Investments | Appendix C – Test Bank 10e

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Student name:__________

FILL IN THE BLANK. Write the word or phrase that best completes each statement or answers the question.
1) ___________________________ are investments in securities that management intends to convert to cash within one year or the operating cycle, whichever is longer, and are readily convertible to cash.

2) __________________________ are investments in securities that are not readily convertible to cash or are not intended to be converted to cash in the short-term.

3) _________________________ securities reflect a creditor relationship while ____________________ securities reflect an owner relationship.

4) An investing company that owns more than ________ of another (investee) company's voting stock is presumed to have controlling influence over the investee.

5) Short-term investments in held-to-maturity debt securities are accounted for using the ______________________.

6) Long-term investments in held-to-maturity debt securities are accounted for using the ___________________________.

7) Investments in equity securities where the investor has a significant, but not controlling influence, are accounted for using the _______________ method.

8) Investments in equity securities where the investor has a controlling influence are accounted for using the ________________________________.

9) ________________________ refers to all changes in equity for a period except those from owners’ investments and dividends.

10) The _________ method is used to account for long-term investments in equity securities with significant influence.

11) Return on total assets is computed by dividing ___________ by __________.

12) ____________________________ are debt investments that a company actively buys and sells for profit.

13) Investments in trading securities are always reported as _______________ on the balance sheet.

14) _________________ are debt securities a company intends and is able to hold until the maturity date.

15) Long-term investments in available-for-sale securities are reported at their _______ on the balance sheet.

16) An investing company that owns _________ or more of another (investee) company's voting stock (but not more than 50%) is presumed to have a significant influence over the investee.

17) Debt investments that are not classified as trading or held-to-maturity securities are called _____________ securities.

18) A company that is a controlling investor in another company is known as the __________.

19) When one company owns more than 50% of another company’s voting stock and has control over the investee company, the investee is called the _______________________.

20) ______________________ financial statements show the financial statements of all entities under the parent’s control, including all subsidiaries.

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
21) Explain the difference between short-term and long-term investments. Cite examples of each.

22) Discuss the reasons companies make investments.

23) Identify the classifications for debt investments in securities. What are the accounting basics for debt investments, including acquisition, interest earned, and disposition?

24) What are the accounting basics for equity securities, including classification and accounting method?

25) What is comprehensive income and how is it usually reported in the financial statements?

26) Explain how investors report investments in equity securities when the investor has a controlling influence over an investee.

27) Define short-term investment and explain how they are reported on the balance sheet.

28) Define the return on total assets and explain how it is used to measure a company's financial performance.

29) Explain how to record the sale of trading securities.

30) Explain how to account for held-to-maturity debt securities at and after acquisition and how they are reported in the financial statements.

31) Explain how to account for available-for-sale debt securities at and after acquisition and how they are reported in financial statements.

32) Explain how equity securities having significant influence are accounted for and reported in the financial statements. Include a discussion of the criterion for these securities in terms of an investee's voting stock.

33) Define long-term investment and explain how they are reported on the balance sheet.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.
34) On January 1 of the current year, a company paid $150,000 cash to purchase 7%, 10-year bonds, with a par value of $150,000; interest is paid semiannually on June 30 and December 31. The company intends to hold these bonds until they mature. Prepare the journal entries to record the bond purchase and receipt of the semiannual interest payments on June 30 and December 31 of the current year.

35) On May 1 of the current year, a company paid $200,000 cash to purchase 6%, 10-year bonds, with a par value of $200,000; interest is paid semiannually each May 1 and November 1. The company intends to hold these bonds until they mature. Prepare the journal entry to record the bond purchase.

36) On May 1 of the current year, a company paid $200,000 cash to purchase 6%, 10-year bonds, with a par value of $200,000; interest is paid semiannually each May 1 and November 1. The company intends to hold these bonds until they mature. Prepare the journal entry to record the receipt of the first semiannual interest payment on November 1.

37) On January 1 of the current year, a company paid $200,000 cash to purchase 6%, 10-year bonds, with a par value of $200,000; interest is paid semiannually each June 30 and December 31. The company intends to hold these bonds until they mature. Prepare the journal entry for the interest received on December 31 of the current year.

