Question 1

Rye Company purchased 15% of Lena Company's common stock during 2012 for $150,000. The 15% investment in Lena had a $160,000 fair value at the end of 2012 and a $140,000 fair value at the end of 2013. Which of the following statements is correct if Rye classifies the investment as an available-for-sale security and sold it at the beginning of 2014 for $148,000?

Accepted Answer

Since the investment was classified as available-for-sale, the unrealized gains and losses were reported on the balance sheet as part of comprehensive income, not the statement of earnings. Therefore, there is no impact on the statement of earnings for the change in fair value from 2012 to 2013. However, when the investment is sold in 2014 for $148,000, there is a realized loss of $12,000 ($148,000 sales price - $160,000 fair value at end of 2012). Therefore, the correct statement is that the 2014 realized loss reported on the statement of earnings is $2,000 ($12,000 realized loss - $10,000 unrealized gain from 2012).

Question 2

McGinn Company purchased 10% of RJ Company's common stock during 2012 for $100,000. The 10% investment in RJ had a $90,000 fair value at the end of 2012 and a
$105,000 fair value at the end of 2013. Which of the following statements is correct if McGinn classified the investment as an available-for-sale security and sold it at the beginning of 2014 for $102,000?

Accepted Answer

The investment is classified as available-for-sale, so unrealized gains and losses are reported on the statement of earnings. The unrealized loss in 2012 is $10,000 - $90,000 = $10,000. The realized gain in 2014 is $102,000 - $90,000 = $12,000.

Question 3

Fun with Florals Corporation acquired all the voting shares of Crafts to Go Corporation under the purchase method. Which of the following statements about the consolidated statements is true?

Accepted Answer

Under the purchase method, Fun with Florals Corporation will report Crafts to Go Corporation's revenues and expenses on a consolidated income statement, as well as consolidate their assets and liabilities. The market value method is not relevant, as this investment was made through the purchase of all voting shares, not through the market. The assets and liabilities of Crafts to Go Corporation would be revalued and disclosed at their fair values on the date of acquisition, not market values. The equity method is used when a company has significant influence over another company, but not when it has acquired all voting shares through purchase.

Question 4

How is goodwill accounted for subsequent to acquisition?

Accepted Answer

Goodwill should not be amortized because it has an indefinite life. Instead, it should be tested for impairment annually or if there is a triggering event indicating a possible decrease in value. If the carrying value of goodwill exceeds its fair value, an impairment loss must be recognized.

Question 5

Miller Corp. purchased $1,000,000 of bonds at 105. The bonds pay interest at the rate of 10%. Miller intends to hold these bonds to maturity. Which of the following statements is false?

Accepted Answer

Option C is false. Under the held-to-maturity classification, unrealized gains or losses are not recognized on the income statement. Instead, the investment is recorded at amortized cost and any difference between the cost and the maturity value is recognized as interest income over the term of the bond.

Question 6

The balance sheet of Mini Company was as follows immediately before it was acquired b Maxi Company:  On January 1, 2010, Maxi Company paid $350,000 in cash for 100% of the outstanding common stock of Mini Company. The current market value of Mini Company's plant and equipment was $140,000 on the date of acquisition. If the market value and book value ar the same for Mini's remaining assets, what is the net increase in Maxi's assets as a result o the merger with Mini?

Accepted Answer

The answer of The balance sheet of Mini Company was...

Question 7

Chang Corp. purchased $1,000,000 of bonds at par value on April 1, 2010. The bonds pay interest at the rate of 10%. Chang intends to hold these bonds to maturity. Which of the following statements is false?

Accepted Answer

The statement "The bond investment must be accounted for using the fair value approach" is false. Since Chang Corp. intends to hold the bonds to maturity and has classified them as held-to-maturity, they will be accounted for at amortized cost, not fair value. The other statements are true: there will be no unrealized gains or losses recognized on the bonds over their lifetime, the bonds will earn $75,000 of interest by December 31, 2010, and the cash interest will be the same as interest revenue since the bonds were issued at par value.

Question 8

On January 1, 2014, Entertainment Company acquired 15% of the outstanding voting stock of Rocker Company as a long-term investment in available-for-sale securities. During 2014, Rocker Company reported net income of $1,500,000 and dividends declared and paid of $250,000. How much income will be reported during 2014 from the Rocker investment?

