $9,000 will be received at the end of the loan term. The loan term is 5 years. However, because 1 year has already elapsed (as of the end of Year 1), the $9,000 payment will be received after four more years. The present value of this $9,000 payment is computed as follows:
FV = $9,000, N = 4, I = 8% → $6,615
The following journal entry is made to record the loan impairment:
Bad Debt Expense ($10,000 – $6,615) 3,385
Allowance for Loan Impairment 3,385
Before this entry, the carrying amount of the loan was $10,000 because the $800 interest receivable for Year 1 had not been recognized.
PRACTICE 14–22 LOAN IMPAIRMENT: SUBSEQUENT INTEREST REVENUE
An amortization schedule for the annual interest revenue amount is as follows:
| |Payment |Interest (8%) |Principal |Balance |
|End of Year 1 | | | |$6,615 |
|Year 2 |$ 0 |$529 |$ (529) |7,144 |
|Year 3 |0 |572 |(572) |7,716 |
|Year 4 |0 |617 |(617) |8,333 |
|Year 5 |9,000 |667 |8,333 |0 |
Year 2
Allowance for Loan Impairment 529
Interest Revenue 529
Year 3
Allowance for Loan Impairment 572
Interest Revenue 572
Year 4
Allowance for Loan Impairment 617
Interest Revenue 617
Year 5
Allowance for Loan Impairment 667
Interest Revenue 667
Cash 9,000
Allowance for Loan Impairment 1,000
Loan Receivable 10,000
EXERCISES
14–23.
(a) Investment in Trading Securities—Treasury Bonds 108,620*
Interest Revenue 1,200
Cash 109,820
To record purchase of $105,000 of U.S. Treasury 7%
bonds.
*1.03 ( $105,000 = $108,150; $108,150 + $470 brokerage
fee = $108,620
(b) Investment in Available-for-Sale Securities—Sand Co. 146,250
Cash 146,250
To record purchase of 1,700 shares of Sand Co.
common stock.
(c) Cash 3,675
Interest Revenue 3,675
To record receipt of semiannual interest on U.S.
Treasury 7% bonds ($105,000 ( 0.035).
(d) Cash 24,250*
Investment in Available-for-Sale Securities—
Sand Co. 21,507†
Realized Gain on Sale of Securities 2,743
To record sale of 150 shares of Sand Co. stock.
*250 shares at $97 per share = $24,250
†(250/1,700) ( $146,250 = $21,507
(e) Cash 30,950*
Realized Loss on Sale of Securities 434
Investment in Trading Securities—Treasury Bonds 31,034†
Interest Revenue 350
To record sale of $30,000 worth of U.S. Treasury 7%
bonds.
*$30,000 ( 1.02 = $30,600; $30,600 + $350 accrued interest = $30,950
†($30,000/$105,000) ( $108,620 = $31,034 (rounded)
(f) Investment in Trading Securities—Certificate of Deposit 20,000
Cash 20,000
To record purchase of a $20,000, 6-month certificate
of deposit.
14–24.
1. Investment in Trading Securities—Gimli 9,000
Investment in Trading Securities—Treasury Bonds 11,000
Investment in Available-for-Sale Securities—Legolas 22,000
Investment in Available-for-Sale Securities—Glorfindel 42,500
Investment in Held-to-Maturity Securities—Mirkwood 24,000
Cash 108,500
To record the purchase of securities during January.
2. Cash 5,390
Interest Revenue 3,630
Dividend Revenue 1,760
To record the receipt of interest and dividend
revenue during the year.
3. Cash 3,400
Realized Loss on Sale of Securities 200
Investment in Trading Securities—Gimli 3,600
To record sale of 200 shares of Gimli stock;
purchased at $18 per share, sold at $17 per share.
Cash 4,750
Investment in Available-for-Sale Securities—
Glorfindel 4,250
Realized Gain on Sale of Securities 500
To record sale of 250 shares of Glorfindel stock;
purchased at $17 per share, sold at $19 per share.
14–25.
(a) Equity Method with Consolidation. Even though RV Insurance Company is a nonhomogeneous operation, it should be consolidated because it is a majority-owned subsidiary. (See FASB Statement No. 94.)
(b) Cost Method (Available for Sale). Buy Right has 10% ownership (20,000/200,000 shares) with no additional information to suggest that significant influence can be exercised.
(c) Cost Method (Available for Sale). Super Tire holds nonvoting preferred stock. The cost method is used for investments in preferred stock.
(d) Cost Method (Trading or Available for Sale). While Takeover Company owns 30% (15,000/50,000 shares) of Western’s common stock, it has been unable to obtain representation on Western’s board of directors. This is one of the
specific examples given by FASB Interpretation No. 35, indicating that Takeover does not have significant influence and so must use the cost method. The securities would probably not be classified as trading unless Takeover is in the business of regularly making such investments in order to generate short-term trading profits.
14–25. (Concluded)
(e) Equity Method. Espino has 40% (50,000/125,000 shares) ownership and
presumably can exercise significant influence, even though it does not have a controlling interest in Independent Mining.
14–26.
1. Available for Sale
Jan. 10 Investment in Available-for-Sale Securities—
United Company Stock 900,000
Cash 900,000
To record investment in 20,000 shares of
United Company common stock.
Dec. 31 Cash 15,000
Dividend Revenue 15,000
To record dividend received from United
Company for 2008 ($0.75 ( 20,000 shares).
31 Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 100,000
Market Adjustment—Available-for-Sale
Securities 100,000
To record decline in market value of United
Company stock ($5 ( 20,000 shares).
2. Equity Method
Jan. 10 Investment in United Company Stock 900,000
Cash 900,000
To record investment in 20,000 shares of
United Company common stock.
Dec. 31 Investment in United Company Stock 45,000
Income from Investment in United
Company Stock 45,000
To record proportionate share of United
Company’s earnings for 2008 (25% ( $180,000).
31 Cash 15,000
Investment in United Company Stock 15,000
To record dividend received from United
Company for 2008 ($0.75 ( 20,000 shares).
14–27.
2007
Jan. 1 Investment in Beta Co. Stock 240,000
Cash 240,000
To record purchase of 25% interest in Beta Co.
common stock ($12 ( 20,000 shares).
Dec. 31 Investment in Beta Co. Stock 88,000
Income from Investment in Beta Co. Stock 88,000
To record 25% share of income (0.25 ( $360,000 =
$90,000 less amortization of $2,000*).
*Underlying market value of net assets ($240,000/0.25) $ 960,000
Book value of net assets 800,000
Broadcast license $ 160,000
Investor’s interest in net assets ( 0.25
Amount of license to be amortized $ 40,000
Amortization period ÷ 20
Annual amortization $ 2,000
31 Cash 32,000
Investment in Beta Co. Stock 32,000
To record receipt of dividend ($1.60 ( 20,000 shares).
2008
Dec. 31 Investment in Beta Co. Stock 95,500
Income from Investment in Beta Co. Stock 95,500
To record 25% share of income (0.25 ( $390,000 =
$97,500 less amortization of $2,000).
31 Cash 40,000
Investment in Beta Co. Stock 40,000
To record receipt of dividend ($2.00 ( 20,000 shares).
14–28.
Investment in Old Farms Co. Stock 128,000
Cash 128,000
To record the purchase of 40% of the outstanding
common stock of Old Farms Co.
Investment in Old Farms Co. Stock 32,000
Income from Investment in Old Farms Co. Stock 32,000
To report 40% of the net income reported by Old
Farms Co. (0.40 ( $80,000).
Cash 20,000
Investment in Old Farms Co. Stock 20,000
To record the receipt of $20,000 in dividends from
Old Farms Co. (0.40 ( $50,000).
14–28. (Concluded)
Income from Investment in Old Farms Co. Stock 5,000
Investment in Old Farms Co. Stock 5,000
To amortize the differential associated with the
equipment and buildings as follows:
Market Book 40% of Remaining Amount
Value Value Difference Difference Life Amortized
Equipment $100,000 $60,000 $40,000 $16,000 4 years $4,000
Buildings 80,000 50,000 30,000 12,000 12 years 1,000
14–29.
1. Investment in Held-to-Maturity Securities 478,030
Cash 478,030
To record the purchase of the debt security whose
value is computed as follows:
Using present value tables:
$ 24,000 ( 13.0079 = $ 312,190
400,000 ( 0.4146 = 165,840
$ 478,030
Using a business calculator:
PMT = $24,000, FV = $400,000, N = 20, I = 4.5% ( $478,048
Note that the amount in this entry would be the same regardless of whether this security was classified as trading, available for sale, or held to maturity.
2. Cash 24,000
Investment in Held-to-Maturity Securities 2,489*
Interest Revenue 21,511*
To record the cash received for the first interest
payment and to recognize interest revenue.
