APPENDIX B

investments

Summary of Questions by Study Objectives
and Bloom’s Taxonomy

Note: K = Knowledge C = Comprehension AP = Application

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Note: TF = True-False MC = Multiple Choice Ma = Matching

summary of questions by LEVEL OF DIFFICULTY (LOD)

Note: E = Easy M = Medium H=Hard

CHAPTER STUDY OBJECTIVES

1. Identify reasons to invest, and classify investments. Companies purchase debt and equity securities of other companies for two main reasons: (1) for non-strategic reasons as a source of investment income, and (2) for strategic reasons, such as gaining control of a competitor, influencing strategic alliances, or moving into a new line of business.

Non-strategic investments are debt and equity securities that are purchased for purposes of earning interest or dividend revenue or for the purpose of selling them in the short-term at a gain. Investments purchased for selling in the short-term are referred to as trading investments and are reported at fair value. Debt investments reported at amortized cost may be short-term or long-term. Strategic investments are always investments in equity securities and are classified as long-term investments.

2. Account for debt investments that are reported at amortized cost. Companies reporting under IFRS report debt investments purchased for the purposes of earning interest income at amortized cost. Companies reporting under ASPE report all investments in debt instruments at amortized cost. Debt investments include money-market instruments, bonds, and similar items. Entries are required to record the (1) acquisition, (2) interest revenue, and (3) maturity or sale. Interest revenue is recognized as it accrues and any discount or premium is amortized using the effective-interest method.

3. Account for trading investments. Trading investments are reported at fair value. Under IFRS, these investments can be either debt or equity securities that are purchased for the purpose of selling in the short-term at a gain. Under ASPE, only investments in equity securities will be reported at fair value. An equity investment may be in either preferred or common shares of another corporation. Entries are required to record the (1) acquisition, (2) investment revenue, (3) fair value adjustments, and (4) sale. The gains and losses resulting from fair value adjustments are reported in profit.

TRUE-FALSE STATEMENTS

1. Companies purchase investments as a strategic investment with the intention of establishing and maintaining a long-term operating relationship with another company.

2. The purpose of a strategic investment is to generate investment income.

3. When investing excess cash for short periods of time, corporations usually invest in shares of other companies.

4. A short-term debt instrument which is held to earn interest will be valued at fair value on the balance sheet.

5. For companies reporting under IFRS, a short-term debt instrument which is held for trading will be valued at fair value on the balance sheet.

6. An equity investment which is held for trading will be valued at cost on the balance sheet.

7. If an investment is valued at an amount that is most relevant to the type of investment, it will allow investors to better predict future cash flows of the company.

8. The percentage of ownership or the degree of influence determines how a strategic investment is classified.

9. Investments in equity securities bought for the purposes of trading are reported at amortized cost.

10. Investments which are purchased principally for selling in the near future are called trading investments.

11. At acquisition, a debt instrument is recorded at its fair value on the date of purchase.

12. If a debt instrument is sold before maturity, then a gain is recorded if the cash received is less than the carrying amount of the instruments.

13. If a long-term bond investment is sold before maturity, an entry must be made to update any unrecorded interest and amortization of the discount or premium.

14. When a long-term bond investment is sold, a gain will be recorded when amortized cost of the bond is less than the cash received.

15. When a debt instrument is reported at amortized cost, the interest expense is calculated by multiplying the market rate of interest by the carrying value of the investment.

16. Interest revenue is reported under other revenues on the Income statement.

17. The purchaser of the bonds, or the bondholder, is known as the investor.

18. If there is a bond premium, interest revenue is increased by the amortization amount.

19. Under IFRS, trading investments are valued at amortized cost on the balance sheet.

20. A fair value adjustment at the balance sheet date is required only on investments which will be sold within 30 days of the balance sheet date.

21. Under IFRS, trading investments reported at fair value may include investments in common shares, preferred shares, and debt investments.

22. Under ASPE, only debt instruments will be reported at fair value.

23. The advantage of using fair value for trading investments is that it allows users to better predict future cash flows.

24. Dividend revenue is reported under revenues from operations on the Income statement.

25. Companies reporting under IFRS will report all investments in debt instruments at amortized cost.

26. If the market rate changes after a public company purchases bonds to trade, the bonds carrying amount will not change.

27. An investee must record a fair value adjustment on trading investments.

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

28. Which of the following would NOT normally be considered a motive for making an equity investment in another corporation?

a. to invest surplus cash

b. use of the investment for expanding its own operations

c. use of the investment to diversify its own operations

d. an increase in the amount of interest revenue from the equity investment

29. Which of the following is the most accurate?

a. Non-strategic investments maintain a long-term operating relationship with another company.

b. Non-strategic investments are purchased to generate investment income.

c. Preferred shares and common shares are debt instruments.

d. Strategic investments are always short-term instruments.

