Chapter 12 – Investments
TRUE/FALSE
1. Gains and losses on the sale of investments appear as adjustments within the operating activities
section of the statement of cash flows.
2. Investments are valued on the balance sheet at the original purchase price, even if the price has
changed since the date of purchase.
3. If a long-term investment suffers a permanent decline in value, a loss must be recorded, even though
the investment has not yet been sold.
4. Another term for short-term investments is marketable securities.
5. Investments with a maturity of less than a year are classified as cash equivalents.
6. As long as an investment can be sold within a short period of time, it must be classified as a current
asset.
7. Held-to-maturity securities are always debt securities, and never equity securities.
8. Available-for-sale securities may be classified as either short- or long-term, depending on how long
management intends to keep them.
9. A noninfluential and noncontrolling investment is defined as ownership of less than 10 percent of the
stock of another company.
10. An influential but noncontrolling investment is defined as ownership of 20 to 50 percent of the stock
of another company.
11. A controlling investment is defined as ownership of 100 percent of the stock of another company.
12. Detailed information about a company’s investments is appropriately disclosed in the notes to the
financial statements.
13. Insider trading is considered unethical, but it is not illegal in the United States.
14. An individual can be prosecuted by the SEC for insider trading only if that individual is employed by
the company involved.
15. Held-to-maturity securities that will mature within one year are classified on the balance sheet as
short-term investments and are valued at cost adjusted for the effects of interest.
16. Unrealized gains and losses on trading securities appear on the income statement.
17. Trading securities are valued on the balance sheet at market value.
18. Unrealized gains and losses on available-for-sale securities are reported on the income statement.
19. The account Allowance to Adjust Short-Term Investments to Market appears as a contra account on
the income statement.
20. It is not possible for one company to influence the operating policies of another company unless it
owns more than a 50 percent interest in that company.
21. Unless there is evidence to the contrary, an investor owning 25 percent of the stock of an investee is
assumed to have significant influence.
22. An ownership interest of greater than 50 percent is required for an investor to have accounting control
over an investee.
23. The equity method usually is the most appropriate method for accounting for investments of less than
a 20 percent interest.
24. The cost-adjusted-to-market method of accounting for investments allows for a departure from cost
when the market value of the investment falls below or rises above cost.
25. Dividends received on investments are accounted for in the same way under the
cost-adjusted-to-market and the equity methods.
26. Under the equity method of accounting for a stock investment, a proportionate share of the investee’s
income is recorded on the investor’s records.
27. When the cost-adjusted-to-market method is used to account for an investment in stock, dividends
received are accounted for as a reduction in the Investment account.
28. For available-for-sale securities, the Unrealized Loss on Long-Term Investments account appears on
the income statement.
29. Using the cost-adjusted-to-market method of accounting for a long-term investment in stock, the
journal entry to record the receipt of dividends involves a credit to Dividend Income.
30. The Allowance to Adjust Long-Term Investments to Market account is placed in the asset section of
the balance sheet.
31. At any given balance sheet date, the balance of the Unrealized Gain on Long-Term Investments
account is equal in amount to the balance of the Allowance to Adjust Long-Term Investments to
Market account.
32. When the equity method is used to account for an investment in stock, dividends received by the
investor are credited to the Dividend Income account.
33. When the equity method is used to account for an investment in stock, the investor will report its share
of the investee’s annual earnings as income regardless of how much the investee distributes in the form
of dividends.
34. It is possible that an investor with less than a 50 percent ownership interest may qualify for accounting
recognition of control and appropriately prepare consolidated financial statements.
35. When the market value of available-for-sale securities exceeds cost, an unrealized gain appears in
stockholders’ equity as an addition.
36. When the cost of available-for-sale securities exceeds market value, the Allowance to Adjust
Long-Term Investments to Market account is added to Long-Term Investments on the balance sheet.
37. With few exceptions, all subsidiaries in which the parent company owns a controlling interest (more
than 50 percent) must be consolidated with the parent company for financial reporting purposes.
38. If a parent company has four subsidiaries, there are five separate legal entities represented in this
group.
39. Eliminations are important because they avoid double counting when consolidated financial statements
are prepared.
40. The elimination of the investment in the subsidiary company is made against the liabilities, capital
stock, and retained earnings of the subsidiary company.
