Accounting for Investments Quiz

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Questions and Answers

What interest rate did United use to discount cash flows for calculating credit loss?

How much did United amortize the discount on the bond investment by December 31, 2024?

$4,664

What is the total amount United expected to receive as principal at maturity from the bonds?

$600,000

What was the purchase price of the bonds that United acquired from Masterwear Industries?

$666,633 Signup and view all the answers

What is the necessary balance in the allowance for credit losses from the bonds?

$120,497 Signup and view all the answers

What is the investor's significant influence range in terms of voting stock ownership?

Typically between 20% and 50% of the voting stock. Signup and view all the answers

How is an investment accounted for when the investor lacks significant influence?

It is reported at cost, adjusted for fair value changes, and dividend revenue is recognized. Signup and view all the answers

What adjustment must be made to equity investments at year-end if the fair value declines?

A fair value adjustment is recorded to reflect the decline in value. Signup and view all the answers

What financial action is taken when dividends are received from the investee?

The amount received is recognized as dividend revenue. Signup and view all the answers

What was the initial purchase amount for the Arjent, Inc. common stock?

$1,500,000. Signup and view all the answers

What is the impact of selling the stock below its cost?

The loss incurred would affect the reported investment revenue for the period. Signup and view all the answers

What constitutes the consolidation method of accounting for investments?

The financial statements of the investor and investee are combined as if they are a single entity. Signup and view all the answers

What does the fair value adjustment reflect in the case of the Arjent investment?

It reflects a decline in value of $50,000. Signup and view all the answers

What primary factor determines whether the investor will need to sell the investment before its fair value recovers?

The investor's intention to sell the bonds or the likelihood of needing to sell them. Signup and view all the answers

In the event of recognizing an unrealized loss, where is the noncredit portion of this loss reported?

The noncredit portion of the unrealized loss is reported in Other Comprehensive Income (OCI). Signup and view all the answers

What journal entry is made if an investor intends to sell the bonds and recognizes a loss on impairment?

The investor records a 'Loss on impairment' and reduces the 'Discount on bond investment'. Signup and view all the answers

What is the allowance for credit losses used for in the context of AFS investments?

It is used to reduce the carrying value of the investment based on expected credit losses. Signup and view all the answers

What impacts the recognition of credit loss in earnings for investments categorized as AFS?

The assessment of whether any portion of the unrealized loss is deemed a credit loss. Signup and view all the answers

When an investment is not meant to be sold, how is the loss from an AFS investment recognized?

It is recognized in OCI as an unrealized loss, with a fair value adjustment made to the investment's carrying value. Signup and view all the answers

What distinguishing characteristic differentiates the treatment of impairment losses versus unrealized losses?

Impairment losses affect net income, while unrealized losses primarily impact Other Comprehensive Income (OCI). Signup and view all the answers

What happens to the carrying value of an AFS investment if the impairment is recognized?

The carrying value of the investment is reduced by the recognized impairment loss. Signup and view all the answers

What is the effect on the carrying amount of an investment when transitioning between the equity method and another accounting method?

No adjustment is made to the remaining carrying amount, except for any purchase or sale of shares. Signup and view all the answers

What happens to the previous accounting method when a change to a new method occurs?

The previous method is discontinued and the new method is applied from that point onward. Signup and view all the answers

What serves as the starting point for the new accounting method applied after the change?

The balance in the investment account serves as the starting point. Signup and view all the answers

What determines whether a gain or loss is recognized when an investment under the equity method is sold?

If the selling price is greater than the book value, a gain is recognized; if less, a loss is recognized. Signup and view all the answers

In the example provided, what was the loss recognized when United sold its investment in Arjent?

The loss recognized was $99,000. Signup and view all the answers

How is an investment in equity affiliate reported when dividends are received under the equity method?

Cash is increased and the investment in equity affiliate is decreased. Signup and view all the answers

Under the fair value method, what entry is made for unrealized losses?

A loss is recognized in net income. Signup and view all the answers

What must be noted about the adjustments made when using the equity method compared to fair value?

