To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 14 QUESTIONS 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 tions to determine the present value of both the principal sum and the annuity The effective-interest method computes interest revenue by multiplying the effective interest rate by the carrying value of the investment 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 FASB ASC Topic 320 applies to many debt and equity securities All debt securities with a readily determinable fair value fall under its scope Debt securities that not have a readily determinable fair value are accounted for under the rules outlined in FASB ASC Topic 310 (Receivables), as shown in the Expanded Material for this chapter 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 Topic 320 10 (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: Representation on the board of directors of the investee Participation in the policy-making process Material intercompany transactions between investee and investor Interchange of managerial personnel between investee and investor Technological dependency of investee on investor Substantial minority interest of the investor in an investee whose shares of stock are widely distributed and not concentrated for control purposes A security is classified as held to maturity if the business has the intent and the ability to hold the security to maturity 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 Under the fair value option, a company has the option to report, at each balance sheet date, any or all of its financial assets and liabilities at their fair values on the balance sheet date The unrealized gains and losses from changes in the fair values of financial assets and liabilities accounted for using the fair value option are reported in the income statement (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: Opposition by the investee, such as litigation or complaints to governmental regulatory authorities An agreement between the investor and the investee under which the The classification of investment securities under IFRS is essentially the same as the classification under U.S GAAP (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 computa- 597 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 598 Chapter 14 investor surrenders significant rights as a shareholder 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 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 The investor tries and fails to obtain representation on the investee‟s board of directors 11 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 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 12 Under International Financial Reporting Standards, an “equity method investee” is called an “associate.” 13 For trading securities and available-for-sale securities, a market adjustment account is used on the balance sheet to report the securities at their fair 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 14 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 Topic 320 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 15 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 fair value However, the market adjustment account may be used to record any subsequent increases 16 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-forsale securities 17 When 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 18 If the purchase and sale of the trading securities is determined to be an operating activity, 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 19 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 Heldto-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 classi- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 599 fied as either current or long-term, depending on the intention and assessments of management 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 For investment securities reported at fair value, the magnitude of the fair values determined using Level 1, Level 2, and Level inputs is disclosed 20 For all securities not classified as trading and not accounted for using the fair value option, the cash flow effects of purchases and sales are reported in the Investing section of the statement of cash flows For securities classified as trading and for securities accounted for using the fair value option, the purchase and sale of securities are reported in either the Operating or Investing section, depending on the