Test Bank – Chapter 8 – Investments in Equity Securities 8-39
14. Before adjusting its current investments in equity securities, Apex Company has total
current assets and current liabilities of $23,000 and $12,000, respectively. During the
current year, Apex has net income of $200,000 with 50,000 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 $3,000. However, the current market value of those securities is $4,000 at
yearend. If Apex properly accounts for trading securities, determine the effect on Apex’s
current ratio and earnings per share.
Solution:
Current ratio before = $23,000/$12,000 = 1.92
15. On December 31, 2015, trading securities with an original cost of $100,000 have a
market value of $109,000, and available-for-sale securities with an original cost of
$45,000 have a market value of $60,000. It is management’s intent to hold the available
for sale securities indefinitely. Fill in the partial balance sheet at December 31, 2015
provided below showing the results of the investments. Clearly label whether any gains
or losses are realized or unrealized and clearly show the balance sheet classifications.
Balance Sheet at December 31, 2015:
Current Assets
Long-Term Assets
Shareholders’ Equity
Solution:
16. Falcon, Inc. acquired 30% of Dodson Corporation for $100,000 on December 31, 2014.
During the calendar year 2015, Dodson had net earnings of $400,000 and paid total
dividends of $50,000. The fair value of Dodson Corporation’s stock at yearend was
$160,000. Falcon mistakenly recorded these transactions using the fair value method
(available-for-sale classification) rather than the equity method of accounting.
A. Determine the effect the error would have on the investment account at December
31, 2015.
B. Determine the effect the error would have on net income for the year ending
December 31, 2015.
Solution:
A. Fair value method: $160,000
17. On January 3, 2015, Blanton Co. purchased 24% of Martin Company’s voting stock for
$100,000. During 2015, Martin recorded income of $90,000 and paid total dividends of
$15,000. Blanton uses the equity method to account for this investment. Calculate
Blanton’s income from the Martin investment and the December 31, 2015, balance sheet
value of its long-term equity investment in Martin. Show your work.
Solution:
18. Before adjusting its current investments in equity securities, Patton Company has total
current assets and current liabilities of $200,000 and $60,000, respectively. During the
current year, Patton has net income of $20,000 before the effects of any market value
adjustments with 30,000 shares of common stock outstanding. Included in current
assets are trading securities recorded at their original cost of $100,000 and available-for-
sale investments recorded at their original cost of $7,000. The current market value of
both investments increased by 15%. Patton properly accounts for both securities.
A. Determine how Paton’s current ratio and earnings per share will be affected by the
yearend adjustments for its investments.
B. Determine how the current ratio and earnings per share will differ if the available-for–
sale investment is classified as long-term.
Solution:
Current ratio before = $200,000/$60,000 = 3.33
19. On November 30, 2015, Arnold Company purchased 100% of the outstanding voting
common stock of Compton Corporation for $100,000. At that date the fair market value
of Compton assets less liabilities was $80,000. What amount, if any, of goodwill must
Arnold recognize in connection with its purchase of Compton? Where should Arnold
Company report this amount?
Solution:
20. On April 1, 2015, Parrish Company purchased 90% of the outstanding voting common
stock of Hamilton Corporation for $400,000. At that date the fair market value of
Hamilton’s assets less liabilities was $200,000. What amount, if any, of goodwill must
Parrish recognize in its consolidated balance sheet on December 31, 2015? Show your
work.
Solution:
21. On January 1, 2015, Simpson Company purchased all of the assets and assumed all of
the liabilities of Dobson Company for $400,000. Dobson’s balance sheet showed total
assets of $450,000 and total liabilities of $210,000 of this date. An appraiser determined
all assets except for land are valued at fair market value. The land is worth $20,000
more than its book value.
A. Calculate goodwill in connection with this business combination.
B. Prepare the journal entry to record the combination.
Solution:
A.
Book value of the assets
$ 450,000
Increase to fair value for land
20,000
Fair value of assets
470,000
Less fair value of liabilities
(210,000)
Fair value of net assets
$ 260,000
Purchase price
400,000
Goodwill
$ 140,000
B.
Assets
Goodwill
Liabilities
210,000
Cash
400,000
KP App8A BT: AN Difficulty: Moderate TOT: 5 min. AACSB: Analytic
AICPA BB: Critical Thinking AICPA FN: Reporting
22. On May 6, 2015, Galen Company purchased equity securities. At December 31, 2015,
three investments were still owned by Galen. The names, cost, and fair values at
December 31, 2015, are indicated below.
Name
Acquisition Cost
Fair Value
Guy Company
$10,000
$8,000
Nordic Company
$3,000
$4,500
Vernon Company
$7,000
$7,800
The investments have clearly determinable fair values. Galen can’t exercise significant
influence on any of these investments. Galen has determined that the Guy stock will be
held until 2016. Galen intends to sell the Vernon stock by January 2, 2016, for short-term
profits. Galen has no idea how long it will hold the Nordic stock. Show how these
investments and any related yearend adjustments will be reported by completing the
balance sheet below at December 31, 2015.
