Question 1

Which of the following is/are true?

Accepted Answer

All of the statements are true. Choice A explains the ability of management to affect the timing of recognition of gains or losses in net income for securities available-for-sale. Choice B explains that while unrealized gains can be deferred, unrealized losses cannot be indefinitely deferred due to impairment rules. Choice C emphasizes the importance of understanding the effect of accounting treatment on net income when evaluating firms with both trading securities and securities available-for-sale.

Question 2

Both U.S.GAAP and IFRS require that firms record derivatives at their fair values on the balance sheet date.

Accepted Answer

Both U.S.GAAP and IFRS require that firms record derivatives at their fair values on the balance sheet date. This means that the fair value of the derivative is determined and recorded on the balance sheet as an asset or liability, depending on whether the fair value is positive or negative.

Question 3

Measurement of trading securities at fair value reflects income when it occurs in the form of a change in fair value, not when the investor realizes a gain or loss at the time of sale.

Accepted Answer

This statement is true. When an investor holds trading securities, they are measured at fair value and any changes in fair value are recorded as income at the time they occur. This is known as mark-to-market accounting. Realizing a gain or loss at the time of sale may have a cash impact, but it does not affect the recognition of income.

Question 4

If a held-to-maturity security is deemed to be impaired, the investor recognizes (debits) the balance sheet carrying value of the investment and reduces (credits) an impairment loss (included in net income).

Accepted Answer

When a held-to-maturity security is impaired, the investor recognizes an impairment loss by debiting an impairment loss account and crediting the carrying value of the investment on the balance sheet.

Question 5

A firm initially records the purchase of marketable securities at acquisition cost, which includes the purchase price plus any commissions, taxes, and other appropriate costs incurred.

Accepted Answer

According to generally accepted accounting principles (GAAP), marketable securities are recorded at acquisition cost, which includes the purchase price as well as any related expenses such as commissions and taxes. This cost is then adjusted for any changes in fair value, which can result in a gain or loss on the investment.

Question 6

The future value of held-to-maturity debt securities reflects the economic opportunity cost of continuing to hold the securities.

Accepted Answer

The future value of held-to-maturity debt securities reflects the amount of interest and principal that will be received by holding the securities until maturity, not the economic opportunity cost of continuing to hold them.

Question 7

Firms initially record trading securities at fair value, excluding transactions costs (which firms expense as they incur them).

Accepted Answer

Firms do initially record trading securities at fair value, excluding transaction costs, which are expensed as they are incurred.

Question 8

Acquisition and disposition of trading securities are usually financing activities.

Accepted Answer

Acquisition and disposition of trading securities are typically classified as operating activities, not financing activities.

Question 9

Securities available-for-sale that a firm intends to sell within one year appear in marketable securities in the current assets section of the balance sheet.

Accepted Answer

Marketable securities refer to securities that can be easily bought and sold in the market, and those that a firm intends to sell within one year are considered part of the current assets section of the balance sheet.

Question 10

A derivative may have zero initial cost, but potentially large positive or negative fair values later.

Accepted Answer

It is possible for a derivative to have no initial cost, such as in the case of certain options contracts, but its fair value can fluctuate greatly depending on market conditions leading to potentially large positive or negative values later.

Question 11

The transfer of a held-to-maturity investment in debt securities to either trading securities or securities available-for-sale would call into question the original designation of that investment.

Accepted Answer

The transfer of a held-to-maturity investment in debt securities to either trading securities or securities available-for-sale would indicate that the original designation of that investment may have been incorrect or not followed properly. This is because held-to-maturity investments are intended to be held until maturity, while trading and available-for-sale securities are intended for short-term trading or potential sale. Thus, the transfer would suggest that the investor's original intention for the investment has changed, and may require reclassification or adjustment of financial statements.

Question 12

The term marketable securities refers to the financial instruments that firms classify as held-to-maturity, trading, or available-for-sale securities, recognizing that the term does not have a precise definition in U.S.GAAP or IFRS.

Accepted Answer

The statement is true, as marketable securities are indeed classified as held-to-maturity, trading, or available-for-sale securities, and there is no precise definition of the term in U.S.GAAP or IFRS.

Question 13

U.S.GAAP and IFRS require firms to classify marketable securities that are neither debt securities held to maturity nor trading securities as securities available-for-sale.

Accepted Answer

Both U.S.GAAP and IFRS require firms to classify marketable securities that are not held to maturity or trading securities as securities available-for-sale.

Question 14

Management can sell securities with unrealized holding gains (or losses) and transfer through net income to Retained Earnings the entire unrealized holding gain (or loss)-that is, management can affect the timing of gain or loss recognition in net income for both securities available-for-sale and trading securities.

Accepted Answer

Management can only affect the timing of gain or loss recognition in net income for trading securities, not for available-for-sale securities, as unrealized gains or losses for available-for-sale securities are reported in other comprehensive income, not net income.

Question 15

When accounting for a fair value hedge of a recognized asset or liability, at the end of each period, the firm remeasures the hedged asset or liability to fair value and includes the resulting gain or loss in net income, and the derivative instrument (hedging instrument) to fair value and includes the resulting loss or gain in net income.

Accepted Answer

This is correct as per the accounting rules for fair value hedges. The gains or losses from remeasuring the hedged item and the hedging instrument are recognized in net income.

Question 16

In both U.S.GAAP and IFRS, hedge accounting is elective; firms need not designate any derivatives as accounting hedges, regardless of the degree to which the derivatives mitigate the volatility of outcomes of other arrangements.

Accepted Answer

In both U.S. GAAP and IFRS, hedge accounting is elective and firms are not required to designate any derivatives as accounting hedges, regardless of their impact on mitigating the volatility of outcomes of other arrangements.

Question 17

Gains and losses on derivatives not designated as hedges of a specific risk, gains and losses on fair value hedges, and the ineffective portion of cash flow hedges affect net income simultaneously with changes in fair value.

Accepted Answer

Gains and losses on derivatives not designated as hedges of a specific risk, gains and losses on fair value hedges, and the ineffective portion of cash flow hedges are reported in net income and thus affect net income simultaneously with changes in fair value.

Question 18

Firms might use a particular derivative to hedge fair value and to hedge cash flows.

Accepted Answer

The answer of Firms might use a particular derivative to...

Question 19

Gains and losses on effective cash flow hedges initially affect other comprehensive income, not net income.

Accepted Answer

Gains and losses on effective cash flow hedges are initially recognized in other comprehensive income and later reclassified to net income when the hedged transaction affects earnings.

Question 20

A derivative is a financial instrument whose value changes in response to changes in an underlying observable variable, such as a stock price, an interest rate, a currency exchange rate, or a commodity price.

Accepted Answer

This statement is true. Derivatives are financial instruments that derive their value from an underlying asset, index, or reference rate. Their value changes in response to changes in the underlying observable variable. Examples of derivatives include options, futures, swaps, and forwards.

Quiz 13: Marketable Securities and Derivatives