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Appendix E - Reporting and Interpreting Investments in Other Corporations

Appendix EReporting and Interpreting Investments inOther Corporations

ANSWERS TO QUESTIONS

1. A short-term investment is one that meets the two tests of (1) ready marketabilityand (2) management intention to convert it to cash in the short run. In contrast, along-term investment is one that does not meet both of these tests. Most long-term investments are marketable securities, either stocks or bonds. A short-term

investment is classified as a current asset on the balance sheet, while long-terminvestments are reported as noncurrent assets.

2. For passive investments in bonds, companies may report the investment atunamortized cost if the intent is to hold the bonds until maturity. Otherwise, theinvestments in bonds are to be accounted for using the same fair value methodas is used for passive investments in equity securities. Each year end, theinvestments are adjusted to fair value. Passive equity investments are those inwhich the investor has less than 20% of the outstanding shares of votingcommon stock, unless there is evidence to the contrary.

When a company can exert significant influence over the investing and financingdecisions of another company, the equity method is used to account for andreport the investment. In applying the equity method, considered a “one-lineconsolidation,” dividends received from the affiliate company reduce theinvestment account; the investor’s percentage share of the affiliate’s net incomeor loss is included as income or loss on the investor’s income statement with acorresponding change in the investment account. The ability to exert significantinfluence over an affiliate company is presumed if the investor owns between20% and 50% of the outstanding shares of voting common stock.

When an investor owns over 50% of the outstanding shares of voting common

stock, the investor has control over the affiliate. Consolidated statements areprepared.

3. Only bonds that management has the plans and ability to hold until maturity canbe reported in the held-to-maturity portfolio. The investment in held-to-maturitybonds is reported on the balance sheet at unamortized cost, not fair value, at theend of each year.

Financial Accounting, 8/e Appendix E-1

© 2014 by McGraw-Hill Global Education Holdings, LLC. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution

in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

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4. When shares of capital stock of another company are purchased as aninvestment, they are measured and recorded at cost in accordance with the costprinciple. Cost is defined as the total expenditures incurred in obtaining the othershares. The total outlay includes the market price plus all commissions and otherbuying costs.

5. Under the fair value method, revenues are measured by the investor company inperiods during which the other company declares a cash dividend. Unrealizedgains and losses are recorded when the stock price increases or decreases.

6. Under the equity method, investment revenue is measured on a proportionatebasis by the investor company when earnings are reported by the affiliatecompany, rather than when the dividends are received. This is because theequity method is applied in the situation where the investor company has asufficient number of the shares of voting stock of the other company to exercise asignificant influence. When a significant influence can be exercised over thedividend policies of another corporation, it means that income of the othercorporation can be obtained, almost at will, by the investor company. Thus, whenthe affiliate company reports income, the investor company should record aproportionate share of that income as investment revenue because it isconsidered earned under the requirements of the revenue principle.

7. Under the equity method, dividends received from the affiliate company (the othercompany) are not recorded as revenue because to record the dividends asrevenue would involve double counting. There would be double counting becausethe investor company has already shown, as revenue earned, its proportionateshare of the earnings of the affiliate company. Because the dividends from theaffiliate company are paid out of those earnings, to record them as revenue by

the investor company would be double counting. As a consequence, under theequity method, a dividend received from the affiliate company is debited to Cashand credited to the Investment account.

8. The identifiable assets and liabilities of the acquired company are recorded attheir fair values on the date of acquisition. This is called the acquisition method.

9. Goodwill is only recorded when one company purchases a controlling interest inanother. Goodwill is equal to the purchase price minus the fair value of theidentifiable assets less liabilities of the acquired company. The goodwill must berecognized as an asset and is not expensed unless impaired.

Appendix E-2 Solutions Manual



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MULTIPLE CHOICE

1. b

2. a3. b

4. d

5. c

6. c

7. b

8. d

9. d

10. c




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Authors’ Recommended Solut ion Time

(Time in minutes)

Mini-exercises Exercises Problems

Alternate

Problems

Cases and

Projects

No. Time No. Time No. Time No. Time No. Time

1 3 1 10 1 20 1 20 1 20

2 3 2 15 2 30 2 30 2 15

3 6 3 20 3 45 3 45 3 30

4 6 4 20 4 40 4 40 4 20

5 6 5 20 5 40 5 20 5 10

6 6 6 20 6 40 6 20 6 20

7 6 7 25 7 20 8 *

8 6 8 10 8 20

9 5 9 10 9 20 Continuing Case

10 10 10 10 10 30 1 20

11 5 11 15 11 20

* Due to the nature of this project, it is very difficult to estimate the amount of timestudents will need to complete the assignment. As with any open-ended project, it ispossible for students to devote a large amount of time to these assignments. While

students often benefit from the extra effort, we find that some become frustrated bythe perceived difficulty of the task. You can reduce student frustration and anxiety bymaking your expectations clear. For example, when our goal is to sharpen researchskills, we devote class time to discussing research strategies. When we want thestudents to focus on a real accounting issue, we offer suggestions about possiblecompanies or industries.




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ME –3.

December 2, 2014:Investments in AFS securities (+A) .................................. 93,750

Cash (− A) .................................................................. 93,750

(6,250 shares x $15 per share); 12.5% ownership of voting stockDecember 15, 2014:

Cash (+A) ......................................................................... 12,500Dividend revenue (+R, +SE) ..................................... 12,500

(6,250 shares x $2 = $12,500)

December 31, 2014:Net unrealized gains (losses) (−OCI, −SE) ....................... 18,750

Investments in AFS securities ( A) ........................... 18,750

Year Fair Value− Book Value before Adjustment = Amount for Adjusting Entry

2014 $75,000(6,250 x $12)

− $93,750 = −$18,750Unrealized loss




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ME–4.