Balance Sheet at December 31, 2015:
Current Assets
Long-Term Investments
Shareholders’ Equity
Solution:
Balance Sheet at December 31, 2015:
Current Assets
Investment in Trading (Vernon)
$7,800
Long-Term Investments
Investment in Available-for-Sale (Guy)
8,000
Investment in Available-for-Sale (Nordic)
4,500
Shareholders’ Equity
Unrealized Net Price Decrease on Available-for-Sale Sec.
(500)
($2,000) + $1,500
23. On December 31, 2015, Celtic Inc. acquired a 24% interest in Romano Corp. for
$100,000 and appropriately applied the equity method. During 2015, Romano had net
income of $400,000 and paid cash dividends of $50,000. How much will Celtic report for
the year ending December 31, 2016 on its income statement? Show your work.
Solution:
24. On January 1, 2015, Danner Company purchased all of the assets and assumed all of the
liabilities of Clancy Company for cash of $80,000. Clancy’s balance sheet showed total
assets of $120,000 and total liabilities of $70,000. The equipment had a fair market value
on the same date of $10,000 instead of the $6,000 reported on the balance sheet.
Calculate goodwill in connection with this business combination. Prepare the journal entry
to record the combination.
Solution:
Book value of assets
$120,000
Fair value for equipment difference
4,000
Fair value of assets
124,000
Less fair value of liabilities
(70,000)
Fair value of net assets
54,000
Purchase price
80,000
Goodwill
$ 26,000
Assets
124,000
Goodwill
26,000
Liabilities
70,000
Cash
80,000
KP App8A BT: AN Difficulty: Moderate TOT: 4 min. AACSB: Analytic
AICPA BB: Critical Thinking AICPA FN: Reporting
25. On December 31, 2015, Rory Corp. acquired an 18% interest in Batson Corp. for
$100,000 and appropriately applied the cost method. During 2016, Batson had net
income of $200,000 and paid cash dividends of $50,000. On the last day of 2016, Rory
26. York Corporation owns 25% of Carson, Inc. that it purchased on January 1, 2015, for
$100,000. York uses the cost method for accounting for its investment in Carson, Inc.
During 2015, Carson, Inc. paid a total of $45,000 of dividends and recorded income of
$200,000. Determine how much York’s net income would differ if it used the equity
method instead of the cost method. Show your work.
Solution:
27. On December 31, 2015, Tanner Corp. acquired a 20% interest in Gantry Corp. for
$800,000 and appropriately applied the equity method. During 2016, Gantry had net
income of $150,000 and paid cash dividends of $5,000. On last day of 2016, Tanner
sold one-half of its investment in Gantry Corp. for $620,000. How much should Tanner
report on its income statement for the year ending December 31, 2016? Show your
work.
Solution:
Investment income = $150,000 x 20%
$30,000
Gain on sale of investment:
Selling price
$620,000
Book value:
Original cost
$800,000
Net income (20% x $150,000)
30,000
Dividends (20% x $5,000)
(1,000)
Carrying Value
829,000
Portion Sold
50%
414,500
Gain on sale
205,500
Income statement effect of investment income and sale
$235,500
KP 4 BT: AN Difficulty: Moderate TOT: 4 min. AACSB: Analytic
AICPA BB: Critical Thinking AICPA FN: Reporting
28. On January 2, 2016, Merton Co. acquired 30 percent of the outstanding voting common
stock of Tilton, Inc., at a cost of $50,000. With this investment, Merton has the ability to
exercise significant influence over Tilton, Inc. During 2016, Tilton, Inc. reported net
income of $110,000 and paid total cash dividends of $35,000. What amount should be
reported as investment and investment earnings by Merton for the year ending
December 31, 2016? Show your work.
Solution:
Test Bank – Chapter 8 – Investments in Equity Securities 8-47
AICPA BB: Critical Thinking AICPA FN: Reporting
SHORT ESSAY QUESTIONS
1. Why should users be cautious when examining financial statements in which the
company has accounted for investments using the equity method?
Solution: The equity method requires accrual-based, year-end adjustments that
2. How is the purchase method used in accounting for business acquisitions?
Solution: The purchase method requires that assets and liabilities of an acquired
3. How does the concept of “consolidated financial statements” relate to a business
acquisition?
Solution: A business acquisition occurs when the investing company acquires a
4. On November 1, 2015, Nova Company purchased short-term marketable equity
securities in Sandi Corporation and Exeter Corporation. The following valuation of
Nationals’ portfolio in short-term investments on December 31, 2015 is:
Cost
Market
Sandi Corporation
$70,000
$75,000
Exeter Corporation
$45,000
$60,000
Answer the following questions if you assume that only one of these short-term
investments is to be classified as trading, while the other will be classified as available-
for-sale.