purpose for which the securities were acquired 21 The following additional disclosures for the different classifications of securities are required: 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, ‡ Relates to Expanded Material ‡ 22 Topic 320 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 not have a readily determinable fair value because they are not traded on an exchange as are most debt securities Thus, the provisions of Topic 320 are not applicable to impaired loans FASB ASC Section 310-10-35 addresses the accounting for the impairment of a loan To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 600 Chapter 14 PRACTICE EXERCISES PRACTICE 14–1 PURCHASING DEBT SECURITIES Asset approach Feb Investment in Trading Securities Interest Receivable Cash Interest Receivable: $100,000  0.08  (1/12) = $667 June 30 Cash Interest Receivable Interest Revenue Cash: $100,000  0.08  (6/12) = $4,000 100,000 667 100,667 4,000 667 3,333 Revenue approach Feb Investment in Trading Securities Interest Revenue Cash Interest Revenue: $100,000  0.08  (1/12) = $667 June 30 Cash Interest Revenue Cash: $100,000  0.08  (6/12) = $4,000 PRACTICE 14–2 100,000 667 100,667 4,000 4,000 PURCHASING EQUITY SECURITIES Investment in Available-for-Sale Securities Cash 54,000 Investment: 2,000 shares  $27 = $54,000 PRACTICE 14–3 COMPUTING THE VALUE OF DEBT SECURITIES Business Calculator Keystrokes: N = years  = 14 I = 12/2 = PMT = $100,000  0.08  (6/12) = $4,000 FV = $100,000 (the face value is paid at the end of years) PV = $81,410 54,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 601 PRACTICE 14–4 INTEREST REVENUE FOR HELD-TO-MATURITY SECURITIES Investment in Held-to-Maturity Securities Cash 25,518 Cash [$20,000  0.10  (6/12)] Investment in Held-to-Maturity Securities Interest Revenue 1,000 25,518 107 893 Interest Revenue: $25,518  0.07  (6/12) = $893 Cash Investment in Held-to-Maturity Securities Interest Revenue 1,000 111 889 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 by Investor Company Outstanding Ownership 1,200 10,000 6,000 8,000 75 Consolidation 20,000 55,000 36 Equity method PRACTICE 14–6 12% Accounting Classification Trading or available for sale REVENUE FOR TRADING AND AVAILABLE-FOR-SALE SECURITIES Dividends received on trading and available-for-sale securities are both classified as dividend revenue Cash Dividend Revenue Cash: (2,000 shares  $1.75) + (6,000 shares  $0.97) = $9,320 9,320 9,320 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 602 Chapter 14 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 Investment in Company A Stock Cash Investment in Company A Stock Income from Company A Stock 54,000 54,000 10,000 10,000 Income from Company A Stock: $40,000  (2,000 shares/8,000 shares) = $10,000 Cash Investment in Company A Stock 3,200 3,200 Cash: $1.60  2,000 shares = $3,200 Year Investment in Company A Stock Income from Company A Stock 12,500 12,500 Income from Company A Stock: $50,000  (2,000 shares/8,000 shares) = $12,500 Cash Investment in Company A Stock 4,000 4,000 Cash: $2.00  2,000 shares = $4,000 PRACTICE 14–8 EQUITY METHOD: EXCESS DEPRECIATION Underlying fair value of net assets ($82,000  3) Book value of net assets Implied amount of excess value of building $ 246,000 202,000 $ 44,000 Investor’s interest in net assets Amount of excess building value to be depreciated Depreciation period Annual extra depreciation  1/3 $ 14,667 ÷11 years $ 1,333 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 603 PRACTICE 14–8 (Concluded) Year Investment in Company B Stock Cash Investment in Company B Stock Income from Company B Stock 82,000 82,000 24,000 24,000 Income from Company B Stock: $72,000  (5,000 shares/15,000 shares) = $24,000 Cash Investment in Company B Stock 8,250 8,250 Cash: 5,000 shares  $1.65 = $8,250 Income from Company B Stock Investment in Company B Stock 1,333 Investment in Company B Purchase 82,000 Income 24,000 Ending PRACTICE 14–9 1,333 8,250 Dividends 1,333 Extra Depreciation 96,417 EQUITY METHOD: COST GREATER THAN BOOK VALUE Underlying fair value of net assets ($100,000/0.25) Book value of net assets Implied amount of excess of fair value over book value Excess fair value identified with: Inventory Building Goodwill Total $ 400,000 300,000 $ 100,000 $ 10,000 50,000 40,000 $ 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 Depreciation period Annual extra depreciation $ 12,500 ÷ 10 years $ 1,250 No extra expense is associated with