*$478,030 ( 0.045 = $21,511; $24,000 – $21,511 = $2,489
Cash 24,000
Investment in Held-to-Maturity Securities 2,601*
Interest Revenue 21,399*
To record the cash received for the second interest
payment and to recognize interest revenue.
*($478,030 – $2,489) ( 0.045 = $21,399; $24,000 – $21,399 = $2,601
14–30.
1. Amortization Schedule:
Interest Interest
Received Revenue (0.05 Bond
Interest (0.04 ( ( Carrying Discount Unamortized Carrying
Payment $100,000) Value) Amortization Discount Value
$7,723 $ 92,277
1 $4,000 $4,614 $614 7,109 92,891
2 4,000 4,645 645 6,464 93,536
3 4,000 4,677 677 5,787 94,213
4 4,000 4,711 711 5,076 94,924
5 4,000 4,746 746 4,330 95,670
6 4,000 4,784 784 3,546 96,454
7 4,000 4,823 823 2,723 97,277
8 4,000 4,864 864 1,859 98,141
9 4,000 4,907 907 952 99,048
10 4,000 4,952 952 0 100,000
2. Journal Entries:
July 1 Cash 4,000
Investment in Held-to-Maturity Securities 614
Interest Revenue 4,614
Dec. 31 Cash 4,000
Investment in Held-to-Maturity Securities 645
Interest Revenue 4,645
14–31.
This debt security’s book value following the second interest payment is $93,536 (from amortization table). The journal entries to adjust the security to market value under differing assumptions are as follows:
1. Trading Security:
Market Adjustment—Trading Securities 2,964*
Unrealized Gain on Trading Securities 2,964
To record unrealized increase in fair value of security.
Increase is recognized on the income statement.
*Fair value less book value = $96,500 – $93,536 = $2,964 unrealized gain.
14–31. (Concluded)
2. Available-for-Sale Security:
Market Adjustment—Available-for-Sale Securities 2,964
Unrealized Increase/Decrease in Value of Available-
for-Sale Securities 2,964
To record unrealized increase in fair value of security.
Increase is recognized in stockholders’ equity section.
3. For held-to-maturity securities, increases and decreases in value are not
recognized.
14–32.
1.
Security Cost Fair Value (12/31/08)
A $ 65,000 $ 75,000
B 100,000 54,000
C 220,000 226,000
Total $385,000 $355,000
A loss of $30,000 ($385,000 – $355,000) would be recognized, reducing net income to $270,000 ($300,000 – $30,000).
2.
Security Cost Fair Value (12/31/08)
A $ 65,000 $ 75,000
B 100,000 95,000
C 220,000 226,000
Total $385,000 $396,000
If the market value of security B were $95,000, net income would be increased by $11,000 ($396,000 – $385,000). Net income would be reported at $311,000 ($300,000 + $11,000).
14–33.
1. Unrealized Loss on Trading Securities 1,000*
Market Adjustment—Trading Securities 1,000
To record the decrease in fair value of trading
securities.
*Historical cost less fair value = $55,000 – $54,000 = $1,000 decline in fair value.
2. Cash 13,000
Trading Securities—Luthor Corp. 11,000
Realized Gain on Sale of Securities 2,000
To record sale of one-half of Luthor Corp. common
stock.
14–33. (Concluded)
3. (a) Unrealized Loss on Trading Securities 2,000
Market Adjustment—Trading Securities 2,000
To record additional decline in value of trading
securities from cost of $44,000 to market of
$41,000, $1,000 having already been recognized.
(b) Market Adjustment—Trading Securities 500
Unrealized Gain on Trading Securities 500
To record increase in value of trading securities,
reflecting previous decline of $1,000 with cost
now $44,000 and market $43,500.
(c) Market Adjustment—Trading Securities 5,000
Unrealized Gain on Trading Securities 5,000
To record increase in value of trading securities
above cost of $44,000 to market of $48,000, also
reflecting the previous decline of $1,000.
14–34.
1. Unrealized Loss on Trading Securities 4,000
Market Adjustment—Trading Securities 4,000
To record the decline in value of trading securities
from cost of $26,000 to market of $22,000.
Unrealized Increase/Decrease in Value of Available-for-
Sale Securities 2,000
Market Adjustment—Available-for-Sale Securities 2,000
To record decline in value of available-for-sale
securities from cost of $32,000 to market of $30,000.
No entry to adjust held-to-maturity securities to fair value.
2. Reported net income $ 100,000
Less: Unrealized loss on trading securities (4,000)
Adjusted net income $ 96,000
(Note: The decrease in value of available-for-sale securities is not reflected in
net income.)
14–35.
1. In 2007, the historical cost of the trading securities exceeds the fair value by $4,000 ($38,000 – $34,000). Thus, income for 2007 would be reduced by $4,000.
Unrealized Loss on Trading Securities 4,000
Market Adjustment—Trading Securities 4,000
In 2008, the fair value of the securities exceeds historical cost by $1,000. With an existing balance in the market adjustment account of $4,000 (credit), an adjustment would be made to income for $5,000 to obtain the desired $1,000 debit balance in the market adjustment account.
Market Adjustment—Trading Securities 5,000
Unrealized Gain on Trading Securities 5,000
2. If the decline in the fair value of a security is believed to be other than temporary, the loss is recognized in income in the current period and the cost of the security is adjusted.
Unrealized Loss on Trading Securities 5,000
Investment in Trading Securities—Streuling 5,000
To record the other-than-temporary decline in value of the
Streuling security.
Market Adjustment—Trading Securities 10,000
Unrealized Gain on Trading Securities 10,000
To adjust market adjustment account from previous
$4,000 credit balance (as of 12/31/07) to desired
debit balance of $6,000 [$39,000 fair value less
$33,000 ($10,000 + $21,000 + $2,000)adjusted cost].
14–36.
1. Market Adjustment—Trading Securities 8,000
Unrealized Gain on Trading Securities 8,000
To record increase in value of trading securities
from cost of $23,000 to market of $31,000.
2. Investment in Available-for-Sale Securities—Security B 16,500
Unrealized Loss on Transfer of Securities 1,500
Market Adjustment—Trading Securities 3,000
Investment in Trading Securities—Security B 15,000
To reclassify security as available for sale at current
fair value of $16,500 and to remove historical cost of
trading security ($15,000) and associated market
adjustment. Unrealized loss represents difference
between fair value at the beginning of the period
and fair value on date of transfer.
14–37.
1. Market Adjustment—Trading Securities 1,000
Unrealized Gain on Trading Securities 1,000
To record increase in value of trading securities from
cost of $9,000 to market of $10,000.
Unrealized Increase/Decrease in Value of Available-for-
Sale Securities 3,000
Market Adjustment—Available-for-Sale Securities 3,000
To record decline in value of available-for-sale
securities from cost of $23,000 to market of $20,000.
2. Investment in Available-for-Sale Securities—Security B 5,500
Market Adjustment—Trading Securities 1,000
Unrealized Loss on Transfer of Securities 500
Investment in Trading Securities—Security B 7,000
To reclassify security B as available for sale at
current fair value ($5,500), remove historical cost
($7,000) of trading security, remove associated
market adjustment, and record change in value
since balance sheet date ($500).
3. Investment in Trading Securities—Security C 17,000
Market Adjustment—Available-for-Sale Securities 2,000
Unrealized Loss on Transfer of Securities 1,000
Unrealized Increase/Decrease in Value of Available-
for-Sale Securities 2,000
Investment in Available-for-Sale Securities—
Security C 18,000
To reclassify security C as a trading security at its
fair value ($17,000), remove previous adjustments
as a result of changing values, and to recognize on
the income statement the difference between
historical cost and current fair value ($1,000).
14–38.
2007
Dec. 31 Market Adjustment—Trading Securities 5,500
Unrealized Gain on Trading Securities 5,500
To record increase in market adjustment account
from $0 to $5,500.
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 1,300
Market Adjustment—Available-for-Sale Securities 1,300
To record decrease in market adjustment
account from $0 to ($1,300).
2008
Dec. 31 Unrealized Loss on Trading Securities 1,750
Market Adjustment—Trading Securities 1,750
To record decline in market adjustment
account from $5,500 to $3,750.
Market Adjustment—Available-for-Sale Securities 2,200
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 2,200
To record increase in market adjustment
account from ($1,300) to $900.
2009
Dec. 31 Unrealized Loss on Trading Securities 4,950
Market Adjustment—Trading Securities 4,950
To record decline in market adjustment account
from $3,750 to ($1,200).
Market Adjustment—Available-for-Sale Securities 450
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 450
To record increase in market adjustment
account from $900 to $1,350.
14–39.
1. Unrealized Loss on Trading Securities 4,000
Market Adjustment—Trading Securities 4,000
To record decrease in value of trading securities
from cost of $26,000 to market of $22,000.
Market Adjustment—Available-for-Sale Securities 2,000
Unrealized Increase/Decrease in Value of Available-
for-Sale Securities 2,000
To record increase in value of available-for-sale
securities from cost of $41,000 to market of $43,000.
