Question & Answer

Indicate how unrealized holding gains and losses should be reported for investments classified as trading and held for-collection.

Consider the bond investment by Lady Gaga in IFRS17-5. Discuss the accounting for this investment if Lady Gaga’s business model is to hold the investment to collect interest while outstanding and to receive the principal at maturity.

Lady Gaga Co. recently made an investment in the bonds issued by Chili Peppers Inc. Lady

Gaga’s business model for this investment is to profit from trading in response to changes in market interest rates. How should this investment be classified by Lady Gaga? Explain.

Which types of investments are valued at amortized cost? Explain the rationale for this accounting.

Describe the two criteria for determining the valuation of financial assets.

Briefly describe some of the similarities and differences between GAAP and IFRS with respect to the accounting for investments.

Where can authoritative IFRS be found related to investments?

Your client, Cascade Company, is planning to invest some of its excess cash in 5-year revenue bonds issued by the county and in the stock of one of its suppliers, Teton Co. Teton’s shares trade on the over-the-counter market. Cascade plans to classify these investments as available-for-sale. They would like you to conduct some research on the accounting for these investments.

Instructions

If your school has a subscription to the FASB Codification, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.

(a) Since the Teton shares do not trade on one of the large stock markets, Cascade argues that the fair value of this investment is not readily available. According to the authoritative literature, when is the fair value of a security “readily determinable”?

(b) How is an impairment of a security accounted for?

(c) To avoid volatility in their financial statements due to fair value adjustments, Cascade debated whether the bond investment could be classified as held-to-maturity; Cascade is pretty sure it will hold the bonds for 5 years. How close to maturity could Cascade sell an investment and still classify it as heldto- maturity?

(d) What disclosures must be made for any sale or transfer from securities classified as held-to-maturity?

The financial statements of P&G are presented in Appendix 5B. The company’s complete annual report, including the notes to the financial statements, can be accessed at the book’s companion website, www.

wiley.com/college/kieso.

Instructions

Refer to P&G’s financial statements and the accompanying notes to answer the following questions.

(a) What investments does P&G report in 2011, and how are these investments accounted for in its financial statements?

(b) How are P&G’s investments valued? How does P&G determine fair value?

(c) How does P&G use derivative financial instruments?

Addison Manufacturing holds a large portfolio of debt and equity securities as an investment. The fair value of the portfolio is greater than its original cost, even though some securities have decreased in value. Sam Beresford, the financial vice president, and Angie Nielson, the controller, are near year-end in the process of classifying for the first time this securities portfolio in accordance with GAAP. Beresford wants to classify those securities that have increased in value during the period as trading securities in order to increase net income this year. He wants to classify all the securities that have decreased in value as available-for-sale (the equity securities) and as held-to-maturity (the debt securities).

Nielson disagrees. She wants to classify those securities that have decreased in value as trading securities and those that have increased in value as available-for-sale (equity) and held-to-maturity (debt). She contends that the company is having a good earnings year and that recognizing the losses will help to smooth the income this year. As a result, the company will have built-in gains for future periods when the company may not be as profitable.

Instructions

Answer the following questions.

(a) Will classifying the portfolio as each proposes actually have the effect on earnings that each says it will?

(b) Is there anything unethical in what each of them proposes? Who are the stakeholders affected by their proposals?

(c) Assume that Beresford and Nielson properly classify the entire portfolio into trading, availablefor- sale, and held-to-maturity categories. But then each proposes to sell just before year-end the securities with gains or with losses, as the case may be, to accomplish their effect on earnings. Is this unethical?

On July 1, 2014, Selig Company purchased for cash 40% of the outstanding capital stock of Spoor Corporation. Both Selig and Spoor have a December 31 year-end. Spoor Corporation, whose common stock is actively traded on the American Stock Exchange, paid a cash dividend on November 15, 2014, to Selig Company and its other stockholders. It also reported its total net income for the year of $920,000 to Selig Company.

