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Chapter 12 - Investments 12-1 Exercise 12-1 Requirement 1 ($ in millions) Investment in bonds (face amount) 240.0 Discount on bond investment (difference). 40.0 Cash (price of bonds) 200.0 Requirement 2 Cash (3% x $240 million) 7.2 Discount on bond investment (difference).8 Interest revenue (4% x $200). 8.0 Requirement 3 Tanner-UNF reports its investment in the December 31, 2011, balance sheet at its amortized cost that is, its book value: Investment in bonds$240.0 Less: Discount on bond investment ($40 .8 million) 39.2 Amortized cost $200.8 If sale before maturity isnt an alternative, increases and decreases in the market value between the time a debt security is acquired and the day it matures to a prearranged maturity value are relatively unimportant. For this reason, if an investor has the “positive intent and ability” to hold the securities to maturity, investments in debt securities are classified as “held-to-maturity” and reported at amortized cost rather than fair value in the balance sheet. Requirement 4 ($ in millions) Cash (proceeds from sale).190.0 Discount on bond investment (balance, determined above)39.2 Loss on sale of investments (to balance).10.8 Investment in bonds (face amount)240.0 Chapter 12 - Investments 12-2 Exercise 12-2 November 1 ($ in millions) Cash.2.4 Investment revenue .2.4 December 1 Investment in Facsimile Enterprises bonds.30 Cash.30 December 31 Investment in U.S. Treasury bills .8.9 Cash.8.9 December 31 Investment revenue receivableConvenience bonds ($48 million x 10% x 2/12)0.8 Investment revenue receivableFacsimile Enterprises bonds ($30 million x 12% x 1/12).0.3 Investment revenue .1.1 Note: Securities held-to-maturity are not adjusted to fair value. Exercise 12-3 Investment in GM common shares 41,200 Cash (800 shares x $50 + $1,200).41,200 Cash (800 shares x $53 $1,300).41,100 Loss on sale of investments 100 Investment in GM common shares .41,200 Chapter 12 - Investments 12-3 Exercise 12-4 Requirement 1 2011 December 17 Investment in Grocers Supply preferred shares .350,000 Cash350,000 December 28 Cash2,000 Investment revenue2,000 December 31 Fair value adjustment.50,000 Net unrealized holding gains and lossesI/S ($4 x 100,000 shares $350,000).50,000 2012 January 5 Cash (selling price)395,000 Gain on investments (to balance).45,000 Investment in Grocers Supply preferred shares (account balance).350,000 Assuming no other trading securities, the 2012 adjusting entry to remove the fair value adjustment associated with the sold securities would be: December 31 Net unrealized holding gains and lossesI/S .50,000 Fair value adjustment (account balance)50,000 Chapter 12 - Investments 12-4 Exercise 12-4 (concluded) Requirement 2 Balance Sheet (short-term investment): Trading securities$400,000 Income Statement: Investment revenue (dividends). $ 2,000 Net unrealized holding gains and losses (from adjusting entry)50,000 Note: Unlike for securities available-for-sale, unrealized holding gains and losses for trading securities are included in income. Chapter 12 - Investments 12-5 Exercise 12-5 Requirement 1 . Net unrealized holding gains and lossesOCI25,000 Fair value adjustment ($45,000 20,000)25,000 Requirement 2 None. Accumulated net holding gains and losses for securities available-for- sale are reported as a component of shareholders equity (in accumulated other comprehensive income), and changes in the balance are reported as other comprehensive income or loss in the statement of comprehensive income rather than as part of earnings. This statement can be reported either (a) as an extension of the income statement, (b) as part of the statement of shareholders equity, or (c) as a separate statement in a disclosure note. Chapter 12 - Investments 12-6 Exercise 12-6 Requirement 1 Securities “held-to-maturity” are debt securities that an investor has the “positive intent and ability” to hold to maturity. Actively traded investments in debt or equity securities acquired principally for the purpose of selling them in the near term are classified as “trading securities.” The IBM shares are neither. They are classified as “available-for-sale” since all investments in debt and equity securities that dont fit the definitions of the other reporting categories are classified this way. Of course, the equity method isnt appropriate either