1. Equity investments are:
a. investments in bonds of a corporation.
b. investments that pay dividends, not interest.
c. classified as long-term liabilities.
d. marketed by the SEC to any investor who wishes to buy bonds of a public company.
2. Investments in equity securities are current assets if:
a. they can be sold and converted into cash on demand and a ready market exists.
b. the fair market value can’t be determined.
c. management intends to convert them into common stock within one year.
d. management owns less than 50% of the outstanding stock.
3. Income from trading and available-for-sale equity securities is recognized when:
a. dividends are received from the investee due to the uncertainty of payment.
b. dividends are declared by the investee.
c. adjusting entries are made to record fair value adjustments.
d. the investee reports profits for the accounting period.
4. When a company accounts for an investment under the purchase method of accounting,
a. the book value of the subsidiary’s assets is added to the parent company‘s assets.
b. the book value of the subsidiary’s liabilities is added to the parent company’s
liabilities.
c. the company obviously owns more than 50% of the stock of the investee.
d. a year-end adjustment is made to increase or decrease the carrying value of the
investment to fair market value.
5. Trading securities are:
a. readily marketable investments that management intends to hold for extended
periods.
b. always short-term investments.
c. current assets that require the equity method of accounting for investments.
d. actively ‘traded’ on the open market, but can’t be sold until they mature.
6. Available-for-sale securities are:
a. actively ‘traded’ on the open market, but can’t be sold until they mature.
b. readily marketable investments that management intends to sell for short-term
profits.
c. always short-term investments in common stock.
d. adjusted to fair value at yearend.
7. Trading securities:
a. are recorded on the balance sheet at market value.
b. may have unrealized gains or losses on the balance sheet associated with price
increases or decreases.
c. are listed as long-term assets.
d. Both a and b are correct.
8. Benson Incorporated owns 32% of Denver Company’s outstanding voting stock. Benson
Incorporated should account for its investment in Denver using the:
a. fair value method.
b. cost method.
c. consolidation procedure.
d. equity method.
9. Dewey Inc. owns 64% of Felicity Corporation’s outstanding voting stock. Dewey should
account for its investment in Felicity using the:
a. fair value method.
b. cost method.
c. consolidation procedure.
d. mark-to-market method
Test Bank – Chapter 8 – Investments in Equity Securities 8-3
10. During 2015, the market price of trading securities declined. Which one of the following
correctly reflects the effects on the financial statements as a result?
a. Current ratio and earnings per share decrease.
b. Current ratio and earnings per share increase.
c. Current ratio is unchanged and earnings per share increases.
d. Current ratio increases and earnings per share are unchanged.
11. Available-for-sale securities:
a. are reported on the balance sheet at original cost.
b. may have unrealized price increases or decreases, which increase or decrease
shareholders’ equity.
c. are reported in the shareholders’ equity section of the balance sheet at fair value.
d. may have unrealized gains or losses on the income statement associated with price
increases or decreases.
12. When a company recognizes unrealized losses on trading securities, its earnings per
share:
a. decreases.
b. increases.
c. is not affected.
d. may increase or decrease depending on the related market value.
13. Torborg Corp. purchased available-for-sale securities from Hensley Company on
December 23 for $3,000. On December 31, the market value of those securities is
$3,600. Which one of the following journal entries is appropriate on December 31?
a.
Available-for-Sale Securities
3,600
Unrealized Gain on Available-for-Sale Securities
3,600
b.
Available-for-Sale Securities
600
Unrealized Gain on Available-for-Sale Securities
600
c.
Available-for-Sale Securities
600
Unrealized Price Increase on Available-for-Sale Securities
600
d.
No entry is required.
14. Trading securities of Sanchez Inc. were purchased by Hayden Company on December
14 for $1,000. On December 31, the market value of those securities is $1,300. Which
one of the following adjusting journal entries is appropriate at December 31?
a.
Trading Securities
1,300
Unrealized Gain on Trading Securities
Cash
b.
Trading Securities
300
Unrealized Gain on Trading Securities
c.
Trading Securities
300
Securities Revenue
d.
No entry is required.
15. On November 10, 2015, Clark Inc. purchased shares of Landon Corp. for $100,000 and
shares of Norris Incorporated for $50,000. At the end of 2015, the fair market value of
the stock of Landon was $80,000 and for Norris Incorporated was $65,000. How should
Clark Inc. recognize these changes in market price?
a. As a net unrealized loss of $20,000.
b. As a net unrealized gain of $15,000.
c. As a net unrealized loss of $5,000.
d. No adjustment is required since the total fair value is higher than the total original
cost.
16. Which one of the following is true of the equity method?
a. The income recognized by the investor is based on the percentage of stock
ownership and the amount of earnings reported by the investee.
b. Market value adjustments are made at yearend.
c. The receipt of dividends increases net income on the investor’s financial statements.
d. The percent of ownership must be greater than 50% to apply this method.