14–39. (Concluded)
2. Cash 8,000
Realized Loss on Sale of Securities 1,000
Investment in Trading Securities—Security A 9,000
To record sale of one-half of security A.
Cash 15,000
Realized Gain on Sale of Securities 3,000
Investment in Available-for-Sale Securities—
Security D 12,000
To record sale of one-half of security D.
3. Market Adjustment—Trading Securities 6,000
Unrealized Gain on Trading Securities 6,000
To record increase in value of trading securities
from cost of $17,000 to market of $19,000 and also to
reflect the previous recognized decline of $4,000.
Unrealized Increase/Decrease in Value of Available-
for-Sale Securities 1,000
Market Adjustment—Available-for-Sale Securities 1,000
To adjust available-for-sale securities from cost of
$29,000 to market value of $30,000 while reflecting
previously recognized increase of $2,000.
14–40.
a. Because aggregate market value is less than aggregate cost, an unrealized loss of $35,000 will be shown in the income statement. However, because no cash is involved, this $35,000 will be added back to net income in computing net cash from operations in the statement of cash flows.
b. The $50,000 cash payment for trading securities will be reflected as an increase in the balance of trading securities and deducted in the cash from the Operating
Activities section of the statement of cash flows. The $70,000 purchase of
available-for-sale securities will be disclosed as a cash outflow in the Investing Activities section of the statement of cash flows.
c. The $62,000 received from the sale of trading securities will be reflected in the Operating section of the statement of cash flows. The $22,000 realized gain is subtracted in order to avoid double counting because the gain is already included in net income.
d. Because aggregate market value is greater than aggregate cost, an unrealized gain of $20,000 will be shown in the income statement. However, because no cash is involved, this $20,000 will be subtracted from net income in computing net cash from operations in the statement of cash flows.
14–41.
Available for sale:
Realized gain: $470 sales proceeds – $150 cost = $320 realized gain
Unrealized decrease: $460 market value – $750 cost ($900 – $150) = $290 unrealized decrease
Trading:
Realized loss: $220 sales proceeds – $300 cost = $80 realized loss
Unrealized gain: $310 market value – $200 cost ($500 – $300) = $110 unrealized gain
Operating activities:
Net income $1,000
Purchase of trading securities (500)
Sale of trading securities 220
Plus: Realized loss on sale of trading securities 80
Less: Unrealized gain on trading securities (110)
Less: Realized gain on sale of available-for-sale securities (320) $370
Investing activities:
Purchase of available-for-sale securities $ (900)
Sale of available-for-sale securities 470 (430)
14–42.‡
1. Present value of expected future cash flows:
Date Payment Time of Discount Table Value Present Value @ 8%
Jan. 1, 2010 $40,000 now 1.000 $ 40,000
Jan. 1, 2011 40,000 1 year 0.9259 37,036
Jan. 1, 2012 40,000 2 years 0.8573 34,292
Present value at December 31, 2009 $ 111,328
2. 2009
Dec. 31 Bad Debt Expense 8,672
Allowance for Loan Impairment 8,672
To record impairment of loan by comparing
present value of expected future cash flows
with current carrying value, $120,000.
‡ Relates to Expanded Material.
14–42.‡ (Concluded)
3. 2010
Jan. 1 Cash 40,000
Loan Receivable 40,000
To record collection of loan payment.
Dec. 31 Allowance for Loan Impairment 5,706
Interest Revenue 5,706
To recognize interest revenue
[($111,328 – $40,000) ( 0.08] for the period
and reduce the allowance account
accordingly.
‡ Relates to Expanded Material.
PROBLEMS
14–43.
2006
July 10 Investment in Trading Securities—NOP Company
Stock 450,000
Cash ($45 ( 10,000 shares) 450,000
Dec. 31 Market Adjustment—Trading Securities 20,000
Unrealized Gain on Trading Securities 20,000
(Cost = $450,000; Market = $470,000)
2007
Sept. 29 Cash ($51 ( 2,000 shares) 102,000
Realized Gain on Sale of Securities 12,000
Investment in Trading Securities—NOP Company
Stock 90,000
Dec. 31 Unrealized Loss on Trading Securities 68,000*
Market Adjustment—Trading Securities 68,000
*Cost = $45 ( 8,000 shares = $360,000
Market = $39 ( 8,000 shares = $312,000
Loss: Unadjusted allowance $20,000 – required
allowance ($48,000) = $68,000 loss
2008
Aug. 17 Cash ($33 ( 2,500 shares) 82,500
Realized Loss on Sale of Securities 30,000
Investment in Trading Securities—
NOP Company Stock ($45 ( 2,500 shares) 112,500
Dec. 31 Unrealized Loss on Trading Securities 29,000*
Market Adjustment—Trading Securities 29,000
*Cost = $45 ( 5,500 shares = $247,500
Market = $31 ( 5,500 shares = $170,500
Loss on decline in value: Unadjusted allowance ($48,000) –
required allowance ($77,000) = $29,000 loss.
14–44.
1. 2007
Jan. 1 Cash 7,300*
Interest Receivable 7,300
*$80,000 ( 0.070 ( 6/12 = $ 2,800
$120,000 ( 0.075 ( 6/12 = 4,500
$ 7,300
Apr. 1 Cash 62,125
Investment in Trading Securities—7½%
Bonds 60,375*
Realized Gain on Sale of Securities 625*
Interest Revenue 1,125†
To record sale of 7½% treasury bonds.
*Gain on sale: Selling price ($60,000 ( 1.02) $ 61,200
Less: Brokerage fees $ 200
Cost of bonds ($120,750/2) 60,375 60,575
Gain on sale $ 625
†Interest revenue: $60,000 ( 0.075 ( 3/12 = $1,125
May 21 Cash 50
Dividend Revenue 50*
To record receipt of Conway Co. common
dividend.
*$0.25 dividend: $0.25 ( 200 = $50
July 1 Cash 5,050
Interest Revenue 5,050*
To record receipt of interest on U.S. Treasury
bonds.
*$80,000 ( 0.070 ( 6/12 = $ 2,800
$60,000 ( 0.075 ( 6/12 = 2,250
$ 5,050
1 Cash 77,750
Realized Loss on Sale of Securities 1,900*
Investment in Trading Securities—7% Bonds 79,650
To record sale of 7% U.S. Treasury bonds.
*Loss on sale: Selling price ($80,000 ( 0.975) $ 78,000
Less: Brokerage fees $ 250
Cost of bonds 79,650 79,900
Loss on sale $ (1,900)
14–44. (Continued)
Aug. 15 Investment in Trading Securities—Nieman Inc.
Stock 11,650*
Cash 11,650
To record purchase of Nieman Inc. common
stock.
*$11,600 + $50 brokerage fees = $11,650
Nov. 1 Investment in Trading Securities—8% Bonds 50,625*
Interest Revenue 1,333†
Cash 51,958
To record purchase of 8% U.S. Treasury bonds.
COMPUTATIONS:
*$50,000 ( 1.01 = $50,500; $50,500 + $125 brokerage fees = $50,625
†Interest revenue: $50,000 ( 0.08 ( 4/12 = $1,333
Dec. 31 Interest Receivable 4,250*
Interest Revenue 4,250
To accrue interest on U.S. Treasury bonds.
*$60,000 ( 0.075 ( 6/12 = $ 2,250
$50,000 ( 0.080 ( 6/12 = 2,000
$ 4,250
Dec. 31 Unrealized Loss on Trading Securities 615*
Market Adjustment—Trading Securities 615
To adjust for decline of securities.
Cost Market
*Conway Co. common $ 25,450 200 shares @ $110 $ 22,000
7½% U.S. Treasury bonds 60,375 $60,000 @ 101¾ ($60,000 ( 1.0175) 61,050
Nieman Inc. common 11,650 100 shares @ $116.75 11,675
8% U.S. Treasury bonds 50,625 $50,000 @ 101 ($50,000 ( 1.01) 50,500
$148,100 $ 145,225
Balance required in market adjustment account: $148,100 – $145,225 $ 2,875
Balance in market adjustment account, Dec. 31, 2006 2,260
Required adjustment $ 615
2008
Jan. 2 Cash 4,250
Interest Receivable 4,250
To record receipt of bond interest.
14–44. (Concluded)
2008
Feb. 1 Cash 60,675
Realized Loss on Sale of Securities 75*
Investment in Trading Securities—7½% Bonds 60,375*
Interest Revenue 375†
To record sale of 7½% U.S. Treasury bonds.
*Loss on sale: Selling price ($60,000 ( 1.01) $ 60,600
Less: Brokerage fees $ 300
Cost of bonds ($120,750/2) 60,375 60,675
Loss on sale $ (75)
†$60,000 ( 0.075 ( 1/12 = $375
2. Trading securities (at cost) $ 148,100
Less: Market adjustment—trading securities 2,875
Trading securities (at market, December 31, 2007) $ 145,225
14–45.