41. In preparing consolidated financial statements, intercompany receivables and payables must be
eliminated because they do not represent amounts due to or receivable from parties outside the
consolidated entity.
42. When a parent company and a 100 percent owned subsidiary company are consolidated using the
purchase method, only the stockholders’ equity of the parent company remains.
43. If a parent company pays more than book value for a 100 percent owned subsidiary, minority interest
arises on the consolidated financial statements.
44. A company may pay more than book value for a subsidiary because the assets of the subsidiary are
undervalued on its balance sheet.
45. Goodwill is the amount by which specific assets of a subsidiary are undervalued.
46. An eliminating entry is required when a subsidiary owes a parent company but not when the parent
owes the subsidiary.
47. Elimination entries are recorded in the consolidated journal and posted to the consolidated ledger.
48. A minority interest represents the holdings of stockholders other than the parent company who own
less than 50 percent of the voting stock of a subsidiary.
49. Minority interest may be found in the asset section of a consolidated balance sheet.
50. A Goodwill from Consolidation account may rise when a parent acquires a subsidiary company’s
common stock at a price in excess of the stock’s book value.
51. When a parent company pays less than book value for an investment in a subsidiary, the excess of
book value over the cost of the investment should be used to lower the carrying value of the
subsidiary’s long-term assets (other than long-term marketable securities) in preparing the consolidated
financial statements.
52. Although the preparation of a consolidated balance sheet requires elimination entries, a consolidated
income statement may always be prepared without any elimination entries.
53. All intercompany transactions resulting in revenues and/or expenses require elimination entries in the
preparation of a consolidated income statement.
54. Only sales to outsiders and purchases from outsiders are reflected in a consolidated income statement
because all intercompany transactions are eliminated in preparing the consolidated statement.
55. The financial information of a foreign subsidiary should be excluded from the consolidated statements
of the parent.
56. The reporting currency is defined as the currency in which the consolidated financial statements are
presented.
57. The financial statements of a foreign subsidiary must be restated in terms of the reporting currency
before consolidation can take place.
58. U.S. Treasury bills are considered equity securities.
59. Held-to-maturity securities are valued on the balance sheet at fair value.
60. All the interest income on U.S. Treasury bills is recorded at maturity.
61. When a company holds U.S. Treasury bills, it would debit Short-Term Investments and credit Interest
Income at the end of the accounting period (assuming it is prior to the T-bills’ maturity).
62. When bonds are purchased between interest dates, the buyer must pay (in addition to the bonds’ cost)
the amount of interest that has accrued since the last interest payment date.
63. Most long-term bond investments are classified as held-to-maturity securities.
64. Long-term bond investments that are classified as available-for-sale must be valued on the balance
sheet at fair value.
MULTIPLE CHOICE
1. The cash amounts of purchases and sales of investments appear in which section of the statement of
cash flows?
a.
Operating activities
b.
Investing activities
c.
Financing activities
d.
Noncash investing and financing activities
2. Which of the following is not a category of investments?
a.
Held-to-maturity securities
b.
Trading securities
c.
Collateral securities
d.
Available-for-sale securities
3. All of the following are conditions that could affect the valuation of investments on the balance sheet
except
a.
changes in the general purchasing power of the dollar.
b.
changes in the operations of investee companies.
c.
changes in the market value of the investments.
d.
changes due to discount or premium amortization.
4. Which of the following categories of investments are debt, but not equity, securities?
a.
Trading securities
b.
Held-to-maturity securities
c.
Available-for-sale securities
d.
Both trading and available-for-sale securities
5. Which of the following categories of investments can be both debt and equity securities?
a.
Available-for-sale securities
b.
Trading securities
c.
Held-to-maturity securities
d.
Both available-for-sale and trading securities
6. Which is the only type of investment that is always classified as short-term?
a.
Trading securities
b.
Held-to-maturity securities
c.
Available-for-sale securities
d.
Equity securities
7. Which type of investment, if any, could be classified as short- or long-term, as well as debt or equity?
a.
Available-for-sale securities
b.
Trading securities
c.
Held-to-maturity securities
d.
None of the above
8. Significant influence is defined as owning what percent of the stock of another company?
a.
100 percent
b.
More than 50 percent
c.
20 to 50 percent
d.
90 percent
9. A controlling investment is defined as owning what percent of the stock of another company?
a.
More than 50 percent
b.
100 percent
c.
20 to 50 percent
d.
90 percent
10. All of the following are indications of significant influence over another company except
a.
participation in policymaking.
b.
representation on the board of directors.
c.
technological dependency between the two companies.
d.
ownership of all of the other company‘s debt securities.
11. In the United States, insider trading is considered
a.
unethical, but not illegal.
b.
neither unethical nor illegal.
c.
both unethical and illegal.
d.
illegal, but not unethical.
12. Which of the following statements is true about investments categorized as trading securities?
a.
They are valued on the balance sheet at cost.
b.
They can consist of debt, but not equity, securities.
c.
They are purchased to be held to maturity.
d.
Changes in market value are reflected in net income.
13. Held-to-maturity securities are valued on the balance sheet at
a.
market value.
b.
cost, adjusted for the effects of interest.
c.
cost.
d.
lower of cost or market.
14. Stock categorized as trading securities is purchased for $72,000. At year end, when the market value of
the stock is $63,000, the adjusting entry that would be recorded is:
a.
Allowance to Adjust Short-Term Investments to Market 9,000
Unrealized Loss on Investments 9,000
b.
Unrealized Loss on Short-Term Investments 9,000
Allowance to Adjust Short-Term Investments to Market 9,000
c.
Allowance to Adjust Short-Term Investments to Market 9,000
Short-Term Investments 9,000
d.
Realized Loss on Investments 9,000
Short-Term Investments 9,000
15. Trading securities are valued on the balance sheet at
a.
lower of cost or market.
b.
cost.
c.
market value.
d.
cost, adjusted for the effects of interest.
16. The year-end adjusting entry to reflect an increase in the value of trading securities includes a
a.
debit to Unrealized Gain on Investments.
b.
debit to Short-Term Investments.
c.
debit to Allowance to Adjust Short-Term Investments to Market.
d.
credit to Realized Gain on Investments.
17. All of the following are ways one corporation could affect the operating and financial policies of
another corporation except
a.
analysis of data regarding profitability.
b.
material transactions between the companies.
c.
representation on the board of directors.
d.
exchange of managerial personnel.
18. The ability of an investing company to affect the operating and financial policies of another company,
even though the investor holds less than 50 percent of the voting stock, is known as
a.
significant influence.
b.
control.
c.
minority interest.
d.
noninfluential control.
19. The cost-adjusted-to-market method of accounting for investments is used when the investment is
a.
controlling.
b.
influential and noncontrolling.
c.
noninfluential and controlling.
d.
noninfluential and noncontrolling.
20. Petrus Corporation owns a 40 percent interest in the stock of Sunseri Corporation. During 2010,
Sunseri pay $25,000 in dividends to Petrus and reports $107,000 in net income. Petrus Corporation’s
investment in Sunseri will increase Petrus’s income before income taxes by
a.
$17,800.
b.
$42,800.
c.
$52,800.
d.
$32,800.
21. Rapp Corporation has invested in the stock of two other corporations, Hart Corporation and Hilker
Corporation. Rapp does not own a controlling interest or exercise significant influence over either
corporation. Rapp’s accountant is preparing financial statements and has compiled the following
information:
Stock name
No. of shares
Cost
Market
Hart
1,000
$23,000
$24,000
Hilker
500
$27,500
$25,500
What should be the balance in the Allowance to Adjust Long-Term Investments to Market account,
based on the above information?
a.
$1,000 credit
b.
$2,000 debit
c.
$2,000 credit
d.
$1,000 debit
22. A credit balance in the account Allowance to Adjust Long-Term Investments to Market is disclosed in
the financial statements as a
a.
contra account in the stockholders’ equity section of the balance sheet.
b.
contra account to Long-Term Investments.
c.
note to the financial statements.
d.
liability.
23. Milner Corporation owns 25 percent of the voting stock of Vaglia Corporation and accounts for the
investment using the equity method. Vaglia reports a net loss of $10,000. Milner Corporation’s entry to
record its share of loss is:
a.
Cash 2,500
Investment in Vagila Corporation 2,500
b.
Loss on Investments 10,000
Investment in Vagila Corporation 10,000
c.
Loss,Vagila Corporation Investment 2,500
Investment in Vagila Corporation 2,500
d.
Cash 2,500
Loss,Vagila Corporation Investment 2,500
24. Mucura Enterprises has a credit balance of $40,000 in its Allowance to Adjust Long-Term Investments
to Market account before adjustment. Its investment portfolio has a total cost of $250,000 and a market
value of $225,000. The year-end adjustment entry that would be recorded in the books of Mucura
Enterprises is:
a.
Long-Term Investments 15,000
Allowance to Adjust Long-Term Investments to Market 15,000
b.
Allowance to Adjust Long-Term Investments to Market 15,000
Unrealized Loss on Long-Term Investments 15,000
c.
Allowance to Adjust Long-Term Investments to Market 25,000
Long-Term Investments 25,000
d.
Unrealized Loss on Long-Term Investments 25,000
Long-Term Investments 25,000
25. Under the cost-adjusted-to-market method of accounting for an investment,
a.
Dividend Income is credited when dividends are received.
b.
the investment account is credited when dividends are received.
c.
the investment account is credited when the investee reports a net income.
d.
Investment Income is credited when the invested reports a net income.
26. B & L Company has a credit balance of $44,000 in its Allowance to Adjust Long-Term Investments to
Market account at the end of 20xx, before adjustment. Its investment portfolio has a total cost of
$300,000 and a market value of $264,000 at December 31, 20xx, a balance sheet date. The year-end
adjustment entry that would be recorded in the books of B&L Company is:
a.
Long-Term Investments 8,000
Realized Gain on Long-Term Investments 8,000
b.
Allowance to Adjust Long-Term Investments to Market 8,000
Unrealized Loss on Long-Term Investments 8,000
c.
Unrealized Loss on Long-Term Investments 8,000
Allowance to Adjust Long-Term Investments to Market 8,000
d.
Long-Term Investments 8,000
Allowance to Adjust Long-Term Investments to Market 8,000
27. Flubber Corporation owns 40 percent of the voting stock of Rhim Corporation and accounts for the
investment using the equity method; Rhim Corporation reports a net loss of $30,000. Flubber
Corporation’s entry to record the share of loss is:
a.
Loss, Rhim Corporation Investment 12,000
Investment in Rhim Corporation 12,000
b.
Loss, Rhim Corporation Investment 12,000
Loss, Rhim Corporation Investment 12,000
c.
Investment in Rhim Corporation 30,000
Cash 30,000
d.
Investment in Rhim Corporation 12,000
Cash 12,000
28. Use this information to answer the following question. These facts concern the long-term stock
investments of Alpha Corporation:
Paid cash for the following long-term investment: 5,000 shares Carey
Corporation common stock (representing 5 percent of outstanding stock) at
$40 per share; 3,000 shares Burns Corporation common stock (representing 3
percent of outstanding stock) at $24 per share.
Quoted market prices at year end: Carey common stock, $35; Burns common
stock, $27.
A change in policy required the sale of 1,000 shares of Carey Corporation
common stock at $38.
Received a cash dividend from Burns Corporation equal to $.30 per share.
Quoted market prices at year end: Carey common stock, $39; Burns common
stock, $22.
The entry to record the purchase of the Carey Corporation common stock is:
a.
Long-Term Investments 272,000
Cash 272,000
b.
Long-Term Investments 120,000
Cash 120,000
c.
Long-Term Investments 72,000
Cash 72,000
d.
Long-Term Investments 200,000
Cash 200,000
29. Use this information to answer the following question. These facts concern the long-term stock
investments of Alpha Corporation:
Paid cash for the following long-term investment: 5,000 shares Carey
Corporation common stock (representing 5 percent of outstanding stock) at
$40 per share; 3,000 shares Burns Corporation common stock (representing 3
percent of outstanding stock) at $24 per share.
Quoted market prices at year end: Carey common stock, $35; Burns common
stock, $27.
A change in policy required the sale of 1,000 shares of Carey Corporation
common stock at $38.
Received a cash dividend from Burns Corporation equal to $.30 per share.
Quoted market prices at year end: Carey common stock, $39; Burns common
stock, $22.
The entry to set up the Allowance to Adjust Long-Term Investments to Market in 2009 is:
a.
Long-Term Investments 16,000
Realized Loss 16,000
b.
Realized Loss 16,000
Long-Term Investments 16,000
c.
Allowance to Adjust Long-Term Investments to Market 16,000
Long-Term Investments 16,000
d.