December 2, 2014:Investments in TS (+A)..................................................... 93,750

Cash (− A) .................................................................. 93,750

(6,250 shares x $15 per share); 12.5% ownership of voting stockDecember 15, 2014:

Cash (+A) ......................................................................... 12,500Dividend revenue (+R, +SE) ..................................... 12,500

(6,250 shares x $2 = $12,500)

December 31, 2014:Net unrealized gains (losses) (+Loss, −SE) ..................... 18,750

Investments in TS (− A) .............................................. 18,750

Year Fair Value− Book Value before Adjustment = Amount for Adjusting Entry

2014 $75,000(6,250 x $12)

− $93,750 = −$18,750

ME–5.Balance Sheet Income Statement

Transaction Assets Liabilities

Stockholders’

Equity

Revenues/

Gains

Expenses/

Losses

Net

Income12/2 +93,750

–93,750

12/15 +12,500 +12,500 +12,500 +12,500

12/31 –18,750 –18,750


Transaction Assets Liabilities Stockholders’Equity Revenues/Gains Expenses/Losses NetIncome

12/2 +93,750

–93,750

12/15 +12,500 +12,500 +12,500 +12,500

12/31 –18,750 –18,750 +18,750 –18,750




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ME–7.

July 2, 2014:Cash (+A) ......................................................................... 4,000,000

Investments in affiliates ( A) ..................................... 4,000,000

(800,000 shares x $5 = $4,000,000); 35% ownershipDecember 31, 2014:

Investments in affiliates (+A) ............................................ 140,000Equity in affiliate earnings (+R, +SE) ......................... 140,000

(35% x $400,000)


Transaction Assets Liabilities Stockholders’Equity Revenues/Gains Expenses/Losses NetIncome

7/2 +4,000,000

–4,000,000

12/31 +140,000 +140,000 +140,000 +140,000

ME–9.

Property and equipment (+A) ................................................ 750,000

Goodwill (+A) ........................................................................ 85,000Bonds payable (+L) ....................................................... 175,000Cash (–A) ...................................................................... 660,000




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ME–10.

2015 2016 2017Dividends + Change

in Fair Value* $3,000 + $6,000 $4,200 + $12,000 $3,500 - $2,000

Beginning Fair Valueof Investments $64,000 $70,000 $82,000

Economic return frominvesting

= .1406 (14.06%) .2314 (23.14%) .0183 (1.83%)

* 2015: $70,000 - $64,000 = $6,000 increase in fair value2016: $82,000 - $70,000 = $12,000 increase in fair value2017: $80,000 - $82,000 = $2,000 decrease in fair value

Economic return from investing ratio measures the performance of a securities

investment portfolio during the year. For N.M.S. Company, the return was 14.06% in2015 and increased to 23.14% in 2016. However, the return dropped significantly in2017 to 1.83%, primarily due to a decline in the fair value of the securities.

ME–11.

Disney reports a large amount of goodwill because it has purchased otherbusinesses, paying more than the fair market value of the net assets (assets –liabilities) of the acquired companies.




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EXERCISES

EE–1.

Req. 1

July 1, 2015:Held-to-maturity investments (+A) .................................... 12,000,000

Cash (–A) .................................................................. 12,000,000

Req. 2

Dec 31, 2015:Cash (+A) ......................................................................... 480,000

Interest revenue (+R, +SE) ........................................ 480,000($12 million x 8% x 6/12 of a year)

EE–2.Questions Method of Measurement

Fair value Method Equity Method

a Less than 25%. At least 25% but not more than 50%.

b At cost: 4,500 shares x $25 = $112,500. At cost: 10,800 shares x $25 = $270,000.

c When Co. B declares a cash dividend; notfor any holding gains and losses onavailable-for-sale securities.

When Co. B reports income or loss for theperiod; not when dividends are declaredor paid.

d Company A should increase and decreasethe investment account based on stockprice changes (to fair value).

Increase the investment account forproportionate part of income, lessproportionate part of dividends and lossesof Co. B.

e 4,500 shares x $22 = $99,000 fair value. Cost of $270,000 plus $20,100 ($67,000 x30%) equity in affiliate’s earnings minus$6,000 ($20,000 x 30%) dividendsreceived equals $284,100.

f Company A owns 12.5% of Company B(4,500 shares ÷ 36,000 sharesoutstanding). $20,000 dividends declaredx 12.5% = $2,500 dividend revenue forCompany A.

$67,000 Company B net income x 30% =$20,100 equity in earnings of affiliate.




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g 4,500 x ($25 – $22) = $13,500 netunrealized loss reported in stockholders’equity.

None.

EE–3.

June 30, 2014:Investments in AFS securities (+A) (7,000 shares x $15) 105,000

Cash (–A) ..................................................................... 105,000

Dec. 31, 2014:Investments in AFS securities (+A).. ................................ 14,000

Net unrealized gains (losses) (+OCI, +SE) .................... 14,000

Dec. 31, 2015:Net unrealized gains (losses) (–OCI, –SE) ...................... 21,000Investments in AFS securities (–A). .............................. 21,000

Dec. 31, 2016:Investments in AFS securities (+A). ................................. 28,000


Computations:

Year Fair ValueBook Value before

Adjustment=

Amount for Adjust ing Entry

2014 $119,000($17 x 7,000) shares

− $105,000($15 x 7,000 shares)

= +$14,000

2015 98,000($14 x 7,000 shares)

− 119,000(from prior fair value)

= − 21,000

2016 126,000($18 x 7,000 shares)


= + 28,000

Balance in Net Unrealized Gains (Losses) +$21,000

Feb. 14, 2017:

Cash (+A) (7,000 shares x $20). ...................................... 140,000Net unrealized gains (losses) (–OCI, –SE) ...................... 21,000Investments in AFS securities (–A). .............................. 126,000Gain on sale of investment (+Gain, +SE) ..................... 35,000

Note: The net unrealized gains (losses) account is a balance sheet account. It doesnot affect the computation of net income each year. Because it is a balance sheetFinancial Accounting, 8/e Appendix E-11



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account, it maintains its balance from year to year. Therefore, the decline in stockprice that occurs in 2015 is reported as an adjustment to the net unrealized gains(losses) account. When the stock is sold in 2017, the net unrealized gains (losses) isclosed, and the difference between the purchase price (original cost) and the sellingprice is reported as a gain on the income statement.