30. Which of the following is a true statement regarding an investment in short-term debt instruments?

a. The instruments usually do not pay interest.

b. They are often made when the company has surplus cash on hand.

c. This type of investment is never traded in the securities market.

d. A chequing account is a type of short-term debt investment.

31. Short-term and long-term debt instruments purchased to earn interest are reported at

a. cost.

b. unamortized cost.

c. fair value.

d. amortized cost.

32. For companies reporting under IFRS, debt instruments purchased to trade are reported on the balance sheet at

a. amortized cost.

b. cost.

c. fair value.

d. lower of cost and market.

33. All of the following are considered debt instruments EXCEPT

a. term deposits.

b. treasury bills.

c. bonds.

d. preferred shares.

34. Which of the following statements is INCORRECT with regards to non-strategic instruments?

a. They can be debt instruments.

b. They maintain an operating relationship with another company.

c. They can be equity instruments.

d. They generate investment income.

35. Excess cash may be invested for the long-term to

a. generate dividend income on bonds.

b. generate interest income on bonds.

c. generate interest income on shares.

d. generate additional operating income.

36. Debt & Equity securities that are purchased for the purpose of selling in the short-term at a gain are referred to as

a. debt instruments.

b. equity instruments.

c. long-term instruments.

d. trading investments.

37. Short-term debt instruments that are held to earn interest income are recorded as

a. current assets at amortized cost.

b. non-current assets at amortized cost.

c. current asset at fair value.

d. non-current assets at fair value.

38. Long-term debt instruments held to earn interest income are recorded as

a. current assets at amortized cost.

b. non-current assets at amortized cost.

c. current asset at fair value.

d. non-current assets at fair value.

39. Short- or long-term debt instruments held for trading are recorded as

a. current assets at amortized cost.

b. non-current assets at amortized cost.

c. current asset at fair value.

d. non-current assets at fair value.

40. Equity instruments held for trading are recorded as

a. current assets at amortized cost.

b. non-current assets at amortized cost.

c. current asset at fair value.

d. non-current assets at fair value.

41. Companies make strategic investments for several reasons. Which of the following reasons is INCORRECT?

a. to speculate that their investment will increase in value and result in a gain when it is sold

b. to become a part of a different industry

c. to expand operations

d. to eliminate competition

Use the following information for questions 42–44.

On January 1, 2014, Connors Landscaping Ltd. purchased at face value, a $1,000, 5%, bond that pays interest on January 1 and July 1. Connors has a calendar year end.

42. The entry for the receipt of interest on July 1, 2014, is

a. Cash 25

Interest Revenue 25

b. Cash 50

Interest Revenue 50

c. Interest Receivable 25

Interest Revenue 25

d. Interest Receivable 50

Interest Revenue 50

43. The adjusting entry on December 31, 2014, is

a. not required.

b. Cash 25

Interest Revenue 25

c. Interest Receivable 25

Interest Revenue 25

d. Interest Receivable 25

Long-term investment -Bonds 25

44. The entry for the receipt of interest on January 1, 2015, is

a. Cash 50

Interest Revenue 50

b. Cash 50

Interest Receivable 50

c. Cash 25

Interest Revenue 25

d. Cash 25

Interest Receivable 25

45. Any premium or discount on an investment in bonds to earn interest is amortized

a. to interest expense over the remaining term of the bonds.

b. only if the effective-interest method is used.

c. to interest revenue over the remaining term of the bonds.

d. only if the investor owns 20% or more of the bonds.

46. Instruments that will mature within 12 months of the balance sheet date are

a. long-term debt instruments.

b. fair value instruments.

c. short-term debt instruments.

d. unamortized instruments.

47. Interest income is calculated by multiplying

a. market rate of interest by the face value of the investment.

b. contract rate of interest by the face value of the investment.

c. market rate of interest by the carrying value of the investment.

d. stated interest rate by the carrying value of the investment.

48. Regardless of the bonds purchase price, their amortized cost at maturity will equal

a. face value.

b. face value less premium amounts.

c. purchase price.

d. face value plus discount amounts.

49. Losses and gains on the sale of instruments are reported on

a. the income statement under current operations.

b. the balance sheet with long-term investments.

c. the income statement under other revenue and expenses.

d. the balance sheet with short-term investments.

