chapter 15 leases - departamento de...

Appendix D - Investments

© The McGraw-Hill Companies, Inc., 2014

Solutions Manual, Appendix D D-1

Appendix D Investments

REVIEW QUESTIONS

Question D-1 (LO D-1) A company might invest in another company to (1) receive dividends, earn interest, and gain

from the increase in the value of their investment, (2) temporarily invest excess cash created by

operating in seasonable industries, or (3) build strategic alliances, increase market share, or enter

new industries.

Question D-2 (LO D-1) Companies can gain from the increase in the value of their investment. Even without receiving

dividends, investors still benefit when companies reinvest earnings, leading to even more profits in

the future and eventually higher stock prices. Many companies also make investments for strategic

purposes to develop closer business ties, increase market share, or expand into new industries.

Question D-3 (LO D-1) Companies in seasonal industries often invest excess funds generated during the busy season and

draw on these funds in the slow season.

Question D-4 (LO D-1) PepsiCo purchased Tropicana in order to diversify beyond soft drinks.

Question D-5 (LO D-1) The flip side of an investment in equity securities is the issuance of stock.

Question D-6 (LO D-1) The method depends on the level of influence. An insignificant level of influence results in the

use of the fair value method. A significant, but not controlling, level of influence results in the use of

the equity method. A controlling level of influence results in the use of the consolidation method.

Question D-7 (LO D-2) The two categories are trading securities and available-for-sale securities.

Question D-8 (LO D-2) Dividends received are accounted for as dividend revenue under the fair value method.

Question D-9 (LO D-2) An unrealized holding gain is the gain in value while holding the investment, while a realized

gain is recognized in cash (or the right to receive cash) after the investment has been sold.



D-2 Financial Accounting, 3e

Answers to Review Questions (continued)

Question D-10 (LO D-2) The way unrealized holding gains and losses are reported in the financial statements depends on

whether the investments are classified as “trading” or “available-for-sale.” Trading securities are

reported at fair value, and resulting holding gains and losses are included in the determination of net

income for the period.

Question D-11 (LO D-2) The way unrealized holding gains and losses are reported in the financial statements depends on

whether the investments are classified as “trading” or “available-for-sale.” Available-for-sale

securities are reported at fair value, and resulting holding gains and losses are not included in the

determination of net income for the period. Rather, they are reported as part of other comprehensive

income.

Question D-12 (LO D-3) The equity method is used when an investor control

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 D-13 (LO D-3) 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

recognize revenue again when earnings are distributed as dividends.

Question D-14 (LO D-4) These statements combine the parent’s and subsidiary’s operating activities as if the two

companies were a single reporting company, even though both companies continue to operate as

separate legal entities.

Question D-15 (LO D-4) It is appropriate to consolidate financial statements of two companies when the parent company

owns a controlling interest (more than 50%) in the voting stock of the subsidiary.

Question D-16 (LO D-5) The flip side of an investment in debt securities is the issuance of debt, such as bonds.

Question D-17 (LO D-5) If bonds are purchased at a discount, the carrying value of the investment in bonds and the

amount recorded for interest revenue will increase over time. Recall that interest revenue is

calculated as the carrying value of the bond times the market interest rate. As carrying value

increases, interest revenue also increases.




Answers to Review Questions (continued)

Question D-18 (LO D-5) If bonds are purchased at a premium, the carrying value of the investment in bonds and the

amount recorded for interest revenue will decrease over time. Recall that interest revenue is

calculated as the carrying value of the bond times the market interest rate. As carrying value

decreases, interest revenue also decreases.

Question D-19 (LO D-5) When interest rates go down, the value of a bond with fixed interest payments goes up because

the fixed interest payments are now more attractive to investors.

Question D-20 (LO D-5) Investments in debt securities are classified as “held-to-maturity,” “trading,” or “available-for-

sale” securities. Held-to-maturity securities are debt securities that the company expects to hold until

they mature, which means until they become payable. Trading securities are securities that the

investor expects to sell in the near future. These investments are adjusted to fair value with the

unrealized gain or loss included in net income. Available-for-sale securities are investments that do

not fit the other two categories; they are not expected to be sold in the near future, yet they are not

expected to be held to maturity either. These investments are adjusted to fair value with the

unrealized gain or loss included in comprehensive income.