38) A company paid $600,000 for 1-year, 10% bonds with a par value of $600,000 on July 1. The bonds pay 5% interest semiannually on December 31 and June 30. The company intends to hold the bonds until they mature. Prepare the journal entries for the following dates and transactions related to this bond acquisition.

(1) Bonds purchased on July 1.
(2) Receipt of semiannual interest only on December 31.
(3) Receipt of semiannual interest only on June 30.
(4) Redemption of the bonds at maturity on June 30.

39) On July 1 of the current year, a company paid $200,000 to purchase 7%, 10-year bonds with a par value of $200,000; interest is paid semiannually on June 30 and December 31. The company intends to hold the bonds until they mature. Prepare the journal entries to record (1) the bond purchase, (2) the receipt of the first semiannual interest payment on December 31 of the current year, and (3) the receipt of the second semiannual payment on June 30 of the next year.

40) A company reported net sales of $850,500, net income of $200,100 and average total assets of $575,000. Calculate its return on total assets.

41) A company had net income of $350,000 in Year 1 and $519,000 in Year 2. The company had average total assets of $2,500,000 in Year 1 and $3,000,000 in Year 2. Calculate the return on total assets for Year 1 and Year 2. Did the company’s performance improve? Explain.

42) A company had net income of $45,000, net sales of $390,000, and average total assets of $450,000 for the current year. Calculate the company's profit margin, total asset turnover, and return on total assets.

43) A company reported net income of $225,000, net sales of $2,500,000, and average total assets of $2,100,000 for the current year. Calculate this company's profit margin, total asset turnover, and return on total assets.

44) A company reported net income for Year 1 of $98,000 and $106,000 for Year 2. It also reported net sales of $835,000 in Year 1 and $918,000 in Year 2. The company's average total assets in Year 1 were $1,850,000 and $1,720,000 in Year 2. Calculate the company's profit margin, total asset turnover and return on total assets for Year 1 and Year 2. Did the company’s return on total assets improve? What component(s) might explain this change?

45) A company had net income of $86,000 in Year 1 and $118,000 in Year 2. Its net sales were $640,000 in Year 1 and $611,000 in Year 2. Its average total assets in Year 1 were $1,670,000 and $1,712,000 in Year 2. Calculate the profit margin, total asset turnover and return on total assets for both years. Comment on the results.

46) Hubbard Company had the following trading securities in its portfolio at December 31. The Fair Value Adjustment—Trading account had a balance of zero prior to any year-end adjustment. Prepare the appropriate adjusting journal entry for this portfolio.

47) Element Company had the following long-term available-for-sale securities in its portfolio at December 31 for each of the years listed. The year-end cost and fair values for its portfolio follow. Beginning with Year 1, prepare the appropriate journal entry to record each year-end market adjustment for these securities.

48) Scotsland Company had the following transactions relating to stock investments with insignificant influence during the year. Prepare the required journal entries for these transactions.

49) Mire Corporation had the following transactions involving stock investments with insignificant influence during the year. Prior to these transactions, Mire had never had any investments. Prepare the required journal entries to record these transactions.

50) On October 31, Augustas Company received cash dividends of $0.15 per share from its investment in Lamb Corporation's common stock. Augustas owned 1,200 shares of Lamb Corporation's stock on October 31 and the investment is considered a stock investment with insignificant influence. Prepare the investor's journal entry to record the receipt of the cash dividends.

51) Landers, Incorporated, held 1,500 of Shipman Company common stock with a cost of $36,900. The investment is considered a stock investment with insignificant influence. Landers sold the shares on December 13 for $42,100 cash. Prepare Lander’s journal entry to record this sale.

52) Washington Corporation held 1,500 of Vashon Company common stock with a cost of $74,387. The investment is considered a stock investment with insignificant influence. Washington sold the shares on December 13 for $55,275 cash. Prepare Washington’s journal entry to record this sale.

53) In the current year, Logic Company purchased stock of Waterford Company with a cost of $125,000 and a year-end fair value of $123,700. Logic also purchased 1,500 shares of Jasper Company common stock with a cost of $25,000 and a year-end fair value of $26,100. These investments are considered stock investments with insignificant influence. Prepare the journal entry to record any necessary fair value adjustment to the stock investments as of its December 31 year-end.