the goodwill, assuming that it is not impaired during the year To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 604 Chapter 14 PRACTICE 14–9 (Concluded) Year Investment in Company C Stock Cash Investment in Company C Stock Income from Company C Stock 100,000 100,000 17,500 17,500 Income from Company C Stock: $70,000  (2,500 shares/10,000 shares) = $17,500 Cash Investment in Company C Stock 5,000 5,000 Cash: 2,500 shares  $2.00 = $5,000 Income from Company C Stock Investment in Company C Stock 3,750 3,750 Extra inventory cost $2,500 + Extra depreciation $1,250 = $3,750 Investment in Company C Purchase Income Ending PRACTICE 14–10 (a) (b) 100,000 17,500 5,000 Dividends 3,750 Extra Expense 108,750 CHANGES IN VALUE: TRADING SECURITIES Market Adjustment—Trading Securities Unrealized Gain on Trading Securities 1,350 Unrealized Loss on Trading Securities Market Adjustment—Trading Securities 1,250 (c) $3,000 + $1,350 = $4,350 (d) $3,000  $1,250 = $1,750 1,350 1,250 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 PRACTICE 14–11 (a) (b) 605 CHANGES IN VALUE: AVAILABLE-FOR-SALE SECURITIES Market Adjustment—Available-for-Sale Securities Unrealized Increase/Decrease in Available-for-Sale Securities Unrealized Increase/Decrease in Available-for-Sale Securities Market Adjustment—Available-for-Sale Securities (c) $3,000 + No income impact = $3,000 (d) $3,000 – No income impact = $3,000 PRACTICE 14–12 No adjusting entry (b) No adjusting entry (c) $3,000 + No income impact = $3,000 (d) $3,000 – No income impact = $3,000 No adjusting entry (b) No adjusting entry (c) $3,000 + No income impact = $3,000 (d) $3,000 – No income impact = $3,000 1,250 1,250 CHANGES IN VALUE: EQUITY METHOD (a) PRACTICE 14–14 1,350 CHANGES IN VALUE: HELD-TO-MATURITY SECURITIES (a) PRACTICE 14–13 1,350 SALE OF SECURITIES Cash (400  $27) Realized Gain on Trading Securities Investment SecuritiesTrading (400  $24) 10,800 Cash (400  $20) Realized Loss on Trading Securities Investment SecuritiesTrading (400  $24) 8,000 1,600 1,200 9,600 9,600 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 606 Chapter 14 PRACTICE 14–15 SALE OF SECURITIES AND THE MARKET ADJUSTMENT ACCOUNT Cash proceeds – Cost Realized loss $ 9,500 10,000 $ (500) Cumulative unrealized loss, end of year ($5,800 – $9,000) Cumulative unrealized gain, beginning of year ($26,000 – $19,000) Unrealized loss for the year $ (3,200) 7,000 $ (10,200) PRACTICE 14–16 TRANSFER BETWEEN CATEGORIES: TO AND FROM TRADING Security A Investment Securities—Available for Sale Market Adjustment—Trading Unrealized Gain on Transfer of Securities Investment Securities—Trading 5,500 1,000 1,500 5,000 Security B Investment Securities—Trading Unrealized Loss on Transfer of Securities Market Adjustment—Available for Sale Investment Securities—Available for Sale PRACTICE 14–17 4,100 3,900 2,000 6,000 TRANSFER BETWEEN CATEGORIES: AVAILABLE FOR SALE Security A Investment Securities—Held to Maturity Market Adjustment—Available for Sale Unrealized Increase in Available-for-Sale Securities Investment Securities—Available for Sale 8,850 1,100 1,750 8,200 Security B Investment Securities—Available for Sale Unrealized Decrease in Available-for-Sale Securities Investment Securities—Held to Maturity 9,450 550 10,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 636 Chapter 14 14–52 (Concluded) Explanation of the difference: Book Value Equipment $175,000 Buildings 40,000 Net difference Fair Value $140,000 65,000 35% of Difference $ (12,250) 8,750 $ (3,500) Remaining Life 10 years 20 years Amount Amortized $(1,225)* 438 $ (787) *In previous examples, fair 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 fair 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 2013 Investment in ABC Cash To record the initial purchase of 35% of the stock of ABC 280,000 Investment in ABC Income from Investment in ABC To record 35% of the reported net income of ABC (0.35  $80,000) 28,000 Cash Investment in ABC To record the receipt of $5,250 in dividends from ABC (0.35  $15,000) 5,250 Investment in ABC Income from Investment in ABC To record the amortization of the net difference between book value and fair value of the net assets of ABC ($1,225 – $438) 787 2014 Loss from Investment in ABC Investment in ABC To record 35% of the reported net loss of ABC (0.35  $10,000) 3,500 Cash Investment in ABC To record the receipt of $2,800 in dividends from ABC (0.35  $8,000) 2,800 Investment in ABC Income from