BRIEF EXERCISES

Brief Exercise D-1 (LO D-1)

X 1. To invest excess cash created by operating in seasonal industries.

2. To increase employees’ morale.

X 3. To build strategic alliances.

4. To reduce government regulation.

X 5. To receive interest and dividends.

Brief Exercise D-2 (LO D-2) September 1 Debit Credit

Investments (150 shares × $13) 1,950

Cash 1,950 (Purchase common stock)

November 1

Cash (150 shares × $17) 2,550


Gain (difference) 600 (Sell investments above recorded amount)





December 28 Debit Credit

Investments 485,000

Cash 485,000

(Purchase common stock)

December 31

Unrealized Holding Loss—Net Income 2,000

Investments 2,000 (Adjust investments to fair value)


December 28 Debit Credit

Investments 485,000


December 31 Unrealized Holding Loss—Other Comprehensive Income 2,000

Investments 2,000

(Adjust investments to fair value)




Brief Exercise D-5 (LO D-2) These are trading securities and are reported at their fair value, $20,000. We know

this because 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.” Of course, the equity method isn’t appropriate because 1,000 shares of GE certainly don’t constitute “significant influence.” Investments in trading securities are reported at fair value.

Brief Exercise D-6 (LO D-2) These are available-for-sale securities and are reported at their fair value,

$20,000. 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 GE shares have been held for over a year. They are classified as “available-for-sale” since all investments in debt and equity securities that don’t fit the definitions of the other reporting categories are classified this way. Of course, the equity method isn’t appropriate either because 1,000 shares of GE certainly don’t constitute “significant influence.” Investments in available-for-sale securities are reported at fair value.

Brief Exercise D-7 (LO D-3) An investor should account for net income from an equity method investee as an

increase in its investments account and an increase in equity income. Therefore, Strong String’s reported net income of $20 million will increase investments and equity income for Wendy Day Kite Company by $8 million (= $20 million × 40%).

Brief Exercise D-8 (LO D-3) An investor should account for dividends from an equity method investee as a

reduction in its investment account. Since investment revenue is recognized as the investee earns it, it would be inappropriate to recognize revenue again when earnings are distributed as dividends. Instead, the dividend distribution is considered to be a reduction of the investee’s net assets, reflecting the fact that the investor’s ownership interest in those net assets declined proportionately. Wendy Day’s cash increased by $4 million (= $10 million × 40%). Its investment account declined by the same amount. There is no effect on the income statement.




Brief Exercise D-9 (LO D-4) Wendy Day would report total inventory of $22,000 in the consolidated financial

statements. Since Wendy Day owns all of the outstanding stock in Strong String

Company, Wendy Day will combine their total inventory of $14,000 with Strong

String’s total inventory of $8,000 in Wendy Day’s consolidated financial statements.


1. Debit Credit

January 1

Investments 40,000

Cash 40,000 (Purchase bonds)

2. June 30

Cash 1,400

Interest Revenue 1,400 (Receive semiannual interest revenue) ($1,400 = $40,000 × 7% × ½)




Brief Exercise D-11(LO D-5)

1. Debit Credit

January 1

Investments 37,282


2. June 30

Cash ($40,000 × 7% × ½) 1,400

Investments (difference) 91

Interest Revenue ($37,282 × 8% × ½) 1,491 (Receive semiannual interest revenue)


1. Debit Credit

January 1

Investments 42,975


2. June 30

Cash ($40,000 × 7% × ½) 1,400






EXERCISES

Exercise D-1 (LO D-1) __T__ 1. A reason companies invest in other companies is to build strategic alliances.

__F__ 2. All companies are required to pay dividends to their investors.

__F__ 3. When market interest rates increase, the market value of a bonds increases

as well.

__T__ 4. One way for a company to expand operations into a new industry is to

acquire the majority of another company’s common stock that already

operates in that industry.

__T__ 5. Stocks typically have greater upside potential, providing a higher average

return to their investors over the long-run than do bonds.