17. The recognition of unrealized gains on available-for-sale investments
a. increases the current ratio.
b. decreases the current ratio.
c. does not affect the current ratio.
d. increases the current ratio if the investment is classified as current, otherwise it has
no effect.
Test Bank – Chapter 8 – Investments in Equity Securities 8-7
18. An investor owns trading equity securities in Noah Company. Noah Company declared
dividends of $300 during July. What entry is required in August when the dividends are
received?
a.
Cash
300
Dividends Receivable
300
b.
Dividends Receivable
300
Trading Securities
300
c.
Dividends Receivable
300
Dividend Revenue
300
d.
Cash
300
Trading Securities
300
19. Which one of the following journal entries is appropriate for an investor who owns short–
term equity securities when dividends of $500 have been declared on those equity
securities?
a.
Cash
500
Dividends Receivable
500
b.
Dividends Receivable
500
Trading Securities
500
c.
Cash
500
Trading Securities
500
d.
Dividends Receivable
500
Dividend Revenue
500
20. Which one of the following correctly reflects the effects on the financial statements
caused by the increase in the market price of long-term available-for-sale securities?
a. Current ratio is unchanged and earnings per share increases.
b. Current ratio and earnings per share increase.
c. Current ratio and earnings per share are unchanged.
d. Current ratio is unchanged and earnings per share decreases.
21. Trading securities were purchased on April 1 for $900. On December 31, the market
value of those securities is $700. Which of the following is part of the adjusting entry
necessary on December 31?
a. Debit Unrealized Loss on Trading Securities for $700
b. Debit Realized Loss on Trading Securities for $200
c. Credit Trading Securities for $200
d. Credit Unrealized Loss on Trading Securities for $200
22. Available-for-sale securities were purchased on May 2 for $1,000. On December 31, the
market value of those securities is $1,100. Which of the following is part of the adjusting
entry necessary on December 31?
a. Debit Unrealized Gain on Available-for-Sale Securities for $1,100
b. Debit Realized Gain on Available-for-Sale Securities for $100
c. Credit Available-for-Sale Securities for $100
d. Credit Unrealized Gain on Available-for-Sale Securities for $100
23. The recognition of unrealized losses on trading securities:
a. decreases the quick and current ratios.
b. increases the quick and current ratios.
c. does not affect the quick ratio, but decreases the current ratio.
d. does not affect the current ratio, but decreases the quick ratio.
24. Which of the following correctly reflects the effects on the financial statements caused by
the increase in market price of trading securities?
a. Current ratio and earnings per share decrease.
b. Current ratio and earnings per share increase.
c. Current ratio is unchanged but earnings per share decrease.
d. Current ratio decreases and earnings per share are unchanged.
25. The recognition of realized losses on short-term available-for-sale securities
a. increases the current ratio.
b. decreases working capital.
c. decreases comprehensive income.
d. decreases the debt/equity ratio.
8-10 Test Bank – Chapter 8 – Investments in Equity Securities
26. Which one of the following is an area of subjectivity which opens the incentive of window
dressing to management as it relates to investments?
a. The timing of when an investment is sold.
b. The proclamation of the intention to sell an investment within the next year.
c. The determination of the percentage of stock acquired.
d. Whether management has available cash to acquire investments.
27. The cost method of accounting for long-term equity investments is typically used when:
a. between 20% and 50% of the investee company is owned.
b. over 50% of the investee company is owned.
c. at least 20% of the investee company is owned.
d. None of the above is a consideration in choosing the cost method.
28. Which one of the following correctly reflects the effects on the financial statements
caused by dividends declared on trading securities owned by a firm?
a. Current ratio decreases.
b. Earnings per share increases.
c. Current ratio is unchanged.
d. Earnings per share is unchanged.
29. The equity method of accounting for long-term equity investments is typically used when:
a. less than 20% of the investee company is owned.
b. between 20% and 50% of the investee company is owned.
c. over 50% of the investee company is owned.
d. any amount over 20% is acquired.
30. The consolidation procedure of accounting for long-term equity investments is typically
used:
a. when less than 20% of the investee company is owned.
b. in situations when over 50% of the investee company is owned.
c. only when 100% of the investee company is owned.
d. when between 20% and 50% of the investee company is owned.
31. Walsh Company purchased 1,000 shares of Pierce Company for $20 per share and
classified the investment as trading securities. At the end of the year, the fair market
value of the investment was $23 per share. How should Walsh recognize this change?
a. Debit the investment account by $23,000.
b. Credit the investment account by $3,000.
c. Report an unrealized gain on the income statement.
d. Show an unrealized loss on the balance sheet.