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EE–4.

June 30, 2014:Investments in TS (+A)..................................................... 105,000

Cash (–A) ..................................................................... 105,000

(7,000 shares x $15 per share)Dec 31, 2014:

Investments in TS (+A)..................................................... 14,000Net unrealized gains (losses) (+Gain, +SE) ................... 14,000

Dec. 31, 2015:Net unrealized gains (losses) (+Loss, –SE) ..................... 21,000

Investments in TS (–A) ................................................. 21,000

Dec. 31, 2016:Investment in TS (+A). ..................................................... 28,000

Net unrealized gains (losses) (+Gain, +SE) ................... 28,000

Computations:


Adjustment=


2014 $119,000($17 x 7,000) shares

− $105,000($15 x 7,000 shares)

= +$14,000

2015 98,000($14 x 7,000 shares)


= − 21,000

2016 126,000($18 x 7,000 shares)


= + 28,000

Feb. 14, 2017:Cash (+A) (7,000 shares x $20) ............................................ 140,000

Gain on sale of investment (+Gain, +SE) .......................... 14,000Investments in TS (–A). ..................................................... 126,000

Note: The net unrealized gains (losses) is an income statement account. This item isreported on the current income statement and affects the computation of net income.It is closed to Retained Earnings at the end of each year.




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EE–5.

March 10, 2014:Investments in AFS securities (+A) (15,000 shares x $35) 525,000

Cash (–A) ..................................................................... 525,000

Dec. 31, 2014:Net unrealized gains (losses) (–OCI, –SE) ...................... 30,000

Investments in AFS securities (–A) ............................... 30,000

Dec. 31, 2015:Investments in AFS securities (+A) .................................. 45,000


Dec. 31, 2016:Net unrealized gains (losses) (–OCI, –SE) ...................... 60,000


Computations:


Adjustment=


2014 $495,000($33 x 15,000) shares

− $525,000($35 x 15,000 shares)

= −$30,000

2015 540,000($36 x 15,000 shares)


= + 45,000

2016 480,000

($32 x 15,000 shares)

− 540,000

(from prior fair value)

= − 60,000

Balance in Net Unrealized Gains (Losses) −$45,000

Sept. 12, 2017:Cash (+A) (15,000 shares x $30) ..................................... 450,000Loss on sale of securities (+Loss, –SE) ........................... 75,000

Investments in AFS securities (–A) ............................... 480,000Net unrealized gains (losses) (+OCI, +SE) ................... 45,000

Note: The unrealized gains (losses) account is a balance sheet account. It does notaffect the computation of net income each year. Because it is a balance sheetaccount, it maintains its balance from year to year. Therefore, the decline in stock

price that occurs in 2014 and 2016 is reported as an adjustment to the net unrealizedgains (losses) account and the increase in stock price that occurs in 2015 is alsoreported as an adjustment to the net unrealized gains (losses) account. When thestock is sold in 2017, the net unrealized gains (losses) is closed, and the differencebetween the purchase price and the selling price is reported as a loss on the incomestatement.Appendix E-14 Solutions Manual



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EE–6.

March 10, 2014:Investments in TS (+A)..................................................... 525,000

Cash (–A) ..................................................................... 525,000

(15,000 shares x $35 per share)Dec. 31, 2014:

Net unrealized gains (losses) – TS (+Loss, –SE) ............. 30,000Investments in TS (–A) ................................................. 30,000

Dec. 31, 2015:Investments in TS (+A)..................................................... 45,000

Net unrealized gains (losses) – TS (+Gain, +SE) ......... 45,000

Dec. 31, 2016:Net unrealized gains (losses) – TS (+Loss, –SE) ............. 60,000


Computations:


Adjustment=


2014 $495,000($33 x 15,000) shares

− $525,000($35 x 15,000 shares)

= −$30,000

2015 540,000($36 x 15,000 shares)


= + 45,000

2016 480,000($32 x 15,000 shares)


= − 60,000

Sept. 12, 2017:Cash (+A) (15,000 shares x $30) ..................................... 450,000Loss on sale of investment (+Loss, –SE) ......................... 30,000


Note: The net unrealized gains (losses) is an income statement account. This item isreported on the current income statement and affects the computation of net income.It is closed to Retained Earnings at the end of each year.




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EE–7.

Req. 1

The equity method must be used because the company owns 27.5% (17,875 ÷65,000) of the total shares outstanding of Tristezza Corporation. The equity methodmust be used when there is at least 20% but not more than 50% ownership inexistence. The Gioia Company must use the equity method because it can exercisesignificant influence, but not control, over the operating and financing policies ofTristezza Corporation.

Req. 2

January 10, 2014:Investments in affiliates (+A) ........................................... 196,625

Cash (–A) ..................................................................... 196,625

(17,875 shares x $11 per share)

27.5% of the voting common stockDecember 31, 2014:

Investments in affiliates (+A). ........................................... 22,000Equity in affiliate earnings (+R, +SE) ............................ 22,000

($80,000 x 27.5% = $22,000)

December 31, 2014:Cash (+A) ......................................................................... 10,725

Investments in affiliates (–A).......................................... 10,725(17,875 shares x $.60 = $10,725)

No entry is made under the equity method to record changes in fair value.