54) In the current year, Largo Company purchased bonds of MacDermott Corporation with a cost of $125,000 and a year-end fair value of $127,000. These are classified as long-term available-for-sale debt securities. Prepare the journal entry to record any necessary fair value adjustment to the debt investments as of December 31.

55) Barzetti had no investments prior to the current year. It had the following transactions during the year involving stock investments with insignificant influence and also held-to-maturity debt securities. Prepare Barzetti’s journal entries to record the transactions and events associated with these investment purchases.

56) Weston Company had the following stock investments with insignificant influence in its portfolio at December 31, Year 1. Weston had several investment transactions during year 2.

(1) Determine the amount Weston should report on its December 31, Year 1 balance sheet for its stock investments.
(2) Determine the amount Weston should report on its December 31, Year 2 balance sheet for its stock investments.

57) On January 2, Froxel Company purchased 10,000 shares of Sandia Corporation common stock at $19 per share. This represents 30% of Sandia Corporation's outstanding stock. On August 6, Sandia Corporation declared and paid cash dividends of $1.75 per share, and on December 31 it reported net income of $150,000. Prepare the necessary entries for Froxel to account for these transactions and events.

58) Cosmos Corporation had the following long-term investment transactions.

Prepare the journal entries Cosmos Corporation should record for these transactions and events.

59) On January 3, Kostansas Corporation purchased 5,000 shares of Morton, Incorporated for $40 per share. These shares represent a 40% ownership in Morton, Incorporated Prepare the journal entry Kostansas Corporation should record for the purchase of this investment.

60) On January 3, Kostansas Corporation purchased 5,000 shares of Morton, Incorporated for $40 per share. These shares represent a 40% ownership in Morton, Incorporated Prepare the journal entry Kostansas Corporation should record for the receipt of cash dividends of $2 per share from Morton on July 10.

61) On January 3, Kostansas Corporation purchased 5,000 shares of Morton, Incorporated for $40 per share. These shares represent a 40% ownership in Morton, Incorporated Prepare the journal entry Kostansas Corporation should record when Morton reports net income of $52,000 for the year on December 31.

62) Draft Company purchased 14,000 shares of Hamburg Corporation's 40,000 shares of common stock on January 1. This represented 35% of Hamburg’s outstanding shares and gave Draft Company significant influence over Hamburg’s management and operations. On October 11, Hamburg declared and paid cash dividends of $30,000. On December 31, Hamburg reported net income of $125,000 for the year. Prepare the journal entries Draft Company should record to account for the dividends received and the earnings reported by Hamburg Corporation.

63) On January 1, Year 1, Rickson Corporation purchased 7,500 shares of AutoTech as an equity method investment for a total of $235,000. The 7,500 shares represent 30% of the outstanding (25,000) shares of AutoTech. Prepare the journal entries for Rickson to record the following transactions and events:

64) MVP Incorporated purchases debt investments as trading securities at a cost of $185,000 on October 27. This is the first and only purchase of such securities. At December 31, these securities had a fair value of $181,000. Prepare the journal entry to record the purchase of the debt investments.

65) Ilyasova Incorporated purchases debt investments as trading securities at a cost of $200,000 on June 15. This is the first and only purchase of such securities. At December 31, these securities had a fair value of $204,000. Prepare the December 31 year-end fair value adjusting entry for the trading securities’ portfolio:

66) Buck’s Corporation purchases debt investments as trading securities at a cost of $150,000 on December 1. This is its first and only purchase of such securities. On January 5, Buck’s Corporation decides to sell a portion of its trading securities (costing $18,000) for $20,000 cash. Prepare the journal entry to record the January 5 sale:

67) Prepare journal entries to record the following transactions and events of Kodax Company.

Answer Key

Test name: Appendix C Test Bank (Problem Material)

1) Short-term investments or marketable securities

2) Long-term investments

3) [Debt, equity]

4) 50%

5) cost method without amortization

6) cost method with amortization

7) equity

8) consolidation method

9) Comprehensive income

10) equity

11) [net income, average total assets]

12) Trading securities

13) current assets

14) Held-to-maturity (HTM) securities

15) fair value

16) 20%

17) available-for-sale

18) parent

19) subsidiary

20) Consolidated

21) Short-term investments are securities expected to be converted into cash within one year or the operating cycle, whichever is longer, and are readily convertible to cash. All other investments in securities are long-term investments. Short-term investments may include debt or equity securities. Long-term investments may include equity and debt securities and other assets not used in operations, and those held for a special purpose such as land.

