17 Investments EXERCISES 17.2
E17-21 (L01,2,4) (Fair Value Option) Presented below is selected information related to the financial instruments of Dawson Company at December 31, 2017. This is Dawson Company’s first year of operations...
Instructions
(a) Dawson elects to use the fair value option for these investments. Assuming that Dawson’s net income is $100,000 in
2017 before reporting any securities gains or losses, determine Dawson’s net income for 2017. Assume that the difference between the carrying value and fair value is due to credit deterioration.
(b) Record the journal entry, if any, necessary at December 31, 2017, to record the fair value option for the bonds payable.
E17-22 (L04) (Impairment) Elaina Company has the following investments as of December 31, 2017:
Investments in common stock of Laser Company $1,500,000
Investment in debt securities of FourSquare Company $3,300,000
In both investments, the carrying value and the fair value of these two investments are the same at December 31, 2017. Elaina’s stock investments does not result in significant influence on the operations of Laser Company. Elaina’s debt investment is considered held-to-maturity. At December 31, 2018, the shares in Laser Company are valued at $1,100,000; the debt investment securities of FourSquare are valued at $2,500,000. Assume that these investments are considered impaired.
Instructions
(a) Prepare the journal entries to record the impairment of these two securities at December 31, 2018.
(b) Assuming the fair value of the Laser shares is $1,400,000 and the value of its debt investment is $2,950,000, what entries, if any, should be recorded in 2019 related to impairment?
(c) Prepare the journal entries at December 31, 2018, assuming these securities are not impaired. (Ignore interest revenue entries.)
(d) Assume that the debt investment in FourSquare Company was available-for-sale and the expected credit loss was $900,000.
Prepare the journal entry to record this impairment on December 31, 2018.
*E17-23 (L05) (Derivative Transaction) On January 2, 2017, Jones Company purchases a call option for $300 on Merchant common stock. The call option gives Jones the option to buy 1,000 shares of Merchant at a strike price of $50 per share. The market price of a Merchant share is $50 on January 2, 2017 (the intrinsic value is therefore $0). On March 31, 2017, the market price for Merchant stock is $53 per share, and the time value of the option is $200.
Instructions
(a) Prepare the journal entry to record the purchase of the call option on January 2, 2017.
(b) Prepare the journal entry(ies) to recognize the change in the fair value of the call option as of March 31, 2017.
(c) What was the effect on net income of entering into the derivative transaction for the period January 2 to March 31, 2017?
*E17-24 (L06) (Fair Value Hedge) On January 2, 2017, MacCloud Co. issued a 4-year, $100,000 note at 6% fixed interest, interest payable semiannually. MacCloud now wants to change the note to a variable-rate note.
As a result, on January 2, 2017, MacCloud Co. enters into an interest rate swap where it agrees to receive 6% fixed and pay LIBOR of 5.7% for the first 6 months on $100,000. At each 6-month period, the variable rate will be reset. The variable rate is reset to 6.7% on June 30, 2017.
Instructions
(a) Compute the net interest expense to be reported for this note and related swap transaction as of June 30, 2017.
(b) Compute the net interest expense to be reported for this note and related swap transaction as of December 31, 2017.
*E17-25 (L06) (Cash Flow Hedge) On January 2, 2017, Parton Company issues a 5-year, $10,000,000 note at LIBOR, with interest paid annually. The variable rate is reset at the end of each year. The LIBOR rate for the first year is 5.8%.
Parton Company decides it prefers fixed-rate financing and wants to lock in a rate of 6%. As a result, Parton enters into an interest rate swap to pay 6% fixed and receive LIBOR based on $10 million. The variable rate is reset to 6.6% on January 2, 2018.
Instructions
(a) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2017.
(b) Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2018.
*E17-26 (L06) (Fair Value Hedge) Sarazan Company issues a 4-year, 7.5% fixed-rate interest only, nonprepayable $1,000,000 note payable on December 31, 2016. It decides to change the interest rate from a fixed rate to variable rate and enters into a swap agreement with M&S Corp. The swap agreement specifies that Sarazan will receive a fixed rate at 7.5% and pay variable with settlement dates that match the interest payments on the debt. Assume that interest rates have declined during 2017 and that Sarazan received $13,000 as an adjustment to interest expense for the settlement at December 31, 2017. The loss related to the debt (due to interest rate changes) was $48,000. The value of the swap contract increased $48,000.
Instructions
(a) Prepare the journal entry to record the payment of interest expense on December 31, 2017.
(b) Prepare the journal entry to record the receipt of the swap settlement on December 31, 2017.
(c) Prepare the journal entry to record the change in the fair value of the swap contract on December 31, 2017.
(d) Prepare the journal entry to record the change in the fair value of the debt on December 31, 2017.
*E17-27 (L05) (Call Option) On August 15, 2016, Outkast Co. invested idle cash by purchasing a call option on Counting Crows Inc. common shares for $360. The notional value of the call option is 400 shares, and the option price is $40. The option expires on January 31, 2017. The following data are available with respect to the call option…
Instructions
Prepare the journal entries for Outkast for the following dates.
(a) Investment in call option on Counting Crows shares on August 15, 2016.
(b) September 30, 2016—Outkast prepares financial statements.
(c) December 31, 2016—Outkast prepares financial statements.
(d) January 15, 2017—Outkast settles the call option on the Counting Crows shares.
*E17-28 (L06) (Cash Flow Hedge) Hart Golf Co. uses titanium in the production of its specialty drivers. Hart anticipates that it will need to purchase 200 ounces of titanium in November 2017, for clubs that will be sold in advance of the spring and summer of 2018. However, if the price of titanium increases, this will increase the cost to produce the clubs, which will result in lower profit margins.
To hedge the risk of increased titanium prices, on May 1, 2017, Hart enters into a titanium futures contract and designates this futures contract as a cash flow hedge of the anticipated titanium purchase. The notional amount of the contract is 200 ounces, and the terms of the contract give Hart the option to purchase titanium at a price of $500 per ounce. The price will be good until the contract expires on November 30, 2017.
Assume the following data with respect to the price of the call options and the titanium inventory purchase...
Instructions
Present the journal entries for the following dates/transactions.
(a) May 1, 2017—Inception of futures contract, no premium paid.
(b) June 30, 2017—Hart prepares financial statements.
(c) September 30, 2017—Hart prepares financial statements.
(d) October 5, 2017—Hart purchases 200 ounces of titanium at $525 per ounce and settles the futures contract.
(e) December 15, 2017—Hart sells clubs containing titanium purchased in October 2017 for $250,000. The cost of the finished goods inventory is $140,000.
(f) Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions on December 31, 2017.