No adjustments for unrealized gains or losses are made under the equity method. Signup and view all the answers

What is the entry when cash dividends are received under the fair value method?

Cash is debited and dividend revenue is credited. Signup and view all the answers

What happens to the investment account when dividends are received under the equity method?

The 'Investment in equity affiliate' account is debited when receiving dividends. Signup and view all the answers

How does United record a credit loss of $120,497 in their journal entries?

United records a debit to Credit Loss Expense for $120,497 and a credit to Allowance for Credit Losses for the same amount. Signup and view all the answers

What is the significance of the 20% discount rate used by United for valuing the Masterwear bonds?

The 20% discount rate reflects the market's assessment of the risks associated with Masterwear Industries' financial troubles. Signup and view all the answers

What is the total discounted cash flow calculated for the bonds, based on the provided information?

The total discounted cash flow calculated for the bonds is $486,276. Signup and view all the answers

How is the unrealized loss of $185,021 determined for the Masterwear bonds?

The unrealized loss of $185,021 is the difference between the amortized cost and the fair value of the bonds. Signup and view all the answers

What actions must be taken if fair value is less than amortized cost for available-for-sale investments?

If fair value is less than amortized cost, the investor must assess whether to recognize the entire unrealized loss in OCI or not. Signup and view all the answers

What is the principal amount calculated using the present value factor for the Masterwear bonds?

The principal amount calculated is $372,552, derived from $600,000 multiplied by 0.62092. Signup and view all the answers

How is the non-credit loss of $64,524 identified within the financial statements?

The non-credit loss of $64,524 is identified as part of the total unrealized loss on the bonds after accounting for the credit loss. Signup and view all the answers

What financial entry reflects the outcome of not intending to sell an impaired investment?

If an investor does not intend to sell, they would recognize unrealized gains in Other Comprehensive Income (OCI). Signup and view all the answers

What percentage of Arjent, Inc.'s common stock did United Intergroup purchase?

30% Signup and view all the answers

How much cash did United Intergroup pay to acquire its investment in Arjent, Inc.?

$1,500,000 Signup and view all the answers

What is the total fair value of Arjent at the time of United's purchase?

$5,000,000 Signup and view all the answers

What was Arjent's net income for the year 2024?

$500,000 Signup and view all the answers

How is goodwill calculated in the equity method?

Goodwill is calculated as the difference between the purchase price and the fair value of identifiable net assets. Signup and view all the answers

What is the purpose of amortizing the differential in the equity method?

To approximate the effects of consolidation without actually consolidating financial statements. Signup and view all the answers

How much was attributed to goodwill in the investment?

$420,000 Signup and view all the answers

What journal entry is made when Arjent declares and pays dividends?

Debit Cash and Investment in equity affiliate. Signup and view all the answers

How much did the identifiable net assets amount to at the time of purchase?

$2,100,000 Signup and view all the answers

What is the duration of the buildings' useful life as mentioned?

10 years Signup and view all the answers

What is the investment revenue gained by United for the financial year?

$150,000 Signup and view all the answers

What portion of net income is United Intergroup entitled to from Arjent's earnings?

$150,000 Signup and view all the answers

What amount reflects the cumulative difference in fair values for buildings specifically?

$300,000 Signup and view all the answers

Which accounting method is used by United Intergroup to account for its investment?

Equity method Signup and view all the answers

What are the total liabilities of Arjent, Inc. listed in the information?

$3,600,000 Signup and view all the answers

Study Notes

Chapter 8: Investments

This chapter covers various investment strategies and accounting practices.
Investments involve financial instruments categorized as equity and debt securities.
Equity securities include common stock and preferred stock, purchased by individuals, mutual funds, or corporations. Objective is to gain returns from dividends or appreciation in market prices.
Debt securities like bonds and notes are also investment options. Investors purchase them to collect interest and achieve price appreciation.

Financial Instruments

Financial instruments are the cornerstones of investments.
Two main categories are equity securities and debt securities.

