土豆妮

Cosmo Inc. (Cosmo) invests in two portfolios – Portfolio 1 and Portfolio 2. Portfolio 1 contains securities with an overall intent to profit within a month or two. Portfolio 2 contains equity securities with a moderate amount of acquisition and disposition activity. Which of the following treatments of Cosmo’s reporting of the investments in Portfolios 1 and 2, respectively, is most accurate?

Portfolio 1

Portfolio 2

A) Unrealized amounts reported on balance sheet. Assets reported at fair value.

B) Unrealized amounts reported on income statement. Assets reported at cost.

C) Unrealized amounts reported on income statement. Assets reported at fair value.

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Portfolio 1 contains held-for-trading securities because it is clear that the securities are acquired with the intent to profit over the near term. Therefore, the unrealized gains and losses would be reported immediately in the income statement.

Portfolio 2 contains available-for-sale securities. There are no debt securities and therefore, it cannot contain held-to-maturity securities. As well, there is no indication that the securities are acquired with the intent to profit over the near term. By default, the correct classification would be available-for-sale. Therefore, the securities (assets) would be reported at fair value.

土豆妮

Omricon Capital Associates specializes in making investments in the small cap market sector. In some cases the firm operates as a supplier of private equity for restructurings. In this instance, the firm views itself as having a value investment focus. In others, it acts as a venture capital firm. Here, the investment focus is usually growth. Finally, in some cases it simply takes passive investment positions in publicly-traded firms. The positions in marketable securities are sometimes considered trading positions, and other times the view is to hold for a longer period until valuation parameters are met or exceeded.

Omricon’s chief compliance officer, Raymond “Buzz” Richards has recently become concerned that the firm may not be correctly following the relevant accounting standards for these investments. To ensure that the rules are being effectively adhered to, he is seeking advice from the accounting firm of Merz-Brokaw and Associates on the matter. Sally Lee is the Merz-Brokaw partner heading up the consulting team assigned to review the situation.

The size of the investments ranges from a few percent of the firm’s outstanding equity, to positions of greater than 50%. Richards says that it has always been his understanding that the percentage of the equity held is the major determinant with respect to which accounting method applies. Lee reminds him that the firm’s intent for its investments also plays a role in determining how they are accounted for.

Some of the firm’s investments have not worked out as planned. Richards has conferred with the firm’s portfolio managers regarding securities being held by the firm that are worth less than when they were acquired, and has presented a list of these investments to Lee. His concern is what this implies for the accounting for these investments. Lee tells him that the issue here is whether or not the security can be considered impaired, and that designating a security as impaired implies that the decline in value is permanent.

Top managers at Omricon have asked Lee to help them evaluate the impact of the choice of accounting method on the firm’s profitability. Some members of the management team are of the belief that the accounting method does not affect financial measures because these are driven by underlying economic factors. Others believe that these measures can be affected by the accounting method chosen.

Which of the following statements concerning percentage ownership and accounting method is most accurate?

A) When the ownership is less than 20%, both US GAAP and IFRS require the investment in financial assets method.

B) When the ownership is less than 20%, US GAAP requires the investment in financial assets method, IFRS the equity method.

C) When the ownership is less than 20%, both US GAAP and IFRS require the equity method.

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When the percentage ownership is less than 20% (with no significant influence over the investee firm), both US GAAP and IFRS require the investment in financial assets method. (Study Session 6, LOS 23.a)

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For instances in which Omricon holds exactly 50% of the outstanding equity of the investee firm’s equity (i.e., the investee firm is a joint venture), which of the following statements is most accurate?

A) IFRS and US GAAP both permit a choice between the equity method and proportional consolidation.

B) IFRS requires that the equity method be used; US GAAP permits a choice between the equity method and proportional consolidation.

C) US GAAP requires that the equity method be used; IFRS permits a choice between the equity method and proportional consolidation.

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When the percentage ownership is exactly 50% (i.e., the investment is a joint venture), IFRS allows for the choice between the equity method and proportionate consolidation, while US GAAP requires the equity method. (Study Session 6, LOS 23.b)

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The three classifications for passive investments in securities that trade in secondary markets are:

A) marketable securities, available-for-sale securities, held-to-maturity securities.

B) trading securities, available-for-sale securities, held-to-maturity securities.

C) trading securities, marketable securities, held-to-maturity securities.

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The three classifications for passive investments in securities that trade in secondary markets (i.e., marketable securities) are trading securities, available-for-sale securities, and held-to-maturity securities. (Study Session 6, LOS 23.a)

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When a passive investment in marketable equity securities is classified as available-for-sale:

A) US GAAP requires that unrealized gains and losses are reported on the income statement, while under IFRS the firm can elect to report on either the income statement or in comprehensive income on the balance sheet.

B) IFRS requires that unrealized gains and losses are reported in comprehensive income on the balance sheet, while under US GAAP the firm can elect to report on either the income statement or in comprehensive income on the balance sheet.

C) US GAAP and IFRS require that unrealized gains and losses are reported as equity in other comprehensive income on the balance sheet.

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When a passive investment in marketable equity securities is classified as available-for-sale, US GAAP and IFRS require that unrealized gains and losses are reported as equity in other comprehensive income on the balance sheet. (Study Session 6, LOS 23.b)

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With respect to Lee’s statement concerning securities that are currently worth less than when they were acquired, a security should be considered impaired when the:

A) decline in value is permanent, its value should be written down to the new fair value, and a loss reported on the income statement.

B) decline in value is other than temporary, its value should be written down to the new fair value, and a loss reported in comprehensive income in equity on the balance sheet.

C) decline in value is other than temporary, its value should be written down to the new fair value, and a loss reported on the income statement.