Investment in ABC To record the amortization of the net difference between book value and fair value of the net assets of ABC ($1,225 – $438) 787 280,000 28,000 5,250 787 3,500 2,800 787 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 637 14–53 2012 Market Adjustment—Trading Securities Unrealized Gain on Trading Securities To record increase in value of trading securities from cost of $49,000 to fair value of $60,000, given an existing debit balance in the market adjustment account of $9,000 Market Adjustment—Available-for-Sale Securities Unrealized Increase/Decrease in Value of Available-for-Sale Securities To record decrease in market adjustment account from previous credit balance of $3,600 to required credit balance of $1,000 2013 Investment in Available-for-Sale Securities—Security A Market Adjustment—Trading Securities Investment in Trading Securities—Security A Unrealized Gain on Transfer of Securities To reclassify security A from trading to availablefor-sale security 2,000 2,000 2,600 2,600 24,400 5,000 18,000 1,400 Investment in Trading Securities—Security C Unrealized Increase/Decrease in Value of Available-for-Sale Securities Unrealized Gain on Transfer of Securities Market Adjustment—Available-for-Sale Securities Investment in Available-for-Sale Securities— Security C To reclassify security C from available for sale to trading security Record previously unrealized increase in value ($2,200) as an unrealized gain 5,200 Investment in Held-to-Maturity Securities—Security D Investment in Available-for-Sale Securities— Security D Unrealized Increase/Decrease in Value of Availablefor-Sale Securities Market Adjustment—Available-for-Sale Securities To reclassify security D from available for sale to held to maturity at its current fair value 15,000 3,000 2,200 3,000 3,000 12,000 1,000 2,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 638 Chapter 14 14–53 (Concluded) Investment in Trading Securities—Security F Unrealized Loss on Transfer of Securities Investment in Held-to-Maturity Securities—Security F To reclassify security F from held to maturity to trading security at its current fair value Also to recognize the decrease in fair value on the income statement 63,500 1,500 65,000 14–54 (a) (b) Cash Realized Loss on Sale of Securities Investment in Trading Securities—West Data, Inc Sold 500 shares for $19; cost, $27 *Purchase price $27,000/1,000 = $27 per share Selling price $9,500/500 = 19 per share $ loss per share Total loss = ($8  500) = $4,000 9,500 4,000* Cash Investment in Available-for-Sale Securities— Disks, Inc Realized Gain on Sale of Securities Sold 200 shares at $15; cost, $12 3,000 *Purchase price $60,000/5,000 Selling price $3,000/200 = = 13,500 2,400 600* $12 per share 15 per share $ gain per share Total gain = ($3  200) = $600 (c) Investment in Available-for-Sale Securities—Albert Groceries, Inc Market Adjustment—Trading Securities Investment in Trading Securities—Albert Groceries, Inc Unrealized Gain on Transfer of Securities To transfer Albert Groceries stock from trading securities portfolio to available-for-sale portfolio *$12,900 – $11,500 = $1,400 12,900 2,500 9,000 1,400* To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 639 14–54 (Continued) (d) Investment in Trading Securities—Disks, Inc Unrealized Increase/Decrease in Value of Available-for-Sale Securities Investment in Available-for-Sale Securities— Disks, Inc Market Adjustment—Available-for-Sale Securities Unrealized Gain on Transfer of Securities To transfer Disks stock from available for sale to trading portfolio and recognize gain in increase in fair value as income 96,000 Cash Realized Loss on Sale of Securities Investment in Trading Securities—Disks, Inc To record sale of Disks stock 86,400 9,600 20,000 57,600 20,000 38,400 96,000 Dec 31, 2013 Trading Securities West Data, Inc Steel Co Shares 500 450 Cost $13,500 9,900 $23,400 Per Share $15 21 Fair Value, 12/31/2013 $ 7,500 9,450 $ 16,950 Balance in market adjustment—Trading securities, Dec 31, 2013, before valuation adjustment ($6,185 Cr + $2,500 Cr.) Balance required at Dec 31, 2013, per above computation Adjustment required at Dec 31, 2013 Market Adjustment—Trading Securities Unrealized Gain on Trading Securities To recognize increase in fair value of trading security portfolio Dec 31, 2013 Available-for-Sale Securities Shares Dairy Products 2,000 Vern Movies, Inc 15,000 Albert Groceries, Inc 600 Cost $ 86,000 390,000 