Instructions

Prepare a one-page memorandum of instructions on how Selig Company should report the above facts in its December 31, 2014, balance sheet and its 2014 income statement. In your memo, identify and describe the method of valuation you recommend. Provide rationale where you can. Address your memo to the chief accountant at Selig Company.

On July 1, 2015, Fontaine Company purchased for cash 40% of the outstanding capital stock of Knoblett Company. Both Fontaine Company and Knoblett Company have a December 31 year-end. Knoblett Company, whose common stock is actively traded in the over-the-counter market, reported its total net income for the year to Fontaine Company and also paid cash dividends on November 15, 2015, to Fontaine Company and its other stockholders.

Instructions

How should Fontaine Company report the above facts in its December 31, 2015, balance sheet and its income statement for the year then ended? Discuss the rationale for your answer.

Presented below are three unrelated situations involving equity securities.

Situation 1: An equity security, whose fair value is currently less than cost, is classified as available-for-sale but is to be reclassified as trading.

Situation 2: A noncurrent portfolio with an aggregate fair value in excess of cost includes one particular security whose fair value has declined to less than one-half of the original cost. The decline in value is considered to be other than temporary.

Situation 3: The portfolio of trading securities has a cost in excess of fair value of $13,500. The availablefor- sale portfolio has a fair value in excess of cost of $28,600.

Instructions

What is the effect upon carrying value and earnings for each of the situations above?

Lexington Co. has the following available-for-sale securities outstanding on

December 31, 2014 (its first year of operations).

Cost Fair Value

Greenspan Corp. Stock $20,000 $19,000

Summerset Company Stock 9,500 8,800

Tinkers Company Stock 20,000 20,600

$49,500 $48,400

During 2015, Summerset Company stock was sold for $9,200, the difference between the $9,200 and the “fair value” of $8,800 being recorded as a “Gain on Sale of Investments.” The market price of the stock on December 31, 2015, was Greenspan Corp. stock $19,900; Tinkers Company stock $20,500.

Instructions

(a) What justification is there for valuing available-for-sale securities at fair value and reporting the unrealized gain or loss as part of stockholders’ equity?

(b) How should Lexington Company apply this rule on December 31, 2014? Explain.

(c) Did Lexington Company properly account for the sale of the Summerset Company stock? Explain.

(d) Are there any additional entries necessary for Lexington Company at December 31, 2015, to reflect the facts on the financial statements in accordance with generally accepted accounting principles?

Explain.

You have just started work for Warren Co. as part of the controller’s group involved in current financial reporting problems. Jane Henshaw, controller for Warren, is interested in your accounting background because the company has experienced a series of financial reporting surprises over the last few years. Recently, the controller has learned from the company’s auditors that there is authoritative literature that may apply to its investment in securities. She assumes that you are familiar with this pronouncement and asks how the following situations should be reported in the financial statements.

Situation 1: Trading securities in the current assets section have a fair value that is $4,200 lower than cost.

Situation 2: A trading security whose fair value is currently less than cost is transferred to the availablefor- sale category.

Situation 3: An available-for-sale security whose fair value is currently less than cost is classified as noncurrent but is to be reclassified as current.

Situation 4: A company’s portfolio of available-for-sale securities consists of the common stock of one company. At the end of the prior year, the fair value of the security was 50% of original cost, and this reduction in fair value was reported as an other than temporary impairment. However, at the end of the current year, the fair value of the security had appreciated to twice the original cost.

Situation 5: The company has purchased some convertible debentures that it plans to hold for less than a year. The fair value of the convertible debentures is $7,700 below its cost.

Instructions

What is the effect upon carrying value and earnings for each of the situations above? Assume that these situations are unrelated.

On November 3, 2014, Sprinkle Co. invested $200,000 in 4,000 shares of the common stock of Pratt Co. Sprinkle classified this investment as available-for-sale. Sprinkle Co. is considering making a more significant investment in Pratt Co. at some point in the future but has decided to wait and see how the stock does over the next several quarters.

Date Market Price of Pratt Shares Time Value of Put Option

December 31, 2014 $50 per share $375

March 31, 2015 45 per share 175

June 30, 2015 43 per share 40

Instructions

(a) Prepare the journal entries for Sprinkle Co. for the following dates.

