财务会计英文版课后习题答案Ch12

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CHAPTER 12

DISCUSSION QUESTIONS

1. There are several reasons for a firm to make 7. When an investor purchases debt and equity

investments in assets not directly related to

the primary operations of its business (that is,

investments in assets other than property,

plant, equipment, and inventory). Companies

usually make short-term investments be-

cause of a temporary surplus of cash. They

make long-term investments either

because they believe that purchased

investments provide a good return on money

8.

invested or because they want to gain influ-

ence or control over investee companies.

2. The risk and return trade-off of investments

is that investors must usually decide whether

they want a potentially higher return with

more risk or a lower return with less risk.

Most investments fall somewhere along a

9.

risk-return continuum. Investments that pro-

vide high returns but have low risk are desir-

able, but rare.

3. The FASB has defined four different classifi-

cations for debt and equity securities: trading

securities, available-for-sale securities, held-

to-maturity securities, and equity method se-

curities.

4. A security will be classified as trading if the

investor is making the investment with the

intent of selling the security should the need

for cash arise, or to realize short-term profits

should the price of the security increase.

5. A security will be classified as held-to-

maturity if the investor intends to hold the

10.

security until it matures. This criterion means

that only debt securities can be classified as

held-to-maturity, as equity securities typically

do not mature. If a debt security is classified

as held-to-maturity, any premium or discount

associated with the security must be amor-

tized over the life of the debt security.

6. To be classified as an equity method securi-

ty, an investor must typically own between

20 and 50% of the outstanding common

stock of the investee. Ownership of between

20 and 50% generally indicates the ability of

11.

the investor to significantly influence the

operations and decisions of the investee.

433

securities, two types of returns may be rea-

lized. The first type of return is the receipt of

interest (in the case of debt) or dividends (in

the case of equity). The second type of re-

turn is from an increase in the price of the

security. To realize this type of return, the in-

vestor must sell the security.

When a security is sold, the seller must have

several pieces of information to properly ac-

count for the transaction. The seller must

know the selling price as well as the histori-

cal cost of the security. The difference

between these two amounts results in a rea-

lized gain or loss on the sale.

The difference between a realized gain or

loss and an unrealized gain or loss relates to

the accounting concept of arm’s-length

transactions. The term ―realized‖ indicates

that an arm’s-length transaction has taken

place and a security has been sold. A rea-

lized gain indicates that the security was sold

for more than its historical cost, while a rea-

lized loss means that the security was sold

for less than its original purchase price. An

unrealized gain means that the price of the

security being held has increased above its

historical cost, but the security has not been

sold. If the security is still being held and the

price falls below its historical cost, an unrea-

lized loss has occurred.

The account ―Market Adjustment‖ is used to

value both trading and available-for-sale se-

curities at their market value. Trading and

available-for-sale securities are initially

recorded at their historical cost, and as their

value changes, the historical cost remains

the same on the books. To reflect market

values on the books, the market adjustment

account is used to record both increases

and decreases in value. A separate market

adjustment account is used for both trading

and available-for-sale securities.

Changes in the value of trading securities,

both increases and decreases, are recorded

on the books of the investor. Prior to 1994,

only declines below historical cost were

recorded on the books. In 1994, however,

434

the rules were changed to allow companies

to record both increases and decreases in

value. At the end of each accounting period,

the market value of the portfolio of trading

securities is compared to its historical cost,

and the difference is recorded in the market

adjustment account. The offsetting credit (in

the case of increases in value) or debit (in

the case of decreases in value) is recorded

in an income statement account as an un-

realized gain or loss.

12. Accounting for changes in the value of

available-for-sale securities is similar to the

procedures applied when accounting for

trading securities with one important differ-

ence. Instead of recording any unrealized

increases or decreases in value on the

income statement, unrealized increases

and decreases in value are recorded in a

stockholders’ equity account, Unrealized

Increase/Decrease in Value of Available-for-

Sale Securities—Equity. Thus, the journal

entry to record unrealized changes in value

always contains the stockholders’ equity ac-

count and the market adjustment—available-

for-sale securities account.

13. The market adjustment account can be

further adjusted; however, the adjustment

account should always report the total net

change in the value of the security. For ex-

ample, if a security that cost $200 rose in

value to $300 during the first period and then

to $350 during the second period, the mar-

ket adjustment account would show a bal-

ance of $150 at the end of the second period.

14. Premiums and discounts on available-for-

sale securities are not amortized because it

is assumed that trading and available-for-

sale securities will not be held long enough

to warrant the need to amortize a premium

or discount.

15. Changes in the value of held-to-maturity and

equity method securities are not accounted

for on the books of the investor. For held-to-

maturity securities, the investor intends to

hold the debt security until it matures, and as

a result, changes in value will not affect

the eventual maturity value of the security.

For equity method securities, the investor

is holding the security for the purpose of

being able to influence the operating deci-

sions of the investee on a long-term basis.

Thus, temporary changes in value of equity

Chapter 12

method securities are ignored for accounting

purposes.

16. The only difference between the accounting

for trading securities and available-for-sale

securities lies in unrealized changes in value

of those securities. For trading securities,

the changes in value are recorded on the in-

come statement. For available-for-sale se-

curities, the unrealized changes in value are

recorded in a stockholders’ equity account.

17.* When buying a held-to-maturity security, an

investor purchases the right to receive two

different types of future cash receipts. First,

the investor receives periodic interest pay-

ments over the life of the security; second,

the investor receives the face amount (prin-

cipal) of the security at maturity.

18.* A company would usually be willing to pay

more than the face amount (a premium) for

a held-to-maturity security when the interest

rate on the security is higher than the market

rate of interest for similar investments. The

paying of a higher price reduces the stated

rate of interest to a point where it approx-

imates the market rate of interest.

19.* The amortization of a discount increases the

amount earned on a held-to-maturity security

because at maturity investors receive the

face value, which is higher than the amount

originally paid. These increased proceeds

must be recognized over the life of the secu-

rity through amortization. The amortization of

a discount increases interest from a stated

rate to a higher effective rate.

20.* An investor purchasing held-to-maturity

securities (typically bonds) between interest

dates must pay for accrued interest because

at the next interest payment date a full

period’s interest will be received, even

though the securities have been held for only

a portion of the period. Because the securi-

ties are sold in relatively small denomina-

tions and are usually owned by numerous

individuals, it is almost impossible for a

company to know who bought how many

bonds on which dates. Therefore, with many

held-to-maturity securities, whoever owns

the securities on the interest payment date

receives the full period’s interest.

*Relates to expanded material.

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