APPENDIX INTERNATIONAL FINANCIAL
1 REPORTING STANDARDS
MULTIPLE-CHOICE QUESTIONS
A1-1. c
A1-2. b
A1-3. d
A1-4. c
A1-5. d
A1-6. a
A1-7. b
A1-8. d
A1-9. a
A1-10. b
A1-1
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, APPENDIX
2 INVESTMENTS
DISCUSSION QUESTIONS
1. From a financial reporting viewpoint, the principal difference between long-term and short-term
investments is the length of the expected holding period. If a firm intends to sell a security within
1 year or one operating cycle, then the security is reported as a short-term investment;
otherwise, it is reported as a long-term investment. Thus, securities that cannot be converted
into cash on short notice must be classified as long-term investments.
From an operating viewpoint, long-term investments, which include both equity and debt
securities, are used to accomplish long-term objectives. For example, a firm may purchase the
stock of another firm that manufactures products it uses or sells in order to assure long-term
availability. Indeed, many long-term investments in the stock of another firm are motivated by
the desire of the investor to gain a degree of influence or control over the operations of the
investee. In contrast, short-term investments are related to short-term objectives, such as
providing a temporary repository for liquid assets.
2. The classification for investments in debt are:
a. Held-to-maturity securities are debt investments that management intends to
hold until the debt contract requires the borrower to repay the debt in its entirety.
On the balance sheet, held-to-maturity securities are classified as noncurrent assets
unless the date of maturity is within 1 year or one operating cycle, whichever is
longer.
b. Trading securities are debt or equity investments that management intends to sell in
the near term. Trading securities are bought and sold frequently and typically are owned
for under 1 month. Trading securities are always classified as current assets on the
balance sheet.
c. Available-for-sale securities are debt investments that management intends to sell in the
future, but not necessarily in the near term. Therefore, investments in debt securities
that do not warrant inclusion as trading securities or held-to-maturity securities are
considered available-for-sale. On the balance sheet, available-for-sale securities are
classified as current or noncurrent assets depending on whether they will be sold within
1 year or one operating cycle, whichever is longer.
3. The amortized cost method is used for investments in debt securities that are to be held
to maturity. It is implemented by:
● Recording securities purchased at cost.
● Carrying those investments on the balance sheet at cost adjusted for unamortized premium
or discount amortization during the holding period.
● Recording receipt of interest income with appropriate amortization of premium/discount each
accounting period.
● Removing cost from the accounting records when the securities are redeemed at
maturity.
A2-1
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,APPENDIX 2 Investments
4. The fair value method is used for investments in equity securities or for investments in
debt securities that are classified as trading or available-for-sale. It is implemented by:
● Recording securities purchased at cost (fair value on the date of purchase)
● Adjusting the carrying amount of those investments to their fair (or market) value at
the end of each accounting period
● Recognizing the adjustment to the carrying amount (for unrealized gains or losses)
of these investments as a separate element of stockholders’ equity (available-for-sale
debt securities) or as income on the income statement (all equity investments and
investments in debt securities classified as trading)
● Recording interest or dividends as income as they are realized each accounting
period
● Removing the investment carrying amount from the accounting records when the
securities are sold and recognizing a gain (or loss) measured by the difference
between the selling price and the cost of the investment
5. The equity method is used to account for long-term investments in common stock
that enable the investor to significantly influence the operations of another business.
When an investment represents an ownership of 20% or more, the investor
can usually influence the operations of the investee, and the equity method is used.
It is implemented by:
● Recording securities purchased at cost
● Recognizing as income the investor’s share of investee net income (or net loss)
● Adding the investor’s share of investee net income (or subtracting the investor’s
share of net loss) to the investment account
● Recording dividends received as a reduction in the investment account
● Removing the investment carrying amount from the accounting records when the
securities are sold and recognizing a gain (or loss) measured by the difference
between the selling price and the carrying amount
6. Trading securities are equity or debt investments that management intends to sell in the
near term. Trading securities are bought and sold frequently and typically are owned for
less than 1 month. Trading securities are always classified as current assets. On the
income statement, unrealized gains (losses) on trading securities are included on the income
statement as part of net income. Available-for-sale securities are debt investments that
management intends to sell in the future but not necessarily in the near term. On the balance
sheet, available-for-sale debt securities are classified as current or noncurrent assets
depending on whether they will be sold within 1 year or one operating cycle, whichever is
longer. Unrealized gains (losses) on available-for-sale securities are not included on the
income statement; instead, they are reported in accumulated other comprehensive
income, which is an element of stockholders’ equity.
7. Investment income is recognized for: (1) the amortized cost method when interest is earned
each accounting period and when amortization of premium or discount is recorded; (2) the fair
value method when interest or dividends are received and when investments are sold; and (3) the
equity method when the investee earns income (or loss) and when investments are sold.
