Solution manual accounting 25th editon warren chapter 15

However, changes in the fair value of trading securities during a period are reported as an unrealized gain or loss on the income statement.. For available-for- sale securities, changes

INVESTMENTS AND FAIR VALUE ACCOUNTING

DISCUSSION QUESTIONS

1 A company may temporarily have excess cash that is not needed for use in its current

operations Instead of letting excess cash remain idle in a checking account, most companies

invest their excess cash in temporary investments The primary objective of investing in

temporary investments is to:

a earn interest revenue.

b receive dividends.

c realize gains from increases in the market price of the securities

2 A gain or loss can occur when the selling price of the bond differs from the book value (cost) of

the bond The price of bond investments can change due to changes in the market rate of interest

If the proceeds from the sale exceed the book value (cost) of the bonds, then a gain is recorded

3 The equity method is used for equity investments representing more than 20% and less than 50%

of the outstanding shares of the investee

4 Under the cost method, a dividend received is treated as dividend revenue Under the equity

method, a dividend received is not treated as dividend revenue, but is treated as a reduction in

the book value of the investment

5 An investment greater than 50% of the investee is considered to be an investment that exerts

control Thus, the financial statements of the investee (subsidiary) are consolidated (combined) with that of the investor (parent company)

6 Both portfolios are reported at fair value However, changes in the fair value of trading securities

during a period are reported as an unrealized gain or loss on the income statement For available-for- sale securities, changes in the fair value of the securities are reported in stockholders’ equity and, thus, are not recognized as part of net income

7 A credit balance in Valuation Allowance for Available-for-Sale Investments is subtracted from

Available-for-Sale Investments (at cost) The net reported amount is the available-for-sale securities

at fair value

8 A debit balance in Unrealized Gain (Loss) on Available-for-Sale Investments would be reported as a

reduction in the Stockholders’ Equity section of the balance sheet, after Retained Earnings

9 Current GAAP requires fair value accounting for impaired assets Current GAAP allows financial

assets and liabilities to be reported at fair value The assets and liabilities reported at fair value are becoming a more significant portion of many companies’ balance sheets International Financial Reporting Standards are also moving more aggressively toward fair value accounting As a result

of the desire to converge U.S and international standards, the United States is also moving

toward fair value reporting

10 Fair values may not be readily obtainable for some assets or liabilities, which causes financial

statement valuations to become more subjective In addition, comparability between financial

statements among different companies may be hampered by different methods of determining fair value Lastly, using fair value can result in greater fluctuations in reported results, making predictions

of future trends potentially more difficult

15-1

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Total proceeds from sale……… $61,100

CHAPTER 15 Investments and Fair Value Accounting

Mar 20 Investments—Thorlite Company Stock* 300,250

*(1,200 shares × $42) – $150

**1,200 shares × ($100,200 ÷ 2,000 shares)

PE 15–3A

Recorded 30% of ARO Company income, 30% × $60,000.

Recorded 40% of Fain Company income, 40% × $140,000.

To record decrease in fair value of trading investments.

* Trading investments at fair value, December 31, 2014……… $203,600

Trading investments at cost, December 31, 2014……… 212,500

Unrealized loss on trading investments……… $ (8,900)

To record increase in fair value of trading investments.

* Trading investments at fair value, December 31, 2014……… $46,300

Trading investments at cost, December 31, 2014……… 41,500

Unrealized gain on trading investments……… $ 4,800

Available-for-sale investments at cost, December 31, 2014……… 78,400

Unrealized gain (loss) on available-for-sale investments……… $ (5,800)

Available-for-sale investments at cost, December 31, 2014……… 24,260

Unrealized gain (loss) on available-for-sale investments……… $ 2,090

*$75,000 × 102%

Interest earned on sold bonds (September 1 to November 1) 2 ……… 225 Interest earned on remaining bonds (September 1 to December 31) 3 ………… 750

*(2,400 shares × $38.00) – $200

**($192,240 ÷ 6,000 shares) × 2,400 shares

Jan 16 Investments—McDowell Inc Stock* 75,140

*(400 shares × $100) – $75

**400 shares × ($85,150 ÷ 1,000 shares)

b Stieg’s investment in Larson Corp represents 40% of the outstanding shares

of Larson Corp An investment amount between 20% and 50% of the outstanding common stock of the investee is presumed to represent significant influence The equity method is appropriate when the investor can exercise significant influence over the investee.

Record 40% share of Larson Corp.

net income, $1,200,000 × (160,000 shares ÷ 400,000 shares).

*160,000 shares × $2.00

Cash dividends received……… (136,400 ) Investment in Hi Energy Co Stock balance, December 31, 2014……… $5,567,600

Ex 15–12

a.

b Initial acquisition cost $212,000 Equity loss for 2014 (19,040) Cash dividends received (8,160) Investment in Gator Co Stock balance, December 31, 2014 $184,800

Record 31% share of Hi Energy

Co net income, $800,000 × (124,000 shares ÷ 400,000 shares).

