1. A company may temporarily have excess cash that is not needed for use in its current operations. Instead of letting excess cash remain idle in a checking account, most companiesinvest their excess cash in temporary investments. The primary objectives of investing in temporary investments are to:a. earn interest revenueb. receive dividendsc. realize gains from increases in the market price of the securities
2. A gain or loss can occur when the selling price of the bond differs from the carrying amount (cost) of the bond. The price of bond investments can change due to changes in the market rate of interest. If the proceeds from the sale exceed the carrying amount (cost) of the bonds, then a gain is recorded.
3. The equity method is used for equity investments representing more than 20% and less than 50% of the outstanding shares of the investee.
4. Under the cost method, a dividend received is treated as dividend revenue. Under the equity method, a dividend received is not treated as dividend revenue, but is treated as a reduction inthe carrying amount of the investment.
5. An investment greater than 50% of the investee is considered to be an investment that exerts control. Thus, the financial statements of the investee (subsidiary) are consolidated (combined)with that of the investor (parent company).
6. Both portfolios are reported at fair value. However, changes in the fair value of trading securitiesduring a period are reported as an unrealized gain or loss on the statement of comprehensive income. For available-for-sale securities, changes in the fair value of the securities are reported in equity and,thus, are not recognized as part of net profit.
7. A credit balance in Valuation Allowance for Available-for-Sale Investments is subtracted fromAvailable-for-Sale Investments (at cost). The net reported amount is the available-for-sale securitiesat fair value.
8. A debit balance in Unrealized Gain (Loss) on Available-for-Sale Investments would be reported as areduction in the Equity section of the statement of financial position, after Retained Earnings.
9. Current GAAP requires fair value accounting for impaired assets. Current GAAP allows financialassets and liabilities to be reported at fair value. The assets and liabilities reported at fair value arebecoming a more significant portion of many companies’ statement of financial positions. International Financial Reporting Standards are also moving more aggressively toward fair value accounting. As a result of the desire to converge U.S. and international standards, the United States is also moving toward fair value reporting.
10. Fair values may not be readily obtainable for some assets or liabilities, which causes financial statement valuations to become more subjective. In addition, comparability between financial statements among different companies may be hampered by different methods of determining fairvalue. Lastly, using fair value can result in greater fluctuations in reported results, making predictionsof future trends potentially more difficult.
11. IAS 39 classifies investment in financial securities into four categories: (1)fair value through profit and loss (FVTPL), which includes securities held for tradingand designed as FVTPL, (2) loans and receivables, (4) securities held to maturity,and securities available for sale.IFRS 9 Financial Instruments reorganizes four categories of classification of financialassets under IAS 39 into two categories. Under IFRS 9, financial assets aremeasured at either fair value (FV) or amortized cost (AC).
12. A reporting entity should apply amortized cost if both of the following conditionsare met:1. The asset is held within a business model whose objective is to hold assets in orderto collect contractual cash flows.2. The contractual terms of the financial asset give rise on specified dates to cash flowsthat are solely payments of principal and interest on the principal amount outstanding.
13. Under US GAAP, a short-term investment in financial assets can be a trading securities, available-for sale invesment, or held-to-maturity investment.IAS 39 classifies short-term investment into four categoriesfair value through profit and loss (FVTPL), which includes securities held for tradingand designed as FVTPL, (2) loans and receivables, (4) securities held to maturity,and securities available for sale.IFRS 9 classifies short-term investment in financial assets into two categories according to their valuation: (1) fair value and (2) amortized cost.
14. The accounting for available-for-sale securities is similar to the accounting for trading securities,except for the reporting of changes in fair values. Specifically, changes in the fair values of tradingsecurities are reported as an unrealized gain or loss on the statement of comprehensiveincome. In contrast, changes in the fair values of available-for-sale securities arereported as part of equity and, thus, excluded from the statement of comprehensiveincome.Under IFRS 9, trading securities are classified into the category “Fair Value throughProfit and Loss (FVTPL)”. Changes in fair value result in a direct write-down of financialassets and financial asset will be restated at fair value. Valuation provision account is not used and gain and loss pass through profit and loss.Under IFRS 9, changes in fair value of available-for-sale (AFS) investment do notpass through profit and loss. Instead, they are recognized in other comprehensiveincome (OCI).
a. 1. Investment in Larson Corp. Stock 480,000Income of Larson Corp. 480,000
Record 40% share of Larson Corp.net profit, $1,200,000 × (160,000 shares ÷ 400,000 shares).