12,900 $488,900 Per Share $46 31 22 Market Adjustment $6,000 Cr 450 Cr $6,450 Cr $8,685 Cr 6,450 Cr $2,235 Dr 2,235 Fair Value, 12/31/2013 $ 92,000 465,000 13,200 $ 570,200 2,235 Market Adjustment $ 6,000 Dr 75,000 Dr 300 Dr $81,300 Dr To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 640 Chapter 14 14–54 (Concluded) Balance in market adjustment—Available for sale, Dec 31, 2013, before valuation adjustment ($1,000 Cr + $20,000 Cr.) $ 21,000 Cr Balance required at Dec 31, 2013, per above computation 81,300 Dr Adjustment required at Dec 31, 2013 $102,300 Dr Market Adjustment—Available-for-Sale Securities Unrealized Increase/Decrease in Value of Available-for-Sale Securities To recognize increase in portfolio 102,300 102,300 14–55 2011 (Equity Method) Jan Investment in Startile Stock Cash (200,000  0.20  $18) 720,000 720,000 Oct 31 Cash Investment in Startile Stock ($28,000  0.20) 5,600 Dec 31 Investment in Startile Stock Income from Investment in Startile Stock ($93,000  0.20) 18,600 5,600 18,600 No valuation adjustment under equity method 2012 (Equity Method) Oct 31 Cash Investment in Startile Stock ($29,000  0.20) Dec 31 Investment in Startile Stock Income from Investment in Startile Stock ($105,000  0.20) No valuation adjustment under equity method 5,800 5,800 21,000 21,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 641 14–55 (Continued) 2013 (Equity Method) Jan Cash Realized Gain on Sale of Startile Stock Investment in Startile Stock 276,000* 51,540† 224,460** *Cash proceeds = 12,000  $23 = $276,000 **Cost of investment = 12,000/40,000  carrying value of investment, $748,200 = $224,460 ($720,000 – $5,600 + $18,600 – $5,800 + $21,000 = $748,200) † Gain on sale = $276,000 – $224,460 = $51,540 Investment in Available-for-Sale Securities—Startile 523,740 Investment in Startile Stock To reclassify stock because ownership is now only 14% ($748,200 – $224,460) Oct 31 Cash Dividend Revenue ($22,000  28,000/200,000) Dec 31 Unrealized Increase/Decrease in Value of Available-for-Sale Securities Market Adjustment—Available-for-Sale Securities $523,740 – (28,000  $14) = $131,740 Cost Method 2011 Dec 31 Market Adjustment—Available-for-Sale Securities Unrealized Increase/Decrease in Value of Available-for-Sale Securities ($21 – $18)  40,000 = $120,000 2012 Dec 31 Unrealized Increase/Decrease in Value of Available-for-Sale Securities Market Adjustment—Available-for-Sale Securities ($21 – $20)  40,000 = $40,000 2013 Dec 31 Unrealized Increase/Decrease in Value of Available-for-Sale Securities Market Adjustment—Available-for-Sale Securities 523,740 3,080 3,080 131,740 131,740 120,000 120,000 40,000 40,000 192,000* 192,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 642 Chapter 14 14–55 (Concluded) COMPUTATIONS: Original cost (40,000 shares  $18) Less: Cost of sale on Jan 2, 2013 (12,000 shares  $18) Cost on Dec 31, 2013 Less: Fair value on Dec 31, 2013 (28,000 shares  $14) Balance required in market adjustment account Balance in market adjustment account before 2013 adjustment Adjustment required $720,000 216,000 $504,000 392,000 $112,000 Cr 80,000 Dr $192,000 Cr 14–56 Income statement Sales Cash expenses Depreciation expense Operating income Realized gain on sale of trading securities Realized loss on sale of available-for-sale securities Unrealized loss on trading securities Net income $ 3,200 (2,700) (50) $ 450 140 (40) (90) $ 460 Available for sale: Realized loss: $60 sales proceeds – $100 cost = $40 realized loss Unrealized increase: $270 fair value – $200 cost ($300 – $100) = $70 unrealized increase Trading: Realized gain: $340 sales proceeds – $200 cost = $140 realized gain Unrealized loss: $210 fair value – $300 cost ($500 – $200) = $90 unrealized loss To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 643 14–56 (Concluded) Statement of cash flows Operating activities: Net income Plus: Depreciation Purchase of trading securities Sale of trading securities Less: Increase in accounts receivable Less: Realized gain on sale of trading securities Plus: Realized loss on sale of available-for-sale securities Plus: Unrealized loss on trading securities $ 460 50 (500) 340 (190) (140) 40 90 Investing activities: Purchase of building Purchase of available-for-sale securities Sale of available-for-sale securities $ (550) (300) 60 $ 150 (790) Financing activities: Initial investment by owners 2,000 Net increase in cash $1,360 Balance sheet Assets: Cash Accounts receivable