Question 1

The recognition of realized losses on short-term equity securities

Accepted Answer

The answer of The recognition of realized losses on short-term...

Question 2

A passive investment in equity securities was purchased on April 1 for $900. On December 31, the market value of those securities is $700. Which of the following is part of the adjusting entry necessary on December 31?

Accepted Answer

The adjusting entry should reflect the decrease in market value. The investment account is credited to reduce its value by the unrealized loss of $200 ($900 - $700).

Question 3

Which one of the following is evidence of a ready market?

Accepted Answer

A security that is actively traded on a public stock exchange demonstrates a ready market, meaning there are many investors interested in buying and selling the security, which makes it easier to buy and sell the security quickly and at a fair price. The other options do not necessarily indicate a ready market.

Question 4

The consolidation procedure of accounting for long-term equity investments is typically used:

Accepted Answer

The consolidation procedure is used when the investor owns more than 50% of the investee company. This is because ownership of over 50% indicates control over the investee company and the ability to influence its financial and operating decisions.

Question 5

Walsh Company purchased, as a passive investment, 1,000 shares of Pierce Company for $20 per share. At the end of the year, the fair market value of the investment was $23 per share. How should Walsh recognize this change?

Accepted Answer

Unrealized gains for passive investments are recognized in the income statement. Since the fair market value increased from the cost, this change is an unrealized gain because the securities have not been sold yet.

Question 6

The mark-to-market method of accounting for long-term equity investments is typically used when:

Accepted Answer

The mark-to-market method, also known as fair value accounting, is typically used when the investor has a passive interest in the investee, which is generally considered to be when the investor owns less than 20% of the investee company. This is because ownership of less than 20% usually does not give the investor significant influence over the investee, making fair value a more appropriate measure of the investment's value on the balance sheet.

Question 7

Equity securities intended to be held for a short time period are held primarily for the purpose of:

Accepted Answer

Equity securities intended to be held for a short time period are typically held in order to generate profits from short-term price increases. Some investors engage in short-term trading, buying and selling shares quickly in order to take advantage of short-term market fluctuations.

Question 8

Which one of the following correctly reflects the effects on the financial statements of the investor caused by dividends declared on securities held as a passive investment?

Accepted Answer

The answer of Which one of the following correctly reflects...

Question 9

The equity method of accounting for long-term equity investments is typically used when:

Accepted Answer

The equity method of accounting is typically used when an investor has between 20% and 50% ownership in an investee company. When an investor owns less than 20% of an investee company, the investor is deemed to have insignificant influence and is required to use the fair value method. When an investor owns more than 50% of an investee company, the investor is deemed to have control and is required to use the consolidation method.

Question 10

The treatment of unrealized gains on equity securities:

Accepted Answer

The treatment of unrealized gains on equity securities indeed depends on the ownership percentage in the investee. Different accounting methods (e.g., cost method, equity method, consolidation) are applied based on the level of ownership, which affects how unrealized gains are recognized.

Question 11

Which one of the following correctly reflects the effects on the financial statements caused by a decrease in the market price of a 30% interest long-term equity security investment?

Accepted Answer

A decrease in the market price of a 30% interest long-term equity security investment affects the other comprehensive income and equity sections of the financial statements but does not directly impact the income statement where earnings per share is calculated. Therefore, earnings per share remains unaffected.

Question 12

The recognition of unrealized losses on a current investment:

Accepted Answer

The recognition of unrealized losses on a current investment decreases both the quick and current ratios because it reduces the value of current assets, which are a component of both ratios.

Question 13

Which one of the following correctly reflects the effects on the financial statements caused by dividends declared on passive investments owned by a firm?

Accepted Answer

Dividends declared on passive investments owned by a firm would increase its earnings, thereby increasing its earnings per share (EPS). The current ratio, which is a measure of a firm's short-term liquidity, would not be affected by dividends declared on passive investments. Therefore, option B is the correct answer.

Question 14

An unrealized gain or loss that relates to a passive investment represents:

Accepted Answer

A passive investment is one in which the investor does not have significant control or influence over the investee company. Therefore, the unrealized gain or loss from such an investment reflects the extent to which the investor's wealth has increased or decreased due to holding the investment, even though it remains unrealized until the investment is sold. It does not represent an undervalued investment or the profit or loss made when trading securities were sold, nor does it necessarily include the total dividends received from the investee company during the year.

Question 15

A controlling interest in another company:

Accepted Answer

A controlling interest typically requires the parent company to prepare consolidated financial statements, as it implies ownership of more than 50% of the voting stock of another company, giving the parent control over the subsidiary's operations and policies.

Question 16

Camber Corp. owns 10% of Nova Corp's outstanding voting stock. Camber should account for its long-term equity investment in Nova Corp. using:

Accepted Answer

Camber Corp. should use the mark-to-market method (also known as the fair value method) for its investment in Nova Corp. because it owns only 10% of Nova's outstanding voting stock. This level of ownership suggests that Camber does not have significant influence over Nova, which is typically presumed when ownership is between 20% and 50%. Therefore, the equity method and consolidated financial statements are not appropriate. The amortization method is not used for accounting for investments in other companies.

Question 17

Which of the following correctly reflects the effects on the financial statements caused by the increase in market price of a current investment in equity securities?

Accepted Answer

An increase in market price of a current investment in equity securities will result in an increase in the value of the investment, which will in turn increase the total assets and owner's equity of the company. This will lead to an increase in the current ratio and earnings per share.

Question 18

A small long-term investment in equity securities was purchased on May 2 for $1,000. On December 31, the market value of those securities is $1,100. Which of the following is part of the adjusting entry necessary on December 31?

Accepted Answer

The adjusting entry necessary on December 31 is to recognize the unrealized gain on the equity securities. Unrealized gain is the increase in value of an investment that has not yet been sold. Therefore, we need to credit Unrealized Gain for the increase in value, which is $100. The correct entry would be: 
Debit Unrealized Gain for $100
Credit Short-term Equity Investments for $100. 
Therefore, the best choice is D, Credit Unrealized Gain for $100.

Question 19

Which one of the following is an area of subjectivity which opens the incentive of window dressing to management as it relates to investments?

Accepted Answer

The proclamation of the intention to sell an investment within the next year is an area of subjectivity because it can influence how the investment is classified and reported in financial statements, potentially leading to window dressing to make the financial position appear more favorable.

Question 20

Which one of the following must be met prior to classifying an investment as current?

Accepted Answer

In order for an investment to be classified as current, it must be readily marketable. This means that the investment can be easily sold in the near future without affecting the market price. The other choices (A, B, and D) do not apply to the criteria for classifying an investment as current.

Quiz 8: Investments in Equity Securities