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A security should be considered impaired when the decline in value is “other than temporary”. That is to say that it is obviously not due to a temporary decline in the market. No one knows for sure if any decline in value is permanent, but in most cases it is obvious that it is not simply a market phenomenon. When this is the case, the asset’s value should be written down to the new fair value, and a loss reported on the income statement. (Study Session 6, LOS 23.a)

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In most situations, when IFRS allows for a choice between the equity method and proportionate consolidation, the use of the equity method will result in:

A) ROA being higher and leverage being higher than under proportionate consolidation.

B) ROA being lower and leverage being higher than under proportionate consolidation.

C) ROA being higher and leverage being lower than under proportionate consolidation.

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In most cases, the choice of the equity method will result in leverage being lower, net profit margin being higher, and ROA being higher than would be the case under proportionate consolidation. (Study Session 6, LOS 23.c)

土豆妮

Company X owns 15% of company S and exerts significant influence over the operations of the company. The book value of the investment on December 31, 2001, is $48,000. In 2002, company S earned $100,000 and paid dividends of $20,000. The value of the investment account on December 31, 2002, is:

A) $60,000.

B) $63,000.

C) $48,000.

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Because company X exerts significant influence over company S, the investment will be treated using the equity method, even though the ownership is less than the 20% guideline. The value of the investment account is equal to the beginning balance plus the proportionate income of company S minus the dividends received from company S, which equals 48,000 + (0.15 x 100,000) ? (0.15 x 20,000) = 60,000.

土豆妮

Harter Company recently acquired a 40% stake in Compton Corp. for $40 million in cash by borrowing at 10%. Harter will account for this acquisition using which of the following methods:

A) Acquisition Method.

B) Equity method.

C) Held to maturity debt securities method.

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The 40% ownership stake would indicate significant control has been gained over the affiliate company. The equity method would be used.

土豆妮

Sawbuck Corporation recently acquired a 60% stake in Rawboard Inc. for $70 million in newly issued common stock. Given this information, which of the following methods should be used to account for the acquisition of Rawboard?

A) The purchase method.

B) Proportionate consolidation.

C) Acquisition.

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When the parent company has at least a 50% ownership stake and control over the subsidiary, the acquisition method is used.

土豆妮

Company X owns 15% of company S and exerts significant control over the operations of the company. The book value of the investment on December 31, 2008, is $48,000. In 2009, company S earned $100,000 and paid dividends of $20,000. The impact of the investment on the income statement of company X is:

A) $3,000.

B) $12,000.

C) $15,000.

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Because company X exerts significant control over company S, the investment will be treated using the equity method, even though the ownership is less than the 20% guideline. The impact on the income statement is the proportionate income of company S, which is 0.15 × 100,000 = 15,000.

土豆妮

Acme Corporation purchases a 3% interest in Bandy Company to become the single largest shareholder of Bandy. Acme will hold a seat on the Board of Directors of Bandy. Acme will account for its investment in Bandy using the:

A) equity method.

B) lower of cost or market method.

C) acquisition method.

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Even though Acme’s interest is low at only 3%, they have significant influence by having a seat on Bandy’s Board of Directors. As such, they must use the equity method.

土豆妮

GTH Corporation has just purchased 18% of the common stock of Pittor Corporation, one of their major suppliers, making GTH the largest single shareholder in Pittor. The primary motivation for the purchase is that managerial problems at Pittor have resulted in quality control difficulties, thereby affecting the reliability of several critical component parts for GTH products. At the time of the purchase, GTH management announced they plan to be an active and significant influence on Pittor so the quality problems can be resolved. Given these circumstances, the accounting method used to record the intercorporate investment will most likely be the:

A) acquisition method

B) investment in financial assets method.

C) equity method.

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Less than 20% ownership of the acquired corporations common stock would ordinarily mean the cost or market method of accounting would be used to record this investment in financial assets. However, percentage ownership rules are guidelines only and the appropriate accounting method is dependant on the degree of influence the acquirer intends to exert. In this case, GTH has announced their desire to exert significant influence, hence, the equity method is the appropriate choice.

土豆妮

Carter Schmitz, Inc. (Schmitz) purchased 200 shares of Intelismart at $21 a share in June 2006 and intends to actively trade 80 shares in the near future and hold the remaining 120 shares as available for sale securities. Intelismart's closing price was $26 on December 31, 2006, and Schmitz did not sell any of its shares.

What amount should Schmitz report on this investment under the income statement?

A) $1,000.

B) $600.

C) $400.

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The unrealized gain on the 120 shares available for sale is $600 (26 - 21 = 5 × 120 shares). There is also an unrealized gain of $400 (5 × 80) related to the 80 shares that are trading securities which would be reported on the income statement. For trading securities, realized and unrealized gains and losses are reported on the income statement. For available for sale securities, only realized gains and losses are reported on the income statement.

土豆妮

The Anderson Company acquired 100,000 shares of the Birschbach Company on January 1, 2000, at $25 per share. The market price of a share of Birschbach stock on December 31, 2000, was $35 per share. During 2000, Birschbach paid dividends of $1.50 per share and had earnings of $2.50 per share.

If the Anderson Company accounts for the Birschbach shares as trading securities, the carrying amount of these shares on Anderson's balance sheet at the end of 2000 is:

A) $2.6 million.

B) $2.5 million.

C) $3.5 million.

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Click for Answer and Explanation

Trading securities are measured at fair market value.

(100,000)($35) = $3,500,000

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If Anderson Company accounts for the Birschbach Company shares as securities available-for-sale, the carrying amount of these shares on Anderson's balance sheet at the end of 2000 is:

A) $2.6 million.

B) $2.5 million.

C) $3.5 million.

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Available-for-sale securities are measured at fair market value.

(100,000)($35) = $3,500,000