Trading securities (cost, $300) Available-for-sale securities (cost, $200) Building (less accumulated depreciation of $50) $1,360 190 210 270 500 $2,530 Liabilities Equity: Paid-in capital Retained earnings (beginning balance = $0) Accumulated other comprehensive income $ $2,000 460 70 $2,530 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 644 Chapter 14 14–57 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 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 value and any difference between the original cost and the fair value is reported as part of accumulated other comprehensive income in stockholders' equity 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 ‡ December 31, 2013, cash flow projection: Date Payment Time Dec 31, 2014 $ 40,000 year Dec 31, 2015 120,000 years Dec 31, 2016 150,000 years Dec 31, 2017 200,000 years Dec 31, 2018 90,000 years $600,000 Table Value 0.9091 0.8264 0.7513 0.6830 0.6209 Book value of loan receivable at December 31, 2013: Principal 2012 interest receivable Total loan receivable Present Value @ 10% $ 36,364 99,168 112,695 136,600 55,881 $440,708 $ 600,000 60,000 $ 660,000 Loan impairment: $660,000 – $440,708 = $219,292 Allowance required: $219,292 – $60,000 = $159,292 2013 Dec 31 Bad Debt Expense Interest Receivable Allowance for Loan Impairment To record loan impairment ‡ Relates to Expanded Material 219,292 60,000 159,292 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 645 14–58.‡ (Continued) 2014 Dec 31 Cash Loan Receivable 40,000 40,000 31 Allowance for Loan Impairment Interest Revenue $440,708  0.10 = $44,071 44,071 44,071 Although a work sheet is not required, it facilitates understanding of the annual interest computation, assuming the 2013 cash flow projection was not changed Interest Revenue from Loan Impairment: (1) (2) Loan Receivable Allowance before for Current Loan Date Payment Impairment Dec 31, 2014 $600,000 $159,292 Dec 31, 2015 560,000 115,221 Dec 31, 2016 440,000 70,743 Dec 31, 2017 290,000 33,817 Dec 31, 2018 90,000 8,199 (3) (4) Net Receivable (1) – (2) $440,708 444,779 369,257 256,183 81,801 (5) Interest Revenue 10%  (3) $ 44,071 44,478 36,926 25,618 8,199* $159,292 Payment Received $ 40,000 120,000 150,000 200,000 90,000 $600,000 *Rounded to close allowance account December 31, 2014, cash flow projection: Date Dec 31, 2015 Dec 31, 2016 Dec 31, 2017 Payment $140,000 220,000 200,000 $560,000 Time year years years Table Value 0.9091 0.8264 0.7513 Present Value @ 10% $127,274 181,808 150,260 $459,342 Balance in loan receivable and allowance accounts before valuation adjustment: Loan Receivable Bal 600,000 Bal 560,000 2014 Pmt Allowance for Loan Impairment 40,000 44,071 159,292 Bal 115,221 Net balance before adjustment: $560,000 – $115,221 = $444,779 Decrease in Allowance for Loan Impairment: $459,342 – $444,779 = $14,563 ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 646 Chapter 14 14–58.‡ (Concluded) 2014 Dec 31 Allowance for Loan Impairment Bad Debt Expense To adjust net loan receivable to present value of new cash flow projections 14,563 14,563 Alternative computation: Current balance in allowance Required balance ($560,000 – $459,342) Adjustment $115,221 100,658 $ 14,563 2015 Dec 31 Cash Loan Receivable 140,000 31 Allowance for Loan Impairment Interest Revenue 140,000 45,934 45,934 $459,342  0.10 = $45,934 Although a work sheet is not required, it facilitates understanding of the annual interest computation, assuming the 2014 cash flow projection was not changed Interest Revenue from Loan Impairment: Date Dec 31, 2015 Dec 31, 2016 Dec 31, 2017 (1) Loan Receivable before Current Payment $560,000 420,000 200,000 (2) (3) (4) (5) Allowance for Loan Impairment $100,658 54,724 18,196 Net Receivable (1) – (2) $459,342 365,276 181,804 Interest Revenue 10%  (3) $ 45,934 36,528 18,196* $100,658 Payment Received $140,000 220,000 200,000 $560,000 *Rounded to close allowance account ‡ Relates to Expanded Material To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 647 CASES Discussion Case 14–59 The issue of fair 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, pre-Codification 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 Pre-Codification FASB Statement No 115 was a compromise: It moved the profession toward fair value 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 fair 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 fair values in accounting will certainly appear Perhaps future