Req. 3

Balance Sheet—At December 31, 2014Long-term Investments:Investments in affiliates (equity basis*) ........................................................ $207,900

Income Statement—For the Year Ended December 31, 2014Equity in affiliate earnings ............................................................................. $ 22,000

* Investments in AffiliatesCost 196,625% Affiliate’s net income 22,000 10,725 % Affiliate’s dividends declared

207,900




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EE–8.

Req. 1 Investing activitiesPurchase of investments in affiliated companies (196,625)

Req. 2 Operating activitiesNet Income $ xxxxx Adjusted for:

Equity in earnings of affiliated companies (22,000)(no cash received)Dividends received from affiliated companies 10,725(cash received)

EE–9.

(in millions) Assets (+A, not detailed). ...................................................... 1,036Goodwill (+A) [$1,377 – ($1,036 – $70)] ............................... 411

Liabilities (+L, not detailed) .............................................. 70Cash (–A) .......................................................................... 1,377

EE–10.

Req. 1

Economic Return = Dividends Received + Change in Fair Value*

from Investing Beginning Fair Value of Investment Portfolio

2014: ($23,906 – $76,452) ÷ $836,451 = -0.0628 (-6.28%)

2015: ($24,399 + $46,346) ÷ $759,999 = +0.0931 (+9.31%)

2016: ($25,538 + $38,815) ÷ $806,345 = +0.0798 (+7.98%)

Change in fair value (ending – beginning):2014: $759,999 - $836,451 = - $76,4522015: $806,345 - $759,999 = +$46,3462016: $845,160 - $806,345 = +$38,815

Req. 2




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Kukenberger, Inc.’s investment portfolio had a negative economic return in 2014(-6.28%) primarily due to the negative change in fair value. However, in 2015 and2016, the portfolio experienced positive economic returns of 9.31% and 7.98%respectively, again primarily due to the positive change in fair value each year.Dividends remained relatively constant over the three years.




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EE–11 (Supplement A)

Req. 1

July 1, 2014:

Held-to-maturity investments (+A) ................................... 8,041,600Cash (–A) ................................................................... 8,041,600(Present value of the bond investment = PV of the principal + PV of the interest annuity

$8,041,600 = ($7,000,000 x .5537) + ($280,000 x 14.8775))

Req. 2

December 31, 2014:Cash (+A) ....................................................................... 280,000

Held-to-maturity investments (–A) .............................. 38,752Interest revenue (+R, +SE) ......................................... 241,248

(Cash = $7,000,000 principal x .08 x 6/12 months = $280,000Interest revenue = $8,041,600 present value x .06 x 6/12 months = $241,248)

PROBLEMS

PE–1.

Req. 1When the bonds are purchased, the company increases Held-to-MaturityInvestments and decreases Cash.

Req. 2When interest is received on the investments, Cash increases and InterestRevenue increases. The bonds were purchased at par; the Held-to-MaturityInvestments account is not affected.

Req. 3No journal entry is required. A decrease in the fair value of bonds in the held-to-maturity portfolio is not recorded.




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PE–2.Req. 1

March 1, 2014Investments in TS (+A) (20,000 shares x $10 per share) . 200,000

Cash (–A) ..................................................................... 200,000

Dec. 31, 2014Net unrealized gains (losses) (+Loss, –SE) ..................... 40,000


Dec. 31, 2015Investments in TS (+A)..................................................... 120,000



Net unrealized gains (losses) (+Gain, +SE) ................... 60,000Req. 2

March 1, 2014Investments in AFS securities (+A) .................................. 200,000

Cash (–A) ..................................................................... 200,000

Dec. 31, 2014Net unrealized gains (losses) (–OCI, –SE) ...................... 40,000


Dec. 31, 2015Investments in AFS securities (+A) .................................. 120,000




Computations:


Adjustment=


2014 $160,000($8 x 20,000) shares

− $200,000($10 x 20,000 shares)

= −$40,000

2015 280,000($14 x 20,000 shares)


= + 120,000

2016 340,000($17 x 20,000 shares)


= + 60,000




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Balance in Net Unrealized Gains (Losses) for AFS Secur ities +$140,000

PE–3.

a. Investments in AFS securities (+A) .................................. 19,000Cash (–A) ..................................................................... 19,000

b. Cash (+A) ......................................................................... 7,771Dividend revenue (+R, +SE) ......................................... 7,771

c. Cash (+A) ......................................................................... 16,531Net unrealized gains (losses) (-OCI, -SE) ........................ 1,092

Investments in AFS securities (-A) ............................... 15,239Gain on sale of investments (+Gain, +SE) ................... 2,384

d. Investments in AFS securities (+A) .................................. 5,210Net unrealized gains (losses) (+OCI, +SE) ................... 5,210

Fair Book Value Amount of

Value - Before Adjustment = Adjusting Entry

$14,558 - $9,348 = +$5,210

($5,587 beg. bal. + $19,000purchase - $15,239 sale)

e. Balance Sheet

Assets:

Other investments $14,558

Stockholders’ Equity:

Net unrealized gains (losses) 5,683

(in Other Comprehensive Income)




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f. Income Statement

Other Items:

Gain on sale of investments $ 2,384

Dividend revenue 7,771

g. If the securities were categorized as trading securities, no net unrealized gainwould appear on the balance sheet. Therefore, when the securities were sold in(c), no debit would be made to the Net Unrealized Gains (Losses) account.Rather, there would be a gain on the sale of $1,292 [$16,531 cash − $15,239 fairvalue] reported on the income statement. Then at year-end, the net unrealizedgain of $5,210 would be reported on the income statement (not in stockholders’equity).




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PE–4.

Req. 1

The fair value method must be used for both the D common stock and F bonds. Thefair value method must be used for D common stock because only 14.74% of it isowned. If less than 20% of the outstanding stock is owned, it is assumed there can beno exercise of significant influence or control; therefore, the fair value method must beused. The fair value method is used for F bonds because they are passiveinvestments not intended to be held to maturity.