Equity Securities

Common stock: Ownership shares in a company.
Preferred stock: Stock with preferential rights compared to common stock (e.g., dividends).
Purchased by individual investors, mutual funds, and corporations.
Goal is to earn a return from dividends or increases in market price of securities.
Also designed to build ongoing affiliations with affiliated companies.

Debt Securities

Bonds: Issued by corporations and governments promising to pay principal and interest to bondholders.
Notes: Similar to bonds but with shorter maturity periods.
Individual investors, mutual funds, and corporations purchase debt securities.
Objective is to earn a return from interest or accrued appreciation in market price.
Establishing ongoing affiliations with the issuing companies is also a goal.

Accounting for Debt Investments

Debt security accounting involves recording transactions at cost (including brokerage fees) and calculating maturity dates with interest payments.
Investments are valued at cost.
The face amount is recorded for investment in the bonds.
The purchase price difference is recorded as Discount on bond investment.
Recording interest revenue is also a critical component of accounting for debt investments.

Debt Investment: Bonds Discount

Masterwear Industries issued $700,000 of 12% bonds in 2024, maturing in 2027.
United Intergroup purchased the entire issue at a 14% market interest rate.
Calculating the bonds' price involves discounting future interest and principal payments using the current market rate of 14% per year. The purchase price of the bonds was $666,633.

Bond Investments: Premiums and Discounts

Bond fair values change with fluctuations in market interest rates.
Prices of fixed-rate investments are influenced by changes in market interest rates.
Prices of bonds are higher when the stated interest rate is greater than the market rate.
When stated rates are less than market rate, bonds are cheaper.

Purchase of a Debt Investment

When purchasing debt investments the total amount paid is recorded.
Brokerage fees are also included in this total.
Debt investments are recorded using the cost method.

Recording Interest Revenue

Recording interest revenue involves determining the interest received.
Determining the amount is done by multiplying the face amount of the bonds by the stated rate.
The present values are calculated based on the market rate.

Amortization Schedule-Discount

An amortization schedule details the period-wise distribution of a discount on bond investment.
Amortization gradually reduces the discount on bond investment to zero when bonds mature.

Reporting Approach of Debt Investments

Held-to-maturity (HTM) investments are intended for long-term holding until maturity. They do not recognize unrealized gains and losses.
Trading (TS) investments are held for the near term and are recorded at fair value. Unrealized gains/losses are recognized.
Available-for-sale (AFS) investments are held with potential for future sale. Unrealized gains and losses are not recognized in the income statement, instead are included in OCI.

Financial Statement Presentation—HTM

Realized gains and losses are recorded in the income statement.
Unrealized gains and losses are disclosed in footnotes.
Financial statements do not reflect unrealized gains and losses.
Investments are reported at amortized cost less allowances for credit losses.
Cash flows from HTM securities are classified as investing activities.

Reporting Held-to-Maturity Investments

Discloses revenues, expenses, other income, net income and other comprehensive income (OCI) in the statement of comprehensive income.
Shows investments in bonds at amortized cost minus credit losses in the balance sheet.
Shows cash flows from interest received and buying, selling HTM securities as investing activities in the statement of cash flows.

Reporting Trading Securities

Includes realized gains/losses in the income statement, regardless of whether the gains/losses were realized or unrealized.
Investments reported at fair value in the balance sheet.
Cash flows from buying and selling trading securities are considered operating activities.

Debt Investments: Available-for-Sale Securities

Available-for-sale (AFS) securities are not held for trading or designated as held-to-maturity.
These securities are reported at fair value in the balance sheet.
Unrealized holding gains and losses are not recorded in the income statement, but rather in other comprehensive income (OCI).

Adjusting AFS Investments to Fair Value

Fair value adjustments are made for AFS securities when their market price differs from their carrying value. This is generally done annually, and any difference is recorded in other comprehensive income.

Sale of AFS Investments

If an AFS investment is sold, the adjustment is reversed, and the gain or loss on sale is recognized in the income statement.

Impairment of AFS Investments

Companies need to recognize impairments when the fair value of AFS investments falls below the carrying value.
The recognition of impairment loss depends on management's intention to sell the investment.