years will reveal that this move to fair value accounting was very significant in long-term transition to relevance Discussion Case 14–60 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 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 By not being required to consolidate, the $2.4 billion debt that is on the financial statements of CocaCola 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 14–61 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 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 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 648 Discussion Case 14–61 Chapter 14 (Concluded) Subsidiary 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 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 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 14–62 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 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 fair 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 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 649 Discussion Case 14–63 In many areas, particularly in the area of accounting for investment securities, International Financial Reporting 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 pre-Codification Statement No 115, which was adopted by the FASB in 1993 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 14–64 According to Note 6, as of October 3, 2009, Disney held $78 million of securities classified as available for sale The total investment balance for Disney was $2,554 million Available-for-sale securities constituted approximately 3.1% 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 that it held $263 million in nonpublic securities that are reported at cost These securities must be reported at cost because fair values are not available Note 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 accumulated other comprehensive income/(loss), 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 months or less as cash equivalents Thus, certain of Disney‟s investments are not reported under Investments in the balance sheet Per Note 16, on October 3, 2009, the fair value of investments was $78 million Although Disney reported an investment account balance of $2,554 million, 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 fair values are available Case 14–65 The gross realized gain of $43 million was included in the 2009 income statement Unrealized gains and losses from available-for-sale securities are not reported in the income statement By the end of 2009, the fair value of the “marketable equity securities” portion of Intel‟s available-forsale portfolio was almost exactly twice as much as the original cost As of the beginning of the year, this portion of Intel‟s portfolio had a fair value that was actually less than the original cost Thus, the marketable equity securities portion of Intel‟s available-for-sale portfolio appears to have performed very well in 2009 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 650 Chapter 14 Case 14–66 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 Response to FASB position  Basically, it sounds like the FASB is saying that including unrealized gains and losses on available-forsale 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 pre-Codification SFAS No 115 and included a mark-to-market provision for financial liabilities This is exactly what has happened with the fair value option Case 14–67 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: 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 A strict reading of FASB ASC Topic 320 would indicate that this reclassification is within the rules Auditors, however, may question the reclassification policy Reclassifying securities in an attempt to inflate income would be inconsistent with the objectives of FASB ASC Topic 320 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 14–68 Solutions to this problem can be found on the Instructor‟s Resource CD-ROM or downloaded from the Web at www.cengage.com/accounting/stice ... slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 14 599 fied as either current or long-term, depending on the intention and assessments of management and the basis... 0.06] for the period and reduce the allowance account accordingly ‡ Relates to Expanded Material 11,662 70,000 70,000 7,700 7,700 To download more slides, ebook, solutions and test bank, visit... 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