A. If Nova Company wants to maximize its 2015 earnings per share, which investment
should be classified as trading? Justify your choice.
B. If Nova Company desires to minimize its December 31, 2015, debt/equity ratio,
which investment should be classified as trading? Justify your choice.
Solution:
A. The market appreciation of investment in Sandi and Exeter is $5,000 and $15,000,
respectively. If the investment in Exeter is classified as trading, then Nova will
recognize an unrealized gain on its income statement of $15,000. Then the
5. What are several features about the equity method that should cause financial report
users to view it carefully?
Solution:
• First, the equity method provides another reason why a company’s net income
Test Bank – Chapter 8 – Investments in Equity Securities 8-49
KP 5 BT: AP Difficulty: Moderate TOT: 4 min. AACSB: Communication, Analytic
AICPA BB: Critical Thinking AICPA FN: Reporting
6. What is the concept of ‘non–controlling interest’?
Solution: Non-controlling interest is recognized when an investor purchases
between 50 and 100 percent of the stock of another company at a price greater than the
7. What two criteria must be met for an investment in a security to be considered as current
on an investor’s balance sheet?
Solution: In order to classify an investment as current, it must be readily
8. How do current accounting rules put U.S. corporations at a distinct disadvantage
compared to foreign corporations?
Solution: When a U.S. corporation wishes to bid against foreign buyers for
9. On November 15, 2015, Torborg Company purchased short-term marketable equity
securities in Radar Corporation and Booker Corporation. The following valuation of
Twins’ portfolio in short-term investments on December 31, 2015 is:
Cost
Market
Radar Corporation
$34,000
$38,000
Booker Corporation
$22,000
$35,000
It is management policy that only one of its short-term investments can be classified as
trading, while the other, therefore, must be classified as available-for-sale. Because
Torborg’s 2015 income exceeds market expectations and its 2016 income prospects are
suspect, the management desires to classify its short-term investments so that 2010
income is maximized. On January 11, 2016, Torborg Company sells its investments in
Radar and Booker for $40,000 and $39,000, respectively.
In order to achieve management’s desires, which investment should be classified as
trading and which as available-for-sale? Numerically justify your response.
Solution: The holding gains (losses) associated with a trading security are
recognized during the period of market price appreciation (depreciation). Therefore,
when a trading security is sold, the realized gain (loss) reflects only the market price
Radar (trading)
Total gains
Booker (trading)
Total gains
10. On December 1, 2015, Fox Corporation purchased 10,000 common shares of Daniels
Corporation as a short-term investment. The valuations of these securities on December
31, 20159 are:
Cost
Market Value
Daniels Corporation
$100,000
$70,000
On the afternoon of December 31, 2015, the management of Fox is deciding whether to
sell its investment in Daniels before the 2015 statements are issued. However, it wants
to avoid any loss on the 2015 income statement associated with its short-term
investment in Daniels.
A. What advice would you give the management of Fox if its investment in Daniels were
classified as trading? Justify your advice.
B. What advice would you give the management of Fox if its investment in Daniels were
classified as available-for-sale? Justify your advice.
Solution:
A. If the short-term investment in Daniels is classified as a trading security, then 2015
net income is affected by the decision to sell or hold the security. The market price
KP 2,4 BT: AP Difficulty: Moderate TOT: 7 min. AACSB: Communication, Analytic
AICPA BB: Critical Thinking AICPA FN: Reporting
11. How does the concept of ‘merger’ differ from an ‘acquisition’?
Solution: A business acquisition occurs when the investing company acquires a
controlling interest (more than 50 percent of the voting stock) in another company. A
12. List the primary reasons a company might invest in equity securities. Explain how each
of these reasons helps to achieve the primary goal of a business entity—to make profit.
Solution: Companies make investments in equity securities for two basic reasons:
(1) to earn investment income in the form of dividends and stock price appreciation, and
13. How does the concept of comprehensive income relate to accounting for investments?
Solution: FASB requires companies to provide disclosure of comprehensive
income, which 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
14. Magnolia Products has a trading security investment that has suffered a permanent
market value decline and is not expected to recover? What should it do in this case?
Solution:
In such cases, the security should be written down to its market value, and a realized
Test Bank – Chapter 8 – Investments in Equity Securities 8-55
IFRS QUESTIONS
68. Under GAAP, A Statement of Comprehensive Income must be prepared by companies.
The comparable statement under IFRS is called:
a. The Statement of Recognized Income and Expense (SORIE)
b. The Statement of Comprehensive Equity (SCE)
c. The Statement of Comprehensive Assets and Income (SCAI)
d. The Statement of Equity and Expenses (SEE)
69. Under GAAP, investee companies that are 20 to 50 percent owned by investor
companies are often referred to as affiliate companies. Under IFRS, affiliate companies
are referred as:
a. Sister companies
b. Associate companies
c. Brother companies
d. Subordinate companies