Accepted Answer

Since Entertainment Company owns less than 20% of Rocker Company, it should use the cost method. Under this method, the income reported is based on dividends received. Entertainment Company would report 15% of the dividends declared and paid, which is 15% of $250,000, equaling $37,500.

Question 9

Rye Company purchased 15% of Lena Company's common stock during 2012 for $150,000. The 15% investment in Lena had a $160,000 fair value at the end of 2012 and a $140,000 fair value at the end of 2013. Which of the following statements is incorrect if Rye classifies the investment as an available-for-sale security?

Accepted Answer

Unrealized gains and losses for available-for-sale securities are reported in other comprehensive income, not in net earnings.

Question 10

Use of the consolidated financial statement method of accounting for a long-term investment in common stock of another company is required when the ownership of its voting stock is

Accepted Answer

The consolidated financial statement method is used when a company owns more than 50% of another company's voting stock, indicating control over the subsidiary.

Question 11

Photo Finish Corporation bought a 40% interest in the voting stock of Click It Corporation's $1 par value common stock for $20 million (2 million shares at a $10 market price) on March 31, 2014. On December 31, 2014, Click It paid a $1 million cash dividend declared earlier in 2014 and reported net earnings for the year ended 2014 of $10 million. On December 31, 2014, Click Its stock was trading at $11.50 per share. What effect will the dividend have on Photo Finish's financial statements?

Accepted Answer

The dividend received by Photo Finish will increase cash and decrease the investment in Click It, as dividends are considered a return on investment, reducing the carrying amount of the investment under the equity method.

Question 12

Libby Company purchased equity securities for $100,000 and classified them as available-for-sale securities on September 15, 2014. At December 31, 2014, the current market value of the securities was $105,000. How should the investment be reported in the 2014 financial statements?

Accepted Answer

Under the available-for-sale classification, changes in market value are reported as unrealized holding gains or losses in the stockholders' equity section of the balance sheet. Therefore, the investment in available-for-sale securities should be reported on the balance sheet at its current market value of $105,000, and the $5,000 unrealized holding gain should be reported in the stockholders' equity section. The unrealized gain should not be reported in the income statement because it is not a realized gain until the securities are sold.

Question 13

On January 1, 2014, Palmer, Inc. bought 40% of the outstanding shares of Arnold Corporation at a cost of $137,000. The equity method of accounting for this investment is used. During 2014, Arnold Corporation reported $30,000 of net income and paid $10,000 in cash dividends. At the end of 2014, the shares had a market value of
$150,000. At what amount should the Arnold investment be reported at on the December 31, 2014 statement of financial position?

Accepted Answer

Under the equity method, the investment is initially recorded at cost and adjusted for the investor's share of the investee's net income and dividends received. Palmer's share of Arnold's net income is 40% of $30,000, which is $12,000. Dividends received are 40% of $10,000, which is $4,000. The investment is increased by the share of net income and decreased by the dividends received: $137,000 + $12,000 - $4,000 = $145,000. The market value is not considered under the equity method.

Question 14

On January 1, 2014, Turtle Inc. bought 30% of the outstanding shares of Shell Corporation at a cost of $150,000. The equity method of accounting for this investment is used. During 2014, Shell Corporation reported $40,000 of net earnings and paid $5,000 in cash dividends. At the end of 2014, the shares had a market value of $160,000. How much investment income will Turtle report from the Shell investment during 2014?

Accepted Answer

The equity method involves recognizing a share of the investee's income or loss in the investor's income statement. 
Turtle bought 30% of Shell's outstanding shares, therefore, its share of earnings would be 30% x $40,000 = $12,000. 
In addition, Turtle would also recognize its share of the dividend received, which would be 30% x $5,000 = $1,500. 
Therefore, Turtle's investment income from the Shell investment during 2014 would be $12,000 + $1,500 = $13,500, which is not one of the answer choices. However, Turtle should also recognize its share of the increase in the market value of the investment, which would be 30% x ($160,000 - $150,000) = $3,000. 
Thus, the total investment income for Turtle during 2014 would be $12,000 + $1,500 + $3,000 = $16,500, which is closest to choice C ($12,000).

Question 15

The primary difference in accounting for available-for-sale investments in stock and accounting for trading investments in stock is which of the following?

