Reading 22- LOS d ～ Q1－6

1.Passive investments in the equity securities of other companies, if there is no liquid public market for the securities, should be accounted for using the:

A)   cost method.

B)   equity method.

C)   consolidation.

D)   market method.

The correct answer was A)

When a company makes a passive ownership investment in another firm whose securities are not publicly traded, the investment should be accounted for using the cost method. That is, the securities are held on the books of the acquirer at the original fair market value cost.

2.Which of the following is NOT a basic premise of the cost method of accounting for intercorporate investments?

A)   Dividends are recognized as income in the period they are declared.

B)   A realized gain or loss is reported on the income statement at the time of sale.

C)   The cost method is utilized for passive investments in companies that are not publicly traded.

D)   Impairments are not recognized until they exceed 10 percent of the original cost of the investment.

The correct answer was D)

Impairment occurs when fair value is less than book value and the decline in market value is “other than temporary.” Impairments are recognized immediately and reported as a loss on the income statement.

3.Which of the following transactions would necessitate the use of the cost method of accounting for an investment?

A)   A controlling interest in a company that represents greater than 50 percent of ownership.

B)   Shared control of a company in which each party owns a 50 percent stake.

C)   A passive investment in a company that represents less than 20 percent of ownership.

D)   A minority ownership investment that permits significant influence of the company.

The correct answer was C)

The cost method is utilized for passive investments in other companies that are not traded in a liquid secondary market.

4.When utilizing the cost method when accounting for intercorporate investments, the investment is recorded at the:

A)   fair market value on the date of purchase.

B)   higher of the original cost or the market value at the end of the reporting period.

C)   lower of the original cost or the market value at the end of the reporting period.

D)   historical cost adjusted for any unrealized gains or losses.

The correct answer was A)

The cost method dictates that the investment is recorded at the original cost, which is the fair market value on the date it was purchased.

5.Under the cost method, the investment’s book value will be held at cost:

A)   unless the value is irreparably impaired, in which case the value is reduced and the amount is recognized as a loss on the balance sheet.

B)   unless the value is irreparably impaired, in which case the value is reduced and the amount is recognized as a loss on the income statement.

C)   unless the value is temporarily impaired, in which case the value is reduced and the amount is recognized in a balance sheet account for unrealized losses.

D)   in all cases until the security is sold.

The correct answer was B)

Under the cost method, the investment’s book value will be held at cost unless the value is irreparably impaired (meaning that the loss of value is not believed to be a temporary occurrence). Under this circumstance, value is reduced to its estimated current fair market value, and the amount of the loss is recognized on the income statement.

6.Which of the following statements is most accurate concerning income recognition from passive investments in the equity securities of other companies, if there is no liquid public market for the securities?

A)   Unrealized gains and losses are recognized annually in comprehensive shareholders’ equity.

B)   Dividends are recognized as income during the period in which they are declared.

C)   Impairments in the value of an investment are amortized over 10 years under U.S. GAAP and IAS rules.

D)   The book value of the holding is adjusted to reflect the lower of cost or market annually.

The correct answer was B)

Dividends are recognized as income during the period in which they are declared for passive investments in the equity securities of other companies, if there is no liquid public market for the securities.