Record 34% share of Gator Co.

net loss, $56,000 × 34%.

Ex 15–12 (Concluded)

c Under the equity method, the investor will record their proportionate share of the net increase (or decrease) of the book value of the investee resulting from

earnings and dividend distributions The fair value method uses market price

information to value the investment in the investee These two methods result

in different valuations because the equity method is based upon book

accounting, while the fair value approach uses market information The two

methods need not be related to each other over time While changes in book

value can influence market prices, many other variables can influence the

market price of a stock.

Ex 15–13

(in millions)

Investment in Raven Company stock, December 31, 2014……… $264

Plus equity earnings in Raven Company……… 25

Less dividends received*……… (8 )

Investment in Raven Company stock, December 31, 2015……… $281

* The Raven Company investment is accounted for under the equity method Since

there were no purchases or sales of Raven Company stock, a dividend must have

been received This would explain how the ending balance of the investment

account went from $264 to $281, with $25 million in equity earnings Since the

investment is accounted for under the equity method, the fair value is not used

for valuation purposes.

Ex 15–14

a $6,000 $35,000 [from (c)] – $29,000 [from (b)]

b $29,000 $17,000 – (– $12,000)

c $35,000 $245,000 – $210,000

d $132,000 $144,000 – $12,000

e $39,000 $28,000 + $11,000

f $185,000 $168,000 + $17,000

h $211,000 $205,000 + $6,000

i $273,000 $245,000 + $28,000

b The unrealized gain or unrealized loss for trading investments is disclosed

in the income statement as “other income” (or a separate item if significant)

Unrealized losses would be deducted in determining net income, while

unrealized gains would be added in determining net income.

14,500 shares × $38 per share.

Dec 31 Valuation Allowance for Trading

2014

Valuation Allowance for Trading

Ex 15–17

a.

* $337,500 – $320,000, as determined from the following schedule:

Cost (Dec 31, 2014) Fair Value

1,600 shares × $60 per share

b There would be no adjusting entry for December 31, 2015, if the market prices

remained unchanged from December 31, 2014 This is because the unrealized

gain from the difference between the cost and market has already been

recognized on December 31, 2014 Only changes in market prices would be

recognized subsequent to December 31, 2014.

Ex 15–18

Plus net income………

$ 825,000 245,000

$1,070,000

Less valuation allowance for trading investments……… 72,500 Trading investments (at fair value)……… $ 207,500

33,100 shares × $13 per share.

Dec 31 Unrealized Gain (Loss) on

$66,200, which would be subtracted from stockholders’ equity.

*(1,450 shares × $45 per share) + $100

b Unrealized gains and losses for available-for-sale securities are accumulated over time and reported as a credit (positive) or debit (negative) balance in the Stockholders’ Equity section As a result, the changes in fair value are not reflected on the income statement, as is the case with trading securities Bypassing the income statement

is supported on the grounds that available-for-sale securities will be held for a longer time than trading securities; thus, fluctuations in market prices have a greater

opportunity to “cancel out” over time.

* $259,450 – $263,700, as determined from the following schedule:

Cost (Dec 31, 2014) Fair Value Dust Devil, Inc ……… $ 81,700 $ 76,000 1

Whirlwind Co ……… 114,000 119,700 3 Total……… $263,700 $259,450

2,850 shares × $42 per share

b There is no income statement impact from the December 31, 2014, adjusting

entry Unrealized Gain (Loss) on Available-for-Sale Investments is reported in

the Stockholders’ Equity section of the balance sheet On December 31,

2014, Unrealized Gain or Loss on Available-for-Sale Investments would be

Ex 15–23

a.

* Computation:

Market:

Hawking Inc.: 900 shares × $50……… $45,000

Pavlov Co.: 1,780 shares × $24……… 42,720

$87,720 Cost ($44,000 + $38,000)……… 82,000

Unrealized gain……… $ 5,720

b.

Ex 15–24

COPERNICUS CORPORATION Balance Sheet (selected Stockholders’ Equity items)

Plus valuation allowance for available-for-sale

GALILEO COMPANY Balance Sheet (selected items) December 31, 2014 Stockholders’ Equity

Unrealized gain (loss) on available-for-sale

a Year 1: Dividend Yield = $0.52 ÷ $30.48 = 1.71%

Year 2: Dividend Yield = $0.52 ÷ $27.91 = 1.86%

b Dividends per share remained constant from Year 1 to Year 2 In addition, the dividend yield increased from 1.71% in Year 1 to 1.86% in Year 2 The increase in the dividend yield is a result of a slight decrease in the stock price Microsoft provides a small return to the shareholder in terms of a dividend yield and an additional return in terms of price appreciation of the stock.