Req. 2

2014 2015a. Acquisition of the investments:

Investments in AFS securities (+A) ... 554,000Cash (–A) .................................... 554,000

D common stock: 14,000 shares x $11 = $ 154,000F bonds: at par = 400,000

Total investment ................................. $554,000

b. Income reported by Corporations D & F:No entry is required for either security because, under the fair value method,revenue is recognized only when dividends are declared or interest is earned.

c. Dividends/interest received: Cash (+A) .......................................... 35,000 37,800

Dividend revenue (+R, +SE) ...... 7,000 9,800Interest revenue (+R, +SE) ......... 28,000 28,000

2014: D common stock: 14,000 shares x $.50 = $7,0002015: D common stock: 14,000 shares x $.70 = $9,800




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PE–4. (continued)

2014 2015d. Fair value effects:

Net unrealized gains (losses) (–OCI, –SE) 39,000Investment in AFS securities (–A)…… 39,000

Investment in AFS securities (+A)……… 31,000Net unrealized gains (losses) (+OCI, +SE) 31,000

Computations:

Year Corporation Fair ValueBook Value

before Adjustment

= Amount for Adjusting

Entry2014 D $140,000 − $154,000 = −$14,000

F 375,000 − 400,000 = −25,000

515,000 −39,000

2015 D 161,000 − 140,000 = +21,000

F 385,000 − 375,000 = +10,000

546,000 +31,000

Req. 3a. Balance Sheet: 2014 2015

Long-term Investments:Investments in AFS securities (at fair value) ..................... $515,000 $546,000

b. Stockholders’ Equity:Net unrealized gains (losses) (in OCI) ............................... (39,000) (8,000)

c. Income Statement:Dividend revenue ............................................................... 7,000 9,800Interest revenue ................................................................. 28,000 28,000




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PE–5.

Req. 1

Aug. 4, 2015 Investments in TS (+A) .................................... 180,000

Cash (–A) ..................................................... 180,000

Dec. 31, 2015 Net unrealized gains (losses) (+Loss, –SE) ..... 10,000Investments in TS (–A) ................................. 10,000

June 1, 2016 Cash (+A) ......................................................... 7,000Dividend revenue (+R, +SE) ......................... 7,000

Dec. 31, 2016 Investments in TS (+A) .................................... 12,000Net unrealized gains (losses) (+Gain, +SE) . 12,000


Dec. 31, 2017 Investments in TS (+A) .................................... 6,000Net unrealized gains (losses) (+Gain, +SE) . 6,000

Computations for Year-End Adjustments to Market:


Adjustment=

Amount for Adjust ing

Entry2015 $170,000

($85 x 2,000 shares)

− $180,000 = −$10,000

2016 182,000($91 x 2,000 shares)


= +12,000

2017 188,000($94 x 2,000 shares)


= +6,000




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PE–5. (cont inued)

Req. 2

Aug. 4, 2015 Investments in AFS securities (+A) .................. 180,000Cash (–A) ...................................................... 180,000

Dec. 31, 2015 Net unrealized gains (losses) (–OCI, –SE) ....... 10,000Investments in AFS securities (–A) ............... 10,000


Dec. 31, 2016 Investments in AFS securities (+A) .................. 12,000Net unrealized gains (losses) (+OCI, +SE) .. 12,000


Dec. 31, 2017 Investments in AFS securities (+A) .................. 6,000Net unrealized gains (losses) (+OCI, +SE) .. 6,000



Adjustment=

Amount for Adjusting

Entry

2015 $170,000($85 x 2,000 shares) −

$180,000 =−$10,000

2016 182,000($91 x 2,000 shares)


= +12,000

2017 188,000($94 x 2,000 shares)


= +6,000

Balance in Net Unrealized Gains (Losses) for AFS Securities +$8,000




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PE–5. (continued)

Req. 3

Aug. 4, 2015 Investments in affiliates (+A) ............................ 180,000Cash (–A) ...................................................... 180,000

Dec. 31, 2015 Investments in affiliates (+A) ............................ 9,000Equity in affiliate earnings (+R, +SE) ........... 9,000

(30% x $30,000)

June 1, 2016 Cash (+A) ......................................................... 7,000Investments in affiliates (–A) ........................ 7,000


(30% x $30,000)

June 1, 2017 Cash (+A) ......................................................... 7,000Investments in affiliates (–A) ........................ 7,000


(30% x $30,000)




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PE–6.

Req. 1CASE A The fair value method must be used by Company P because it owns 14%

(4,900 ÷ 35,000) of the total outstanding common shares of Company T. The

fair value method must be used when less than 20% of the outstanding sharesare owned because the investor (Company P) cannot exercise significantinfluence or control.

CASE B The equity method must be used by Company P because it owns 30% (10,500÷ 35,000) of the outstanding common shares of Company T. The equitymethod must be used if the level of ownership is at least 20% but not morethan 50% because the investor (Company P) can exercise significant influence,but not control, over the operating and financing policies of Company T.

Req. 2Case A-14% Case B-30%

a. January 1, 2014 purchase:Investments in AFS securities (+A) ... 117,600

Cash (–A) ...................................... 117,600(4,900 shares x $24)

Investments in affiliates (+A) ............. 252,000Cash (–A) ...................................... 252,000

(10,500 shares x $24)

b. Income reported by Company T: None

Investments in affiliates (+A) ............. 15,000Equity in affiliate earnings (+R, +SE) 15,000

($50,000 x 30%)

c. Dividends declared and paid by Co. T:Cash (+A) ......................................... 3,010

Dividend revenue (+R, +SE) ........ 3,010($21,500 x 14%)

Cash (+A) .......................................... 6,450Investments in affiliates (–A) ....... 6,450

($21,500 x 30%)

d. Net unrealized gains (losses) (–OCI, –SE) 14,700 NoneInvestments in AFS securities (–A) 14,700

4,900 shares x ($21 fair value – $24 cost) = −$14,700.