2. Cash* 320,000Investment in Larson Corp. Stock 320,000
*160,000 shares × $2.00
b. Stieg’s investment in Larson Corp. represents 40% of the outstanding shares of Larson Corp. An investment amount between 20% and 50% of the outstanding ordinary share of the investee is presumed to represent significant influence. The equity method is appropriate when the investor can exercise significant influence over the investee.
31 Loss of Gator Co. 19,040Investment in Gator Co. Stock 19,040
Record 34% share of Gator Co. net loss, $56,000 × 34%.
b. Initial acquisition cost……………………………………………………………… $212,000Equity loss for 2014………………………………………………………………… (19,040)Cash dividends received…………………………………………………………… (8,160)Investment in Gator Co. Stock balance, December 31, 2014………………… $184,800
c. Under the equity method, the investor will record their proportionate share of the net increase (or decrease) of the carrying amount of the investee resulting from earnings and dividend distributions. The fair value method uses market price information to value the investment in the investee. These two methods result in different valuations because the equity method is based upon book accounting, while the fair value approach uses market information. The two methods need not be related to each other over time. While changes in book value can influence market prices, many other variables can influence the market price of a stock.
Ex. 13–14The investor would receive a return on the investment through share price appreciation as internally generated funds are used to fund growth and earningsopportunities. Thus, investors in eBay would likely approve of this policy, because the company is able to earn superior returns with internally generated earnings beyond what investors could likely earn on their own by investing dividend distributions.
Dividend Yield
Dividend Yield 2.6%
= Cash Dividends per Share of Ordinary ShareMarket Price per Share of Ordinary Share
2. If the bonds are classified as available-for-sale securities, then the portfolioof bonds would need to be adjusted to fair value. This would be accomplished by using a valuation provision account and an unrealized gain (loss) accountas part of equity. If the fair value were greater than the cost of the bond portfolio, the two accounts would be positive, and thus added to investments and equity, respectively. If the fair value were less than the cost of thebond portfolio, the two accounts would be negative, and thus subtracted from investments and equity, respectively.
31 Valuation Allowance for Trading Investments* 86,460Unrealized Gain on Trading Investments 86,460
*$7,038 + $79,422
2.
Current assets:Trading investments (at cost) $270,578Plus valuation allowance for trading investments 79,422Trading investments (at fair value) $350,000
3. Unrealized gains or losses are reported on the statement of comprehensive income, often as “Other Income (Losses).” For 2014, Scofield Financial Co. would have reported an unrealized loss of $7,038 as “Other Losses.” For 2015, Scofield Financial Co. would have reported an unrealized gain of $86,460 as “Other Income.” If unrealized gains and losses were significant for Scofield Financial, then they would be separately disclosed on the statement of comprehensive income.
June
SCOFIELD FINANCIAL CO.
Sept.
Statement of Financial Position (selected items)December 31, 2015
Accounts payable $ 69,400 $ 60,000Share Capital—Ordinary 70,000 70,000Excess of issue price over par 225,000 225,000Retained earnings 455,000 308,770Unrealized gain (loss) on available-for-sale
investments (5,800) 2,500Total liabilities and equity $813,600 $666,270
Note 1. Investments are classified as available for sale. The investments at cost and fair value on December 31, 2014, are as follows:
No. of Cost per Total Total FairShares Share Cost Value
and equipment 30,000Office supplies expense 10,000Miscellaneous administrative expense 7,500 267,500
Total operating expenses 1,152,500Operating profit $ 401,500
Other expenses and income:Dividend revenue $ 4,500Interest revenue 2,720Income from Pinkberry Co. investment 76,800Gain on sale of investment 4,980Interest expense -21,000 68,000
Profit before income tax $ 469,500Income tax 140,500Net profit $ 329,000
CP 13–11. Under generally accepted accounting principles, the land would be reported
at $350,000 for Wyatt Corp. and $2,000,000 for TexoPete Inc. These valuationsreflect their historical costs.