because 10,000 shares of IBM certainly dont constitute “significant influence.” Investments in securities available-for-sale are reported at fair value, and holding gains or losses are not included in the determination of income for the period. Instead, they are reported as other comprehensive income or loss in the statement of comprehensive income. This statement can be reported either (a) as an additional section of the income statement, (b) as part of the statement of shareholders equity, or (c) as a separate statement in a disclosure note. Accumulated net holding gains and losses for securities available-for-sale are reported as a separate component of shareholders equity in the balance sheet. Requirement 2 December 31, 2011 Net unrealized holding gains and lossesOCI (10,000 shares x $58 60) .20,000 Fair value adjustment 20,000 Chapter 12 - Investments 12-7 Exercise 12-6 (concluded) Requirement 3 December 31, 2012 Accumulated ($ in 000s)Unrealized Available-for-Sale SecuritiesCostFair ValueGain (Loss) IBM shares Dec. 31, 2012$600$610$10 Moving from a negative $20 (2011) to a positive $10 (2012) requires an increase of $30: - -200+10 +30 - Fair value adjustment 10,000 shares x $61 58)30,000 Net unrealized holding gains and lossesOCI (-$20 less $10).30,000 Fair Value Adjustment Balance needed in fair value adjustment$10 Existing balance in fair value adjustment:($20) Increase (decrease) needed in fair value adjustment:$30 Chapter 12 - Investments 12-8 Exercise 12-7 Requirement 1 2011 March 2 ($ in millions) Investment in Platinum Gauges, Inc. shares .31 Cash.31 April 12 Investment in Zenith bonds .20 Cash.20 July 18 Cash.2 Investment revenue2 October 15 Cash.1 Investment revenue1 October 16 Cash.21 Investment in Zenith bonds .20 Gain on sale of investments.1 November 1 Investment in LTD preferred shares .40 Cash.40 Chapter 12 - Investments 12-9 Exercise 12-7(continued) December 31 Accumulated ($ in millions)Unrealized Available-for-Sale SecuritiesCostFair ValueGain (Loss) Platinum Gauges, Inc. shares$31$32*$1 LTD preferred shares 40 37* (3) Totals$71$69$(2) * $32 x 1 million shares * $74 x 500,000 shares Adjusting entry: Net unrealized holding gains and lossesOCI ($71 69).2 Fair value adjustment ($71 69).2 2012 January 23 ($ in millions) Cash (1 million shares x 1/2 x $32)16.0 Gain on sale of investments (difference)0.5 Investment in Platinum Gauges shares ($31 million cost x 1/2).15.5 March 1 Cash ($76 x 500,000 shares).38 Loss on sale of investments (difference)2 Investment in LTD preferred (cost)40 Note: As part of the process of recording the normal, period-end fair value adjusting entry at 12/31/2012, Construction would debit Fair value adjustment and credit Net unrealized gains and lossesOCI for the $2.5 million associated with the sold investments to remove their effects from the financial statements. (Construction sold only half the Platinum investments so only half of the Platinum fair value adjustment should be removed. The 2.5 amount comes from 3.0 LTD - 0.5 Platinum.) Chapter 12 - Investments 12-10 Exercise 12-7 (concluded) Requirement 2 2011 Income Statement ($ in millions) Investment revenue (from July 18; Oct. 15).$3 Gain on sale of investments (from Oct. 16)1 Other comprehensive income:* Net unrealized holding gains and losses on investments*$2 * Assuming Construction Forms chooses to report Other comprehensive income as an additional section of the income statement. Alternatively, it can report this (a) as part of the statement of shareholders equity or (b) as a separate statement in a disclosure note. Note: Unlike for trading securities, unrealized holding gains and losses are not included in income for securities available-for-sale. Rather, they are included in other comprehensive income, and accumulated in shareholders equity in accumulated other comprehensive income. Chapter 12 - Investments 12-11 Exercise 12-8 Requirement 1 Purchase($ in millions) Investment in Jackson Industry shares 90 Cash 90 Net income No entry Dividends Cash (5% x $60 million)3 Investment revenue3 Adjusting entry Fair value adjustment ($98 90 million).8 Net unrealized holding gains and lossesOCI.8 Requirement 2 Investment revenue$3 million Note: An unrealized holding gain is not included in income for securities available-for-sale. Rather, it is included in other comprehensive income, and accumulated in