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PE–6. (continued)


Balance Sheet:

Investments:Investments in AFS securities (1) ....... $102,900Investments in affiliates (2) .................. $260,550

Stockholders’ Equity:Other comprehensive income:

Net unrealized losses/gains ........... (14,700) None

Income Statement:Dividend revenue .................................Equity in earnings of affiliate ................

3,01015,000

(1) Cost $117,600 – Year-end adjustment to fair value $14,700 = $102,900 fair value(reported on balance sheet)

(2) Cost $252,000 + % Affiliate’s net income $15,000 – % Affiliate’s dividendsdeclared $6,450 = $260,550 book value (reported on balance sheet)

Req. 4

Assets (investments), stockholders’ equity (retained earnings), and revenues (frominvestments) are different because (1) different methods of recognizing revenue arerequired and (2) adjustments for changes in fair value are recorded only under the fairvalue method.




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PE–7.

Req. 1CASE

AThe fair value method must be used by the company because it owns 14% (21,000÷ 150,000) of the total shares of the outstanding common stock of Surge

Corporation. The fair value method must be used when less than 20% of theoutstanding stock is owned because the investor cannot exercise either significantinfluence or control.

CASEB

The equity method must be used by the company because it owns 30% (45,000 ÷150,000) of the total shares of the outstanding common stock of Surge Corporation.The equity method must be used when at least 20% but not more than 50% of theoutstanding stock is owned, because the investor can exercise significant influence,but not control, over the operating and financing policies of the other company.


a. Jan. 10, 2014 purchase:Investments in AFS securities (+A) ........ 462,000

Cash (–A) ........................................ 462,000(21,000 shares x $22)

Investments in affiliates (+A) .................. 990,000Cash (–A) ........................................ 990,00

(45,000 shares x $22)

b. Net income of Surge Co.: None1

Investments in affiliates (+A) .................. 86,700Equity in affiliate earnings (+R, +SE)

($289,000 x 30%) 86,70c. Dividends paid by Surge Corporation:

Cash (+A) .......................................... 12,600Dividend revenue (+R, +SE) .......... 12,600

(21,000 shares x $.6)

Cash (+A) .......................................... 45,000Investments in affiliates (–A) ........ 45,00

(45,000 shares x $1)

d. Year-end valuation:Net unrealized gains (losses) (–OCI, –SE) 42,000 None

2

Investments in AFS securities (–A) 42,000[21,000 x ($20 fair value – $22 cost) = −$42,000]

1 Not recorded under fair value method.2 Not recorded under the equity method.




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PE–7. (continued)

Req. 3Case A Case B

a. Balance Sheet:Long-term Investments:

Investments in AFS securities, at fair value (1) ................. $420,000Investments in affiliates (2) ............................................... $1,049,700

b. Stockholders’ EquityOther comprehensive income:

Net unrealized losses/gains ......................................... (42,000)

c. Income Statement:Dividend revenue .............................................................Equity in affiliate earnings ................................................

12,60086,700

(1) Cost $462,000 – Year-end adjustment to fair value $42,000 = Fair value $420,000reported on the balance sheet

(2) Cost $990,000 + % Affiliate’s net income $86,700 – % Affiliate’s dividendsdeclared $27,000 = $1,049,700 reported on the balance sheet

Req. 4

The amounts reported in Requirement (3) are different because of (1) the twodifferent approaches used in recognizing investment revenue and (2) adjustments forchanges in fair value that are made only under the fair value method.




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PE–8.

a. Investments in affiliates (+A) ............................................ 15,685Cash (–A) ..................................................................... 15,685

b. Cash (+A) ......................................................................... 8,564Investments in affiliates (-A) ......................................... 8,564

c. Investments in affiliates (+A) ............................................ 3,897Equity in affiliate earnings (+R, +SE) ............................ 3,897

d. Balance Sheet

Assets:

Investments in affiliates $67,450

e. Income Statement

Other Items:

Equity in affiliate earnings $ 3,897

PE–9.

Since Bradford Company acquired 42% (37,800/90,000) of Hall’s outstandingcommon stock, this investment is accounted for using the equity method.

Statement of Cash Flows:

Operating activitiesNet Income $ xxx,xxx

Adjusted for:Equity in earnings of affiliates (no cash received) (91,140)Dividends received from affiliates (cash received) 49,140




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Investing activitiesPurchase of investments in affiliates (1,171,800)

(Note that the change in fair value does not have any effect on the cash flowstatement.)




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ALTERNATE PROBLEMS

APE–1.

Req. 1When the bonds were purchased, the company increased Held-to-MaturityInvestments and decreased Cash.

Req. 2When interest was received on the investments, Cash increased (based on thestated rate) and Interest Revenue increased (based on the effective rate). Thebonds were purchased at a premium, so the Held-to-Maturity Investmentsaccount was decreased for the difference between the cash received and theinterest revenue recorded.

Req. 3No journal entry is required. A decrease in the fair value of bonds in the held-to-maturity portfolio is not recorded.




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APE–2.

Req. 1

Sept 15, 2014Investments in TS (+A)..................................................... 224,000

Cash (– A) [7,000 shares x $32] .................................... 224,000



Dec. 31, 2015Net unrealized gains (losses) (+Loss, –SE) ..................... 63,000

Investments in TS (– A) ................................................ 63,000

Dec. 31, 2016

Net unrealized gains (losses) (+Loss, –SE) ..................... 28,000Investments in TS (– A) ................................................ 28,000

Req. 2

Sept 15, 2014Investments in AFS securities (+A) .................................. 224,000

Cash (– A) .................................................................... 224,000



Dec. 31, 2015Net unrealized gains (losses) (–OCI, – SE) ..................... 63,000

Investments in AFS securities (– A) .............................. 63,000

Dec. 31, 2016Net unrealized gains (losses) (–OCI, – SE) ..................... 28,000

Investments AFS securities (– A) ................................. 28,000


Year Fair Value

Book Value before

Adjustment =

Amount for

Adjust ing Entry

2014 $238,000($34 x 7,000 shares)

− $224,000 = +$14,000

2015 175,000($25 x 7,000 shares)


= −63,000

2016 147,000($21 x 7,000 shares)


= −28,000Appendix E-36 Solutions Manual



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APE–3.