1. 2008
Investment in Trading Securities 115,500
Cash 115,500
To record purchase of Honey Company Stock—$48,000,
and Pollen Company stock—$67,500.
Investment in Available-for-Sale Securities 163,500
Cash 163,500
To record purchase of Flower Company
stock—$112,500, and treasury notes—$51,000.
Cash 25,250
Dividend Revenue 24,000*
Interest Revenue 1,250*
*Receipt of revenue from investments:
Honey Co. $ 8,000
Pollen Co. 2,500
Flower Co. 13,500
Total dividend revenue $24,000
Treasury notes—6 months $ 1,250
Unrealized Loss on Trading Securities 6,500
Market Adjustment—Trading Securities 6,500*
To record decline in market value.
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 8,500
Market Adjustment—Available-for-Sale Securities 8,500†
To record decline in market value.
14–45. (Continued)
Market Market
*Trading Securities Cost Dec. 31, 2008 Adjustment
Honey Company $ 48,000 $ 64,000 $16,000 Dr.
Pollen Company 67,500 45,000 22,500 Cr.
Total $115,500 $109,000 $6,500 Cr.
†Available-for-Sale Securities
Flower Company $112,500 $ 103,500 $ 9,000 Cr.
Treasury notes 51,000 51,500 500 Dr.
Total $163,500 $155,000 $ 8,500 Cr.
2009
Mar. 23 Cash 45,000
Realized Loss on Sale of Securities 22,500*
Investment in Trading Securities 67,500
To record sale of Pollen stock.
*Proceeds ($45,000) – Cost ($67,500) = Loss ($22,500).
June 30 Cash 51,750
Realized Loss on Sale of Securities 500*
Investment in Available-for-Sale Securities 51,000
Interest Revenue 1,250
To record sale of treasury notes at 101
plus interest.
*$50,000 ( 0.01 = $500 loss.
Dec. 31 Market Adjustment—Trading Securities 18,500*
Unrealized Gain on Trading Securities 18,500
To recognize increase in market value.
31 Market Adjustment—Available-for-Sale Securities 26,500†
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 26,500
To recognize increase in market value.
Market Market
*Trading Security Cost Dec. 31, 2009 Adjustment
Honey Company $48,000 $60,000 $ 12,000 Dr.
†Available-for-Sale Security
Flower Company $112,500 $130,500 $ 18,000 Dr.
Balance in Market Adjustment—Trading Securities before
valuation adjustment $ 6,500 Cr.
Balance required at Dec. 31, 2009, per above computation 12,000 Dr.
Adjustment required at Dec. 31, 2009 $ 18,500 Dr.
14–45. (Concluded)
Balance in Market Adjustment—Available-for-Sale
Securities before valuation adjustment $ 8,500 Cr.
Balance required at Dec. 31, 2009, per above computation 18,000 Dr.
Adjustment required at Dec. 31, 2009 $ 26,500 Dr.
2. (a) Pollen Stock Sale
Because Pollen stock is classified as a trading security, the sale of the security will be considered an operating transaction. The $22,500 realized loss will be included as reduction of net income. The $22,500 realized loss is added back to net income (using the indirect method) in the computation of operating cash flow. In addition, the $45,000 in proceeds from the sale of the trading securities is added in the computation of operating cash flow.
(b) Treasury Note Sale
Because the treasury notes are classified as available-for-sale securities, the sale of these securities will be considered an investing transaction. The $50,500 net proceeds ($51,750 – $1,250) will be added to the Cash from Investing Activities section and the $500 realized loss ($51,000 – $50,500) from the sale will be added back to net income in the Operating Activities section. The interest revenue of $1,250 is properly reflected in cash from operations.
(c) The $18,500 unrealized gain on the trading securities must be subtracted from net income when computing operating cash flow using the indirect method. The $26,500 unrealized increase in value of the available-for-sale securities does not impact net income; accordingly, no adjustment is needed in computing operating cash flow. In addition, because the unrealized increase has no cash flow effects in the current year, it does not impact the amount of cash flow reported in the investing activities section.
14–46.
1. Jan. 3 Cash 1,250
Interest Receivable 1,250
To record receipt of semiannual interest on
NYC water bonds ($25,000 ( 0.10 × 6/12).
Mar. 1 Investment in Trading Securities—Herzog Corp. 22,950
Cash 22,950
To record purchase of 300 additional shares
of Herzog stock.
Apr. 15 Cash (400 shares ( $69) 27,600
Investment in Trading Securities—Taylor Inc. 27,500*
Realized Gain on Sale of Securities 100
*Cost = 1/2 ( $55,000 = $27,500.
14–46. (Continued)
May 4 Cash (400 shares ( $62) 24,800
Investment in Available-for-Sale
Securities—Martin Inc. 23,600*
Realized Gain on Sale of Securities 1,200
*0.40 ( $59,000 = $23,600
July 1 Cash 1,250
Interest Revenue 1,250
To record receipt of semiannual interest on
NYC water bonds.
Oct. 30 Investment in Trading Securities—Cook Co. 83,250
Cash 83,250
To record purchase of 1,500 shares of Cook
Co. stock.
Dec. 31 Interest Receivable 1,250
Interest Revenue 1,250
To record accrual of interest on NYC water
bonds.
31 Market Adjustment—Trading Securities 3,960*
Unrealized Gain on Trading Securities 3,960
31 Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 3,800†
Market Adjustment—Available-for-Sale
Securities 3,800
*COMPUTATIONS:
Cost Market
*Herzog Corp. stock 1,000 shares at $75 cost, 300
shares at $76.50 cost $ 97,950 $ 99,580
Taylor Inc. stock 400 shares at $68.75 cost 27,500 27,400
Cook Co. stock 1,500 shares at $55.50 cost 83,250 82,875
New York City water bonds 25,000 20,555
$ 233,700 $ 230,410
Trading securities at cost $ 233,700
Trading securities at market (230,410)
December 31, 2007—required market adjustment
balance $ 3,290 credit
December 31, 2007—unadjusted balance 7,250 credit
Required decrease (recovery) $ (3,960) debit
14–46. (Concluded)
Cost Market
†Martin Inc. stock, 600 shares at $59 cost $ 35,400 $ 36,600
Outdoors Unlimited Inc. stock, 2,000 shares
at $24.50 cost 49,000 54,000
$ 84,400 $ 90,600
Available-for-sale securities at market $ 90,600
Available-for-sale securities at cost 84,400
December 31, 2007—required market adjustment
balance $ 6,200 debit
December 31, 2007—unadjusted balance 10,000 debit
Required decrease $ 3,800 credit
2. Current assets:
Trading securities (at cost) $ 233,700
Less: Market adjustment—trading securities (3,290) $ 230,410
Available-for-sale securities (at cost) $ 84,400
Add: Market adjustment—available-for-sale
securities 6,200 90,600
Total investments—current $ 321,010
14–47.
(a) 2008
Nov. 1 Investment in Trading Securities—Treasury
Bonds 103,550*
Interest Revenue 3,333†
Cash 106,883
*($100,000 ( 1.0325) + $300 = $103,550
†$100,000 ( 0.10 ( 4/12 = $3,333
(b) Dec. 31 Unrealized Loss on Trading Securities 450*
Market Adjustment—Trading Securities 450
*Cost Market
$ 25,250 $ 23,350 Cost $ 161,250
32,450 33,950 Market 160,300
103,550 103,000 Balance required in market adjustment
account—credit $ 950
$ 161,250 $ 160,300 Balance in market adjustment account—credit
before adjusting entry 500
Credit to market adjustment account $ 450
Adjusting entry for accrued interest:
Dec. 31 Interest Receivable 5,000
Interest Revenue 5,000
14–47. (Concluded)
(c) 2009
Jan. 1 Cash 5,000
Interest Receivable 5,000
(d) July 1 Entry given is correct.
(e) Dec. 6 Investment in Available-for-Sale Securities—
Fleming Co. 24,500
Market Adjustment—Trading Securities 1,900
Investment in Trading Securities—Fleming Co. 25,250
Unrealized Gain on Transfer of Securities 1,150
(f) Dec. 31 Market Adjustment—Available-for-Sale Securities 450*
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 450
Unrealized Loss on Trading Securities 800†
Market Adjustment—Trading Securities 800
Interest Receivable 5,000
Interest Revenue 5,000
Adjusting entry for accrued interest.
Market Amount in Adjustment
Cost Market Adjustment Account Required
*Fleming Co. stock $ 24,500 $ 24,950 $450 Dr. $ 0 $450 Dr.
†Dobson Co. stock $ 32,450 $ 32,650 $200 Dr.
10% U.S. Treasury bonds 103,550 103,500 50 Cr.
$136,000 $136,150 $150 Dr. $950 Dr. $800 Cr.
14–48.
1.