2. The historical cost valuation reduces the ability to compare the two companies.In this scenario, both companies have nearly identical land holdings. Wyatt Corp. purchased its land in 1996; thus, the land is valued according to a 1996 valuation. TexoPete Inc., purchased its land in 2014, reflecting a more current valuation. Thus, both companies have a similar asset; however, the balance sheet reports very different valuations (Wyatt’s valuation is approximately 17.5% of TexoPete’s). Therefore, comparability is reduced. If the land were valued at fair value, then both companies would report the land at nearly identical valuations, which is a better reflection of reality.
CP 13–21. There is an emerging trend toward more uniform accounting standards
worldwide. This is caused by companies participating in multiple capital markets. For example, many companies not only have their stock trade on the New York Stock Exchange, but might also have their stock trade in London or Japan. In these cases, companies must provide financial reports that conform to the laws of the country in which their stock trades. Lack of accounting uniformity causes unnecessary reporting expenses for companies that wish to broaden the market for their stock worldwide, while making financial statements less comparable for users around the world. Thus, the United States and the European Union are working to align their financial accounting standards. When the International Accounting Standards Board (IASB, European Union) releases a standard such as IAS No. 16 , it influences U.S.GAAP. In this case, the United States does not embrace IAS No. 16 , so it isnot U.S. GAAP. However, as the United States and Europe work to converge standards, we might see the substance of IAS No. 16 reflected in a futureFASB pronouncement.
2. Fair value reporting for property, plant, and equipment is a very aggressive fair value position. This is because property, plant, and equipment fair values are usually very subjective. Given this subjectivity, there is concern that the reported statement of financial position amounts for property, plant, and equipment would be subject to manipulation and possible abuse. Moreover, the lack of objective fair values for these types of assets could reduce the comparability of financial statements across companies, depending on the subjective assumptions selected in the valuation.
CP 13–2 (Concluded)3. The accounting treatment for increases in fair value for property, plant, and
equipment under International Accounting Standards is similar to the treatment for unrealized gains and losses from available-for-sale investments. Increases in fair value bypass the statement of comprehensive income and are reported directly in equity. Thus, increases in property, plant, and equipment fair values would not be reported in earnings. Decreases in fair value are reported on the Statement of comprehensive income as an expense. Statement of comprehensive income treatment is similar to the treatment for unrealized gains and losses from trading securities. If the property, plant, and equipment fair value declines, the statement of comprehensive income impact of this decline is fully disclosed.
CP 13–3Since many complex and exotic investment vehicles do not have ready market values, management must value these investments using mathematical models, subjective inputs, and risk assessments. These mathematically determined valuations are subject to wide variation, depending on the assumptions. Therein lies the ethical challenge. Since the valuation is subjective, it is possible for managers to over- or underestimate fair values to meet their personal objectives. Moreover, the ability for auditors to verify these values independently is difficult, since there is a lack of agreed-upon objectivity.
CP 13–41. Look-through earnings is a Warren Buffett term. It is the GAAP net profit
plus an adjustment for the equity earnings (the “forgotten-but-not-gone"earnings) in investments where less than 20% of the outstanding shares areowned. Thus, look-through earnings would be significantly greater than GAAP net profit for a company that held a large portfolio of these types of investments(which Berkshire does). These are supplemental disclosures that Buffet provides his shareholders in addition to GAAP disclosures. Essentially, he is treating these investments as if they were being accounted for under the equity method.
2. Buffett makes the case that there is no reason for the equity method to be usedonly for 20%–50% investees, but that the rationale for the equity method appliesequally well for investments of less than 20%. Thus, Berkshire Hathaway provides an additional non-GAAP disclosure to its investors, which essentially adds theafter-tax equity earnings of its less than 20% investees to its net profit. In so doing, Buffett argues that the earning power of all of his investments is properlydisclosed in look-through earnings. He argues that the dividends that he receivesfrom his less than 20%-owned investees do not reflect the earning power of hisinvestment, even though that is what is required by GAAP.