Accepted Answer

The primary difference in accounting for available-for-sale investments and trading investments is where the unrealized holding loss or gain on investments is reported within the financial statements. Unrealized gains or losses on trading securities are reported in the income statement, whereas unrealized gains or losses on available-for-sale securities are reported in the equity section of the balance sheet as a separate component of equity called accumulated other comprehensive income. The determination of acquisition cost and unrealized holding gain or loss is similar for both types of investments. Measuring the market value of the long-term and short-term investment portfolios on the balance sheet is not specific to the accounting for available-for-sale or trading investments in stock.

Question 16

When is the equity method not used to account for long-term investments in stocks?

Accepted Answer

When an investment is greater than 50% of the voting stock and control is achieved, consolidation accounting must be used instead of the equity method. The equity method is used when significant influence can be achieved, which is typically when owning between 20% and 50% of the voting stock. Therefore, choices A and D are incorrect. While owning 30% of the voting stock may provide significant influence, it does not trigger the need for consolidation accounting.

Question 17

Rye Company purchased 15% of Lena Company's common stock during 2012 for $150,000. The 15% investment in Lena had a $160,000 fair value at the end of 2012 and a $140,000 fair value at the end of 2013. Which of the following statements is correct if Rye classifies the investment as a trading security and sold it at the beginning of 2014 for
$148,000?

Accepted Answer

Since Rye classified the investment as a trading security, the fair value changes are recorded in the statement of earnings.

In 2012, the investment had a fair value of $160,000, which exceeds the cost of $150,000. Therefore, Rye reports an unrealized gain of $10,000 ($160,000 - $150,000) on the statement of earnings for 2012.

In 2013, the investment had a fair value of $140,000, which had decreased from the prior year. Therefore, Rye reports an unrealized loss of $20,000 ($140,000 - $160,000) on the statement of earnings for 2013.

When Rye sells the investment at the beginning of 2014 for $148,000, it will realize a gain or loss based on the difference between the sale price and the cost of the investment. Since the cost was $150,000 and the sale price was $148,000, Rye will report a realized loss of $2,000 ($148,000 - $150,000) on the statement of earnings for 2014.

Therefore, the correct statement is: The 2014 realized gain reported on the statement of earnings is $8,000.

Question 18

Lyrical Company purchased equity securities for $500,000 and classified them as trading securities on September 15, 2010. On December 31, 2010, the current market value of the securities was $481,000. How should the investment be reported within the 2010 financial statements?

Accepted Answer

Trading securities are reported at fair market value on the balance sheet, and unrealized holding gains or losses are recognized in the income statement. However, the question only asks about the balance sheet reporting.

Question 19

On January 1, 2014, Sheldon Company paid $750,000 cash for 100% of the outstanding common stock of Mullen Company; Mullen's stockholders equity on the date of acquisition was $550,000. The current market value of Mullen's net assets was $70,000 in excess of their book value. What was the amount of goodwill purchased by Sheldon Company?

Accepted Answer

The answer of On January 1, 2014, Sheldon Company paid...

Question 20

Heartfelt Company owns a 40% interest in the voting common stock of Candle Corporation, accounted for using the equity method. During 2014, Candle Corporation reported net earnings of $100,000 and declared and paid cash dividends of $10,000. The carrying value of the Candle investment was $500,000 on January 1, 2014. At what amount is the Candle investment reported on the December 31, 2014 statement of financial position?

Accepted Answer

The equity method is used to account for investments in which a company has significant influence but not control over another company. Under this method, the investor initially records the investment at cost and then adjusts it for its share of the investee's earnings or losses and dividends paid.

In this case, Heartfelt Company owns a 40% interest in the voting common stock of Candle Corporation and reported net earnings of $100,000 and declared and paid cash dividends of $10,000 in 2014. This means that Heartfelt Company's share of Candle Corporation's net earnings is $40,000 ($100,000 x 40%) and its share of dividends is $4,000 ($10,000 x 40%).

To calculate the carrying value of the Candle investment on December 31, 2014, we start with the carrying value from January 1, 2014, which is $500,000. Then we add Heartfelt Company's share of net earnings ($40,000) and subtract its share of dividends ($4,000).

Carrying value on December 31, 2014 = Carrying value on January 1, 2014 + Heartfelt's share of net earnings - Heartfelt's share of dividends 
Carrying value on December 31, 2014 = $500,000 + $40,000 - $4,000 
Carrying value on December 31, 2014 = $536,000

Therefore, the Candle investment is reported at $536,000 on Heartfelt Company's statement of financial position as at December 31, 2014. The correct answer is B.

Quiz 14: Reporting and Interpreting Investments in Other Corporations