QUESTIONS
1. Distinguish between a debt security and an equity security.
2. What purpose does the variety in bond features (types and characteristics) serve?
3. What is the cost of a long-term investment in bonds?
4. Identify and explain the three types of classifications for investments in debt securities.
5. When should a debt security be classified as held-to-maturity?
6. Explain how trading debt securities are accounted for and reported.
7. At what amount should trading, available-for-sale, and held-to-maturity debt securities be reported on the balance sheet?
8. On July 1, 2017, Wheeler Company purchased $4,000,000 of Duggen Company’s 8% bonds, due on July 1, 2024.
The bonds, which pay interest semiannually on January 1 and July 1, were purchased for $3,500,000 to yield 10%.
Determine the amount of interest revenue Wheeler should report on its income statement for the year ended
December 31, 2017.
9. If the bonds in Question 8 are classified as available-for-sale and they have a fair value at December 31, 2017, of $3,604,000, prepare the journal entry (if any) at December 31, 2017, to record this transaction.
10. Indicate how unrealized holding gains and losses should be reported for debt investments classified as trading, available-for-sale, and held-to-maturity.
11. (a) Assuming no Fair Value Adjustment account balance at the beginning of the year, prepare the adjusting entry at the end of the year if Laura Company’s available-for-sale debt securities have a fair value $60,000 below cost.
(b) Assume the same information as part (a), except that Laura Company has a debit balance in its Fair Value
Adjustment account of $10,000 at the beginning of the year. Prepare the adjusting entry at year-end.
12. Identify and explain the different types of classifications for investments in equity securities.
13. Why are held-to-maturity investments applicable only to debt securities?
14. Hayes Company sold 10,000 shares of Kenyon Co. common stock for $27.50 per share, incurring $1,770 in brokerage commissions. These securities originally cost $260,000.
Prepare the entry to record the sale of these securities.
15. Distinguish between the accounting treatment for marketable versus nonmarketable equity securities.
16. What constitutes “significant influence” when an investor’s financial interest is below the 50% level?
17. Explain how the investment account is affected by investee activities under the equity method.
18. Your classmate Kate believes that the equity method is applied with a strict application of the “20%” rule. Do you agree? Explain.
19. Hiram Co. uses the equity method to account for investments in common stock. What accounting should be made for dividends received from these investments subsequent to the date of investment?
20. Raleigh Corp. has an investment with a carrying value
(equity method) on its books of $170,000 representing a
30% interest in Borg Company, which suffered a $620,000 loss this year. How should Raleigh Corp. handle its proportionate share of Borg’s loss?
21. Where on the asset side of the balance sheet are debt investments classified as trading securities, available-for-sale securities, and held-to-maturity securities reported?
Explain.
22. Explain why reclassification adjustments are necessary.
23. Briefly discuss how a transfer of securities from the available- for-sale category to the trading category affects stockholders’ equity and income.
24. Explain how to account for the impairment of a held-to-maturity debt security.
25. What is the GAAP definition of fair value?
26. What is the fair value option?
27. Franklin Corp. has a debt investment that it has held for several years. When it purchased the debt investment,
Franklin classified and accounted for it as available-for-sale.
Can Franklin use the fair value option for this investment? Explain.
28. What is meant by the term “underlying” as it relates to derivative financial instruments?
29. What are the main distinctions between a traditional financial instrument and a derivative financial instrument?
30. What is the purpose of a fair value hedge?
31. In what situation will the unrealized holding gain or loss on inventory be reported in income?
32. Why might a company become involved in an interest rate swap contract to receive fixed interest payments and pay variable?
33. What is the purpose of a cash flow hedge?
34. Where are gains and losses related to cash flow hedges involving anticipated transactions reported?
35. What are hybrid securities? Give an example of a hybrid security.