Req. 1

The fair value method of accounting for long-term investments must be used in thissituation because 6% of the outstanding voting stock of Square Corporation is owned

(12,000 shares ÷ 200,000 shares outstanding). The fair value method must be usedwhen less than 20% of the outstanding stock is owned because the investor companycannot exercise significant influence or control.

Req. 2

a. Acquisition: 2014 2015Investments in AFS securities (+A) ... 300,000

Cash (– A) ..................................... 300,000(12,000 shares x $25 per share)

b. Income reported by Square Corporation:

Revenue should not be recognized by the company on the basis of Square Corp.income in either 2014 or 2015 because, under the fair value method, revenue isnot recognized until dividends are declared.

c. Dividends received:Cash (+A) .......................................... 3,600 4,800

Dividend revenue (+R, +SE) .......... 3,600 4,8002014: $60,000 x 6% = $3,6002015: $80,000 x 6% = $4,800

d. Fair value effects:

Investments in AFS securities (+ A) . 36,000Net unrealized gains (losses) (+OCI,+ SE) ............................................ 36,000

Net unrealized gains (losses) (–OCI,– SE) 12,000Investments in AFS securities (–A) 12,000



Adjustment=


2014 $336,000($28 x 12,000 shares)

− $300,000 = +$36,000

2015 324,000($27 x 12,000 shares)−

336,000(from prior fair value) =−

12,000




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APE–4.

Req. 1CASE A The fair value method must be used by the company because it owns 15%

(30,000 ÷ 200,000) of the total shares. When ownership is less than 20% thefair value method must be used because the investor cannot exercise either

significant influence or control.

CASE B The equity method must be used by the company because it owns 40%(80,000 ÷ 200,000) of the total shares. When ownership is at least 20% but notmore than 50%, the equity method must be used because the investor canexercise significant influence, but not control, over the operating and financingpolicies of the other company.

Req. 2

Case A-15% Case B-40%

January 10, 2015:Investments in AFS securities (+A) .......... 360,000

(30,000 shares x $12)Investments in affiliates (+A) ...................

(80,000 shares x $12)960,000

Cash (– A) ......................................... 360,000 960,000

December 31, 2015: None1

Investments in affiliates (+A) .................... 36,000Equity in affiliate earnings (+R, +SE) .. 36,000

CASE B—$90,000 x 40% = $36,000

December 31, 2015:Cash (+A) ................................................. 18,000 48,000

Investments in affiliates (–A) ................ 48,000Dividend revenue (+R, +SE) ................. 18,000

CASE A—30,000 x $.60 = $18,000CASE B—80,000 x $.60 = $48,000

December 31, 2015:Net unrealized gains (losses) (–OCI, –SE) 90,000 None

Investments in AFS securities (–A) ...... 90,000CASE A—30,000 shares x ($9 fair value –

$12 cost) = $90,000 unrealized loss

1 Not recorded under fair value method.2 Not recorded under the equity method.




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APE–4. (continued)

Req. 3 Case A Case B

December 31, 2015:Balance sheet (partial):

Investments:Investments in AFS securities ......................................... $270,000Investments in affiliates* ................................................ $948,000

Stockholders’ Equity:Other comprehensive income:

Net unrealized gains (losses) .................................... (90,000) None

Income Statement (partial):Dividend revenue ............................................................... 18,000Equity in earnings of affiliate .............................................. 36,000

* Cost $960,000 + $36,000 portion of affiliate’s net income - $48,000 portion ofaffiliate’s dividends declared

APE–5.On the Statement of Cash Flows:

Case A Case B

Operating Activities:

Net income $ xxx,xxx $xxx,xxx Adjusted for:

Equity in earnings of affiliates (no cash received) (36,000)Dividends received (cash received) 48,000

Investing Activities:Purchase of investments (360,000) (960,000)




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APE–6.

Req. 1

Purchase price for the net assets $140,000

Fair value of net assets acquired* 110,000Goodwill purchased $ 30,000

*($12,000 inventory + $180,000 property and equipment – $82,000 liabilities)

Req. 2

Inventory (+A) ....................................................................... 12,000Property and equipment (+A) ................................................ 180,000Goodwill (+A) ........................................................................ 30,000

Liabilities (not detailed) (+L) ............................................. 82,000Cash (–A) .......................................................................... 140,000




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CASES AND PROJECTS

ANNUAL REPORT CASES

CPE–1

Req. 1

Note 2, under the heading “Cash and Cash Equivalents, Short-term Investments and Long-

term Investments,” summarizes the types of securities that American Eagle holds in its

investment portfolio. Note 3 provides additional detail and indicates that short-term

investments totaling $25,499,000, consist of treasury bills and state and local government

auction rate securities (ARS); and long-term investments, totaling $847,000, consist of an

auction rate security call option.

Req. 2

A balance of $11,469,000 was reported for goodwill on the January 28, 2012, balance sheet.

There was a very slight change in goodwill during fiscal 2011 ($3,000 decrease). Since

goodwill can only result from the acquisition of another company at a price which exceeds the

individual fair market values of the assets and liabilities, it is unlikely that the company

purchased another company during this time period. Note 2, under the heading “Goodwill,”

indicates that goodwill was not impaired during fiscal 2011.

CPE–2.