32. Which one of the following correctly reflects the effects on the financial statements
caused by a decrease in the market price of long-term available-for-sale securities?
a. Current ratio decreases.
b. Earnings per share increases.
c. Current ratio increases.
d. Earnings per share remains unchanged.
33. The recognition of unrealized gains on marketable securities:
a. depends on the classification of the securities.
b. causes net income to increase regardless of the securities’ classification.
c. causes earnings per share to increase regardless of the securities’ classification.
d. is a primary concern under the equity method.
34. Which one of the following must be met prior to classifying an investment as current?
a. It must be an equity security accounted for under the equity method.
b. The percentage of ownership must be greater than 50%.
c. The investment must be readily marketable.
d. Management must intend to hold the investment for an undetermined time period.
35. Trading securities are held primarily for the purpose of:
a. anticipated increases in value over extended time periods.
b. increasing the current ratio.
c. window dressing the balance sheet.
d. generating profits on short-term price increases.
36. Which one of the following correctly reflects the effects on the financial statements of the
investor caused by dividends declared on trading securities?
a. Current ratio increases
b. Working capital decreases
c. Revenue and assets decrease
d. Assets increase and shareholders’ equity decreases
37. Camber Corp. owns 10% of Nova Corp’s outstanding voting stock. Camber should
account for its long-term equity investment in Nova Corp. using the:
a. market value method if the stock is not traded on the market.
b. cost method if the stock is traded on the market.
c. cost method if the stock is not traded on the market.
d. equity method if the stock is traded on the market.
38. Which one of the following is evidence of a ready market?
a. The stock was purchased at a negotiated price from an outside party.
b. The security is actively traded on a public stock exchange.
c. A privately held corporation issued the stock.
d. The stock was purchased from an outside investor.
39. An unrealized holding gain or loss that relates to trading securities represents:
a. an undervalued investment.
b. the profit or loss made when the trading securities were sold.
c. the total dividends received from the investee company during the year.
d. the extent to which an investor’s wealth increased or decreased due to holding the
investment.
40. All of the following statements are true regarding comprehensive income except:
a. Comprehensive income includes all nonowner-related changes in shareholders’
equity that do not appear on the income statement and are not reflected in the
balance of retained earnings.
b. Comprehensive income includes adjustments to shareholders’ equity for holding
gains associated with available-for-sale securities.
c. Comprehensive income includes adjustments to shareholders’ equity for holding
losses associated with available-for-sale securities..
d. Comprehensive income must be reported in a specific format established by the
FASB.
41. A controlling interest in another company:
a. exists whenever the relationship between the investor and investee gives the
investor significant influence.
b. requires the parent to prepare consolidated financial statements.
c. is evidence that a merger will soon occur.
d. can be as low as 20 percent.
42. Why might chief executives react very positively to current goodwill accounting?
a. Goodwill increases in value.
b. Goodwill is amortized creating expenses that reduce net income, enabling a
company to pay less income tax.
c. Its amortization increases earnings per share.
d. Goodwill is no longer amortized so income is greater than prior accounting
requirements.
43. James Corporation purchased 100% of the common stock of Rashaad Corporation for
$50 million. James must account for this investment as:
a. an available-for-sale security.
b. an acquisition that requires consolidation accounting.
c. a trading security.
d. an equity security investment.
44. Decuzzi, Inc. paid $10,000 for a stock investment and classified it as available-for-sale.
On December 31, 2015, the company appropriately recognized an unrealized increase
of $3,000. The stock is reported on Decuzzi’s balance sheet at December 31, 2015 at:
a. $10,000.
b. $13,000.
c. $7,000.
d. Not enough information to determine.
45. Which one of the following investments would most likely be held the shortest period of
time?
a. Available-for-sale debt securities
b. Available-for-sale equity securities
c. Trading securities
d. An investment as a result of a merger
46. Multinational US companies usually have a number of foreign subsidiaries with financial
statements expressed in foreign currency. When the consolidated financial statements
are prepared, to combine the financial statements of the US parent and all of its
subsidiaries, the consolidation process involves multiple steps. Which of the following
statements about the combining process and the resultant consolidated financial
statements is always true for multinational US companies?
a. The foreign subsidiaries are separated into three categories, each of which receives
different treatment.
b. The foreign entity’s financial statements are converted into dollars.
c. Foreign currency translation adjustments have no effect on cash flows.
d. The foreign currency translation adjustments are included in consolidated income.
47. Which of the following statements about Special Purpose Entities (SPEs) is not true?
a. SPEs can take on various legal forms, like corporations or partnerships.
b. It can be difficult to determine who actually controls an SPE.
c. Management can structure a transaction using an SPE in such a manner that the
accounting treatment fails to reflect the economic substance of the transaction.
d. SPEs have been used to mislead investors.