(1) November 3, 2014—Investment in Pratt stock and the put option on Pratt shares.

(2) December 31, 2014—Sprinkle Co. prepares financial statements.

(3) March 31, 2015—Sprinkle prepares financial statements.

(4) June 30, 2015—Sprinkle prepares financial statements.

(5) July 1, 2015—Sprinkle settles the put option and sells the Pratt shares for $43 per share.

(b) Indicate the amount(s) reported on the balance sheet and income statement related to the Pratt investment and the put option on December 31, 2014.

(c) Indicate the amount(s) reported on the balance sheet and income statement related to the Pratt investment and the put option on June 30, 2015.

LEW Jewelry Co. uses gold in the manufacture of its products. LEW anticipates that it will need to purchase 500 ounces of gold in October 2014, for jewelry that will be shipped for the holiday shopping season. However, if the price of gold increases, LEW’s cost to produce its jewelry will increase, which would reduce its profit margins.

To hedge the risk of increased gold prices, on April 1, 2014, LEW enters into a gold futures contract and designates this futures contract as a cash flow hedge of the anticipated gold purchase. The notional amount of the contract is 500 ounces, and the terms of the contract give LEW the right and the obligation to purchase gold at a price of $300 per ounce. The price will be good until the contract expires on October 31, 2014. Assume the following data with respect to the price of the futures contract and the gold inventory purchase.

Date Spot Price for October Delivery

April 1, 2014 $300 per ounce

June 30, 2014 310 per ounce

September 30, 2014 315 per ounce

Instructions

Prepare the journal entries for the following transactions.

(a) April 1, 2014—Inception of the futures contract, no premium paid.

(b) June 30, 2014—LEW Co. prepares financial statements.

(c) September 30, 2014—LEW Co. prepares financial statements.

(d) October 10, 2014—LEW Co. purchases 500 ounces of gold at $315 per ounce and settles the futures contract.

(e) December 20, 2014—LEW sells jewelry containing gold purchased in October 2014 for $350,000. The cost of the finished goods inventory is $200,000.

(f) Indicate the amount(s) reported on the balance sheet and income statement related to the futures contract on June 30, 2014.

(g) Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions on December 31, 2014.

On December 31, 2014, Mercantile Corp. had a $10,000,000, 8% fixed-rate note outstanding, payable in 2 years. It decides to enter into a 2-year swap with Chicago First Bank to convert the fixed-rate debt to variable-rate debt. The terms of the swap indicate that Mercantile will receive interest at a fixed rate of 8.0% and will pay a variable rate equal to the 6-month LIBOR rate, based on the $10,000,000 amount. The LIBOR rate on December 31, 2014, is 7%. The LIBOR rate will be reset every

6 months and will be used to determine the variable rate to be paid for the following 6-month period.

Mercantile Corp. designates the swap as a fair value hedge. Assume that the hedging relationship meets all the conditions necessary for hedge accounting. The 6-month LIBOR rate and the swap and debt fair values are as follows.

Date 6-Month LIBOR Rate Swap Fair Value Debt Fair Value

December 31, 2014 7.0% — $10,000,000

June 30, 2015 7.5% (200,000) 9,800,000

December 31, 2015 6.0% 60,000 10,060,000

Instructions

(a) Present the journal entries to record the following transactions.

(1) The entry, if any, to record the swap on December 31, 2014.

(2) The entry to record the semiannual debt interest payment on June 30, 2015.

(3) The entry to record the settlement of the semiannual swap amount receivables at 8%, less amount payable at LIBOR, 7%.

(4) The entry to record the change in the fair value of the debt on June 30, 2015.

(5) The entry to record the change in the fair value of the swap at June 30, 2015.

(b) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2014.

(c) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on June 30, 2015.

(d) Indicate the amount(s) reported on the balance sheet and income statement related to the debt and swap on December 31, 2015.