A2-2
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, APPENDIX 2 Investments
8. Under the equity method, the investor recognizes its share of investee net income as the
income is earned by the investee. The investor records income when income is earned
by the investee and not when a dividend is declared and paid. Dividends are recorded as
a reduction in the Investment account. This prevents the investor’s income from being
manipulated by investor-stimulated changes (since they possess significant influence
over the investee through having greater than 20% stock ownership) in an investee’s
dividend policy. As explained in advanced accounting courses, the equity method also
prevents manipulation through intercorporate transactions, whose effects must be
eliminated.
9. A parent is an investor whose investment in the stock of another firm enables it to control
the other firm (the subsidiary). A subsidiary is a firm whose operations are controlled by
another entity through that entity’s investment in the subsidiary firm’s stock. Usually,
ownership of 50% or more of the outstanding voting stock is sufficient to give a
parent control over a subsidiary.
10. Noncontrolling interest is the portion of a subsidiary’s common stock that is not held by
the parent. This amount must be shown as a component of stockholders’ equity on the
consolidated balance sheet. It represents the equity interest of the noncontrolling
stockholders in the subsidiary’s assets and liabilities.
11. The consolidated balance sheet is essentially the same as the parent’s corporate balance
sheet except that the parent’s Investment—Equity Method account is replaced with the
detailed assets and liabilities of the subsidiary. In addition, other differences may arise
from intercorporate transactions described in advanced accounting courses.
12. The allowance to adjust short-term investments to market is the valuation account
containing unrealized gains and losses on the short-term investment portfolio. It is
adjusted at year end to the current amount of unrealized gain or loss and is reported on
the balance sheet to adjust the cost of the portfolio to its current market value. Use of this
allowance reveals the current cash-generating potential of the short-term investments;
reporting only their cost would deny this information to users of the financial statements.
13. Because a parent and subsidiary are two separate legal entities, they often engage in
business transactions such as buying or selling inventory, borrowing funds, etc. Further,
because they keep separate accounting records, these transactions produce, for example,
sales revenue, receivables, and payables in the financial statements. However, in
consolidation, the two separate legal entities are reported as a single accounting entity.
Because a single entity cannot sell to itself or owe money to itself, these intercompany
transactions must be eliminated in consolidation.
14. An asset acquisition is a business combination in which the assets and liabilities of
another company are acquired. A stock acquisition is a business combination in which
the common stock of another company is acquired with the parent's own common stock.
15. Goodwill represents intangible assets that cannot be specifically identified or separated
from the business, such as a reputation for quality products. It is calculated by subtracting
the fair value of identifiable net assets received from the acquisition price.
A2-3
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
1 REPORTING STANDARDS
MULTIPLE-CHOICE QUESTIONS
A1-1. c
A1-2. b
A1-3. d
A1-4. c
A1-5. d
A1-6. a
A1-7. b
A1-8. d
A1-9. a
A1-10. b
A1-1
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, APPENDIX
2 INVESTMENTS
DISCUSSION QUESTIONS
1. From a financial reporting viewpoint, the principal difference between long-term and short-term
investments is the length of the expected holding period. If a firm intends to sell a security within
1 year or one operating cycle, then the security is reported as a short-term investment;
otherwise, it is reported as a long-term investment. Thus, securities that cannot be converted
into cash on short notice must be classified as long-term investments.
From an operating viewpoint, long-term investments, which include both equity and debt
securities, are used to accomplish long-term objectives. For example, a firm may purchase the
stock of another firm that manufactures products it uses or sells in order to assure long-term
availability. Indeed, many long-term investments in the stock of another firm are motivated by
the desire of the investor to gain a degree of influence or control over the operations of the
investee. In contrast, short-term investments are related to short-term objectives, such as
providing a temporary repository for liquid assets.
2. The classification for investments in debt are:
a. Held-to-maturity securities are debt investments that management intends to
hold until the debt contract requires the borrower to repay the debt in its entirety.
On the balance sheet, held-to-maturity securities are classified as noncurrent assets
unless the date of maturity is within 1 year or one operating cycle, whichever is
longer.
b. Trading securities are debt or equity investments that management intends to sell in
the near term. Trading securities are bought and sold frequently and typically are owned
for under 1 month. Trading securities are always classified as current assets on the
balance sheet.
c. Available-for-sale securities are debt investments that management intends to sell in the
future, but not necessarily in the near term. Therefore, investments in debt securities
that do not warrant inclusion as trading securities or held-to-maturity securities are
considered available-for-sale. On the balance sheet, available-for-sale securities are
classified as current or noncurrent assets depending on whether they will be sold within
1 year or one operating cycle, whichever is longer.
3. The amortized cost method is used for investments in debt securities that are to be held
to maturity. It is implemented by:
● Recording securities purchased at cost.
● Carrying those investments on the balance sheet at cost adjusted for unamortized premium
or discount amortization during the holding period.
● Recording receipt of interest income with appropriate amortization of premium/discount each
accounting period.
● Removing cost from the accounting records when the securities are redeemed at
maturity.
