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Reading 21- LOS B ~ Q26-27

26.If Zeisler were to account for the Market Square Corporation shares using the equity method, assuming that the securities do not change in value between the December 15th meeting and the end of the year, the carrying amount of these shares on Zeisler's December 31, 2004 balance sheet would be:

A)  $2.75 million.

B)  $2.60 million.

C)  $2.50 million.

D)  $3.50 million.

 

27.Regarding the statements made by Dupree and Welch about reclassifying Zeisler’s debt investment in

Market Square
to trading:

A)  Welch’s statement is incorrect; Dupree’s statement is incorrect.

B)  Welch’s statement is correct; Dupree’s statement is incorrect.

C)  Welch’s statement is correct; Dupree’s statement is correct.

D)  Welch’s statement is incorrect; Dupree’s statement is correct.

答案和详解如下:

26.If Zeisler were to account for the Market Square Corporation shares using the equity method, assuming that the securities do not change in value between the December 15th meeting and the end of the year, the carrying amount of these shares on Zeisler's December 31, 2004 balance sheet would be:

A)  $2.75 million.

B)  $2.60 million.

C)  $2.50 million.

D)  $3.50 million.


The correct answer was
B)

Under the equity method the market value of the stock is ignored but the proportionate share of the earnings are added to the original investment and the proportionate share of the dividends are subtracted from the earnings. Hence, we have the original investment + (earnings - dividends) = total value of the investment.

[(100,000 shares)($25)] + [(100,000 shares)($2.50 earnings - 1.50 dividend)] = $2,600,000.

 

27.Regarding the statements made by Dupree and Welch about reclassifying Zeisler’s debt investment in

Market Square
to trading:

A)  Welch’s statement is incorrect; Dupree’s statement is incorrect.

B)  Welch’s statement is correct; Dupree’s statement is incorrect.

C)  Welch’s statement is correct; Dupree’s statement is correct.

D)  Welch’s statement is incorrect; Dupree’s statement is correct.


The correct answer was
A)

Welch’s statement is incorrect because SFAS 115 requires a firm that sells a held-to-maturity security before maturity to carry its remaining held-to-maturity securities at market value instead of cost. Since the

Market Square
debt is the only fixed-income investment trading above Zeisler’s cost, and it represents only a small part of Zeisler’s total fixed-income portfolio, the net effect of selling the
Market Square
debt would be to reduce assets – not raise them – because it would require Zeisler to mark down all its other fixed-income investments. A decline in assets would effectively increase the debt to assets ratio.

Dupree’s statement is also incorrect. The investment in General Nuclear would be carried on the books at fair market value, with the unrealized loss in equity. Selling the asset and converting it to cash would not materially affect total assets. However, selling the General Nuclear shares would reduce net income because the realized loss would have to be recognized in income. Thus, the sale would reduce reported ROA.

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