22) Companies make investments for several reasons.<br><br>Three common reasons for investments are<br><br>1) to invest excess cash in order to earn more income;<br>2) to earn income from investments if the company is set up to manage mutual funds or pension funds;<br>3) for strategic reasons such as investments in competitors or suppliers.

23) Debt investments can be classified as: (1) trading, (2) held-to-maturity, or (3) available-for-sale. Debt securities are recorded at their cost when acquired. Any interest earned is credited to Interest Revenue and reported in the income statement. When the securities are sold, sale proceeds are compared with the cost, and any gain or loss is recorded. Trading securities are reported at fair value with a fair value adjustment to income. Available-for-sale securities are reported at fair value with a fair value adjustment to equity. There is no fair value adjustment for held-to-maturity securities.

24) At acquisition, equity securities are recorded at cost. Classification and the related accounting method is determined based on percentage of ownership. Ownership less than 20% is considered to be insignificant influence and is accounted for at fair value. Ownership between 20% and 50% is considered to be significant influence and is accounted for using the equity method. Ownership more than 50% is considered to be a controlling interest and is accounted for using the consolidation method.

25) Comprehensive income refers to all changes in equity for a period except those due to investments and distributions to owners. It includes all revenues, expenses, gains, and losses reported in the income statement as well as gains and losses that bypass net income but affect equity. Examples would be an unrealized gain or loss on long-term available-for-sale securities and foreign currency translation amounts. Comprehensive income can be reported on a separate statement immediately following the income statement, or on the lower section of the income statement.

26) If an investing company owns more than 50% of another company's voting stock, the investor's financial reports are prepared using the consolidation method. These consolidated financial statements show the financial position, results of operations and cash flows of all entities under the parent's control, including all subsidiaries. The statements are prepared as if the business were organized as one entity. The controlling (parent) company uses the equity method of accounting, but the investments in the investee (subsidiary) companies are not reported on the parent’s financial statements.

27) A short-term investment is an investment that (1) management intends to convert to cash within one year or the operating cycle, whichever is longer, and (2) is readily convertible to cash. They are reported as current assets on the balance sheet.

28) The return on total assets is calculated by dividing net income by average total assets. It can be computed by multiplying the profit margin ratio and total asset turnover. The return on total assets reflects a company's ability to use its assets to make a profit. It can also be used to assess a company's performance compared to competitors.

29) When trading securities are sold, the difference between the net proceeds (sale price less fees) and the cost of the individual trading securities that are sold is recognized as a gain or loss. Any prior period fair value adjustment is not used to compute the gain or loss from the sale. Gains and losses are included in net income for the period. When the period-end fair value adjustment for the portfolio of trading securities is computed, it excludes the cost and fair value of any securities sold.

30) Held-to-maturity (HTM) debt securities are recorded at cost when purchased. After acquisition, any interest is recorded as it is earned. A HTM debt security is classified as a current asset if the maturity date is within one year or the current operating cycle. An HTM debt security is classified as a long-term asset if the maturity date extends beyond the longer of one year or the current operating cycle. Short-term HTM debt securities are not amortized. Long-term HTM debt securities are reported at their amortized cost. There is no fair value adjustment made to the portfolio of the HTM securities, whether current or long-term.

31) Available-for-sale debt securities are recorded at cost when purchased. After acquisition they are reported on the balance sheet at their fair values with any unrealized holding gains or losses shown in the equity section of the balance sheet. Gains and losses realized on the subsequent sale of these investments are reported in the income statement.

32) The equity method of accounting for securities is used when an investor has a significant influence over an investee. Significant influence is presumed to exist when an investing company owns 20% or more of the investee's voting stock, but not more than 50% ownership. The initial investment is recorded at cost. The equity method requires that an investor record its share of the investee's earnings with a debit to the investment account and a credit to earnings from long-term investment. Cash dividends received increase the cash account and reduce the balance of the investment account by the same amount.

33) Long-term investments are investments that are not readily convertible to cash or are not intended to be converted to cash in the short term. Long-term investments are reported as noncurrent assets on the balance sheet.

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