__F__ 6. Companies purchase debt securities primarily for the dividend revenue they

provide.




Exercise D-2 (LO D-2)

Requirement 1 December 20 Debit Credit

Investments 1,500,000

Cash 1,500,000 (Purchase common stock)

December 28

Cash 6,000

Dividend Revenue 6,000 (Receive cash dividends)

December 31

Unrealized Holding Loss—Net Income 60,000

Investments (300,000 shares × $0.20 per share) 60,000 (Adjust investments to fair value)

Note: The investments decreased in value $0.20 per share from $5.00 per share ($1,500,000/300,000 shares) to $4.80 per share. Unlike for securities available-for-sale, unrealized holding gains and losses for trading securities are included in net income.

Requirement 2 Balance of the investments account on December 31: $1,500,000 − 60,000 = $1,440,000.





Requirement 1 February 1 Debit Credit

Investments 2,400


June 15

Cash (50 shares × $14) 700

Loss (difference) 100

Investments (50 shares × $16) 800 (Sell investments below recorded amount)

October 31

Cash (100 shares × $0.50 per share) 50

Dividend Revenue 50 (Receive cash dividends)

December 31 Unrealized Holding Loss Other Comprehensive Income 400

Investments (100 shares × [$16 $12]) 400


Requirement 2 The balance of the investment account on December 31 is $1,200, equal to the 100

remaining shares times $12 per share fair value. The balance of the investment account can be verified by posting all journal entries to a t-account.

Investments

2,400

800 400

1,200





Requirement 1 March 1 Debit Credit

Investments (3,000 shares × $62) 186,000


July 1

Cash ($1.25 × 3,000 shares) 3,750

Dividend Revenue 3,750 (Receive cash dividends)

October 1

Cash (750 shares × $70) 52,500


Gain (difference) 6,000 (Sell investments above recorded amount)

December 31 Investments (2,250 shares × $13) 29,250

Unrealized Holding Gain Other Comprehensive Income 29,250


Requirement 2 The balance of the investment account on December 31 is $168,750, equal to the

2,250 remaining shares times $75 per share fair value. The balance of the investment account can be verified by posting all journal entries to a t-account.

Investments

186,000

29,250

46,500

168,750





Requirement 1 Comprehensive income is an expansion of the familiar net income. Most

revenues, expenses, gains, and losses are included in net income. A few less

traditional gains and losses, though, are reported outside the income statement in the

more inclusive statement of comprehensive income in which we report all changes in

stockholders’ equity other than those caused by investments by stockholders and

payment of dividends. Comprehensive income includes net income as well as other

comprehensive income. The most frequent items in other comprehensive income are

the unrealized holding gains and losses on investments.

Requirement 2

Sales Revenue $ 260,000 Operating expenses (140,000) Gain on sale of investments 13,000

Net income 133,000 Other comprehensive income: Unrealized holding loss (17,000)

Comprehensive income $ 116,000





January 1 Debit Credit

Investments 700,000


December 31

Investments 40,000

Equity Income 40,000 (Earn equity income) ($40,000 = $160,000 × 25%)

December 31

Cash 15,000

Investments 15,000 (Receive cash dividends) ($15,000 = $60,000 × 25%)





January 1 Debit Credit

Investments 600,000


December 31

Investments 45,500


December 31

Cash 14,000

Investments 14,000 (Receive cash dividends) ($14,000 = $40,000 × 35%)

Under the equity method, no adjustment is made to fair value.




Exercise D-8 (LO D-2, D-3)

Requirement 1 Purchase: Debit Credit

Investments 360,000


Net income:

Dividends:

Cash 15,000

Dividend Revenue 15,000 (Receive cash dividends) ($15,000 = $0.25 × 300,000 shares × 20%)

Fair value adjustment:

Investments 15,000

Unrealized Holding Gain Other Comprehensive

Income

15,000

(Adjust investments to fair value) ($15,000 = $375,000 $360,000)




Exercise D-8 (concluded)

Requirement 2 Purchase: Debit Credit

Investments 360,000


Net income:

Investments 27,000


Dividends:

Cash 15,000

Investments 15,000 (Receive cash dividends) ($15,000 = $0.25 × 300,000 shares × 20%)

Fair value adjustment:

No adjustment is made under the equity method





1. 10% of the common stock of Beta.