A2-1
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
,APPENDIX 2 Investments
4. The fair value method is used for investments in equity securities or for investments in
debt securities that are classified as trading or available-for-sale. It is implemented by:
● Recording securities purchased at cost (fair value on the date of purchase)
● Adjusting the carrying amount of those investments to their fair (or market) value at
the end of each accounting period
● Recognizing the adjustment to the carrying amount (for unrealized gains or losses)
of these investments as a separate element of stockholders’ equity (available-for-sale
debt securities) or as income on the income statement (all equity investments and
investments in debt securities classified as trading)
● Recording interest or dividends as income as they are realized each accounting
period
● Removing the investment carrying amount from the accounting records when the
securities are sold and recognizing a gain (or loss) measured by the difference
between the selling price and the cost of the investment
5. The equity method is used to account for long-term investments in common stock
that enable the investor to significantly influence the operations of another business.
When an investment represents an ownership of 20% or more, the investor
can usually influence the operations of the investee, and the equity method is used.
It is implemented by:
● Recording securities purchased at cost
● Recognizing as income the investor’s share of investee net income (or net loss)
● Adding the investor’s share of investee net income (or subtracting the investor’s
share of net loss) to the investment account
● Recording dividends received as a reduction in the investment account
● Removing the investment carrying amount from the accounting records when the
securities are sold and recognizing a gain (or loss) measured by the difference
between the selling price and the carrying amount
6. Trading securities are equity or debt investments that management intends to sell in the
near term. Trading securities are bought and sold frequently and typically are owned for
less than 1 month. Trading securities are always classified as current assets. On the
income statement, unrealized gains (losses) on trading securities are included on the income
statement as part of net income. Available-for-sale securities are debt investments that
management intends to sell in the future but not necessarily in the near term. On the balance
sheet, available-for-sale debt securities are classified as current or noncurrent assets
depending on whether they will be sold within 1 year or one operating cycle, whichever is
longer. Unrealized gains (losses) on available-for-sale securities are not included on the
income statement; instead, they are reported in accumulated other comprehensive
income, which is an element of stockholders’ equity.
7. Investment income is recognized for: (1) the amortized cost method when interest is earned
each accounting period and when amortization of premium or discount is recorded; (2) the fair
value method when interest or dividends are received and when investments are sold; and (3) the
equity method when the investee earns income (or loss) and when investments are sold.
A2-2
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, APPENDIX 2 Investments
8. Under the equity method, the investor recognizes its share of investee net income as the
income is earned by the investee. The investor records income when income is earned
by the investee and not when a dividend is declared and paid. Dividends are recorded as
a reduction in the Investment account. This prevents the investor’s income from being
manipulated by investor-stimulated changes (since they possess significant influence
over the investee through having greater than 20% stock ownership) in an investee’s
dividend policy. As explained in advanced accounting courses, the equity method also
prevents manipulation through intercorporate transactions, whose effects must be
eliminated.
9. A parent is an investor whose investment in the stock of another firm enables it to control
the other firm (the subsidiary). A subsidiary is a firm whose operations are controlled by
another entity through that entity’s investment in the subsidiary firm’s stock. Usually,
ownership of 50% or more of the outstanding voting stock is sufficient to give a
parent control over a subsidiary.
10. Noncontrolling interest is the portion of a subsidiary’s common stock that is not held by
the parent. This amount must be shown as a component of stockholders’ equity on the
consolidated balance sheet. It represents the equity interest of the noncontrolling
stockholders in the subsidiary’s assets and liabilities.
11. The consolidated balance sheet is essentially the same as the parent’s corporate balance
sheet except that the parent’s Investment—Equity Method account is replaced with the
detailed assets and liabilities of the subsidiary. In addition, other differences may arise
from intercorporate transactions described in advanced accounting courses.
12. The allowance to adjust short-term investments to market is the valuation account
containing unrealized gains and losses on the short-term investment portfolio. It is
adjusted at year end to the current amount of unrealized gain or loss and is reported on
the balance sheet to adjust the cost of the portfolio to its current market value. Use of this
allowance reveals the current cash-generating potential of the short-term investments;
reporting only their cost would deny this information to users of the financial statements.
13. Because a parent and subsidiary are two separate legal entities, they often engage in
business transactions such as buying or selling inventory, borrowing funds, etc. Further,
because they keep separate accounting records, these transactions produce, for example,
sales revenue, receivables, and payables in the financial statements. However, in
consolidation, the two separate legal entities are reported as a single accounting entity.
Because a single entity cannot sell to itself or owe money to itself, these intercompany
transactions must be eliminated in consolidation.
14. An asset acquisition is a business combination in which the assets and liabilities of
another company are acquired. A stock acquisition is a business combination in which
the common stock of another company is acquired with the parent's own common stock.
15. Goodwill represents intangible assets that cannot be specifically identified or separated
from the business, such as a reputation for quality products. It is calculated by subtracting
the fair value of identifiable net assets received from the acquisition price.
A2-3
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