shareholders equity in accumulated other comprehensive income. Chapter 12 - Investments 12-12 Exercise 12-9 1. Investments reported as current assets. SecurityA $ 910,000 SecurityB100,000 SecurityC780,000 Security E 490,000 Total$2,280,000 2. Investments reported as noncurrent assets. SecurityD $ 915,000 Security F 615,000 $1,530,000 3. Unrealized gain (or loss) component of income before taxes. Trading Securities: Cost Fair value Unrealized gain (loss) SecurityA$ 900,000$ 910,000$10,000 B 105,000 100,000 (5,000) Totals$1,005,000$1,010,000$ 5,000 4. Unrealized gain (or loss) component of AOCI in shareholders equity. Securities Available-for-Sale: Cost Fair value Unrealized gain (loss) Security C$ 700,000$ 780,000$80,000 D 900,000 915,000 15,000 Totals$1,600,000$1,695,000$95,000 Chapter 12 - Investments 12-13 Exercise 12-10 Requirement 1 Accumulated ($ in 000s)Unrealized Available-for-Sale SecuritiesCostFair ValueGain (Loss) IBM shares Dec. 31, 2011$1,345$1,175$(170) Moving from a negative $145 (Jan.1) to a negative $170 requires a reduction of $25: - -170-1450 Fair value adjustment ($1,275,000 1,200,000) 75,000 Net unrealized holding gains and lossesOCI.75,000 Fair Value Adjustment Balance needed in fair value adjustment($ 70) Existing balance in fair value adjustment:($145) Increase (decrease) needed in fair value adjustment:$ 75 Chapter 12 - Investments 12-15 Exercise 12-10 (concluded) Requirement 3 Accumulated ($ in 000s)Unrealized Available-for-Sale SecuritiesCostFair ValueGain (Loss) IBM shares Dec. 31, 2011$1,345$1,375$30 Moving from a negative $145 (Jan.1) to a positive $30 requires an increase of $175: - -145-700+30 +175 - Fair value adjustment ($1,375,000 1,200,000) 175,000 Net unrealized holding gains and lossesOCI.175,000 Fair Value Adjustment Balance needed in fair value adjustment$ 30 Existing balance in fair value adjustment:($145) Increase (decrease) needed in fair value adjustment:$175 Chapter 12 - Investments 12-16 Exercise 12-11 Requirement 1 The sale of the A Corporation shares decreased Harlons pretax earnings by $5 million. The purchase of the C Corporation shares had no effect on Harlons 2012 earnings (because the shares are classified as available-for-sale investments, any unrealized gains or losses occurring after purchase during 2012 would not affect 2012 earnings). Here are the entries used to record those two transactions: June 1, 2012($ in millions) Cash15 Loss on sale of investments (difference)5 Investment in A Corporation shares (cost)20 September 12, 2012 Investment in C Corporation shares15 Cash15 Chapter 12 - Investments 12-17 Exercise 12-11 (concluded) Requirement 2 Harlons securities available-for-sale portfolio should be reported in its 2012 balance sheet at its fair value of $101 million: December 31, 2012 ($ in millions)Cost, Dec. 31Fair Value, Dec. 31 Securities Available-for-Sale2011201220112012 A Corporation shares$20na$14na B Corporation bonds35$3535$ 37 C Corporation sharesna15na14 D Industries shares 45 45 46 50 Totals$100$95$95$101 In 2011, Harlon would have had a net unrealized loss of $5 (cost of $100 fair value of $95). Moving from a negative $5 (2011) to a positive $6 requires an increase of $11: - -50+6 +11 - Fair value adjustment ($5 credit to $6 debit)11 Net unrealized holding gains and lossesOCI11 The adjustment has no effect on earnings. Unlike for trading securities, unrealized holding gains and losses are not included in income for securities available-for-sale. Rather, they are included in other comprehensive income, and accumulated in shareholders equity in accumulated other comprehensive income. Fair Value Adjustment Allowance Balance needed in fair value adjustment$ 6 Existing balance in fair value adjustment:(5) Increase (decrease) needed in fair value adjustment:$11 Chapter 12 - Investments 12-18 Exercise 12-12 Requirement 1 The investment would be accounted for as an available-for-sale investment: Purchase Investment in AMC common shares480,000 Cash .480,000 Net income No entry Dividends Cash (20% x 400,000 shares x $0.25).20,000 Investment revenue.20,000 Adjusting entry Fair value adjustment ($505,000 480,000)25,000 Net unrealized holding gains and lossesOCI25,000 Requirement 2 The investment would be accounted for using the equity method: Purchase Investment in AMC common shares480,000 Cash .480,000 Net income Investment in AMC common shares (20% x $250,000) .50,000 Investment revenue.50,000 Dividends Cash (20% x 400,000 shares x $0.25).20,000 Investment in AMC common shares 20,000 Adjusting entry No entry Chapter 12 - Investments 12-19 Exercise 12-13 Purchase($ in millions) Investment in Nursery Supplies shares56 Cash 56 Net income Investment in Nursery Supplies shares (30% x $40 million) 12 Investment revenue12 Dividends Cash (30% x 8 million shares x $1.25).3 Investment in Nursery Supplies shares3 Adjusting entry No entry Exercise 12-14 Requirement 1 ($ in millions) Investment in equity securities ($48 million 31 million).17 Retained earnings (investment revenue from the equity method).17 Requirement 2 Financial statements would be recast to reflect the equity method for each year reported for comparative purposes. A disclosure note also should describe the change, justify the switch, and indicate its effects on all financial statement items. Requirement 3 When a company changes from the equity method, no adjustment is made to the carrying amount of the investment. Instead, the equity method is simply discontinued, and the new method is applied from then on. The balance in the investment account when the equity method is discontinued would serve as the new “cost” basis for writing the investment up or down to fair value in the next set of financial statements. There also would be no revision of prior years, but the change should be described in a disclosure note. Chapter 12 - Investments 12-20 Exercise 12-15 Requirement 1: Error discovered before the books are adjusted or closed in 2011. The journal entry the company made is: Cash.100,000 Investments100,000 The journal entry the company should have made is: Cash.100,000 Investments80,000 Gain on sale of investments ($100,000 80,000)20,000 Therefore, to get from what was done to what should have been done, the following entry is needed: Investments ($100,000 80,000).20,000 Gain on sale of investments 20,000 Requirement 2: Error not discovered until early 2012. Investments ($100,000 80,000).20,000 Retained earnings20,000 Chapter 12 - Investments 12-21 Exercise 12-16 Purchase($ in millions) Investment in Carne Cosmetics shares 68 Cash .68 Net income Investment in Carne Cosmetics shares (25% x $40 million) .10 Investment revenue10 Dividends Cash (4 million shares x $1)4 Investment in Carne Cosmetics shares 4 Depreciation Adjustment Investment revenue ($8 million calculation below 8 years)1 Investment in Carne Cosmetics shares 1 Calculations: InvesteeNet AssetsDifference Net AssetsPurchasedAttributed to: Cost$68 Goodwill:$12 Fair value:$224* x 25% = $56 Undervaluation Book value:$192 x 25% = $48of assets:$8 *$192 + 32 = $224 Adjusting entry No entry to adjust for changes in fair value as this investment is accounted for under the equity method. Chapter 12 - Investments 12-22 Exercise 12-17 Requirement 1 Purchase($ in millions) Investment in Lake Construction shares300 Cash .300 Net income Investment in Lake Construction shares (20% x $150 million) 30 Investment revenue30 Dividends Cash (20% x $30 million).6 Investment in Lake Construction shares6 Adjustment for depreciation Investment revenue ($10 million calculation below 10 years)1 Investment in Lake Construction shares1 calculation: InvesteeNet AssetsDifference Net AssetsPurchasedAttributed to: Cost$300 Goodwill:$120 Fair value:$900 x 20% = $180 Undervaluation Book value:$800 x 20% = $160of buildings ($10) and land ($10): $20 Requirement 2 a.Investment in Lake Construction shares _ ($ in millions) Cost300 Share of income30 6Dividends 1Depreciation adjustment _ Balance323 Chapter 12 - Investments 12-23 Exercise 12-17 (concluded) b. As investment revenue in the income statement. $30 million (share of income) $1 million (depreciation adjustment) = $29 million c. Among investing activities in the statement of cash flows. $300 million Cash dividends received ($6 million) also are reported - as part of operating activities. If Cameron reports cash flows using the indirect method, the operations section of its statement of cash flows would include an adjustment of ($23 million) to get from the net income figure that includes $29 million of revenue to a cash flow number that should only include $6 million of cash flow. Chapter 12 - Investments 12-24 Exercise 12-18 Requirement 1 First we need to identif

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