2. 40% of the bonds of Gamma.

X 3. 75% of the common stock of Delta.

4. 15% of the bonds of Epsilon.

5. 25% of the common stock of Zeta.

6. 60% of the bonds of Eta.

X 7. 100% of the common stock of Theta.





Requirement 1

(1)

Date

(2)

Cash

Received

(3)

Interest

Revenue

(4)

Increase in

Carrying

Value

(5)

Carrying

Value Face Amount

× Stated Rate Carrying Value × Market Rate

(3) (2)

Prior Carrying Value + (4)

1/ 1 $159,869 6/30 $ 6,125 $ 6,395 $ 270 160,139

12/31 6,125 6,406 281 160,420

Requirement 2 January 1

Investments 159,869


June 30

Cash ($175,000 × 7% × ½) 6,125


Interest Revenue ($159,869 × 8% ×

½)

6,395

(Receive semiannual interest revenue) December 31

Cash ($175,000 × 7% × ½) 6,125


Interest Revenue ($160,139 × 8% ×

½)

6,395

(Receive semiannual interest revenue)





Requirement 1

(1)

Date

(2)

Cash

Received

(3)

Interest

Revenue

(4)

Decrease in

Carrying

Value

(5)

Carrying

Value Face Amount


(2) (3)

Prior Carrying Value (4)

1/ 1 $ 549,001 6/30 $ 17,500 $ 16,470 $ 1,030 547,971

12/31 17,500 16,439 1,061 546,910


Investments 549,001


June 30

Cash ($500,000 × 7% × ½) 17,500

Investments (difference) 1,030


December 31

Cash ($500,000 × 7% × ½) 17,500






PROBLEMS: SET A

Problem D-1A (LO D-2)

Requirement 1 January 2 Debit Credit

Investments 105,000


February 14

Investments 7,200

Cash 7,200 (Purchase preferred stock)

May 15

Cash (300 shares × $62) 18,600

Loss (difference) 2,400

Investments (300 shares × $70) 21,000 (Sell investments below recorded amount)

December 30

Cash 900

Dividend Revenue 900 (Receive cash dividends) (1,200 shares × $0.50) + (600 shares × $0.50)




Problem D-1A (concluded) Requirement 1 (concluded)

December 31

Investments 3,600


Income

3,600

(Adjust investments in common stock to fair value) ($3,600 = 1,200 shares × $3)

December 31

Investments 1,200


Income

1,200

(Adjust investments in preferred stock to fair value) ($1,200 = 600 shares × $2)

Requirement 2 The balance of the Investments account on December 31 is $96,000, equal to the

1,200 remaining common shares times $73 per share fair value plus the 600 preferred shares times $14 per share fair value.





($ in millions) Purchase: Debit Credit

Investments 178

Cash 178 (Purchase common stock)

Net income:

Investments 32.50

Equity Income 32.50 (Earn equity income) ($32.50 = $130 × 25%)

Dividends:

Cash 9.35

Investments 9.35 (Receive cash dividends) ($9.35 = $1.10 × 34 million shares × 25%)





Requirement 1

(1)

Date

(2)

Cash

Received

(3)

Interest

Revenue

(4)

Increase in

Carrying

Value

(5)

Carrying

Value Face Amount


(3) (2)


1/ 1 $ 133,984 6/30 $ 4,500 $ 4,689 $ 189 134,173

12/31 4,500 4,696 196 134,369


Investments 133,984


June 30

Cash ($150,000 × 6% × ½) 4,500



December 31

Cash ($150,000 × 6% × ½) 4,500






Requirement 3 December 31

Cash 145,000

Gain (difference) 10,631

Investments 134,369 (Sell bonds before maturity)

Requirement 4 Bond prices move in the opposite direction of market interest rates. Since bond prices went up between the beginning and end of the year, market interest rates must have decreased.