48. Carmen Corporation purchased a 40% interest in Sahara Inc. on January 1, 2015,
paying $200,000 for 40% of the outstanding voting stock of Sahara Inc. For its year
ended December 31, 2015, Sahara Inc. reported net income of $40,000. On December
31, 2015, Carmen received a dividend payment from Sahara in the amount of $1,000.
As a result of its ownership interest in Sahara, the financial statements for Carmen
Corporation for the year ended December 31, 2015 will reflect which of the following:
a. An asset in the amount of $200,000.
b. Revenue of $1,000.
c. Cash flows from operations of $1,000.
d. Revenue of $16,000.
49. Before adjusting its current investments in equity securities, Caldwell Company has total
current assets and current liabilities of $45,000 and $15,000, respectively. During the
current year, Caldwell has net income of $243,750 with 75,000 shares of common stock
outstanding. This amount excludes the effects of yearend adjustments related to the
investments. Included in current assets are trading securities recorded at their original
cost of $13,000. However, the current market value of those securities is $4,000 at
yearend. If Caldwell properly accounts for trading securities, what is Caldwell’s current
ratio before and after the investment adjustment?
a. 3.0 and 2.1
b. 3.0 and 3.3
c. 3.0 and 3.6
d. 3.0 and 2.4
Solution: D
AICPA BB: Critical Thinking AICPA FN: Measurement
50. Before adjusting its current investments in equity securities, Caldwell Company has total
current assets and current liabilities of $45,000 and $15,000, respectively. During the
current year, Caldwell has net income of $243,750 with 75,000 shares of common stock
outstanding. This amount excludes the effects of yearend adjustments related to the
investments. Included in current assets are trading securities recorded at their original
cost of $13,000. However, the current market value of those securities is $4,000 at
yearend. If Caldwell properly accounts for trading securities, what is Caldwell’s earnings
per share amount before and after the investment adjustment, respectively?
a. $3.25 and $3.00
b. $3.25 and $3.13
c. $3.25 and $3.37
d. $3.25 and $2.77
Solution: B
Test Bank – Chapter 8 – Investments in Equity Securities 8-19
51. On January 2, 2015, Pfizer Co. purchased 22% of Wiley Company’s voting stock for
$150,000. During 2015, Wiley recorded income of $102,000 and paid total dividends of
$27,000. Pfizer uses the equity method to account for this investment. What is Pfizer’s
income from the Wiley investment?
a. $27,000
b. $28,380
c. $22,440
d. $33,000
Solution: C
52. On January 2, 2015, Pfizer Co. purchased 22% of Wiley Company’s voting stock for
$150,000. During 2015, Wiley recorded income of $102,000 and paid total dividends of
$27,000. Pfizer uses the equity method to account for this investment. What is the
December 31, 2015, balance sheet value of its long-term equity investment in Wiley?
a. $178,380
b. $225,000
c. $150,000
d. $166,500
Solution: D
53. If Howard Company’s balance sheet amount of goodwill is $20,000 and the fair market
value of the goodwill is estimated to be $25,000, which of the following entries would be
recorded in Howard’s books?
a. Goodwill 5,000
Goodwill Market Gain 5,000
b. Goodwill Market Gain 5,000
Goodwill 5,000
c. Goodwill impairment Charge 5,000
Goodwill 5,000
d. No entry will be made.
54. On December 31, 2015, available-for-sale securities with an original cost of $15,000
have a carrying value on the balance sheet equal to their market value of $20,000. On
January 5, 2016, those securities are sold for $18,000. Which of the following would be
part of the appropriate entry to record the sale of the available-for-sale securities?
a. A credit to Realized Gain on Available-for-Sale Securities for $5,000.
b. A debit to Unrealized Price Increase on Available-for Sale Securities for $3,000.
c. A debit to Unrealized Price Increase on Available-for Sale Securities for $5,000.
d. A credit to Available-for Sale Securities for $15,000.
Solution: C
Cash
18,000
Unrealized Price Increase on Available-for-Sale Securities
5,000
Realized Gain on Available-for-Sale Securities
3,000
Available-for-Sale Securities
20,000
Ans: C
KP 5 BT: AP Difficulty: Moderate TOT: 2 min. AACSB: Analytic
AICPA BB: Critical Thinking AICPA FN: Reporting
55. On January 2, 2015, Dellgate Corp. purchased 27% of Galaxy Corporation’s voting stock
for $125,000. During 2015, Galaxy recorded income of $214,000 and paid total
dividends of $17,000. Dellgate uses the cost method to account for this investment.
What is the December 31, 2015, balance sheet value of Dellgate’s long-term equity
investment in Galaxy?
a. $125,000
b. $178,190
c. $187,370
d. $86,940
Solution: A