Warren Co. purchased a put option on Echo common shares on January 7, 2014, for $360. The put option is for 400 shares, and the strike price is $85 (which equals the price of an Echo share on the purchase date). The option expires on July 31, 2014. The following data are available with respect to the put option.

Date Market Price of Echo Shares Time Value of Put Option

March 31, 2014 $80 per share $200

June 30, 2014 82 per share 90

July 6, 2014 77 per share 25

Instructions

Prepare the journal entries for Warren Co. for the following dates.

(a) January 7, 2014—Investment in put option on Echo shares.

(b) March 31, 2014—Warren prepares financial statements.

(c) June 30, 2014—Warren prepares financial statements.

(d) July 6, 2014—Warren settles the put option on the Echo shares.

Johnstone Co. purchased a put option on Ewing common shares on July 7, 2014, for $240. The put option is for 200 shares, and the strike price is $70. (The market price of a share of Ewing stock on that date is $70.) The option expires on January 31, 2015. The following  data are available with respect to the put option.

Date Market Price of Ewing Shares Time Value of Put Option

September 30, 2014 $77 per share $125

December 31, 2014 75 per share 50

January 31, 2015 78 per share 0

Instructions

Prepare the journal entries for Johnstone Co. for the following dates.

(a) July 7, 2014—Investment in put option on Ewing shares.

(b) September 30, 2014—Johnstone prepares financial statements.

(c) December 31, 2014—Johnstone prepares financial statements.

(d) January 31, 2015—Put option expires.

The treasurer of Miller Co. has read on the Internet that the stock price of Wade Inc. is about to take off. In order to profit from this potential development, Miller Co. purchased a call option on Wade common shares on July 7, 2014, for $240. The call option is for 200 shares (notional value), and the strike price is $70. (The market price of a share of Wade stock on that date is $70.)

The option expires on January 31, 2015. The following data are available with respect to the call option.

Date Market Price of Wade Shares Time Value of Call Option

September 30, 2014 $77 per share $180

December 31, 2014 75 per share 65

January 4, 2015 76 per share 30

Instructions

Prepare the journal entries for Miller Co. for the following dates.

(a) July 7, 2014—Investment in call option on Wade shares.

(b) September 30, 2014—Miller prepares financial statements.

(c) December 31, 2014—Miller prepares financial statements.

(d) January 4, 2015—Miller settles the call option on the Wade shares.

Fernandez Corp. invested its excess cash in available-for-sale securities during 2014. As of December 31, 2014, the portfolio of available-for-sale securities consisted of the following common stocks.

Security Quantity Cost Fair Value Lindsay Jones, Inc. 1,000 shares $ 15,000 $ 21,000

Poley Corp. 2,000 shares 40,000 42,000

Arnold Aircraft 2,000 shares 72,000 60,000

Totals $127,000 $123,000

Instructions

(a) What should be reported on Fernandez’s December 31, 2014, balance sheet relative to these securities?

What should be reported on Fernandez’s 2014 income statement?

On December 31, 2015, Fernandez’s portfolio of available-for-sale securities consisted of the following common stocks.

Security Quantity Cost Fair Value

Lindsay Jones, Inc. 1,000 shares $ 15,000 $20,000

Lindsay Jones, Inc. 2,000 shares 33,000 40,000

Duff Company 1,000 shares 16,000 12,000

Arnold Aircraft 2,000 shares 72,000 22,000

Totals $136,000 $94,000

During the year 2015, Fernandez Corp. sold 2,000 shares of Poley Corp. for $38,200 and purchased 2,000 more shares of Lindsay Jones, Inc. and 1,000 shares of Duff Company.

(b) What should be reported on Fernandez’s December 31, 2015, balance sheet? What should be reported on Fernandez’s 2015 income statement?

On December 31, 2016, Fernandez’s portfolio of available-for-sale securities consisted of the following common stocks.

Security Quantity Cost Fair Value

Arnold Aircraft 2,000 shares $72,000 $82,000

Duff Company 500 shares 8,000 6,000

Totals $80,000 $88,000

During the year 2016, Fernandez Corp. sold 3,000 shares of Lindsay Jones, Inc. for $39,900 and 500 shares of Duff Company at a loss of $2,700.