2007
Dec. 31 Unrealized Loss on Trading Securities 2,000
Market Adjustment—Trading Securities 2,000*
To recognize decline in market value.
2007
Dec. 31 Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 17,500
Market Adjustment—Available-for-Sale
Securities 17,500†
To recognize decline in market value.
14–48. (Concluded)
Market Market
*Trading Securities Cost Dec. 31, 2007 Adjustment
Opus Co. common $100,000 $ 95,000 $5,000 Cr.
Garrod Inc. preferred 40,000 43,000 3,000 Dr.
Totals $140,000 $138,000 $2,000 Cr.
Market Market
†Available-for-Sale Securities Cost Dec. 31, 2007 Adjustment
Jennings Co. Common $67,500 $50,000 $17,500 Cr.
No valuation adjustment is necessary for Sherrill Inc. common stock because an influencing investment is held by Morris; therefore, the investment will be accounted for with the equity method.
2. 2007
Dec. 31 Permanent Loss on Securities 17,500
Investment in Available-for-Sale Securities—
Jennings Co. 17,500
To recognize permanent decline in market value.
3. 2008
Dec. 31
Market Adjustment—Trading Securities 7,000*
Unrealized Gain on Trading Securities 7,000
To recognize increase in market value.
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 5,000
Market Adjustment—Available-for-Sale Securities 5,000†
To recognize temporary decline in market value.
Market Market
*Trading Securities Cost Dec. 31, 2008 Adjustment
Opus Co. common $100,000 $102,000 $2,000 Dr.
Garrod Inc. preferred 40,000 43,000 3,000 Dr.
Totals $140,000 $145,000 $5,000 Dr.
Balance in Market Adjustment—Trading Securities before valuation
adjustment $ 2,000 Cr.
Balance required at Dec. 31, 2008, per above computation 5,000 Dr.
Adjustment required at Dec. 31, 2008 $ 7,000 Dr.
Market Market
†Available-for-Sale Securities Cost Dec. 31, 2008 Adjustment
Jennings Co. common $50,000 $45,000 $ 5,000 Cr.
[Note: New cost basis after permanent write-down ($67,500 – $17,500).]
Again, no valuation adjustment is necessary for Sherrill Inc. common stock at year-end 2008 because the equity method applies to this investment.
14–49.
2007 Cash 3,750
Dividend Revenue 3,750*
To record dividend received from Seco Inc.
*World Inc. owns 10% (10,000/100,000) of Seco Inc. stock; therefore, the cost method is used and the dividend is computed as follows:
$37,500 dividends paid by Seco Inc. ( 0.10 = $3,750
2007 Investment in Hillsborough Corp. Stock 21,000
Income from Investment in Hillsborough Corp. Stock 21,000*
To record share of Hillsborough Corp. income.
*World Inc. owns 30% (30,000/100,000) of Hillsborough Corp. stock; therefore, the equity method is used to record the income earned.
$70,000 ( 0.30 = $21,000 share of income of Hillsborough Corp.
Market Adjustment—Available-for-Sale Securities 15,000
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 15,000
Because Seco stock is being held as a long-term
investment, it is properly recorded as an available-
for-sale security. Market adjustment required
($75,000 – $60,000).
2008 Cash 4,500
Dividend Revenue 4,500
To record dividend received from Seco Inc.
($45,000 ( 0.10).
Cash 6,000
Investment in Hillsborough Corp. Stock 6,000
To record dividend received from Hillsborough Corp.
($20,000 ( 0.30).
Investment in Hillsborough Corp. Stock 12,000
Income from Investment in Hillsborough Corp. Stock 12,000
To record share of Hillsborough Corp. income
($40,000 ( 0.30).
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 10,000
Market Adjustment—Available-for-Sale Securities 10,000
To record reduction in market value of $1.00 per
share.
14–50.
2008
Jan. 1 Investment in Freelance Corp. Stock 258,000
Cash 258,000
To record purchase of 30% of Freelance Corp.
common stock.
Dec. 31 Cash 6,000
Investment in Freelance Corp. Stock 6,000
To record receipt of dividend ($20,000 ( 0.30).
Dec. 31 Investment in Freelance Corp. Stock 54,000
Income from Investment in Freelance Corp. Stock 54,000
To record share of income (0.30 ( $180,000).
31 Income from Investment in Freelance Corp. Stock 7,800*
Investment in Freelance Corp. Stock 7,800
To record adjustment to net income.
*Underlying value of net assets of Freelance Corp.
($258,000/0.30) $ 860,000
Carrying value of Freelance Corp. net assets 590,000
Excess underlying value over carrying value $ 270,000
Attributable to undervalued depreciable assets 130,000
Attributable to goodwill $ 140,000
Additional depreciation [($130,000 ( 0.30)/5 yrs.] $ 7,800
No amortization of goodwill 0
Net annual adjustment to income $ 7,800
14–51.
1. Underlying value of International Co. owners’ equity ($700,000/0.25) $ 2,800,000
Carrying value of International Co. owners’ equity ($600,000/0.25) 2,400,000
Excess underlying value over book value $ 400,000
Attributable to plant assets $ 60,000
Attributable to land 300,000 360,000
Goodwill $ 40,000
2. Cost Method:
July 1 Investment in Available-for-Sale Securities—
International Co. 700,000
Cash 700,000
Purchased 25% of outstanding stock of
International Co.
14–51. (Concluded)
Dec. 31 Cash 26,250
Dividend Revenue 26,250
To record dividend received from International
($105,000 ( 0.25).
31 Market Adjustment—Available-for-Sale Securities 50,000
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 50,000
To recognize increase in market value
($750,000 – $700,000).
3. Equity Method:
July 1 Investment in International Co. Stock 700,000
Cash 700,000
Purchased 25% of outstanding stock of
International Co.
Dec. 31 Investment in International Co. Stock 67,500
Income from Investment in International Co.
Stock 67,500
To record share of income in International
($540,000 ( 0.25 ( 6/12).
31 Income from Investment in International Co.
Stock 750*
Investment in International Co. Stock 750
To adjust reported income.
*Additional depreciation [($60,000/10) ( 0.25 ( 6/12] $ 750
No amortization of goodwill 0
$ 750
31 Cash 26,250
Investment in International Co. Stock 26,250
To record receipt of dividends ($105,000 ( 0.25).
14–52.
Preliminary Computations:
Book value of ABC $ 810,000
Percentage purchased by JJJ 0.35
JJJ’s percentage of book value $ 283,500
Price paid by JJJ 280,000
Difference between fair value and book value $ (3,500)
14–52. (Concluded)
Explanation of the difference:
Book Market 35% of Remaining Amount
Value Value Difference Life Amortized
Equipment $175,000 $140,000 $(12,250) 10 years $(1,225)*
Buildings 40,000 65,000 8,750 20 years 438
Net difference $ (3,500) $ (787)
*In previous examples, market value had exceeded book value, and, as a result, the amount amortized was applied to reduce the income from the subsidiary. In this instance, book value exceeds market value for the equipment. Therefore, the ($787) amortization relating to the net difference in equipment and buildings is applied to increase the income from ABC account.
2008 Investment in ABC 280,000
Cash 280,000
To record the initial purchase of 35% of the stock
of ABC.
Investment in ABC 28,000
Income from Investment in ABC 28,000
To record 35% of the reported net income of ABC
(0.35 ( $80,000).
Cash 5,250
Investment in ABC 5,250
To record the receipt of $5,250 in dividends from
ABC (0.35 ( $15,000).
Investment in ABC 787
Income from Investment in ABC 787
To record the amortization of the net difference
between book value and fair value of the net
assets of ABC ($1,225 – $438).
2009 Loss from Investment in ABC 3,500
Investment in ABC 3,500
To record 35% of the reported net loss of ABC
(0.35 ( $10,000).
Cash 2,800
Investment in ABC 2,800
To record the receipt of $2,800 in dividends from
ABC (0.35 ( $8,000).
Investment in ABC 787
Income from Investment in ABC 787
To record the amortization of the net difference
between book value and fair value of the net
assets of ABC ($1,225 – $438).
14–53.
1. 2007
Market Adjustment—Trading Securities 4,000
Unrealized Gain on Trading Securities 4,000
To record increase in value of trading securities
from cost of $36,000 to market of $48,000, given
an existing debit balance in the market adjustment
account of $8,000.
Market Adjustment—Available-for-Sale Securities 1,000
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 1,000
To record decrease in market adjustment account
from previous credit balance of $2,500 to required
credit balance of $1,500.
2. 2008
Investment in Available-for-Sale Securities—Security A 18,000
Market Adjustment—Trading Securities 3,000
Investment in Trading Securities—Security A 14,000
Unrealized Gain on Transfer of Securities 1,000
To reclassify security A from trading to available-
for-sale security.