Requirement 1

Investments ........................................................ 152,000

Cash ................................................................ 152,000 (Purchase bonds)

Requirement 2

Cash ($180,000 × 8% × ½) ............................... 7,200

Investments ........................................................ 400

Interest revenue ($152,000 × 10% × ½) ...... 7,600 (Receive semiannual interest revenue)

Requirement 3

Cash ($180,000 × 8% × ½) ............................... 7,200

Investment .......................................................... 420

Interest revenue ([$152,000 + 400] × 10% × ½) 7,620 (Receive semiannual interest revenue)

Requirement 4 Since these are held-to-maturity securities, Justin Investor reports its investment in the December 31, balance sheet at its amortized cost – that is, its book value:

Investments: $152,000 + 400 + 420 = $152,820

Increases and decreases in the fair value between the time a debt security is acquired and the day it matures are relatively unimportant if sale before maturity isn’t an alternative. For this reason, if an investor has the intent 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.




PROBLEMS: SET B

Problem D-1B (LO D-2)

Requirement 1 February 2 Debit Credit

Investments 52,500


February 4

Investments 19,200

Cash 19,200 (Purchase preferred stock)

July 15

Cash (400 shares ×$40) 16,000


Gain (difference) 2,000 (Sell investments above recorded amount)

November 30

Cash 2,290

Dividend Revenue 2,290 (Receive cash dividends) (1,100 shares × $1.10) + (600 shares × $1.80)




Problem D-1B (concluded) Requirement 1 (concluded)

December 31 Unrealized Holding Loss Other Comprehensive Income 4,400

Investments 4,400

(Adjust investments in common stock to fair value) ($4,400 = 1,100 shares × $4 decrease per share)

December 31 Unrealized Holding Loss Other Comprehensive Income 1,200

Investments 1,200

(Adjust investments in preferred stock to fair value) ($1,200 = 600 shares × $2 decrease per share)

Requirement 2 The balance of the Investments account on December 31 is $52,100, equal to the

1,100 remaining common shares times $31 per share fair value plus the 600 preferred shares times $30 per share fair value.





($ in millions) Purchase: Debit Credit

Investments 52

Cash 52 (Purchase common stock)

Net income:

Investments 2.7

Equity Income 2.7 (Earn equity income) ($2.7 = $9 × 30%)

Dividends:

Cash 1.5

Investments 1.5 (Receive cash dividends) ($1.5 = $0.50 × 10 million shares × 30%)




Problem D-3B (LO D-5) Requirement 1

(1)

Date

(2)

Cash

Received

(3)

Interest

Revenue

(4)

Increase in

Carrying

Value

(5)

Carrying

Value Face Amount


(3) (2)


1/1 $ 419,422 6/30 $ 15,750 $ 16,777 $ 1,027 420,449

12/31 15,750 16,818 1,068 421,517


Investments 419,422


June 30

Cash ($450,000 × 7% × ½) 15,750



December 31

Cash ($450,000 × 7% × ½) 15,750






Requirement 3 December 31

Cash 415,000

Loss (difference) 6,517

Investments 421,517 (Sell bonds before maturity)

Requirement 4 Bond prices move in the opposite direction of market interest rates. Since bond

prices went down between the beginning and end of the year, market interest rates must have increased.





Requirement 1

Investments ........................................................ 124,728

Cash ................................................................ 124,728 (Purchase bonds)

Requirement 2

Cash ($130,000 × 7% × ½) ............................... 4,550

Investments ........................................................ 439

Interest revenue ($124,728 × 8% × ½) ........ 4,989 (Receive semiannual interest revenue)

Requirement 3

Cash ($130,000 × 7% × ½) ............................... 4,550

Investments ........................................................ 457

Interest revenue ([$124,728 + 439] × 8% × ½) 5,007 (Receive semiannual interest revenue)

Requirement 4 Since these are held-to-maturity securities, Tsunami Sushi reports its investment in the December 31, balance sheet at its amortized cost – that is, its book value:

Investments: $124,728 + 439 + 457 = $125,624

Increases and decreases in the fair value between the time a debt security is acquired and the day it matures are relatively unimportant if sale before maturity isn’t an alternative. For this reason, if an investor has the intent 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.

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