Req. 1




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On its balance sheet as of January 31, 2012, Urban Outfitters reported $89,854,000 for short-

term marketable securities and $126,913,000 for long-term marketable securities. Note 3

indicates that short-term investments consist of corporate bonds, municipal bonds, certificates

of deposit, federal government agencies, and commercial paper. Long-term investments

consist of corporate bonds, municipal bonds, auction rate instruments, treasury bills,

certificate of deposit, and federal government agencies.

Req. 2

The company purchased marketable securities for $169,467,000 during the most recent year,

as disclosed on its statement of cash flows under investing activities.




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FINANCIAL REPORTING AND ANALYSIS CASES

CPE–3.

Req. 1Under the equity method, the investment amount (i.e., $485,000) was increased bythe proportionate share in income reported by the affiliate corporation and decreasedby the proportionate share of the dividends declared by the affiliate corporation. Thus,the increase in the investment account was caused by an excess of investmentincome over dividends received.

Req. 2

The net increase in the investment account was $71,000 (i.e., $556,000 – $485,000).Dividends during 2015 reduced the investment account by the amount of $90,000;therefore, investment revenue must be $161,000 (i.e., $90,000 + $71,000).

Req. 3

If the fair value method were used, investment revenue for 2015 would be $90,000(the amount of dividends received). The unrealized gain ($550,000 - $485,000) doesnot affect the income statement because the securities would be classified asavailable for sale (held long term).

Req. 4

The fair value of Maryn stock increased during 2015; therefore, the amount of theinvestment account balance would be $550,000.

CPE–4.

Under the acquisition method of accounting in both the U.S. and under IFRS,identifiable intangible assets acquired in a business combination are initially valued atfair value. Those assets with indefinite useful lives and any goodwill amounts are notamortized. They are subjected to periodic impairment reviews and any impairmentwrite-downs are recorded as losses on the income statement. Those intangible assetswith limited useful lives are amortized on a straight-line basis and recorded as anexpense on the income statement.

The only major differences between Diageo’s accounting and U.S. GAAP relate toacquisitions from prior years. Prior to 2001, goodwill was recorded on the balancesheet as an intangible asset and amortized over a period not to exceed 40 years inthe U.S. Under U.S. GAAP, amortization of these amounts of goodwill was stopped in2001. In England, prior to 2006, the recorded amount of goodwill was subtracted fromretained earnings and not recorded as an asset. The financial statements of both U.S.




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and U.K. companies were not restated for the acquisitions accounted for under theold rules. So the older and newer acquisitions are accounted for in the currentstatements using different methods.

CRITICAL THINKING CASES

CPE–5.

This case deals with inside (non-public) information. The plan to acquire 80% ofanother company is significant because, when announced, it will affect the stock priceof the other company. It is wrong both legally and ethically to trade on insiderinformation regardless of the size of your proposed investment. It is also wrong topass insider information on to another individual even if you do not profit directly from

the information.

CP E–6.

The assets, liabilities, revenues and expenses of the two companies will be addedtogether. It is unlikely that the two companies have significant intercompanytransactions such as intercompany sales. The analyst cannot simply add the twofinancial statements together because the investment account must be eliminated andthe assets of the acquired company stated at their fair value. Unfortunately, thisinformation is not available publicly.

FINANCIAL REPORTING AND ANALYSIS TEAM PROJECT

CPE–7.

The solutions to this project will depend on the company and/or accounting period selectedfor analysis.




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CONTINUING CASE

CCE-1.

Req. 1

November 21, 2012Investments in TS (+A)..................................................... 19,200,000

Cash (–A) ..................................................................... 19,200,000

Dec. 31, 2012Net unrealized gains (losses) (+Loss, –SE) ..................... 1,200,000

Investments in TS (–A) ................................................. 1,200,000

Dec. 31, 2013Net unrealized gains (losses) (+Loss, –SE) ..................... 1,600,000

Investments in TS (–A) .................................................. 1,600,000

Dec. 31, 2014Investments in TS (+A)..................................................... 3,200,000

Net unrealized gains (losses) (+Gain, +SE) ................... 3,200,000

Sept. 15, 2015Cash (+A) ........................................................................ 20,000,000

Investments in TS (–A) .................................................. 19,600,000Gain on sale of investments (+Gain, +SE) .................... 400,000

Computations:


Adjustment=


2012 $18,000,000($45 x 400,000) shares

− $19,200,000($48 x 400,000 shares)

= −$1,200,000

2013 16,400,000($41 x 400,000 shares)

− 18,000,000(from prior fair value)

= − 1,600,000

2014 19,600,000($49 x 400,000 shares)


= + 3,200,000




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CCE-1. (continued)

Req. 2

November 21, 2012Investments in AFS securities (+A) .................................. 19,200,000

Cash (–A) ..................................................................... 19,200,000

Dec. 31, 2012Net unrealized gains (losses) (–OCI, –SE) ...................... 1,200,000

Investments in AFS securities (–A) ............................... 1,200,000

Dec. 31, 2013Net unrealized gains (losses) (–OCI, –SE) ...................... 1,600,000

Investments in AFS securities (–A) ................................ 1,600,000

Dec. 31, 2014Investments in AFS securities (+A) .................................. 3,200,000

Net unrealized gains (losses) (+OCI, +SE) .................... 3,200,000

Sept. 15, 2015Cash (+A) ........................................................................ 20,000,000Net unrealized gains (losses) (–OCI, –SE) ...................... 400,000

Investments in AFS securities (–A) ............................... 19,600,000Gain on sale of investments (+Gain, +SE) .................... 800,000

Computations:


Adjustment = Amount for

Adjust ing Entry

2012 $18,000,000($45 x 400,000) shares

− $19,200,000($48 x 400,000 shares)

= −$1,200,000

2013 16,400,000($41 x 400,000 shares)


= − 1,600,000

2014 19,600,000($49 x 400,000 shares)


= + 3,200,000

Balance in Net Unrealized Gains (Losses) account in OCI +$400,000

SMAppE

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