50. Which of the following is a true statement about the accounting for trading investments under IFRS?

a. The investment is initially recorded at fair value.

b. Gains and losses are recorded in OCI when the market value is different from the purchase price.

c. The accounting for trading investments is the same as the accounting for short-term investments in debt instruments purchased to earn interest.

d. The investment is initially recorded at face value.

51. Chan Corporation sells 100 common shares being held as a trading investment. The shares were acquired six months ago at a cost of $50 a share Chan sold the shares for $40 a share. The entry to record the sale is:

a. Cash 4,000

Loss on Sale of Trading Investment 1,000

Trading Investment 5,000

b. Cash 5,000

Gain on Sale of Trading Investment 1,000

Trading Investment 4,000

c. Cash 4,000

Trading Investment 4,000

d. Trading Investment 4,000

Loss on Sale of Trading Investment 800

Cash 4,800

52. Trading investments in equity instruments are reported on the balance sheet at

a. amortized cost.

b. cost.

c. fair value.

d. lower of cost and fair value.

53. Trading investments are adjusted to fair value when

a. there is a change in fair value.

b. the decline is thought to be permanent.

c. both a. and b.

d. Trading investments should never be recorded at fair value.

54. If a bond is sold at a price which is greater than the amortized cost of the bond

a. a loss is reported in balance sheet.

b. a gain is reported in balance sheet.

c. a gain is reported on the income statement.

d. a loss is reported on the income statement.

55. In recognizing a decline in the market value of a trading investment, Loss on Fair value adjustment account is debited

a. because management intends to realize this loss in the near future.

b. to reflect the fair value of the investment on the balance sheet.

c. because the company is no longer a going concern.

d. because there is a permanent decline in the fair value.

Use the following information for questions 56–57.

At the end of Fanning Corporation's fiscal year, its portfolio of trading investments purchased during the year is as follows:

Security Cost Market Value

A Common shares $10,000 $12,000

B Common shares 8,000 5,000

$18,000 $17,000

56. At the end of the year, Fanning Corporation normally would

a. make no entry.

b. increase trading investments to market value.

c. report an loss on the income statement for $3,000 under "Other Expenses".

d. report an loss on the income statement for $1,000 under "Other Expenses".

57. Fanning subsequently sells B common shares for $10,000. What entry is made to record the sale?

a. Cash 10,000

Trading investments—B Common Shares 10,000

b. Cash 8,000

Trading investments—B Common Shares 8,000

c. Cash 10,000

Trading investments—B Common Shares 8,000

Gain on Sale of Trading investments—B Common Shares 2,000

d. Cash 10,000

Trading investments—B Common Shares 5,000

Gain on Sale of Trading investments—B Common Shares 5,000

58. If the cost of a trading investment exceeds its fair value by $40,000, the entry to recognize the loss

a. is not required since the share prices will likely rebound in the long run.

b. will show a debit to an expense account in the operating section of the income statement.

c. will show a credit to a contra-asset account that appears in the shareholders' equity section of the balance sheet.

d. will show a debit to an loss account that appears in the other expenses section of the income statement.

59. Which of the following statements is correct?

a. A debt instrument purchased to earn interest will be valued at fair value.

b. A debt instrument which is purchased to earn interest will be valued at amortized cost.

c. Gains or losses on trading investments are not recorded until the trading investments are sold and the gains or losses are realized.

d. All gains and losses on fair value adjustment arising from trading investments are charged to operating income.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

MATCHING Questions

60. Match the items below by entering the appropriate code letter in the space provided.

A. Trading investments G. Parent company

B. Subsidiary company H. Strategic Investment

C. Equity method I. Significant Influence

D. Investee J. Long-term investment

E. Fair value K. Strategic investment

F. Consolidated financial statements L. Fair Value adjustment

____ 1. The issuer of a bond

____ 2. Securities that are held for resale in the near future, hopefully at a gain

____ 3. Debt instrument held to earn interest income that does not mature within the next year.

____ 4. An investment in equity securities that is purchased to influence or control another.

____ 5. Amount for which an investment could be sold for in the market.

____ 6. The investor has control over an investee.

____ 7. The Equity Investment in Common Shares account is adjusted for profit and dividends received.

____ 8. Normally exists when the investor owns 20% or more of the investee’s voting shares.

____ 9. Financial statements that present the assets and liabilities of the parent and the subsidiary company.

____ 10. Entity whose shares are owned by the parent company.

_____11. An investment in which there is intention of establishing and maintaining a long-term operating relationship.

_____12. Accounting entries are required to adjust the investment’s carrying value for any increase and decrease in its fair value.

ANSWERS TO MATCHING QUESTIONS

60.

1. D

2. A

3. J

4. H

5. E

6. G

7. C

8. I

9. F

10. B

11. K

12. L

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