Ex 15–27

The investor would receive a return on the investment through share price appreciation as internally generated funds are used to fund growth and earnings opportunities Thus, investors in eBay would likely approve of this policy,

because the company is able to earn superior returns with internally generated earnings beyond what investors could likely earn on their own by investing dividend distributions.

Appendix Ex 15–28

CHEWCO CO.

For the Year Ended December 31, 2014

Other comprehensive income (loss):

Other comprehensive income (loss):

* $200,000 – $185,000

Prob 15–1A (Concluded)

2 If the bonds are classified as available-for-sale securities, then the portfolio

of bonds would need to be adjusted to fair value This would be accomplished

by using a valuation allowance account and an unrealized gain (loss) account as part of stockholders’ equity If the fair value were greater than the cost of the

bond portfolio, the two accounts would be positive, and thus added to investments and stockholders’ equity, respectively If the fair value were less than the cost of the bond portfolio, the two accounts would be negative, and thus subtracted from investments and stockholders’ equity, respectively.

2014

*(5,000 shares × $40 per share) + $500

Valuation Allowance for Trading

* $179,400 – $186,438, in table below

Wilkomm Inc ……… 2,400 $40.10 1 $38 $ 96,240 $ 91,200 McMarsh Inc ……… 1,800 $50.11 2 $49 90,198 88,200

Prob 15–2A (Concluded)

*$7,038 + $79,422 2.

3 Unrealized gains or losses are reported on the income statement, often as

“Other Income (Losses).” For 2014, Scofield Financial Co would have

reported an unrealized loss of $7,038 as “Other Losses.” For 2015, Scofield

Financial Co would have reported an unrealized gain of $86,460 as “Other

Income.” If unrealized gains and losses were significant for Scofield Financial,

then they would be separately disclosed on the income statement.

SCOFIELD FINANCIAL CO.

Balance Sheet (selected items) December 31, 2015 Current assets:

Plus valuation allowance for trading investments 79,422

**1,000 shares × $27 per share

Dec 31 Valuation Allowance for

Prob 15–3A (Concluded)

*11,000 shares × ($0.24 + $0.06)

To record 28% of Shouse Inc.

income $190,000 × (70,000 shares ÷ 250,000 shares).

31 Unrealized Gain (Loss) on

Valuation Allowance for

*($30.00 – $33.00) × 11,000 shares 2.

Available-for-sale investments (at cost) 1 $297,000

Plus valuation allowance for

a $236,170 (see table below)

b $(5,800) ($230,370 – $236,170, from table)

c $230,370 (from table)

Market Cost per Value per

No of Share (or Share (or

Nightline Co bonds…… $40,000 100 98 40,000 39,200

Prob 15–4A (Continued)

The completed comparative unclassified balance sheets are as follows:

O'BRIEN INDUSTRIES, INC.

Balance Sheet December 31, 2015 and 2014

Dec 31, 2015

Dec 31, 2014

Less valuation allowance for available-for-sale

Note 1 Investments are classified as available for sale The investments at cost

and fair value on December 31, 2014, are as follows:

No of Cost per Total Total Fair

Chadwick Co stock……… 1,260 52.00 65,520 63,770

For December 31, 2015:

Market

face amount) face amount) face amount) Cost Value

Nightline Co bonds $40,000 100 98 40,000 39,200

$236,170 $230,370 Note 2 The investment in Jolly Roger Co stock is an equity method investment

representing 30% of the outstanding shares of Jolly Roger Co.

2 If the bonds are classified as available-for-sale securities, then the portfolio

of bonds would need to be adjusted to fair value This would be accomplished

by using a valuation allowance account and an unrealized gain (loss) account.

If the fair value were greater than the cost of the bond portfolio, the two accounts would be positive, and thus added to investments and stockholders’ equity,

respectively If the fair value were less than the cost of the bond portfolio, the two accounts would be negative, and thus subtracted from investments and

stockholders’ equity, respectively.

*(4,800 shares × $26 per share) + $192

* $181,150 – $153,160, in table below

Number of Shares

Cost per Share

Apollo Inc 4,200 $26.041 $33.00 $109,368 $138,600 Ares Co 2,300 $19.042 $18.50 43,792 42,550 Total $153,160 $181,150

*$27,990 + $12,032 2.

*$153,160 (from Dec 31, 2014) + $78,120 – $31,248

3 Unrealized gains or losses are reported in the income statement, often

as “Other Income (Losses).” For 2014, Zeus Investments Inc would have

reported an unrealized gain of $27,990 as “Other Income.” For 2015, Zeus

Investments Inc would have reported an unrealized loss of $40,022 as

“Other Losses.” If unrealized gains and losses were significant for Zeus

Investments, then they would be separately disclosed on the income

statement.

ZEUS INVESTMENTS INC.

Balance Sheet (selected items) December 31, 2015 Current assets: