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Intermediate Accounting, 7e
Question 122
Increases and decreases in the market value between the time a debt security is acquired and the
day it matures to a prearranged maturity value are ignored for a security classified as held-tomaturity. These changes arent important if sale before maturity isnt an alternative, which is the
case if an investor has the positive intent and ability to hold the security to maturity.
Question 123
GAAP distinguishes between three levels of inputs to fair value determination, with level 1 being
readily observable fair values (for example, from a securities exchange), level 2 inputs are other
observable amounts (for example, quoted values for similar items, or important inputs like interest
rates), and level 3 inputs are unobservable, like the companys own assumptions. GAAP requires
disclosure of the amount of fair values based on each of these three classes of inputs.
Question 124
For investments to be held for an unspecified period of time, fair value information is more
relevant than for investments to be held to maturity. Changes in fair values are less relevant if the
investment is to be held to maturity because sale at that fair value is not an option. The investor
receives the same contracted interest payments for the period held to maturity and the stated
principal at maturity, regardless of movements in market values. However, when the investment is
of unspecified length, changes in fair values indicate managements success in deciding when to
acquire the investment and when to sell it, as well as the propriety of investing in fixed-rate or
variable-rate securities and long-term or short-term securities.
Question 125
The way unrealized holding gains and losses are reported in the financial statements depends on
whether the investments are classified as securities available-for-sale or as trading securities.
Securities available-for-sale are reported at fair value, and resulting holding gains and losses are not
included in the determination of income for the period. Rather, they are reported as a separate
component of shareholders equity, as part of other comprehensive income (OCI). (Available-forsale securities for which the investor has chosen the fair value option are reclassified as trading
securities.)
123
Question 127
Unrealized holding gains or losses on trading securities are reported in the income statement as if
they actually had been realized. Trading securities are actively managed in a trading account with the
express intent of profiting from short-term market price changes. So, any gains and losses that result
from holding securities during market price changes are suitable measures of success or lack of
success in achieving that goal.
On the other hand, unrealized holding gains or losses on securities available-for-sale are not
reported in the income statement. By definition, these securities are not acquired for the purpose of
profiting from short-term market price changes, so gains and losses from holding these securities
while prices change are less relevant performance measures to be included in earnings.
Question 128
When acquired, debt and equity securities are assigned to one of the three reporting
classifications: held-to-maturity, trading, or available-for-sale. The appropriateness of the
classification is reassessed at each reporting date. A reclassification should be accounted for as
though the security had been sold and immediately reacquired at its fair value. Any unrealized
holding gain or loss should be accounted for in a manner consistent with the classification into
which the security is being transferred. Specifically, when a security is transferred:
1. Into the trading category, any unrealized holding gain or loss should be recognized in earnings
of the reclassification period.
2. Into the available-for-sale category, any unrealized holding gain or loss should be recorded in
other comprehensive income, which will then increase accumulated other comprehensive
income in shareholders equity.
3. Into the held-to-maturity category, any unrealized holding gain or loss should be amortized
over the remaining time to maturity. This would be the case for Western Die-Castings
investment in the LGB Heating Equipment bonds.
Intermediate Accounting, 7e
Question 1210
Under IFRS No. 9, debt investments are accounted for as either amortized cost or FVTPL (fair
value through profit and loss), while equity investments are accounted for at FVTPL unless the
equity is not held for trading and the investor elects at acquisition to account for the investment at
FVTOCI (fair value through other comprehensive income).
Question 1211
According to U.S. GAAP, the fair value of an equity security is considered readily determinable
only if its selling price is currently available on particular securities exchanges or over-the-counter
markets. If the fair value of an equity security is not readily determinable, U.S. GAAP uses the cost
method. Under IFRS, equity investments typically are measured at fair value, even if they are not
listed on an exchange or over-the-counter market. Under IAS No. 39, the cost method only is used if
fair value cannot be measured reliably, which occurs when the range of reasonable fair value
estimates is significant and the probability of various estimates within the range cannot be
reasonably estimated. Under IFRS No. 9, the cost method is prohibited, although cost can
sometimes be used as an estimate of fair value. Therefore, in general, use of the cost method is less
prevalent under IFRS than under U.S. GAAP.
Question 1212
When a company elects the fair value option for held-to-maturity or available-for-sale
investments, it simply reclassifies those investments as trading securities and accounts for them in
that fashion.
125
Question 1214
The equity method is used when an investor cant control but can significantly influence the
investee. For example, if effective control is absent, the investor still might be able to exercise
significant influence over the operating and financial policies of the investee if the investor owns a
large percentage of the outstanding shares relative to other shareholders. By voting those shares as a
block, the investor often can sway decisions in the direction desired. We presume, in the absence of
evidence to the contrary, that the investor exercises significant influence over the investee when it
owns between 20% and 50% of the investee's voting shares.
Question 1215
The equity method, like consolidation, views the investor and investee as a special type of single
entity. By the equity method, though, the investor doesnt include separate financial statement items
of the investee on an item-by-item basis as in consolidation. Rather, by the equity method, the
investor reports its equity interest in the investee as a single investment account. That single
investment account is periodically adjusted to reflect the effects of consolidation, without actually
consolidating financial statements.
Question 1216
The investor should account for dividends from the investee as a reduction in the investment
account. Since investment revenue is recognized as the investee earns it, it would be inappropriate
to again recognize revenue when earnings are distributed as dividends. Rather, the dividend
distribution is considered to be a reduction of the investees net assets, indicating that the investors
ownership interest in those net assets declines proportionately.
Intermediate Accounting, 7e
Question 1218
The investment account was decreased by $40,000 (40% x $100,000). Cash increased by the
same amount. There is no effect in the income statement.
Question 1219
When it becomes necessary to change from the equity method to another method, no adjustment
is made to the carrying amount of the investment. The equity method is simply discontinued and the
new method is applied from then on. The investment account balance when the equity method is
discontinued would serve as the new cost basis for writing the investment up or down to fair value
in the next set of financial statements.
Question 1220
IFRS require that accounting policies of investees be adjusted to correspond to those of the
investor when applying the equity method. U.S. GAAP has no such requirement. Also, IFRS allow
investors to account for a joint venture using either the equity method or proportionate
consolidation, whereby the investor combines its proportionate share of the investees accounts
with its own accounts on an item-by-item basis. U.S. GAAP generally requires that the equity
method be used to account for joint ventures.
Question 1221
When a company elects the fair value option for a significant-influence investment, that
investment is not reclassified as a trading security. Rather, the investment still appears in the
balance sheet as a significant-influence investment, but the amount that is accounted for at fair value
is indicated in the balance sheet either parenthetically on a single line that includes the total amount
of significant-influence investment or on a separate line. As with trading securities, unrealized gains
and losses are included in earnings in the period in which they occur.
127
Question 1223
These instruments derive their values or contractually required cash flows from some other
security or index.
Question 1224
Since this money wont be used within the upcoming operating cycle, it is a noncurrent asset. It
should be reported as part of investments.
Question 1225
Part of each premium payment the company makes is not used by the insurance company to pay
for life insurance coverage, but rather is invested on behalf of the insured company in a fixedincome investment. As a result, the periodic insurance premium should not be expensed in its
entirety; an appropriate portion should be recorded instead as a noncurrent assetcash surrender
value.
Question 1226
If the investor intends to sell the investment, or thinks it will be more likely than not that it will
be required to sell the investment prior to recovering the impairment, the investor is required to
recognize the entire impairment loss in the income statement as an OTT impairment, writing down
the investment to fair value in the balance sheet.
Otherwise, the investor considers whether credit losses exist. If there are no credit losses, no
impairment loss is recognized. On the other hand, if there are some credit losses, then the
investment is written down to fair value in the balance sheet. However, only the credit loss
component is recognized in net income. Any noncredit losses are recognized in OCI. In the income
statement, the entire impairment loss is shown, and then the amount of noncredit loss is subtracted,
leaving only the credit loss reducing net income.
Intermediate Accounting, 7e
Question 1228
Given that the decline in shares relates to a new law banning a primary approach used by the
company, it likely would be treated as an other-than-temporary impairment. So, when the
investment is written down to its fair value, the amount of the write-down should be treated as if it
were a realized loss, meaning the loss is included in income for the period. This could require a
reclassification adjustment if any unrealized losses were included previously in OCI, just as if the
investment was being sold. Subsequent to the other-than-temporary write-down, the usual treatment
of unrealized gains or losses should be resumed. Therefore, later changes in fair value will be
reported as a separate component of shareholders equity, accumulated other comprehensive income.
Question 1229
U.S. GAAP and IFRS differ somewhat. Under IFRS, OTT impairments only are recognized on
debt that is classified as HTM to the extent that credit losses exist, so there is no noncredit loss
component of OTT impairments under IFRS. OTT impairments are recognized on debt classified as
AFS in their entirety, with no distinction made between credit losses and noncredit losses. Also,
under IFRS, OTT impairments can be recovered in earnings for debt investments, but not for equity
investments. U.S. GAAP does not allow OTT impairments to be recovered in earnings for either
debt or equity investments (unless the debt investment is classified as a loan).
129
Question 1231
To be accounted for at amortized cost, a debt investment must have the characteristics of
simple debt: (1) the debt consists primarily of payments that include interest and return of
principal, (2) the debt agreement doesnt allow the debtor to prepay or settle the debt in a manner
that provides a loss to the investor, and (3) the debt does not involve derivatives. The debt also must
be held for the purpose of collecting contractual cash flows associated with lending or customer
financing.
Question 1232
To be accounted for at FV-OCI, a debt investment must have the characteristics of simple debt
(the debt consists primarily of payments that include interest and return of principal, dont allow the
debtor to prepay or settle the debt in a manner that provides a loss to the investor, and do not involve
derivatives). The debt also must be held for the purpose of maximizing investment return by selling
it after it has appreciated in value or collecting contractual cash flows, or for managing risk.
Question 1233
First, if the debt investment is complex, it is accounted for at FV-NI. The debt investment is
complex if it lacks one or more of the characteristics of simple debt (the debt consists primarily of
payments that include interest and return of principal, dont allow the debtor to prepay or settle the
debt in a manner that provides a loss to the investor, and do not involve derivatives). The debt
investment also is accounted for at FV-NI if it is simple and either is held for sale at acquisition or
issuance or does not qualify for being accounted for at amortized cost or FV-OCI.
Question 1234
If the investor lacks the ability to significantly influence the investee, an equity investment is
accounted for at FV-NI. Nonpublic organizations have a practicability exception with respect to
nonmarketable investments, allowing them to account for the investment at cost less any
impairments and adjusted for any changes in fair value that are observed from transactions of similar
equity.
Intermediate Accounting, 7e
BRIEF EXERCISES
Brief Exercise 121
(a)
Investment in bonds (face amount) .......................
Discount on bond investment (difference) ........
Cash (price of bonds) ..........................................
720,000
10,800
1,200
120,000
600,000
(b)
12,000
875,000
December 31
Net unrealized holding gains and lossesI/S .....................
Fair value adjustment ($875,000 873,000) ........................
2,000
875,000
2,000
1211
880,000
5,000
875,000
Assuming no other trading securities, the 2014 adjusting entry to remove the fair
value adjustment associated with the sold securities would be:
December 31
Fair value adjustment (account balance) ..................................
Net unrealized holding gains and lossesI/S (to balance)
2,000
2,000
Intermediate Accounting, 7e
875,000
December 31
Net unrealized holding gains and lossesOCI.....................
Fair value adjustment ($875,000 873,000) ........................
2,000
875,000
2,000
2014
January 3
Cash (selling price) .................................................................
Gain on investments (to balance) .......................................
Investment in Coca Cola shares (cost)..............................
880,000
5,000
875,000
2,000
2,000
1213
60,000
60,000
Intermediate Accounting, 7e
875,000
December 31
Net unrealized holding gains and lossesI/S .....................
Fair value adjustment ($875,000 873,000)...................
2,000
875,000
2,000
2014
January 3
Cash (selling price) .................................................................
Gain on investments (to balance) .......................................
Investment in Coca Cola shares (account balance) .............
880,000
5,000
875,000
Assuming no other trading securities, the 2014 adjusting entry to remove the fair
value adjustment associated with the sold securities would be:
December 31
Fair value adjustment (account balance) .................................
Net unrealized holding gains and lossesI/S (to balance)
2,000
2,000
1215
Intermediate Accounting, 7e
1217
200,000
200,000
December 31
Fair value adjustment ($11.5M 10M) ................................... 1,500,000
Net unrealized holding gains and lossesI/S
(may also labeled investment revenue) ........................
1,500,000
Note: A different approach to reach the same outcome would be for Turner to use
equity-method accounting throughout the year, and then at the end of the
year make whatever adjustment to fair value is necessary to adjust the
investment account to fair value. Under that approach, Turner would
recognize 40% of ICAs $750,000 income ($300,000) as investment
income, it would not recognize investment income associated with ICAs
dividend, and it would end up with an investment account containing
$10,100,000 ($10,000,000 + 300,000 200,000). Turner then would need
to make a fair value adjustment of $1,400,000 ($11,500,000 10,100,000)
to its ICA investment. So the total amount of income recognized would be
$1,700,000 ($300,000 investment income + $1,400,000 unrealized gain).
Note that this alternative produces the same total amount of investment
income as is produced above, $1,700,000 ($200,000 investment revenue +
$1,500,000 unrealized gain).
Intermediate Accounting, 7e
450,000
100,000
100,000
450,000
In the income statement, the entire $450,000 will be shown as an OTT impairment
loss. A $100,000 reclassification adjustment will increase OCI (because the $100,000
decreased OCI and therefore AOCI in a prior period, it must be backed out of OCI and
AOCI in the current period). Therefore, the net effect on comprehensive income
during the current period will be $350,000.
1219
450,000
100,000
100,000
450,000
In the income statement, the entire $450,000 will be shown as an OTT impairment
loss. A $100,000 reclassification adjustment will increase OCI (because the $100,000
decreased OCI and therefore AOCI in a prior period, it must be backed out of OCI and
AOCI in the current period). Therefore, the net effect on comprehensive income
during the current period will be $350,000.
Intermediate Accounting, 7e
200,000
250,000
100,000
100,000
200,000
250,000
LED still would have to include the entire $450,000 in the income statement before
backing out the $250,000 to leave a $200,000 reduction of earnings. The $100,000
reclassification adjustment will increase OCI (because the $100,000 decreased OCI
and therefore AOCI in a prior period, it must be backed out of OCI and AOCI in the
current period). Therefore, the net effect on comprehensive income will be $350,000
during the current period ($200,000 from net income, $150,000 from OCI).
1221
500,000
500,000
Upon recovery of $300,000 of fair value, Wickum would reverse the impairment
by that amount:
Discount on debt investment ...............................
300,000
Recovery of other-than-temporary impairment lossI/S
300,000
Intermediate Accounting, 7e
1223
EXERCISES
Exercise 121
Requirement 1
Investment in bonds (face amount) ........................
Discount on bond investment (difference).........
Cash (price of bonds) ..........................................
Requirement 2
Cash (3% x $240 million) ........................................
Discount on bond investment (difference) ............
Interest revenue (4% x $200) .............................
($ in millions)
240.0
40.0
200.0
7.2
.8
8.0
Requirement 3
Tanner-UNF reports its investment in the December 31, 2013, balance sheet at
its amortized costthat is, its book value:
Investment in bonds ............................................
Less: Discount on bond investment ($40 0.8 million)
Amortized cost ................................................
$240.0
39.2
$200.8
($ in millions)
190.0
39.2
10.8
240.0
Intermediate Accounting, 7e
Exercise 122
November 1
($ in millions)
Cash ................................................................
Investment revenue .....................................
2.4
2.4
December 1
Investment in Facsimile Enterprises bonds ....
Cash.............................................................
30
30
December 31
Investment in U.S. treasury bills ...................
Cash.............................................................
8.9
8.9
December 31
Investment revenue receivableConvenience
bonds ($48 million x 10% x 2/12) .......................
Investment revenue receivableFacsimile
Enterprises bonds ($30 million x 12% x 1/12) ....
Investment revenue ...................................
0.8
0.3
1.1
1225
Exercise 123
Requirement 2
The specific citation that specifies the circumstances and conditions under which it is
appropriate to account for investments as held-to-maturity is FASB ACS 3201025
4: InvestmentsDebt and Equity SecuritiesOverallRecognition
Circumstances Not Consistent with Held-to-Maturity Classification.
Requirement 3
FASB ACS 32010254 reads as follows:
An entity shall not classify a debt security as held-to-maturity if the entity has the
intent to hold the security for only an indefinite period. Consequently, a debt security
shall not, for example, be classified as held-to-maturity if the entity anticipates that the
security would be available to be sold in response to any of the following
circumstances:
a. Changes in market interest rates and related changes in the security's
prepayment risk
b. Needs for liquidity (for example, due to the withdrawal of deposits,
increased demand for loans, surrender of insurance policies, or payment of
insurance claims)
c. Changes in the availability of and the yield on alternative investments
d. Changes in funding sources and terms
e. Changes in foreign currency risk.
Exercise 124
Investment in GM common shares ................
Cash ([800 shares x $50] + $1,200) ...................
41,200
41,100
100
41,200
41,200
Intermediate Accounting, 7e
Exercise 125
Requirement 1
2013
December 17
Investment in Grocers Supply preferred shares ................
Cash .................................................................................
350,000
December 28
Cash .....................................................................................
Investment revenue ..........................................................
2,000
December 31
Fair value adjustment ..........................................................
Net unrealized holding gains and lossesI/S
([$4 x 100,000 shares] $350,000) .........................................
350,000
2,000
50,000
50,000
2014
January 5
Cash (selling price) .................................................................
Gain on investments (to balance) .......................................
Investment in Grocers Supply preferred
shares (account balance).................................................
395,000
45,000
350,000
Assuming no other trading securities, the 2014 adjusting entry to remove the fair
value adjustment associated with the sold securities would be:
December 31
Net unrealized holding gains and lossesI/S .....................
Fair value adjustment (account balance) .............................
50,000
50,000
1227
$400,000
$ 2,000
50,000
Intermediate Accounting, 7e
Exercise 126
The FASB Accounting Standards Codification represents the single source of
authoritative U.S. generally accepted accounting principles. The specific citation for
each of the following items is:
1. Unrealized holding gains for trading securities should be included in earnings:
FASB ACS 32010351a: InvestmentsDebt and Equity Securities
OverallSubsequent MeasurementGeneral.
2. Under the equity method, the investor accounts for its share of the earnings or
losses of the investee in the periods they are reported by the investee in its
financial statements: FASB ACS 32310354: InvestmentsEquity Method
and Joint VenturesOverallSubsequent MeasurementGeneral.
3. Transfers of securities between categories shall be accounted for at fair value:
FASB ACS 320103510: InvestmentsDebt and Equity Securities
OverallSubsequent MeasurementGeneral.
4. Disclosures for available-for-sale securities should include total losses for
securities that have net losses included in accumulated other comprehensive
income: FASB ACS 32010502: InvestmentsDebt and Equity
SecuritiesOverallDisclosureSecurities Classified as Available for Sale.
1229
Exercise 127
Requirement 1
.
25,000
25,000
Requirement 2
None. Accumulated net holding gains and losses for securities available-forsale are reported as a component of shareholders equity (in accumulated
other comprehensive income), and changes in the balance are reported as
other comprehensive income or loss in the statement of comprehensive
income rather than as part of earnings. This statement can be reported either
(a) as a combined statement of comprehensive income that includes net
income and other comprehensive income, or (b) as a separate statement of
comprehensive income.
Intermediate Accounting, 7e
Exercise 128
Requirement 1
Securities held-to-maturity are debt securities that an investor has the positive
intent and ability to hold to maturity. Actively traded investments in debt or
equity securities acquired principally for the purpose of selling them in the near
term are classified as trading securities. The IBM shares are neither. They are
classified as available-for-sale since all investments in debt and equity securities
that dont fit the definitions of the other reporting categories are classified this
way. Of course, the equity method isnt appropriate either because 10,000 shares
of IBM certainly dont constitute significant influence.
Investments in securities available-for-sale are reported at fair value, and holding
gains or losses are not included in the determination of income for the period.
Instead, they are reported as other comprehensive income or loss in the statement
of comprehensive income. This statement can be reported either (a) as a
combined statement of comprehensive income that includes net income and other
comprehensive income, or (b) as a separate statement of comprehensive income.
Accumulated net holding gains and losses for securities available-for-sale are
reported as a separate component of shareholders equity in the balance sheet.
Requirement 2
December 31, 2013
Net unrealized holding gains and lossesOCI
(10,000 shares x [$58 60]) .........................................................
Fair value adjustment ...........................................................
20,000
20,000
1231
Cost
$600
Fair Value
$610
Accumulated
Unrealized
Gain (Loss)
$10
Moving from a negative $20 (2013) to a positive $10 (2014) requires an increase
of $30:
Balance needed in fair value adjustment
Existing balance in fair value adjustment:
Increase (decrease) needed in fair value adjustment:
Fair Value
Adjustment
$10
($20)
$30
--------------------------------------------------------20
0
+10
+30 ----------------------------->
30,000
30,000
Intermediate Accounting, 7e
Exercise 129
Requirement 1
2013
March 2
($ in millions)
31
31
April 12
Investment in Zenith bonds .........................................................
Cash .........................................................................................
20
July 18
Cash .............................................................................................
Investment revenue ..................................................................
October 15
Cash .............................................................................................
Investment revenue ..................................................................
October 16
Cash .............................................................................................
Investment in Zenith bonds .....................................................
Gain on sale of investments.....................................................
November 1
Investment in LTD preferred shares ...........................................
Cash .........................................................................................
20
1
21
20
1
40
40
1233
Exercise 129(continued)
December 31
($ in millions)
Available-for-Sale Securities
Platinum Gauges, Inc., shares
LTD preferred shares
Totals
Cost
$31
40
$71
Fair Value
$32*
37**
$69
Accumulated
Unrealized
Gain (Loss)
$1
(3)
$(2)
Adjusting entry:
Net unrealized holding gains and lossesOCI ($71 69) ..........
Fair value adjustment ($71 69) ...............................................
2
2
2014
January 23
($ in millions)
([1 million shares x 1/2] x $32)
Cash
................................................
Gain on sale of investments (difference) ...................................
Investment in Platinum Gauges
shares ($31 million cost x 1/2) ...................................................
March 1
Cash ($76 x 500,000 shares) ............................................................
Loss on sale of investments (difference) .......................................
Investment in LTD preferred (cost) .........................................
16.0
0.5
15.5
38
2
40
Note: As part of the process of recording the normal, period-end fair value adjusting
entry at 12/31/2014, Construction would debit fair value adjustment and credit net
unrealized gains and lossesOCI for the $2.5 million associated with the sold
investments to remove their effects from the financial statements. (Construction sold
only half the Platinum investments so only half of the Platinum fair value adjustment
should be removed. The 2.5 amount comes from 3.0 LTD 0.5 Platinum.)
Intermediate Accounting, 7e
$3
1
$2
* Note: Unlike for trading securities, unrealized holding gains and losses are not included in
income for securities available-for-sale. Rather, they are included in other comprehensive
income, and accumulated in shareholders equity in accumulated other comprehensive
income.
1235
Exercise 1210
Requirement 1
Purchase
($ in millions)
90
90
Net income
No entry
Dividends
Cash (5% x $60 million)..................................................................
Adjusting entry
8
8
Requirement 2
Investment revenue ..........................
$3 million
Intermediate Accounting, 7e
Exercise 1211
1. Investments reported as current assets.
Security A
$ 910,000
Security B
100,000
Security C
780,000
Security E
490,000
Total
$2,280,000
2. Investments reported as noncurrent assets.
Security D
$ 915,000
Security F
615,000
$1,530,000
Security
A
B
Totals
Cost
Fair value
$ 900,000
105,000
$1,005,000
$ 910,000
100,000
$1,010,000
Unrealized
gain (loss)
$10,000
(5,000)
$ 5,000
Security
C
D
Totals
Cost
Fair value
$ 700,000
900,000
$1,600,000
$ 780,000
915,000
$1,695,000
Unrealized
gain (loss)
$80,000
15,000
$95,000
1237
Exercise 1212
Requirement 1
($ in 000s)
Available-for-Sale Securities
IBM sharesDec. 31, 2013
Cost
$1,345
Fair Value
$1,175
Accumulated
Unrealized
Gain (Loss)
$(170)
Fair Value
Adjustment
($170)
($145)
($ 25)
------------------------------------------------------- 170
145
0
<---------------- 25
25,000
25,000
Intermediate Accounting, 7e
Cost
$1,345
Fair Value
$1,275
Accumulated
Unrealized
Gain (Loss)
$(70)
Fair Value
Adjustment
($ 70)
($145)
$ 75
------------------------------------------------------------------------------------------ 145
70
0
+75 ---------------------->
75,000
75,000
1239
Cost
$1,345
Fair Value
$1,375
Accumulated
Unrealized
Gain (Loss)
$30
Fair Value
Adjustment
$ 30
($145)
$175
------------------------------------------------------------------------------------------ 145
70
0
+ 30
+175 -------------------------------------------------------->
175,000
175,000
Intermediate Accounting, 7e
Exercise 1213
Requirement 1
The sale of the A Corporation shares decreased Harlons pretax earnings by $5
million. The purchase of the C Corporation shares had no effect on Harlons 2014
earnings (because the shares are classified as available-for-sale investments, any
unrealized gains or losses occurring after purchase during 2014 would not affect 2014
earnings). Here are the entries used to record those two transactions:
June 1, 2014
Cash
Loss on sale of investments (difference)
Investment in A Corporation shares (cost)
September 12, 2014
Investment in C Corporation shares
Cash
($ in millions)
15
5
20
15
15
1241
A Corporation shares
B Corporation bonds
C Corporation shares
D Industries shares
Totals
$20
35
na
45
$100
na
$35
15
45
$95
$14
35
na
46
$95
na
$ 37
14
50
$101
In 2013, Harlon would have had a net unrealized loss of $5 (cost of $100 fair
value of $95). Moving from a negative $5 (2013) to a positive $6 requires an
increase of $11:
Fair Value
Adjustment
Allowance
$6
(5)
$11
--------------------------------------------------------5
0
+6
+ 11 ----------------------------->
11
11
Intermediate Accounting, 7e
Exercise 1214
Requirement 1
The investment would be accounted for as an available-for-sale investment:
Purchase
480,000
480,000
Net income
No entry
Dividends
20,000
20,000
Adjusting entry
25,000
25,000
Requirement 2
The investment would be accounted for using the equity method:
Purchase
480,000
480,000
Net income
50,000
50,000
20,000
20,000
Adjusting entry
No entry
The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol. 1, Chapter 12
1243
Exercise 1215
Purchase
($ in millions)
56
56
Net income
12
12
3
Adjusting entry
No entry
Exercise 1216
Requirement 1
($ in millions)
17
17
Requirement 2
Financial statements would be recast to reflect the equity method for each year
reported for comparative purposes. A disclosure note also should describe the
change, justify the switch, and indicate its effects on all financial statement items.
Requirement 3
When a company changes from the equity method, no adjustment is made to the
carrying amount of the investment. Instead, the equity method is simply
discontinued, and the new method is applied from then on. The balance in the
investment account when the equity method is discontinued would serve as the new
cost basis for writing the investment up or down to fair value in the next set of
financial statements. There also would be no revision of prior years, but the change
should be described in a disclosure note.
Intermediate Accounting, 7e
Exercise 1217
Requirement 1: Error discovered before the books are adjusted or closed in
2013.
The journal entry the company made is:
Cash .............................................................
Investments ..............................................
100,000
100,000
100,000
80,000
20,000
Therefore, to get from what was done to what should have been done, the
following entry is needed:
Investments ($100,000 80,000) .....................
Gain on sale of investments.....................
20,000
20,000
20,000
20,000
1245
Exercise 1218
Purchase
($ in millions)
68
68
Net income
10
10
4
Depreciation Adjustment
Calculations:
Investee
Net Assets
Net Assets
Purchased
Difference
Attributed to:
Cost
1
1
$68
Fair value:
Book value:
Goodwill:$12
Undervaluation
of assets: $8
No entry to adjust for changes in fair value as this investment is accounted for
under the equity method.
Intermediate Accounting, 7e
Exercise 1219
Requirement 1
Purchase
($ in millions)
300
300
Net income
30
30
Dividends
Cash (20% x $30 million) ........................................................
1
1
calculation:
Investee
Net Assets
Net Assets
Purchased
Cost
$300
Fair value:
Goodwill:
$120
Book value:
Difference
Attributed to:
Undervaluation
of buildings ($10) and land ($10): $20
Requirement 2
a. Investment in Lake Construction shares
________________________________________
($ in millions)
Cost
300
Share of income 30
Balance
6 Dividends
1 Depreciation adjustment
_________________
323
The McGraw-Hill Companies, Inc., 2013
1247
Intermediate Accounting, 7e
Exercise 1220
Requirement 1
First we need to identify the amount of difference between book value and fair value
associated with goodwill, buildings, and land:
Investee
Net Assets
Cost
Net Assets
Purchased
Difference
Attributed to:
$750
Fair value:
$300
Book value:
Goodwill:
Undervaluation
of buildings ($25) and land ($25): $50
a.
b.
c.
d.
1249
c.
d.
Requirement 3
The effect of the investment on Camerons December 31, 2013, retained
earnings would not differ between the equity method and proportionate
consolidation treatments. Under the equity method, Cameron would
recognize investment revenue based on its share of Lakes net income,
while under proportionate consolidation, Cameron would include its share
of Lakes revenue and expenses on those lines of the consolidated income
statement. Regardless, the same total amount would be included in
Camerons net income and closed to Camerons retained earnings.
Intermediate Accounting, 7e
Exercise 1221
Requirement 1
Electing the fair value option for held-to-maturity securities simply requires
reclassifying those securities as trading securities. Therefore, this investment
would be classified as a trading security on Tanner-UNFs balance sheet.
Requirement 2
Investment in bonds (face amount) .......................
Discount on bond investment (difference) ........
Cash (price of bonds) ..........................................
($ in millions)
240
40
200
Requirement 3
Cash (3% x $240 million) .......................................
Discount on bond investment (difference) ............
Interest revenue (4% x $200) ..................................
7.2
.8
8.0
Requirement 4
The carrying value of the bonds is $240 ($40 0.8) = $200.8. Therefore, to
adjust to fair value of $210, Tanner-UNF would need the following journal entry:
Fair value adjustment .........................................
Net unrealized holding gains and lossesI/S ($210 200.8)
9.2
9.2
Requirement 5
Tanner-UNF reports its investment in the December 31, 2013, balance sheet at
fair value of $210 million.
Requirement 6
Cash (proceeds from sale) .......................................
Loss on sale of investments (to balance)...............
Discount on bond investment (account balance)....
Investment in bonds (account balance)...............
($ in millions)
190.0
10.8
39.2
240.0
Assuming no other trading securities, the 2014 adjusting entry would be:
Net unrealized holding gains and lossesI/S ....
9.2
Fair value adjustment (account balance) ...........
9.2
The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol. 1, Chapter 12
1251
Exercise 1222
Requirement 1
Electing the fair value option for available-for-sale securities simply requires
reclassifying those securities as trading securities. Therefore, this investment
would be classified as a trading security on Sanborns balance sheet.
Requirement 2
Purchase
($ in millions)
90
90
Net income
No entry
Dividends
Cash (5% x $60 million)..................................................................
Adjusting entry
8
8
Requirement 3
Investment revenue (dividends)...........................................
Net unrealized holding gains and losses (from adjusting entry)
Total effect on 2013 net income before taxes
$ 3,000
8,000
11,000
Intermediate Accounting, 7e
Exercise 1223
Requirement 1
Electing the fair value option for significant-influence investments requires use
of the same basic accounting approach that is used for trading securities.
However, the investments will still be classified as significant-influence
investments and shown either on the same line of the balance sheet as
equitymethod investments (but with the amount at fair value indicated
parenthetically) or on a separate line of the balance sheet.
Requirement 2
Purchase
($ in millions)
56
56
Net income
No entry.
Dividends
Cash (30% x 8 million shares x $1.25) ...........................................
3
4
4
Note: A different approach to reach the same outcome would be for Florists to use
equity method accounting throughout the year, and then at the end of the year
make whatever adjustment to fair value is necessary to adjust the investment
account to fair value. Under that approach, Florists would recognize 30% of
Nurserys $40 million of income ($12 million) as investment income, it would not
recognize investment income associated with Nurserys dividend, and would end
up with an investment account containing $65 ($56 million + 12 million 3
million). The company would need to make a fair value adjustment of $13
million ($65 million 52 million). So the total amount of loss recognized would
be $1 million ($12 million investment income 13 million unrealized loss). Note
that this alternative produces the same total amount of investment loss as is
produced above: $1 million ($3 million investment revenue 4 million unrealized
loss).
The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol. 1, Chapter 12
1253
Exercise 1224
Requirement 1
Insurance expense (difference) ...............................................
Cash surrender value of life insurance ($27,000 21,000)......
Cash (2013 premium) ..........................................................
Requirement 2
Cash (death benefit) .........................................................
Cash surrender value of life insurance (account balance)
Gain on life insurance settlement (to balance) ...........
64,000
6,000
70,000
4,000,000
27,000
3,973,000
Exercise 1225
Requirement 1
Insurance expense (difference) .......................................
Cash surrender value of life insurance ($4,600 2,500) ..
Cash (premium) ..........................................................
22,900
2,100
25,000
Requirement 2
Cash (death benefit) .........................................................
Cash surrender value of life insurance (account balance)
Gain on life insurance settlement (to balance) ...........
250,000
16,000
234,000
Intermediate Accounting, 7e
Exercise 1226
Requirement 1
Bloom believes it is more likely than not it will have to sell the investment before
fair value recovers, so the portion of the impairment that consists of credit and
noncredit losses is not relevant. Bloom must recognize the entire OTT impairment in
earnings as follows:
Other-than-temporary impairment lossI/S ....
Discount on bond investment .........................
400,000
400,000
In the income statement, the entire $400,000 will be shown as an OTT impairment
loss.
Requirement 2
Bloom does not plan to sell the investment, and does not believe it is more likely
than not that it will have to sell the investment before fair value recovers, so the
portion of the impairment that consists of credit and noncredit losses is relevant.
Bloom must recognize the $250,000 of credit losses as an OTT impairment in
earnings, and the other $150,000 as a reduction of OCI, as follows:
Other-than-temporary impairment lossI/S ....
Discount on bond investment .........................
250,000
150,000
150,000
250,000
In the income statement, the entire $400,000 will be shown as an OTT impairment
loss, then the amount of noncredit loss is subtracted to leave only the credit loss
reducing earnings:
OTT impairment on HTM investments
Total OTT impairment loss .......................
Less portion recognized in OCI .................
Net OTT impairment recognized in earnings
($400,000)
$150,000
($250,000)
1255
Intermediate Accounting, 7e
Exercise 1227
Requirement 1: Assuming Bloom has not previously recorded a $100,000 loss
Scenario 1: Bloom believes it is more likely than not it will have to sell the
investment before fair value recovers, so the portion of the impairment that consists of
credit and noncredit losses is not relevant. Bloom must recognize the entire OTT
impairment in earnings. Bloom makes the following entry:
Other-than-temporary impairment lossI/S ....
Discount on bond investment .........................
400,000
400,000
In the income statement, the entire $400,000 will be shown as an OTT impairment
loss. There is no effect on OCI, and a $400,000 effect on comprehensive income.
Scenario 2: Bloom does not plan to sell the investment, and does not believe it is
more likely than not that it will have to sell the investment before fair value recovers,
so the portion of the impairment that consists of credit and noncredit losses is relevant.
Bloom must recognize the $250,000 of credit losses as an OTT impairment in
earnings, and the other $150,000 as a reduction of OCI. Bloom makes the following
entry:
Other-than-temporary impairment lossI/S ....
Discount on bond investment .........................
250,000
150,000
250,000
150,000
In the income statement, the entire $400,000 will be shown as an OTT impairment
loss, then the amount of noncredit loss is subtracted to leave only the credit loss
reducing earnings:
OTT impairment on AFS investments
Total OTT impairment loss .......................
Less portion recognized in OCI .................
Net OTT impairment recognized in earnings
($400,000)
$150,000
($250,000)
So, net income will be decreased by $250,000, OCI by $150,000, and comprehensive
income by $400,000.
The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol. 1, Chapter 12
1257
400,000
400,000
Assuming a previously recorded $100,000 unrealized loss, Bloom must also reclassify
that loss out of OCI and the fair value adjustment. In 2012 Bloom would have made
the following entry:
Net unrealized holding gains and lossesOCI .
Fair value adjustment ......................................
100,000
100,000
100,000
100,000
In the income statement, the entire $400,000 will be shown as an OTT impairment
loss. OCI will be increased by the $100,000 reclassification, such that the net effect
on comprehensive income is $300,000.
Intermediate Accounting, 7e
250,000
150,000
250,000
150,000
Assuming a previously recorded $100,000 unrealized loss, Bloom must also reclassify
that loss out of OCI and the fair value adjustment:
Fair value adjustment .........................................
Net unrealized holding gains and lossesOCI
100,000
100,000
Note that, when combined with the other journal entries, the net effect is that net
income is decreased by $250,000, OCI is decreased by $50,000 ($150,000 100,000),
and comprehensive income therefore is decreased by $300,000. That makes sense,
because $100,000 of decrease in OCI and comprehensive income occurred in 2012,
when the $100,000 unrealized loss was recognized.
Scenario 3: Bloom does not plan to sell the investment, and does not believe it is
more likely than not that it will have to sell the investment before fair value recovers,
but the entire impairment consists of noncredit losses, so Bloom does not record any
OTT impairment.
1259
Exercise 1228
December 31, 2013:
Kettle must record an unrealized loss of $10,000 to account for the fact that the fair
value of Icalcs shares has fallen from the original cost of $50,000 to $40,000.
Net unrealized holding gains and lossesOCI .....................
Fair value adjustment ($50,000 40,000) ...........................
10,000
10,000
This adjustment has no effect on net income, but it reduces OCI and
comprehensive income by $10,000.
December 31, 2014:
Kettle now must record an OTT impairment. To reduce the investment from its
original cost of $50,000 to $25,000, Kettle makes the following entry:
Other-than-temporary impairment loss ($50,000 25,000)
Investment in Icalc ..........................................
25,000
25,000
Kettle also must reclassify the 2013 unrealized loss out of OCI and remove the fair
value adjustment, making the following entry that reverses the 2013 entry:
Fair value adjustment ..........................................
Net unrealized holding gains and lossesOCI
10,000
10,000
In the income statement, the $25,000 will be shown as an OTT impairment loss. OCI
will be increased by the $10,000 reclassification, such that the net effect on
comprehensive income is $15,000.
December 31, 2015:
Subsequent to recording the OTT impairment, Kettle continues to treat the
investment as AFS, but with an amortized cost of $25,000. Given an increase in fair
value to $30,000 during 2015, Kettle records a $5,000 unrealized gain, with no effect
on net income but an increase of $5,000 to OCI and comprehensive income:
Fair value adjustment ..........................................
Net unrealized holding gains and lossesOCI
5,000
5,000
Intermediate Accounting, 7e
Exercise 1229
Requirement 1
HTM investment, December 31, 2013
Under IFRS, only credit losses are recognized as OTT impairments with respect to
HTM investments. Therefore, Flower would make the following journal entry to
reduce the carrying value of the investment from its amortized cost of 1,000,000 to
the present value of expected future cash flows (computed at the discount rate that
applied when the investment was purchased) of 750,000:
Other-than-temporary impairment loss ..............
Investment in James bonds .............................
250,000
250,000
Requirement 2
HTM investment, December 31, 2014
Under IFRS, OTT impairments associated with debt investments can be recovered.
Therefore, Flower would record a reversal of OTT impairment to increase the carrying
value of the James investment from 750,000 to 800,000 (the present value of
expected future cash flows as of December 31, 2014, computed at the discount rate
that applied when the investment was purchased):
Investment in James bonds .................................
Recovery of other-than-temporary impairment loss
50,000
50,000
Requirement 3
AFS debt investment, December 31, 2013
Under IFRS, the entire difference between amortized cost and fair value is shown
as an OTT impairment with respect to an AFS investment. Therefore, Flower would
make the following journal entry to reduce the carrying value of the investment from
its amortized cost of 1,000,000 to fair value of 600,000:
Other-than-temporary impairment loss ..............
Investment in James bonds .............................
400,000
400,000
1261
275,000
275,000
275,000
275,000
Intermediate Accounting, 7e
SUPPLEMENT EXERCISES
Exercise 1230
Requirement 1
Cash (3% x $10,000) ..............................................
Interest revenue ...............................................
300
300
Requirement 2
Watney would report the bonds at amortized cost, given that the bonds are
simple debt and Watney intends to hold the bonds to maturity. Therefore,
Watney would not record any unrealized gain or loss (but would need to
consider whether impairment recognition is appropriate).
Exercise 1231
Requirement 1
Cash (3% x $10,000) ..............................................
Interest revenue ...............................................
300
300
Requirement 2
The bonds are simple debt, so Watney would report half of the bonds at FVNI (because the bonds are held for sale) and the other half at FV-OCI (because
the bonds are held for investment purposes). Therefore, Watney would prepare
the following journal entry:
Net unrealized holding gains and lossesI/S
([$10,000 9,000] 2) .............................................................
Net unrealized holding gains and lossesOCI
([$10,000 9,000] 2) .............................................................
Fair value adjustment ($10,000 9,000) ................
500
500
1,000
1263
$28,000
(1,400)
$26,600
(31,500)
$(4,900)
Intermediate Accounting, 7e
1265
8,000
2,000
8,000
2,000
Intermediate Accounting, 7e
$400,000
50,000
(15,000)
$435,000
1267
Intermediate Accounting, 7e
PROBLEMS
Problem 121
Requirement 1
Investment in bonds (face amount) .......................
Discount on bond investment (difference) ........
Cash (price of bonds) ..........................................
($ in millions)
80
14
66
Requirement 2
Cash (4% x $80 million) .........................................
Discount on bond investment (difference) ............
Interest revenue (5% x $66) ....................................
3.20
.10
Requirement 3
Cash (4% x $80 million) .........................................
Discount on bond investment (difference) ............
Interest revenue (5% x [$66 + 0.1]) ........................
3.20
.11
3.30
3.31
Requirement 4
Fuzzy Monkey reports its investment in the December 31, 2013, balance sheet
at its amortized cost; that is, its book value:
Investment in bonds ............................................................
Less: Discount on bond investment ($14 0.1 0.11 million)
Amortized cost ................................................................
$80.00
13.79
$66.21
Increases and decreases in the fair value between the time a debt security is
acquired and the day it matures to a prearranged maturity value are relatively
unimportant if sale before maturity isnt an alternative. For this reason, if an
investor has the positive intent and ability to hold the securities to maturity,
investments in debt securities are classified as held-to-maturity and reported
at amortized cost rather than fair value in the balance sheet.
1269
Intermediate Accounting, 7e
Problem 122
Requirement 1
Investment in bonds (face amount)........................
Discount on bond investment (difference) ........
Cash (price of bonds) ..........................................
($ in millions)
80
14
66
Requirement 2
Cash (4% x $80 million) .........................................
Discount on bond investment (difference) ............
Interest revenue (5% x $66) ....................................
3.20
.10
Requirement 3
Cash (4% x $80 million) .........................................
Discount on bond investment (difference) ............
Interest revenue (5% x [$66 + 0.1]) ........................
3.20
.11
3.30
3.31
Requirement 4
Fuzzy Monkey reports its investment in the December 31, 2013, balance sheet
at its fair value, $70 million in this case. For investments in trading securities,
changes in market values, and thus market returns, provide an indication of
managements success in deciding when to acquire the investment, when to sell
it, whether to invest in fixed-rate or variable-rate securities, and whether to
invest in long-term or short-term securities.
To do this, we first need to determine the investments amortized cost (or book
value) at the end of the year:
Investment in bonds ............................................................
Less: Discount on bond investment ($14 0.10 0.11 million)
Amortized cost ................................................................
$80.00
13.79
$66.21
3.79
3.79
Because these are trading securities, the unrealized holding gain of $3.79 would
be recognized in Fuzzy Monkeys 2013 income statement.
1271
Intermediate Accounting, 7e
Problem 123
Requirement 1
Investment in bonds (face amount)........................
Discount on bond investment (difference) ........
Cash (price of bonds) ..........................................
($ in millions)
80
14
66
Requirement 2
Cash (4% x $80 million) .........................................
Discount on bond investment (difference) ............
Interest revenue (5% x $66) ....................................
3.20
.10
Requirement 3
Cash (4% x $80 million) .........................................
Discount on bond investment (difference) ............
Interest revenue (5% x [$66 + 0.1]) ........................
3.20
.11
3.30
3.31
Requirement 4
Fuzzy Monkey reports its investment in the December 31, 2013, balance sheet
at its fair value, $70 million in this case. For investments in securities
available-for-sale, changes in market values, and thus market returns, provide
an indication of managements success in deciding when to acquire the
investment, when to sell it, whether to invest in fixed-rate or variable-rate
securities, and whether to invest in long-term or short-term securities.
To do this, we first need to determine the investments amortized cost (or book
value) at the end of the year:
Investment in bonds ............................................................
Less: Discount on bond investment ($14 0.1 0.11 million)
Amortized cost ................................................................
$80.00
13.79
$66.21
3.79
3.79
1273
Intermediate Accounting, 7e
Problem 124
Note: Because Fuzzy Monkey elected the fair value option, these investments will be
reclassified as trading securities and accounted for under that approach. Therefore,
the answers to Requirements 15 are the same as those to Problem 122.
Requirement 1
Investment in bonds (face amount)........................
Discount on bond investment (difference) ........
Cash (price of bonds) ..........................................
($ in millions)
80
14
66
Requirement 2
Cash (4% x $80 million) .........................................
Discount on bond investment (difference) ............
Interest revenue (5% x $66) ....................................
3.20
.10
Requirement 3
Cash (4% x $80 million) .........................................
Discount on bond investment (difference) ............
Interest revenue (5% x [$66 + 0.1]) ........................
3.20
.11
3.30
3.31
Requirement 4
Fuzzy Monkey reports its investment in the December 31, 2013, balance sheet
at its fair value, $70 million in this case. For investments in trading securities,
changes in market values, and thus market returns, provide an indication of
managements success in deciding when to acquire the investment, when to sell
it, whether to invest in fixed-rate or variable-rate securities, and whether to
invest in long-term or short-term securities.
To determine the journal entry that Fuzzy Monkey must make, we first need to
determine the investments amortized cost (or book value) at the end of the
year:
Investment in bonds ............................................................
Less: Discount on bond investment ($14 0.10 0.11 million)
Amortized cost ................................................................
$80.00
13.79
$66.21
1275
3.79
3.79
Because these are trading securities, the unrealized holding gain of $3.79 would
be recognized in Fuzzy Monkeys 2013 income statement.
Requirement 5
Fuzzy Monkeys 2013 statement of cash flows would be affected as follows:
Operating activities cash flows: Cash inflow from interest of $3.2
+ 3.2 = $6.4. (Note: if Fuzzy Monkey prepares an indirect
method statement of cash flows, it would have included in net
income interest revenue of $3.30 + 3.31 = $6.61 and an
unrealized holding gain of $3.79, totaling $10.4, so would have to
include an adjustment of $6.4 10.4 = ($4.0) to get from net
income to the correct operating activities cash flow.)
Fuzzy Monkey would also be likely to treat the cash outflow
from purchasing trading securities of $66 as an operating
activities cash flow. However, if Fuzzy Monkey anticipates
holding these investments for a sufficiently long period, it could
classify this cash outflow as an investing activities cash flow.
Requirement 6
The answers to requirements 15 would not differ if the investment
qualified for treatment as a held-to-maturity investment, because Fuzzy
Monkeys choice of the fair value option still requires reclassification of
the investment as trading securities.
Intermediate Accounting, 7e
Problem 125
Requirement 1
2013
February 21
Investment in Distribution Transformers shares ........
Cash .........................................................................
400,000
400,000
March 18
Cash .............................................................................
Investment revenue ..................................................
8,000
September 1
Investment in American Instruments bonds ...............
Cash .........................................................................
900,000
October 20
Cash .............................................................................
Investment in Distribution Transformers ..............
Gain on sale of investments.....................................
November 1
Investment in M&D Corporation shares ....................
Cash .........................................................................
8,000
900,000
425,000
400,000
25,000
1,400,000
1,400,000
1277
Available-for-Sale Securities
M & D Corporation shares
American Instruments bonds
TotalsDec. 31, 2013
Cost
$1,400,000
900,000
$2,300,000
30,000
Fair Value
$1,460,000
850,000
$2,310,000
30,000
Accumulated
Unrealized
Gain (Loss)
$60,000
(50,000)
$10,000*
10,000
10,000*
* The $10,000 credit balance in the net unrealized holding gain is reported as 2013 other
comprehensive income in the statement of comprehensive income. It serves to increase
accumulated other comprehensive income, a component of shareholders equity in the 2013
balance sheet.
Intermediate Accounting, 7e
38,000
25,000
10,000
Balance sheet:
Current Assets
Investment revenue receivable
30,000
Note: Unlike for trading securities, unrealized holding gains and losses are not
included in income for securities available-for-sale.
Securities available-for-sale
Plus: Fair value adjustment
$2,300,000
10,000 $2,310,000
Shareholders Equity
Accumulated other comprehensive income
Net unrealized holding gain (loss) ($60,000 50,000)
$ 10,000
* Can be reported either (a) as a combined statement of comprehensive income that includes net
income and other comprehensive income, or (b) as a separate statement of comprehensive
income.
1279
1,485,000
85,000
1,400,000
45,000
30,000
15,000
August 12
Investment in Vast Communications shares ...............
Cash ..........................................................................
650,000
September 1
Cash ..............................................................................
Investment revenue ..................................................
45,000
650,000
45,000
Intermediate Accounting, 7e
Securities
Vast Communication shares
American Instruments bonds
TotalsDec. 31, 2014
Cost
$650,000
900,000
$1,550,000
30,000
30,000
Fair Value
$670,000
830,000
$1,500,000
Accumulated
Unrealized
Gain (Loss)
$20,000
(70,000)
$(50,000)*
Fair Value
Adjustment
($50)
$10
($60)
------------------------------------------------------------------------------------------ $50,000
0 + $10,000
<-------------------------------------------- $60,000
60,000*
60,000
* The $60,000 debit balance in the net unrealized holding gains and losses is
reported as 2014 other comprehensive income in the statement of
comprehensive income. It serves to decrease accumulated other comprehensive
income, a component of shareholders equity in the 2014 balance sheet, from
the $10,000 credit balance it showed on the 2013 balance sheet to the $50,000
debit balance it shows in the 2014 balance sheet.
1281
90,000
85,000
Note: Unlike for trading securities, unrealized holding gains and losses are not
included in income for securities available-for-sale.
Statement of comprehensive income*:
Net unrealized holding gains and losses on investments
$ (60,000)
Balance sheet:
Current Assets
Investment revenue receivable
Securities available-for-sale
Less: Fair value adjustment
30,000
$1,550,000
(50,000) $1,500,000
Shareholders Equity
Accumulated other comprehensive income
Net unrealized holding gain (loss) ($20,000 70,000)
$ (50,000)
Intermediate Accounting, 7e
Problem 126
Requirement 1
2013
December 12
Investment in FF&G Corporation bonds .....................................
Cash ..........................................................................................
December 13
Investment in Ferry common shares ...........................................
Cash ..........................................................................................
December 15
Cash ..............................................................................................
Investment in FF&G Corporation bonds .................................
Gain on sale of investments ($12.1 12) ....................................
($ in millions)
12
12
22
22
12.1
12.0
0.1
December 22
Investment in U.S. treasury bills .................................................
Investment in U.S. treasury bonds ...............................................
Cash ..........................................................................................
56
65
December 23
Cash ..............................................................................................
Loss on sale of investments ($10 11)...........................................
Investment in Ferry common shares ($22 x 1/2) .........................
10
1
December 26
Cash (selling price) ..........................................................................
Gain on sale of investments ($57 56) ......................................
Investment in U.S. treasury bills (account balance) .....................
December 27
Cash (selling price) ..........................................................................
Loss on sale of investments ($63 65)...........................................
Investment in U.S. treasury bonds (account balance) ..................
121
11
57
1
56
63
2
65
1283
0.2
0.2
December 31
($ in millions)
Adjusting entry:
Net unrealized holding gains and lossesI/S
($10 million [$22 million x 1/2]) ....................................................
Fair value adjustment ................................................................
Closing entry:
Income summary (to balance)..........................................................
Investment revenue ($5 + 0.2 million) ..............................................
Gain on sale of investments ($8 + 0.1 + 1 million) ...........................
Loss on sale of investments ($11 + 1 + 2 million) ........................
Net unrealized holding gains and lossesI/S (adjusting entry)...
1.0
1.0
.7
5.2
9.1
14.0
1.0
11
(1)
10
Income statement:
Investment revenue (closing entry)
5.2
Gain on sale of investments (closing entry)
9.1
Loss on sale of investments (closing entry)
(14.0)
Net unrealized holding gains and losses on investments (closing entry) (1.0)
Intermediate Accounting, 7e
2014
January 2
($ in millions)
10.2
0.8
11.0
1.0
1.0
34
34
1285
Problem 127
($ in millions)
2013
October 18
Investment in Millwork Ventures preferred shares .....................
58
Cash ...........................................................................................
58
October 31
Cash ...............................................................................................
Investment revenue ...................................................................
1.5
1.5
November 1
Investment in Holistic Entertainment bonds .................................
Cash ...........................................................................................
18
November 1
Cash ...............................................................................................
Loss on sale of investments ($28 30) ...........................................
Investment in Kansas Abstractors bonds .................................
28
2
December 1
Investment in Household Plastics bonds ......................................
Cash ...........................................................................................
60
December 20
Investment in U.S. treasury bonds ...............................................
Cash ...........................................................................................
December 21
Investment in NXS common shares .............................................
Cash ...........................................................................................
December 23
Cash ...............................................................................................
Investment in U.S. treasury bonds ...........................................
Gain on sale of investments ($5.7 5.6) .....................................
18
30
60
5.6
5.6
44
44
5.7
5.6
.1
Intermediate Accounting, 7e
December 29
Cash ..............................................................................................
Investment revenue ................................................................
December 31
Accrued interest:
Investment revenue receivable - Holistic
Entertainment ($18 million x 10% x 2/12) ........................................
Investment revenue receivableHousehold
Plastics ($60 million x 12% x 1/12) ..................................................
Investment revenue ...............................................................
0.3
0.6
0.9
Revaluations:
Net unrealized holding gains and lossesOCI
([2 million shares of Millwork Ventures x $27.50] $58 million) .........
3
2
2
2.0
5.4
.1
2.0
5.5
1287
43
1
44
2.0
2.0
Intermediate Accounting, 7e
Problem 128
Requirement 1
Beale should report its securities available-for-sale in its December 31, 2014,
balance sheet at their fair value, $54 million.
Requirement 2
The journal entry needed to enable the investment to be reported at fair value is:
($ in millions)
Requirement 3
As of December 31, 2013, the cost of the Schwab Pharmaceuticals investment was
$25 million and its fair value was $27 million. Therefore, in the year-end 2013
adjustment process, Beale must have made whatever adjustment was necessary to
produce a debit balance of $2 in the fair value adjustment valuation allowance for
Schwab Pharmaceuticals and a credit balance of that amount in accumulated other
comprehensive income. Because the Schwab Pharmaceuticals investment was sold
during 2014, the reclassification adjustment would have to remove that amount in
2014. Beales statement of comprehensive income can be provided (a) as a
combined statement of comprehensive income that includes net income and other
comprehensive income, or (b) as a separate statement of comprehensive income in
a manner similar to this:
STATEMENT OF COMPREHENSIVE INCOME
($ in millions)
$xxx
$3
(2)
1
$xxx
1289
Intermediate Accounting, 7e
Problem 129
Requirement 1
Purchase
Investment in Lavery Labeling shares..........................................
Cash .........................................................................................
($ in millions)
324
324
Net income
Investment in Lavery Labeling shares (30% x $160 million) ..........
Investment revenue ...................................................................
48
Dividends
Cash (10 million shares x $2) ............................................................
Investment in Lavery Labeling shares......................................
20
Depreciation adjustment
48
20
Calculations:
Investee
Net Assets
Net Assets
Purchased
Cost
$324
Fair value:
Goodwill:
$60
Undervaluation
of depr. assets:
$24
Book value:
Difference
Attributed to:
1291
($ in millions)
324
324
Net income
No entry
Dividends
Cash (10 million shares x $2) .............................................................
Investment revenue ...................................................................
20
20
Adjusting entry
Net unrealized holding gains and lossesOCI
([10 million shares x $31] $324 million) ................................................
14
14
Intermediate Accounting, 7e
Problem 1210
Requirement 1
Purchase
Investment in Lavery Labeling shares..........................................
Cash .........................................................................................
($ in millions)
324
324
Net income
No entry
Dividends
Cash (10 million shares x $2) ............................................................
Investment revenue ...................................................................
20
20
Adjusting entry
Net unrealized holding gains and lossesI/S
([10 million shares x $31] $324 million) ..................................................
14
14
Requirement 2
Because Runyan is accounting for the Lavery investment under the fair value
option, the unrealized holding loss would be included in 2013 net income.
Therefore, total effect on net income would be $20 million 14 million, or $6
million.
1293
Problem 1211
Requirement 1 (note: requirement 1 has the same answer as does P 1210)
Purchase
Investment in Lavery Labeling shares ..........................................
Cash ..........................................................................................
($ in millions)
324
324
Net income
No entry
Dividends
Cash (10 million shares x $2) .............................................................
Investment revenue ...................................................................
20
20
Adjusting entry
Net unrealized holding gains and lossesI/S
([10 million shares x $31] $324 million) ................................................
14
14
Because Runyan is accounting for the Lavery investment under the fair value
option, the unrealized holding loss would be included in 2013 net income.
Therefore, total effect on net income would be $20 of dividend $14 of
unrealized holding loss, or $6. The investment would be shown in the balance
sheet at its fair value of $310.
Intermediate Accounting, 7e
($ in millions)
324
324
Net income
Investment in Lavery Labeling shares (30% x $160 million) ..........
Investment revenue ...................................................................
48
Dividends
Cash (10 million shares x $2) ............................................................
Investment in Lavery Labeling shares......................................
20
Depreciation adjustment
48
20
Calculations:
Investee
Net Assets
Net Assets
Purchased
Cost
$324
Fair value:
Goodwill:
$60
Undervaluation
of depr. assets:
$24
Book value:
Difference
Attributed to:
1295
Cost
324
Share of income 48
Balance
20 Dividends
4 Depreciation adjustment
_________________
348
At December 31, 2013, the fair value of that investment is $310 (= 10 million
shares x $31/share), implying need for the following adjusting entry to adjust
the carrying value of the investment to fair value:
Net unrealized holding gains and lossesI/S
([10 million shares x $31] $348 million) ................................................
38
38
Because Runyan is accounting for the Lavery investment under the fair value
option, the unrealized holding loss would be included in 2013 net income.
Therefore, total effect on net income would be $48 million for Runyans share of
Lavery income minus $4 million of depreciation adjustment and minus the $38
million unrealized holding loss, yielding a total of $6 of income. The
investment would be shown in the balance sheet at its fair value of $310 million.
Note that the income effect and the carrying value in the balance sheet are the
same in requirements 1 and 2.
Intermediate Accounting, 7e
Problem 1212
Requirement 1
Purchase
Investment in Vancouver T&M shares ........................................
Cash .........................................................................................
($ in millions)
400.0
400.0
Net income
Investment in Vancouver T&M shares (40% x $140 million) .........
Investment revenue ...................................................................
56.0
Dividends
Cash (40% x $30 million) .................................................................
Investment in Vancouver T&M shares ....................................
12.0
Inventory adjustment
Investment revenue ($5 million x 40%: all sold in 2013) ....................
Investment in Vancouver T&M shares ....................................
2.0
Depreciation adjustment
.5
56.0
12.0
2.0
.5
Calculations:
Investee
Net Assets
Net Assets
Purchased
Cost
$400
Fair value:
inventory
plant facilities
Book value:
Difference
Attributed to:
Goodwill:
$80 [plug]
Undervaluation
of inventory:
$2
Undervaluation
of plant:
$8
x 40% = $310
* $775 + 5 + 20
1297
Requirement 3
Investment in Vancouver T&M shares
($ in millions)
Cost
Share of income
Balance
400.0
56.0
12.0 Dividends
2.0 Inventory
.5 Depreciation
_________________
441.5
Requirement 4
$400 million cash outflow from investing activities
$12 million cash inflow (dividends) among operating activities
(Note: If Northwest uses the indirect method to report its cash flows from
operating activities, it would need an adjustment of ($41.5) to get from the
$53.5 included as investment revenue in net income to the $12 of cash actually
received in dividends and needing to be shown in cash flow from operating
activities.)
Intermediate Accounting, 7e
Problem 1213
Requirement 1
Millers management should decide whether it has the ability to exercise significant
influence over operating and financial policies of the Marlon Company. Ability to
exercise significant influence is presumed for investments of 20 percent or more of
voting stock and presumed not to exist for investments of less than 20 percent, other
things being equal. Evidence to the contrary should be considered, including
participation on the board of directors, technological dependency, material
intercompany transactions, or interchange of managerial personnel.
Requirement 2
a. Income statement:
Investment revenue ($12 million x 1/6)
Patent amortization adjustment ($4 million* 10)
($ in millions)
$2.0
(.4)
$1.6
b. Balance sheet:
Investment in Marlon Company
($19 million + 2 million 1 million 0.4 million)
$19.6*
1299
Cost
Share of income
Balance
19.0
2.0
1.0 Dividends ($6 million x 1/6)
.4 Amortization adjustment
_________________
19.6
Intermediate Accounting, 7e
Problem 1214
Item
__A_ 1. 35% of the nonvoting preferred stock
of American Aircraft Company.
__M_ 2. Treasury bills to be held-to-maturity.
__M_ 3. Two-year note receivable from affiliate.
__N_ 4. Accounts receivable.
__M_ 5. Treasury bond maturing in one week.
Reporting Category
T.
M.
A.
E.
C.
N.
Trading securities
Securities held-to-maturity
Securities available-for-sale
Equity method
Consolidation
None of these
12101
Problem 1215
Requirement 1
Bond Fair Value at 1/1/2013:
Interest [($150,000 x 6%) 2] x 14.21240 *
Principal
$150,000 x 0.50257 ** =
Present value of the receivable
$ 63,956
75,386
$139,342
January 1, 2013
Investment in bonds (face amount) ........................
Discount on bond investment (difference).........
Cash (price of bonds) ..........................................
150,000
10,658
139,342
Requirement 2
January 1, 2013
Investment in bonds (face amount) ........................
Discount on bond investment (difference).........
Cash (price of bonds) ..........................................
150,000
10,658
139,342
4,500
377
4,500
390
4,877
4,890
Intermediate Accounting, 7e
150,000
10,658
139,342
4,500
377
4,877
$ 59,103
71,196
$130,299
$139,342
377
$139,719
Comparing the amortized initial cost with the fair value of the bonds on that date
provides the amount needed to adjust the investment to its fair value.
June 30 amortized initial cost
June 30 fair value
Fair value adjustment needed
$139,719
130,299
$ 9,420
9,420
9,420
12103
4,500
390
4,890
$139,719
390
$140,109
Comparing the amortized initial cost with the fair value of the bonds on that date
provides the amount needed to adjust the investment to its fair value.
Dec. 31 amortized initial cost
Dec. 31 fair value
Fair value adjustment balance needed: debit/(credit)
Less: Current fair value adjustment debit/(credit)
Change in fair value adjustment needed
Net unrealized holding gains and lossesI/S ...........................
Fair value adjustment ...........................................................
$140,109
122,640
$ 17,469
(9,420)
$ 8,049
8,049
8,049
Intermediate Accounting, 7e
Problem 1216
Bee Company Investment
2013: Stewart does not plan to sell the Bee investment, and does not believe it is more
likely than not that it will have to sell the investment before fair value recovers, so the
portion of the impairment that consists of credit and noncredit losses is relevant.
Stewart must recognize the $240,000 of credit losses as an OTT impairment in
earnings, and the other $260,000 as a reduction of OCI, as follows:
Other-than-temporary impairment lossI/S .....
Discount on bond investment .........................
240,000
260,000
260,000
240,000
2014: Stewart ignores the change in Bees fair value during 2014, as the Bee
investment is accounted for as an HTM investment and fair value changes are not
relevant unless viewed as OTT impairments. GAAP does not allow recovery of prior
OTT impairments when fair value increases. Over the remaining life of the bonds,
Stewart would amortize the bonds as if they had a $240,000 discount. Stewart also
would amortize the $260,000 of Fair value adjustmentNoncredit loss in AOCI
over the remaining life of the bonds by crediting that account and debiting Fair value
adjustmentNoncredit loss for a portion each period, thus gradually decreasing the
amount shown in AOCI and increasing the carrying amount of the bonds.
Oliver Corporation Investment
2013: Stewart accounts for the Oliver investment as a trading security, so OTT
impairment accounting is not relevant. Stewart simply continues to recognize in
earnings any unrealized gains and losses associated with fair value changes. Given
that the bonds already have a negative fair value adjustment of $200,000, and need a
negative fair value adjustment of $300,000 to adjust from amortized cost of
$2,500,000 to fair value of $2,200,000, Stewart must recognize additional unrealized
losses of $100,000 for 2013.
Net unrealized holding gains and lossesI/S ........
Fair value adjustment .............................. .............
100,000
100,000
12105
500,000
500,000
225,000
575,000
225,000
575,000
Stewart also must reclassify the previously recognized $400,000 unrealized loss out of
OCI and the fair value adjustment:
Fair value adjustment ..........................................
Net unrealized holding gains and lossesOCI
400,000
400,000
Note that Stewart could net the latter two journal entries together to be:
Net unrealized holding gains and lossesOCI ..
Fair value adjustment ......................................
175,000
175,000
Intermediate Accounting, 7e
200,000
200,000
400,000
400,000
Stewart also must reclassify the previously recognized $120,000 unrealized gain out
of OCI and the fair value adjustment:
Net unrealized holding gains and lossesOCI..
Fair value adjustment ......................................
120,000
120,000
2014: Stewart continues to treat the Helms investment as AFS. Therefore, Stewart
would show an unrealized gain associated with an increase of fair value from
$600,000 to $700,000. Note that this is not a recovery of the OTT impairment, but
just normal ongoing accounting for an AFS investment.
Fair value adjustment .........................................
Net unrealized holding gains and lossesOCI
100,000
100,000
12107
Problem 1217
Bee Company Investment
2013: Under IFRS only the credit loss component is relevant for debt impairments.
Therefore, Stewart recognizes the $240,000 of credit losses as an OTT impairment in
earnings, as follows:
Other-than-temporary impairment loss ..............
Discount on bond investment ..........................
240,000
240,000
100,000
100,000
Intermediate Accounting, 7e
500,000
500,000
800,000
800,000
Stewart also must reclassify the previously recognized $400,000 unrealized loss out of
OCI and the fair value adjustment:
Fair value adjustment .........................................
Net unrealized holding gains and lossesOCI
400,000
400,000
12109
400,000
400,000
Stewart also must reclassify the previously recognized $120,000 unrealized gain out
of OCI and the fair value adjustment:
Net unrealized holding gains and lossesOCI ..
Fair value adjustment ......................................
120,000
120,000
2014: IFRS does not allow recovery of OTT impairments for equity investment.
However, Stewart continues to treat the Helms investment as AFS, so Stewart would
show an unrealized gain associated with an increase of fair value from $600,000 to
$700,000. This is not a recovery of the OTT impairment, but just normal ongoing
accounting for an AFS investment.
Fair value adjustment ..........................................
Net unrealized holding gains and lossesOCI
100,000
100,000
Intermediate Accounting, 7e
SUPPLEMENT PROBLEM
Problem 1218
Requirement 1
The Donald Company bonds are simple debt, so Fehertys business purpose
is relevant for the purpose of classification and reporting. Ten bonds are to be
held to collect contractual cash flows over the life of the debt, so they would be
accounted for at amortized cost. Ten of the bonds are held for investment
purposes, so they would be accounted for at FV-OCI. Thirty of the bonds are
held for immediate resale, so they would be accounted for at FV-NI.
The Watson company stock would be accounted for at FV-NI because it does
not qualify for the equity method, and equity investments for which significant
influence is absent are accounted for at FV-NI.
Requirement 2
The Donald Company bonds would be reported as follows:
Ten bonds are accounted for at amortized cost. No unrealized gain or loss
would be recognized in OCI or net income, but five of the bonds were sold
at a price of $1,040 per bond, yielding a gain on sale of 5 x ($1,040 1,000)
= $200. That gain would be included in net income. Ten bonds are
accounted for at FV-OCI. Five of the bonds were sold at a price of $1,040
per bond, yielding a gain on sale of 5 x ($1,040 1,000) = $200. If there is
an unrealized gain or loss already recorded in OCI associated with these
bonds, that amount would be reclassified out of OCI, but in this case no
such amount exists. Therefore, that gain would be included in net income
and, therefore, in comprehensive income.
For the other five of the bonds accounted for at FV-OCI and not sold as of
the end of the period, 5 x ($1,040 1,000) = $200 of unrealized gains and
losses would be included in OCI and, therefore, in comprehensive income.
Thirty bonds are accounted for at FV-NI. Fifteen of the bonds were sold at
a price of $1,040 per bond, yielding a gain on sale of 15 x ($1,040 1,000)
= $600. That gain would be included in net income and, therefore, in
comprehensive income.
For the other 15 of the bonds accounted for at FV-NI, unrealized gains of
15 x ($1,040 1,000) = $600 would be included in net income and,
therefore, in comprehensive income.
12111
Problem 1218(concluded)
The Watson Company common stock investment is accounted for at FV-NI, so
an unrealized loss of $5,000 ($25,000 20,000) would be included in net
income and, therefore, in comprehensive income.
Total effects are as follows:
Net income: $200 (sold amortized cost) + 200 (sold FV-OCI) + 600 (sold FVNI) + 600 (retained FV-NI) 5,000 (retained equity) = ($3,400) net loss.
OCI: $200 (retained FV-OCI)
Comprehensive income = Net income + OCI = ($3,400) + 200 = ($3,200)
Note: You might expect the total amount shown in comprehensive income to
equal the total change in fair value for the investments ($2,000 5,000 =
($3,000)), but that does not have to be the case because unrealized gains
and losses on investments accounted for at amortized cost do not affect
net income, OCI, or comprehensive income. In this case, $200 of
unrealized gains associated with the five unsold amortized cost bonds is
not recognized, which explains the difference between the change in fair
value of ($3,000) and the amount of change recognize in comprehensive
income of ($3,200).
Intermediate Accounting, 7e
CASES
Real World Case 121
Requirement 1
Fair Value Adjustment, AFS Investments
$648 gain 19 loss on 12/25/2012
629
72 reduction over first half of 2011
____________
557
Requirement 2
Intel needs to record unrealized holding gains and losses associated with its AFS
investments during the first half of 2013:
Fair value adjustment, AFS investment .................
Net unrealized holding gains and lossesOCI
24
24
Requirement 3
Fair Value Adjustment, AFS Investments
$648 gain 19 loss on 12/25/2012
unrealized gains
629
24
96 to balance
____________
557
12113
Intermediate Accounting, 7e
12115
Intermediate Accounting, 7e
12117
Intermediate Accounting, 7e
2009
$10,900
$9,311
Short-term investments
$ 1,301
$293
$ 2,175
$432
CURRENT ASSETS:
NONCURRENT ASSETS:
Investments
12119
Intermediate Accounting, 7e
12121
Intermediate Accounting, 7e
12123
Intermediate Accounting, 7e
12125
Intermediate Accounting, 7e
12127