Financial Statement Presentation: AFS

Gains and losses from fair value changes are reported in other comprehensive income (OCI).
Investments are reported at fair value in the balance sheet.
Cash flows from buying and selling AFS securities are reported in investing activities.

Investments in Securities Available-for-Sale—Cisco Systems

This note provides a breakdown of various types of available-for-sale securities, including their amortized cost, gross unrealized gains, gross unrealized losses, and fair values in millions of dollars.

Comparison of HTM, TS, and AFS Approaches

Summarizing different accounting methods for investments.
Providing a quick comparison of investment accounting methods.

Transfers between Reporting Categories

When transitioning between investment accounting categories, unrealized gains or losses are treated differently depending on the category transitioning to.
Unrealized holding gains and losses are not recognized in the income statement during the transfer if one investment category transfers to a different category.

Fair Value Option (FVO-HTM & AFS)

An optional accounting method for HTM and AFS investments to value them at fair value rather than amortized cost.
Unrealized gains and losses are reported in the income statement.

Financial Statement Presentation and Disclosure

Investors must disclose specific investment data in financial statements, including aggregated fair value, realized gains/losses, and their change in net unrealized gains/losses.

Fair Value Disclosures of Investment Securities

Providing a snapshot of fair values for specific investments for HP Incorporated as of October 31, 2020.

Accounting for Equity Investments

Explains how equity investments are accounted for, from purchasing them to holding them, and eventually selling them.

Reporting Categories for Equity Investments

Discusses different investor influence levels and how these influence reporting methods for equity investments.

Investor Lacks Significant Influence

This section details the accounting treatment for an investor who has less than a 20% ownership stake in another company's stock (lacks significant influence).
Purchase, recognizing investment revenue, adjusting fair value, and recording sales are explained.

Adjustments for Other Assets and Liabilities

Addresses the accounting treatment of unrealized gains or losses when inventory purchased by an investor is sold and when the fair value of purchased inventory exceeds its original book value.

Reporting the Investment

In the equity method, the investor's share of the investee's undistributed earnings gets recorded in the investment account. However, the fair value of the investment shares is not reported annually.

Reporting the Investment: Losses & Mid-Year

Explaining accounting for equity investments bought during the middle of the year.
Provides examples for understanding the proportion of income/losses in relation to the timeframe the investment was held.

Equity Method Investments: AT&T

Presenting a summary of equity investments for AT&T, broken down by category (current and noncurrent assets) as of December 31, 2018 and 2019.

Impairment of Equity Method Investments

Outlines and describes the accounting procedures to be followed if the fair value of an equity investment falls below its carrying value.

What If Conditions Change?

If the circumstances surrounding investment change, accounting treatment can shift from an equity method to another approach, though no adjustments are made to the current investment balance.

If an Equity Method Investment is Sold

Provides a summary of the accounting treatment when an equity investment that has been valued using the equity method is sold.
Explains the journal entries for such events in a straightforward manner.

Comparison of Fair Value and Equity Methods

Explains how accounting differs for evaluating investments under fair value method vs. equity method.

Fair Value Option: Equity Method

Clarifies how the fair value option affects accounting for investments using the equity method.

Credit Losses for Held-to-Maturity Investments

Defines credit losses for held-to-maturity (HTM) investments.
Explains how credit losses are estimated and calculated.

Credit Losses for Available-for-Sale Investments

Covers the process of calculating credit losses for investments that are classified as available-for-sale (AFS).

Account for Impairment of AFS Investments

Presents a decision tree to illustrate recognizing or not recognizing impairment for AFS investments.

Impairment of AFS Investments (Case 1)

Explains the journal entry for impairment cases when the investor intends to sell the investment before fair value recovers to amortized cost.

Impairment of AFS Investments (Case 2)

Explains the journal entry process, when the investor doesn't intend to sell the AFS investment and doesn't see it likely that the fair value will recover.

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Description

Test your knowledge on accounting for investments, including the effects of discount rates, amortization, and equity valuations. This quiz covers essential concepts like credit losses, significant influence, and the consolidation method of accounting. Perfect for finance students and professionals.