Investment in Trading Securities—Security C 8,500
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 2,000
Unrealized Gain on Transfer of Securities 1,500
Market Adjustment—Available-for-Sale Securities 2,000
Investment in Available-for-Sale Securities—
Security C 7,000
To reclassify security C from available-for-sale to
trading security. Record previously unrealized
increase in value ($1,500) as an unrealized gain.
Investment in Held-to-Maturity Securities—Security D 21,000
Investment in Available-for-Sale Securities—
Security D 18,000
Unrealized Increase/Decrease in Value of Available-
for-Sale Securities 500
Market Adjustment—Available-for-Sale Securities 2,500
To reclassify security D from available for sale to
held to maturity at its current fair value.
14–53. (Concluded)
Investment in Trading Securities—Security F 48,000
Unrealized Loss on Transfer of Securities 2,000
Investment in Held-to-Maturity Securities—Security F 50,000
To reclassify security F from held-to-maturity to
trading security at its current market value. Also to
recognize the decrease in fair value on the income
statement.
14–54.
(a) Cash 9,500
Realized Loss on Sale of Securities 4,000*
Investment in Trading Securities—West Data, Inc. 13,500
Sold 500 shares for $19; cost, $27.
*Purchase price $27,000/1,000 = $27 per share
Selling price $9,500/500 = 19 per share
$ 8 loss per share
Total loss = ($8 ( 500) = $4,000
(b) Cash 3,000
Investment in Available-for-Sale Securities—
Disks, Inc. 2,400
Realized Gain on Sale of Securities 600*
Sold 200 shares at $15; cost, $12.
*Purchase price $60,000/5,000 = $12 per share
Selling price $3,000/200 = 15 per share
$ 3 gain per share
Total gain = ($3 ( 200) = $600
(c) Investment in Available-for-Sale Securities—Albert
Groceries, Inc. 12,900
Market Adjustment—Trading Securities 2,500
Investment in Trading Securities—Albert Groceries,
Inc. 9,000
Unrealized Gain on Transfer of Securities 1,400*
To transfer Albert Groceries stock from trading
securities portfolio to available-for-sale portfolio.
*$12,900 – $11,500 = $1,400
14–54. (Continued)
(d) Investment in Trading Securities—Disks, Inc. 96,000
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 20,000
Investment in Available-for-Sale Securities—
Disks, Inc. 57,600
Market Adjustment—Available-for-Sale Securities 20,000
Unrealized Gain on Transfer of Securities 38,400
To transfer Disks stock from available for sale to
trading portfolio and recognize gain in increase in
market value as income.
Cash 86,400
Realized Loss on Sale of Securities 9,600
Investment in Trading Securities—Disks, Inc. 96,000
To record sale of Disks stock.
Dec. 31, 2008
Per Market Value Market
Trading Securities Shares Cost Share 12/31/08 Adjustment
West Data, Inc. 500 $13,500 $15 $ 7,500 $6,000 Cr.
Steel Co. 450 9,900 21 9,450 450 Cr.
$23,400 $ 16,950 $6,450 Cr.
Balance in market adjustment—Trading securities, Dec. 31, 2008, before
valuation adjustment ($6,185 Cr. + $2,500 Cr.) $8,685 Cr.
Balance required at Dec. 31, 2008, per above computation 6,450 Cr.
Adjustment required at Dec. 31, 2008 $2,235 Dr.
Market Adjustment—Trading Securities 2,235
Unrealized Gain on Trading Securities 2,235
To recognize increase in market value of trading
security portfolio.
Dec. 31, 2008
Available-for-Sale Per Market Value Market
Securities Shares Cost Share 12/31/08 Adjustment
Dairy Products 2,000 $ 86,000 $42 $ 84,000 $ 2,000 Cr.
Vern Movies, Inc. 15,000 390,000 28 420,000 30,000 Dr.
Albert Groceries, Inc. 600 12,900 22 13,200 300 Dr.
$488,900 $ 517,200 $28,300 Dr.
14–54. (Concluded)
Balance in market adjustment—Available for sale, Dec. 31, 2008,
before valuation adjustment ($1,000 Cr. + $20,000 Cr.) $21,000 Cr.
Balance required at Dec. 31, 2008, per above computation 28,300 Dr.
Adjustment required at Dec. 31, 2008 $49,300 Dr.
Market Adjustment—Available-for-Sale Securities 49,300
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 49,300
To recognize increase in portfolio.
14–55.
1. 2006 (Equity Method)
Jan. 2 Investment in Caldecott Stock 400,000
Cash 400,000
(100,000 ( 0.20 ( $20)
Oct. 31 Cash 6,000
Investment in Caldecott Stock 6,000
($30,000 ( 0.20)
Dec. 31 Investment in Caldecott Stock 15,000
Income from Investment in Caldecott Stock 15,000
($75,000 ( 0.20)
No valuation adjustment under equity method.
2007 (Equity Method)
Oct. 31 Cash 6,400
Investment in Caldecott Stock 6,400
($32,000 ( 0.20)
Dec. 31 Investment in Caldecott Stock 18,000
Income from Investment in Caldecott Stock 18,000
($90,000 ( 0.20)
No valuation adjustment under equity method.
14–55. (Continued)
2008 (Equity Method)
Jan. 2 Cash 120,000*
Realized Gain on Sale of Caldecott Stock 14,850†
Investment in Newberry Stock 105,150**
*Cash proceeds = 5,000 ( $24 = $120,000
**Cost of investment = 5,000/20,000 ( carrying
value of investment, $420,600 = $105,150
($400,000 – $6,000 + $15,000 – $6,400 + $18,000 = $420,600)
†Gain on sale = $120,000 – $105,150 = $14,850
2 Investment in Available-for-Sale
Securities—Caldecott 315,450
Investment in Caldecott Stock 315,450
To reclassify stock because ownership is now
only 15% ($420,600 – $105,150).
Oct. 31 Cash 3,000
Dividend Revenue 3,000
($20,000 ( 15,000/100,000)
Dec. 31 Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 90,450
Market Adjustment—Available-for-Sale
Securities 90,450
$315,450 – (15,000 ( $15) = $90,450
2. Cost Method
2006
Dec. 31 Market Adjustment—Available-for-Sale Securities 100,000
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 100,000
($25 – $20) ( 20,000 = $100,000
2007
Dec. 31 Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 20,000
Market Adjustment—Available-for-Sale
Securities 20,000
($25 – $24) ( 20,000 = $20,000
2008
Dec. 31 Unrealized Increase/Decrease in Value of
Available-for-Sale Securities 155,000
Market Adjustment—Available-for-Sale
Securities 155,000
14–55. (Concluded)
COMPUTATIONS:
Original cost (20,000 shares ( $20) $ 400,000
Less: Cost of sale on Jan. 2, 2008 (5,000 shares ( $20) 100,000
Cost on Dec. 31, 2008 $ 300,000
Less: Market on Dec. 31, 2008 (15,000 shares ( $15) 225,000
Balance required in market adjustment account $ 75,000 Cr.
Balance in market adjustment account before 2008 adjustment 80,000 Dr.
Adjustment required $ 155,000 Cr.
14–56.
1. Income statement
Sales $ 3,200
Cash expenses (2,700)
Depreciation expense (50)
Operating income $ 450
Realized gain on sale of trading securities 140
Realized loss on sale of available-for-sale securities (40)
Unrealized loss on trading securities (90)
Net income $ 460
Available for sale:
Realized loss: $60 sales proceeds – $100 cost = $40 realized loss
Unrealized increase: $270 market value – $200 cost ($300 – $100) = $70 unrealized
increase
Trading:
Realized gain: $340 sales proceeds – $200 cost = $140 realized gain
Unrealized loss: $210 market value – $300 cost ($500 – $200) = $90 unrealized loss
14–56. (Concluded)
2. Statement of cash flows
Operating activities:
Net income $ 460
Plus: Depreciation 50
Purchase of trading securities (500)
Sale of trading securities 340
Less: Increase in accounts receivable (190)
Less: Realized gain on sale of trading securities (140)
Plus: Realized loss on sale of available-for-sale securities 40
Plus: Unrealized loss on trading securities 90 $ 150
Investing activities:
Purchase of building $ (550)
Purchase of available-for-sale securities (300)
Sale of available-for-sale securities 60 (790)
Financing activities:
Initial investment by owners 2,000
Net increase in cash $ 1,360
3. Balance sheet
Assets:
Cash $ 1,360
Accounts receivable 190
Trading securities (cost, $300) 210
Available-for-sale securities (cost, $200) 270
Building (less accumulated depreciation of $50) 500
$ 2,530
Liabilities $ 0
Equity:
Paid-in capital $ 2,000
Retained earnings (beginning balance = $0) 460
Accumulated other comprehensive income 70
$ 2,530
14–57.
1. The correct answer is d. Marketable equity securities are reported at fair value. When they are classified as trading securities, all holding gains and losses are reported in earnings.
2. The correct answer is b. When a company holds securities that it does not intend to sell in the near term, they are classified as securities available for sale.
