Question 1

Management must have the intent and ability to hold a bond investment until maturity if it is to be classified as a held-to-maturity security.

Accepted Answer

This statement is true. In order for a bond investment to be classified as held-to-maturity, the management must have both the intent and the ability to hold the investment until maturity. If the management does not have both these factors, the investment should be classified as available-for-sale or trading.

Question 2

An unrealized holding gain is reported within other comprehensive income when the fair value of a trading debt security exceeds its fair value reported in the prior period.

Accepted Answer

An unrealized holding gain on a trading security is reported in net income, not in other comprehensive income. Other comprehensive income records unrealized gains and losses on available-for-sale securities, not trading securities.

Question 3

Ocean Corporation owns 30% of Woods Corp.for which it paid $5.5 million and uses the equity method to account for the investment.Woods Corp.paid stockholders a $100,000 dividend.Therefore,the Investment in Woods Corp.account will decrease by Ocean's $30,000 proportionate share of the Woods.Corp.dividend.

Accepted Answer

Since Ocean Corporation owns 30% of Woods Corp., its proportionate share of the $100,000 dividend would be $30,000. Using the equity method, the Investment in Woods Corp. account will decrease by this amount, so the statement is true.

Question 4

Under the equity method,dividends received are recognized by increasing the Investment Revenue account.

Accepted Answer

Under the equity method, dividends received from the investee reduce the carrying amount of the investment on the investor's books, rather than being recognized as investment revenue.

Question 5

A decline in the fair value of the available-for-sale debt securities portfolio reduces assets and net income.

Accepted Answer

A decline in the fair value of available-for-sale debt securities reduces assets but does not affect net income; instead, it impacts other comprehensive income.

Question 6

The equity investment portfolio is adjusted to fair value at the end of each period with the offsetting effect reported on the income statement as a realized gain or loss.

Accepted Answer

The adjustment to fair value of an equity investment portfolio is typically reported in other comprehensive income (OCI) for available-for-sale securities, not as a realized gain or loss on the income statement, until the securities are actually sold.

Question 7

For all periods in which a debt security is held in the available-for-sale securities portfolio,the only income reported on the income statement is interest revenue

Accepted Answer

Interest revenue is the only income reported on the income statement for available-for-sale securities, as unrealized gains and losses are reported in other comprehensive income until realized.

Question 8

An increase in the fair value of the debt trading securities portfolio increases both assets and net income.

Accepted Answer

An increase in the fair value of the debt trading securities portfolio results in a gain, which increases both assets and net income.

Question 9

An unrealized holding loss is reported on the income statement when the fair value of a debt trading security is less than its fair value reported in the prior period.

Accepted Answer

Unrealized holding gains and losses for trading securities are reported on the income statement as they reflect changes in fair value.

Question 10

An unrealized holding gain is reported on the income statement when the fair value of an available-for-sale debt security exceeds its fair value reported in the prior period.

Accepted Answer

An unrealized holding gain for an available-for-sale debt security is reported in other comprehensive income, not in the income statement.

Question 11

Passive debt investments other than held-to-maturity investments are reported on the balance sheet at fair value.

Accepted Answer

Passive debt investments, such as available-for-sale and trading securities, are reported on the balance sheet at fair value. Held-to-maturity investments are the only type of debt investments that are reported at amortized cost on the balance sheet.

Question 12

The extent of influence and control over another company is a critical factor in determining the proper method of accounting for an investment in the common stock of another company.

Accepted Answer

The level of control exerted over another company will determine whether the investment should be accounted for using the equity or consolidation method.

Question 13

Use of the equity method is required for investments between 20 and 50% of a company's voting common stock regardless of the investor's ability to influence the affiliate.

Accepted Answer

The equity method is used when the investor has significant influence over the investee, typically indicated by ownership of 20% to 50% of the voting stock, but the ability to exercise significant influence is a key determinant, not just the percentage ownership.

Question 14

Barnum Company owns an investment and uses the equity method of accounting.Under the equity method of accounting,Barnum would decrease the Investment account for the proportionate share of the affiliate's reported net loss.

Accepted Answer

According to the equity method of accounting, the investor decreases its investment account for the proportionate share of the affiliate's reported net loss. This method reflects the investor's ownership percentage in the affiliate and the investor recognizes its share of the affiliate's profits and losses, which affects the investment account.

Question 15

Held-to-maturity bond investments must be reported on the balance sheet at fair value.

Accepted Answer

Held-to-maturity bond investments are reported on the balance sheet at amortized cost, not fair value. Fair value reporting is required for available-for-sale and trading securities.

Question 16

All investments other than held-to-maturity bond investments are reported on the balance sheet at their fair value as of the balance sheet date.

Accepted Answer

Not all investments are reported at fair value; for example, equity investments that do not result in significant influence over the investee are reported at fair value, but investments in subsidiaries (where there is control) are consolidated, and held-to-maturity debt securities are reported at amortized cost.

Question 17

The equity method is required to be used when an investor has the ability to exert significant influence over the affiliate.

Accepted Answer

The equity method is used when an investor has significant influence, defined as the ability to participate in the financial and operating policy decisions of the affiliate, but not control over those decisions. This is typically demonstrated by ownership of between 20% and 50% of the voting stock of the affiliate.

Question 18

When a trading security is sold,three journal entries are required: one to adjust the security to fair value,another to record the sale,and a third to adjust retained earnings.

Accepted Answer

When a trading security is sold, only two journal entries are required: one to record the sale (which includes removing the security at its cost and recording any gain or loss based on the difference between its sale price and its carrying value on the balance sheet), and another to adjust the income statement for the gain or loss on the sale (which affects net income and thus retained earnings indirectly through the income statement, not through a direct adjustment to retained earnings).

Question 19

Investments in bonds intended to be sold before they reach maturity should be reported under the fair value method.

Accepted Answer

According to Generally Accepted Accounting Principles (GAAP), investments in bonds intended to be sold before they reach maturity should be reported under the fair value method. This means that the bonds should be reported at their fair market value on the balance sheet.

Question 20

A realized gain or loss is reported on the income statement when an equity investment account is adjusted to reflect changes in fair value.

Accepted Answer

A realized gain or loss is reported on the income statement when an asset is actually sold, not when its fair value changes on paper. Adjustments to reflect changes in fair value are typically recognized in other comprehensive income, not the income statement, until the asset is sold.

Quiz 14: Reporting and Interpreting Investments in Other Corporations