Question & Answer

Why might a company become involved in an interest rate swap contract to receive fixed interest payments and pay variable?

In what situation will the unrealized holding gain or loss on an available-for-sale security be reported in income?

What is the purpose of a fair value hedge?

What are the main distinctions between a traditional financial instrument and a derivative financial instrument?

What is meant by the term “underlying” as it relates to derivative financial instruments?

Franklin Corp. has an investment that it has held for several years. When it purchased the investment, Franklin classified and accounted for it as available-for-sale. Can Franklin use the fair value option for this investment? Explain.

What is the fair value option?

What is the GAAP definition of fair value?

When is a debt security considered impaired? Explain how to account for the impairment of an available-for-sale debt security.

Briefly discuss how a transfer of securities from the available- for-sale category to the trading category affects stockholders’ equity and income.

Explain why reclassification adjustments are necessary.

Where on the asset side of the balance sheet are trading securities, available-for-sale securities, and held-to-maturity securities reported? Explain.

Raleigh Corp. has an investment with a carrying value (equity method) on its books of $170,000 representing a 30% interest in Borg Company, which suffered a $620,000 loss this year. How should Raleigh Corp. handle its proportionate share of Borg’s loss?

Hiram Co. uses the equity method to account for investments in common stock. What accounting should be made for dividends received from these investments subsequent to the date of investment?

Your classmate Kate believes that the equity method is applied with a strict application of the “20%” rule. Do you agree? Explain.

Explain how the investment account is affected by investee activities under the equity method.

What constitutes “significant influence” when an investor’s financial interest is below the 50% level?

Distinguish between the accounting treatment for availablefor- sale equity securities and trading equity securities.

Hayes Company sold 10,000 shares of Kenyon Co. common stock for $27.50 per share, incurring $1,770 in brokerage commissions. These securities were classified as trading and originally cost $260,000. Prepare the entry to record the sale of these securities.

Why are held-to-maturity investments applicable only to debt securities?

Identify and explain the different types of classifications for investments in equity securities.

(a) Assuming no Fair Value Adjustment (available-forsale) account balance at the beginning of the year, prepare the adjusting entry at the end of the year if Laura Company’s available-for-sale securities have a fair value $60,000 below cost. (b) Assume the same information as part (a), except that Laura Company has a debit balance in its Fair Value Adjustment account of $10,000 at the beginning of the year. Prepare the adjusting entry at year-end.

Indicate how unrealized holding gains and losses should be reported for investments securities classified as trading, available-for-sale, and held-to-maturity.

If the bonds in Question 8 are classified as available-forsale and they have a fair value at December 31, 2014, of $3,604,000, prepare the journal entry (if any) at December 31, 2014, to record this transaction.

On July 1, 2014, Wheeler Company purchased $4,000,000 of Duggen Company’s 8% bonds, due on July 1, 2021. The bonds, which pay interest semiannually on January 1 and July 1, were purchased for $3,500,000 to yield 10%. Determine the amount of interest revenue Wheeler should report on its income statement for the year ended December 31, 2014.