As such, they are reported at fair market value and any difference between the original cost and the fair value is reported as part of accumulated other comprehensive income in stockholders' equity.
3. The correct answer is b. An investment in bonds that is to be held to maturity is initially recorded at cost. Any difference between the cost and the face value is amortized as a discount or premium using the effective-interest method. As a
result, at any balance sheet date, the amount reported will be the cost, net of
amortization, or the amortized cost.
14–58.‡
1. December 31, 2008, cash flow projection:
Date Payment Time Table Value Present Value @ 11%
Dec. 31, 2009 $ 50,000 1 year 0.9009 $ 45,045
Dec. 31, 2010 100,000 2 years 0.8116 81,160
Dec. 31, 2011 200,000 3 years 0.7312 146,240
Dec. 31, 2012 300,000 4 years 0.6587 197,610
Dec. 31, 2013 100,000 5 years 0.5935 59,350
$750,000 $529,405
Book value of loan receivable at December 31, 2008:
Principal $ 750,000
2007 interest receivable 82,500
Total loan receivable $ 832,500
Loan impairment:
$832,500 – $529,405 = $303,095
Allowance required:
$303,095 – $82,500 = $220,595
2008
Dec. 31 Bad Debt Expense 303,095
Interest Receivable 82,500
Allowance for Loan Impairment 220,595
To record loan impairment.
‡ Relates to Expanded Material.
14–58.‡ (Continued)
2. 2009
Dec. 31 Cash 50,000
Loan Receivable 50,000
31 Allowance for Loan Impairment 58,235
Interest Revenue 58,235
$529,405 ( 0.11 = $58,235
Although a work sheet is not required, it facilitates understanding of the annual interest computation, assuming the 2008 cash flow projection was not changed.
Interest Revenue from Loan Impairment:
(1) (2) (3) (4) (5)
Loan
Receivable Allowance
before for Net Interest
Current Loan Receivable Revenue Payment
Date Payment Impairment (1) – (2) 11% ( (3) Received
Dec. 31, 2009 $750,000 $220,595 $529,405 $ 58,235 $ 50,000
Dec. 31, 2010 700,000 162,360 537,640 59,140 100,000
Dec. 31, 2011 600,000 103,220 496,780 54,646 200,000
Dec. 31, 2012 400,000 48,574 351,426 38,657 300,000
Dec. 31, 2013 100,000 9,917 90,083 9,917* 100,000
$ 220,595 $750,000
*Rounded to close allowance account.
3. December 31, 2009, cash flow projection:
Date Payment Time Table Value Present Value @ 11%
Dec. 31, 2010 $150,000 1 year 0.9009 $135,135
Dec. 31, 2011 300,000 2 years 0.8116 243,480
Dec. 31, 2012 250,000 3 years 0.7312 182,800
$700,000 $561,415
Balance in loan receivable and allowance accounts before valuation adjustment:
|Loan Receivable | |Allowance for Loan Impairment |
|Bal. 750,000 |2009 Pmt. 50,000 | |58,235 | 220,595 |
|Bal. 700,000 | | | |Bal. 162,360 |
Net balance before adjustment: $700,000 – $162,360 = $537,640
Decrease in Allowance for Loan Impairment: $561,415 – $537,640 = $23,775
‡ Relates to Expanded Material.
14–58.‡ (Concluded)
2009
Dec. 31 Allowance for Loan Impairment 23,775
Bad Debt Expense 23,775
To adjust net loan receivable to present
value of new cash flow projections.
Alternative computation:
Current balance in allowance $ 162,360
Required balance ($700,000 – $561,415) 138,585
Adjustment $ 23,775
4. 2010
Dec. 31 Cash 150,000
Loan Receivable 150,000
31 Allowance for Loan Impairment 61,756
Interest Revenue 61,756
$561,415 ( 0.11 = $61,756
Although a work sheet is not required, it facilitates understanding of the annual interest computation, assuming the 2009 cash flow projection was not changed.
Interest Revenue from Loan Impairment:
(1) (2) (3) (4) (5)
Loan
Receivable Allowance
before for Net Interest
Current Loan Receivable Revenue Payment
Date Payment Impairment (1) – (2) 11% ( (3) Received
Dec. 31, 2010 $700,000 $138,585 $561,415 $ 61,756 $150,000
Dec. 31, 2011 550,000 76,829 473,171 52,049 300,000
Dec. 31, 2012 250,000 24,780 225,220 24,780* 250,000
$138,585 $700,000
*Rounded to close allowance account.
‡ Relates to Expanded Material.
CASES
Discussion Case 14–59
The issue of current value accounting has been a difficult one for all standard-setting bodies throughout the world. In the United States, the issue of supplementing the historical cost statements with current value information was a topic of discussion by the original Committee on Accounting Principles, the
Accounting Principles Board, and the Financial Accounting Standards Board. For several years, FASB Statement No. 33 required certain companies to report limited current value information in supplemental notes to the financial statements. In many cases, a lower-of-cost-or-market valuation method was used. Inventories and marketable equity securities were primary examples of this type of valuation.
Because of the savings and loan losses in the 1980s, many critics complained that historical cost balance sheets were of little value when evaluating the soundness of an institution. The SEC has periodically pushed the FASB to move toward “market” accounting. FASB Statement No. 115 was a compromise: It moved the profession toward market on the balance sheet but left many unrealized gains and losses off the income statement. The majority of members of the FASB argued that only trading securities should reflect increases in market values on the income statement. If the security is not considered to be a
trading security, valuation changes are to be deferred as an adjustment of equity and recognized on the income statement only when the investment is sold or reclassified.
If international accounting standards move toward the use of more current values or if inflation returns in our economy, further extensions of market values in accounting will certainly appear. Perhaps future years will reveal that this move to market accounting as evidenced by FASB Statement No. 115 was very significant in long-term transition to relevance.
Discussion Case 14–60
This case demonstrates how FASB statements may lead to manipulation of the financial statements to reflect the desires of management. If Diamond classifies the securities as trading securities, all market gains and losses would be recognized in net income. If the securities are classified as available for sale, none of the changes in market value would be reflected on the income statement. A strategy available to Diamond would be to classify securities that are increasing in market value as trading securities and securities that are declining in value as available-for-sale securities. When a profitable security reverses and starts going down, Diamond could either sell the security or reclassify the security to available for sale and vice versa. The classification selected depends on management’s intent, and, thus, auditors must judge the veracity of the explanation in deciding whether to accept management’s decision. One way Diamond could justify this policy would be to indicate that profitable securities are subject to immediate sale and thus are trading securities, whereas securities with declining market values will be held until such time as management no longer feels they will increase in value or they do increase. The auditor would have a difficult time refuting whatever management indicated regarding classification. In order to prevent this type of manipulation, SFAS No. 115 requires securities to be classified as trading, available for sale, or held to maturity at the time the securities are initially acquired (see paragraph 6).
Discussion Case 14–61
Students should discuss the question of applying this standard to nonfinancial institutions and why it may be difficult to apply. The concept of a trading security is less clear for a nonfinancial institution than it is for a bank. The possibility of manipulation as discussed in Case 14–60 is real. If a company classifies its
investments as available for sale, all market value changes, both increases and decreases, bypass the income statement. Pre–FASB Statement No. 115 standards required the lower-of-cost-or-market method; thus, losses would have been recognized on the income statement for marketable securities, but now, under Statement No. 115, the same losses would be charged directly to equity.
Students might explore some definitions for trading securities that can help users and auditors to
consistently classify investments.
Discussion Case 14–62
1. As stated in APB Opinion No. 18, if a firm owns 50% or more of the outstanding stock of a company, consolidation is required unless the parent company’s investment is temporary or the parent company does not have control of the subsidiary. Owning more than 50% of a firm ensures, in most cases, the parent’s control of the management decisions of the subsidiary.
2. By owning less than 50%, The Coca-Cola Company is not required to prepare consolidated financial statements. Rather, by a proper application of the equity method, the investment in the subsidiary account will reflect the parent company’s 49% interest in the net assets of the subsidiary.
3. By not being required to consolidate, the $2.4 billion debt that is on the financial statements of Coca-Cola Enterprises is not required to be recognized by the parent company. Thus, The Coca-Cola Company was able to finance a substantial purchase without reporting the debt on its balance sheet.
Discussion Case 14–63
This case illustrates the complexities associated with assessing the differences among control, significant influence, and simple ownership. While the FASB has provided guidance in the form of ownership percentages, the student must recognize that certain factors can override the application of those
percentages.
Subsidiary 1
Although International owns 75% of Subsidiary 1, it is not clear if control of the company rests with the management of International. If it is likely that the oil company will be nationalized, consolidation of the subsidiary would not be the most appropriate accounting method. Use of the cost or equity methods along with a note discussing the potential loss would be appropriate.