(c) What should be reported on the face of Fernandez’s December 31, 2016, balance sheet? What should be reported on Fernandez’s 2016 income statement?

(d) What would be reported in a statement of comprehensive income at (1) December 31, 2014, and

(2) December 31, 2015?

Castleman Holdings, Inc. had the following availablefor- sale investment portfolio at January 1, 2014.

Evers Company 1,000 shares @ $15 each $15,000

Rogers Company 900 shares @ $20 each 18,000

Chance Company 500 shares @ $9 each 4,500

Equity investments (available-for-sale) @ cost 37,500

Fair value adjustment (available-for-sale) (7,500)

Equity investments (available-for-sale) @ fair value $30,000

During 2014, the following transactions took place.

1. On March 1, Rogers Company paid a $2 per share dividend.

2. On April 30, Castleman Holdings, Inc. sold 300 shares of Chance Company for $11 per share.

3. On May 15, Castleman Holdings, Inc. purchased 100 more shares of Evers Co. stock at $16 per share.

4. At December 31, 2014, the stocks had the following price per share values: Evers $17, Rogers $19, and Chance $8.

During 2015, the following transactions took place.

5. On February 1, Castleman Holdings, Inc. sold the remaining Chance shares for $8 per share.

6. On March 1, Rogers Company paid a $2 per share dividend.

7. On December 21, Evers Company declared a cash dividend of $3 per share to be paid in the next month.

8. At December 31, 2015, the stocks had the following price per share values: Evers $19 and Rogers $21.

Instructions

(a) Prepare journal entries for each of the above transactions.

(b) Prepare a partial balance sheet showing the investment-related amounts to be reported at December 31, 2014 and 2015.

On January 1, 2014, Acker Inc. had the following balance sheet.

ACKER INC.

BALANCE SHEET

AS OF JANUARY 1, 2014

Assets Equity

Cash $ 50,000 Common stock $260,000

Equity investments (available-for-sale) 240,000 Accumulated other comprehensive income 30,000

Total $290,000 Total $290,000 The accumulated other comprehensive income related to unrealized holding gains on available-for-sale securities. The fair value of Acker Inc.’s available-for-sale securities at December 31, 2014, was $190,000; its cost was $140,000. No securities were purchased during the year. Acker Inc.’s income statement for 2014 was as follows. (Ignore income taxes.)

ACKER INC.

INCOME STATEMENT

FOR THE YEAR ENDED DECEMBER 31, 2014

Dividend revenue $ 5,000

Gain on sale of investments 30,000

Net income $35,000

Instructions

(Assume all transactions during the year were for cash.)

(a) Prepare the journal entry to record the sale of the available-for-sale securities in 2014.

(b) Prepare a statement of comprehensive income for 2014.

(c) Prepare a balance sheet as of December 31, 2014.

Kennedy Company has the following portfolio of available-for-sale securities at December 31, 2014.

Percent Per Share Security Quantity Interest Cost Price

Frank, Inc. 2,000 shares 8% $11 $16

Ellis Corp. 5,000 shares 14% 23 19

Mendota Company 4,000 shares 2% 31 24

Instructions

(a) What should be reported on Kennedy’s December 31, 2014, balance sheet relative to these long-term available-for-sale securities?

On December 31, 2015, Kennedy’s portfolio of available-for-sale securities consisted of the following common stocks. Percent Per Share

Security Quantity Interest Cost Price

Ellis Corp. 5,000 shares 14% $23 $28

Mendota Company 4,000 shares 2% 31 23

Mendota Company 2,000 shares 1% 25 23

At the end of 2015, Kennedy Company changed its intent relative to its investment in Frank, Inc. and reclassified the shares to trading securities status when the shares were selling for $8 per share.

(b) What should be reported on the face of Kennedy’s December 31, 2015, balance sheet relative to available-for-sale securities investments? What should be reported to reflect the transactions above in Kennedy’s 2015 income statement?