Subsidiary 2
While International owns less than 20% of the stock of Ecological Inc., with two officers on Ecological’s board of directors, it would appear that International is able to significantly influence decisions made by Ecological. The fact that Ecological’s stock is widely held also allows International, which holds a large voting block, to influence company policy. Thus, the equity method seems appropriate in this situation.
Subsidiary 3
Even though a financial institution’s accounting information may be drastically different from the information relating to a manufacturing facility, FASB Statement No. 94 states that majority-owned, nonhomogeneous operations must be consolidated unless there is a question as to control.
Subsidiary 4
If the percentages provided in APB Opinion No. 18 are strictly applied in this situation, International would use the equity method. However, with another company owning 50% of Campton’s common stock, International cannot significantly influence Campton’s policy without approval of Beatrix. Thus, use of the cost method may be most appropriate in this instance.
Discussion Case 14–64
This case requires students to understand the fundamental differences between the cost and equity methods. The varying methods reflect the parent company’s different levels of influence on the operating decisions of the subsidiary.
Logical’s notes could state the following:
Investments in companies in which ownership interests are more than 20% and in which the Company exercises significant influence over operating and financial policies are accounted for using the equity method. Other investments are accounted for using the cost method.
Discussion Case 14–64 (Concluded)
It is important to note that Logical applies two criteria for using the equity method. It must own more than 20% of the subsidiary’s stock and be able to exercise significant influence.
Using the cost method, the receipt of dividends is recorded as revenue by the parent company. The initial purchase is recorded in the same way under both the cost and equity methods.
The equity method requires journal entries when income is reported by the subsidiary as well as when dividends are paid. A major difference is that under the equity method, the declaration of dividends by the subsidiary serves to reduce the investment account on the books of the parent. Revenue is recognized by the parent when income is reported by the subsidiary. In addition, when the equity method is employed, any difference between the price paid for the stock and the underlying book value of the subsidiary must be analyzed and amortized, if appropriate, over time.
Under the cost method, the investment account typically remains at the initial cost of the investment. Only under unusual circumstances (e.g., when there is a liquidating dividend or a permanent decline in value) does the investment account change. However, the companion account to the investment account, called the market adjustment account, changes each period to reflect changes in the market value of the
investment. When the equity method is used, the investment account changes when net income (or loss) is reported by the subsidiary, a dividend is declared, or when an additional amount involved in the
purchase is amortized. The investment account changes when the net assets of the subsidiary change.
Discussion Case 14–65
In many areas, particularly in the area of accounting for investment securities, international accounting standards are very similar to U.S. GAAP. In fact, as discussed in the text, IAS 39, which was
approved by the IASB in December 1998, draws heavily on Statement No. 115, which was adopted by the FASB in 1993. The only significant difference is that under IAS 39, a company can elect to recognize all unrealized gains and losses as part of net income, even those unrealized items related to available-for-sale securities. The general point to remember is that someone who understands U.S. GAAP should be able to grasp the differences between U.S. GAAP and international standards. As international accounting harmonization increases, those differences should decrease in the future.
Case 14–66
1. According to Note 4, as of September 30, 2004, Disney held $60 million of securities classified as available for sale. The total investment balance for Disney was $1.292 billion. Available-for-sale securities constituted approximately 4.6% of the total. The remainder of the investment portfolio consisted of securities classified as held to maturity or as equity method securities. In addition, Disney reports in Note 4 that it held $105 million in nonpublic securities that are reported at cost. These securities must be reported at cost because market values are not available.
2. Note 2 discusses the various types of investment securities that Disney holds: “Debt securities that the Company has the positive intent and ability to hold to maturity are classified as ‘held-to-maturity’ and reported at amortized cost. Debt securities not classified as held-to-maturity and marketable equity securities are classified as either ‘trading’ or ‘available-for-sale,’ and are recorded at fair value with unrealized gains and losses included in earnings or shareholders' equity, respectively. All other equity securities are accounted for using either the cost method or the equity method.” Also in Note 2, we find that Disney classifies marketable securities with an original maturity of 3 months or less as cash equivalents. Thus, certain of Disney’s investments are not reported under Investments in the balance sheet.
3. Per Note 12, on September 30, 2004, the fair value of investments was $60 million and the carrying value was $60 million. While Disney reported an investment account balance of $1.292 billion, not all of that was subject to fair value accounting. For example, recall that Disney has a substantial number of investments in nonpublic companies for which no reliable market values are available.
Case 14–67
1. You might think that because ADM buys and sells billions of dollars worth of securities each year, much of its portfolio would be classified as trading. However, ADM classifies most of its investment securities as being available for sale. The reason for this classification is that ADM is buying and
selling securities as they mature and in order to rebalance its portfolio. ADM claims that it is not using this trading activity to try to make money on short-term price fluctuations. This is the common practice for most large U.S. companies.
2. Given the large turnover in its securities portfolio, one might question ADM’s policy of classifying all of its investment securities as available for sale. However, FASB Statement No. 115 allows management discretion in classifying securities. In addition, the bulk of this buying and selling is associated with routine management of ADM’s portfolio as short-term debt securities mature and are sold and replaced with other securities. Remember, trading securities are restricted to those purchased with the intent of making money on short-term price fluctuations.
3. The company’s investment portfolio experienced an unrealized net gain for the year of $249,913,000. Had these securities been classified as trading, this amount would have been reported as an unrealized gain on the income statement.
Case 14–68
1. The net realized loss of $6 million was included in the 2004 income statement. Unrealized gains and losses from available-for-sale securities are not reported in the income statement.
2. The net unrealized holding gain for available-for-sale securities as of the end of 2004 was $32 million.
3. The change in the cumulative unrealized gain during 2004 was $10 computed as follows:
Cumulative net unrealized gain as of December 31, 2004 ($55 – $23) $32 m
Cumulative net unrealized gain as of December 31, 2003 ($58 – $16) 42
Decrease in cumulative net unrealized gain during 2004 $10 m
The net realized loss for the year was $6 million. Accordingly, the sum of the realized and unrealized net losses for the year is $16 million; this is the economic return on the available-for-sale portfolio for the year (ignoring interest and dividends).
Case 14–69
The objective of this assignment is to have students put themselves in the position of the FASB and figure out why the FASB made the decision it did regarding the recognition of changes in value of available-for-sale securities. In completing this assignment, students should examine the pros and cons associated with recognizing changes in value of available-for-sale securities on the income statement. There is no “right” answer for this assignment. Points that might be made are as follows:
Reasons given by the FASB for not including unrealized gains and losses on available-for-sale securities in the computation of net income.
• Including unrealized holding gains and losses in the computation of net income increases income volatility.
• It isn’t fair to include unrealized holding gains and losses on assets in the computation of net income when unrealized gains and losses on liabilities are not also included in income. If a company, particularly a financial institution, carefully manages its assets and liabilities, these unrealized gains and losses will offset one another.
Case 14–69 (Concluded)
Response to FASB position.
• Basically, it sounds like the FASB is saying that including unrealized gains and losses on
available-for-sale securities will increase the volatility of reported net income of companies,
particularly financial institutions, and the harm to these companies should be mitigated. This sounds like the FASB is bowing to pressure from one particular industry (banks and other financial institutions).
• The second point sounds like a “two wrongs make a right” argument. If the problem is that unrealized gains and losses on assets and liabilities should be allowed to offset one another, then the better approach is to include both of them in net income. It seems that the FASB should have gone further with SFAS No. 115 and included a mark-to-market provision for financial liabilities.
Case 14–70
1. Unrealized holding gains and losses on trading securities are to be included in earnings. Unrealized gains and losses on available-for-sale securities are to be excluded from earnings and instead to be reported as a separate component of stockholders’ equity.
2. If it is determined that available-for-sale and held-to-maturity securities are permanently impaired, the difference between the amount recorded on a company’s books and the fair market value is to be
reported in earnings and the securities are to be written down to their fair value. Trading securities are not included in paragraph 16 as they are adjusted to market value every period whether the
decline is deemed temporary or permanent.
Case 14–71
With this ethical dilemma, students will come to understand the difference between applying the “letter of the law”—the rule—and the “spirit of the law”—the rule’s intent. While this reclassification may be within the rules, if management’s intent is to manipulate income, then this reclassification could be considered a violation of the rules. Specific answers to the questions in the case are as follows:
1. Reclassifying available-for-sale securities as trading would result in all increases in value being
recognized as gains in the income statement in the period of reclassification.
2. A strict reading of FASB Statement No. 115 would indicate that this reclassification is within the rules. Auditors, however, may question the reclassification policy.
3. Reclassifying securities in an attempt to inflate income would be inconsistent with the objectives of FASB Statement No. 115.
4. If this reclassification policy were consistently applied year after year, it would be difficult for auditors to question the policy. But the inconsistent application of this policy would surely get the attention of the external auditor.
Case 14–72
Solutions to this problem can be found on the Instructor’s Resource CD-ROM or downloaded from the Web at .
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