Unrealized Loss on Long-Term Investments 16,000
Allowance to Adjust Long-Term Investments to Market 16,000
30. Use this information to answer the following question. These facts concern the long-term stock
investments of Alpha Corporation:
Paid cash for the following long-term investment: 5,000 shares Carey
Corporation common stock (representing 5 percent of outstanding stock) at
$40 per share; 3,000 shares Burns Corporation common stock (representing 3
percent of outstanding stock) at $24 per share.
Quoted market prices at year end: Carey common stock, $35; Burns common
stock, $27.
A change in policy required the sale of 1,000 shares of Carey Corporation
common stock at $38.
Received a cash dividend from Burns Corporation equal to $.30 per share.
Quoted market prices at year end: Carey common stock, $39; Burns common
stock, $22.
The entry to record the sale of 1,000 shares of Carey Corporation common stock is:
a.
Long-Term Investments 38,000
Cash 38,000
b.
Long-Term Investments 38,000
Allowance to Adjust Long- Term Investments to Market 38,000
c.
Allowance to Adjust Long -Term Investments to Market 38,000
Cash 38,000
d.
Cash 38,000
Loss on Sale of Investments 2,000
Long-Term Investments 40,000
31. Use this information to answer the following question. These facts concern the long-term stock
investments of Alpha Corporation:
Paid cash for the following long-term investment: 5,000 shares Carey
Corporation common stock (representing 5 percent of outstanding stock) at
$40 per share; 3,000 shares Burns Corporation common stock (representing 3
percent of outstanding stock) at $24 per share.
Quoted market prices at year end: Carey common stock, $35; Burns common
stock, $27.
A change in policy required the sale of 1,000 shares of Carey Corporation
common stock at $38.
Received a cash dividend from Burns Corporation equal to $.30 per share.
Quoted market prices at year end: Carey common stock, $39; Burns common
stock, $22.
The entry to record the receipt of the cash dividend from Burns Corporation is:
a.
Investment in Burns Corporation 900
Cash 900
b.
Cash 900
Dividend Income 900
c.
Dividend Income 900
Cash 900
d.
Cash 900
Investment in Burns Corporation 900
32. Use this information to answer the following question. These facts concern the long-term stock
investments of Alpha Corporation:
Paid cash for the following long-term investment: 5,000 shares Carey
Corporation common stock (representing 5 percent of outstanding stock) at
$40 per share; 3,000 shares Burns Corporation common stock (representing 3
percent of outstanding stock) at $24 per share.
Quoted market prices at year end: Carey common stock, $35; Burns common
stock, $27.
A change in policy required the sale of 1,000 shares of Carey Corporation
common stock at $38.
Received a cash dividend from Burns Corporation equal to $.30 per share.
Quoted market prices at year end: Carey common stock, $39; Burns common
stock, $22.
The entry to adjust the Allowance to Adjust Long-Term Investments to Market in 2010 is:
a.
Unrealized Loss on Long-Term Investments 6,000
Allowance to Adjust Long Term Investment to Market 6,000
b.
Allowance to Adjust Long Term Investment to Market 10,000
Unrealized Loss on Long-Term Investments 10,000
c.
Unrealized Loss on Long-Term Investments 10,000
Allowance to Adjust Long Term Investment to Market 10,000
d.
Allowance to Adjust Long Term Investment to Market 6,000
Unrealized Loss on Long-Term Investments 6,000
33. Hauser Corporation holds 1,900 shares of Marlow Corporation common stock as its sole long-term
investment. Hauser does not have significant influence or control over Marlow. The stock was
purchased during 2009 at a price of $60 per share. On December 31, 2009, the market price of
Marlow’s stock was $54 per share. On December 31, 2010, the market price of Marlow’s stock was
$68 per share. What should be reported as the carrying value of the investment on Hauser’s December
31, 2009, and December 31, 2010, balance sheets, respectively?
a.
114,000; 114,000
b.
102,600; 114,000
c.
102,600; 102,600
d.
102,600; 129,200
34. Morse Company often invests in the stock of other companies for long-term purposes. None of the
stocks currently held by Morse qualify for use of the equity method. The following amounts relate to
Morse’s long-term portfolio of marketable equity securities.
Dec. 31, 2009
Dec. 31, 2010
Total cost
$280,000
$330,000
Total market
230,000
292,000
Based on the above information, the adjusting entry on December 31, 2010 is:
a.
Allowance to Adjust Long Term Investment to Market 38,000
Unrealized Loss on Long-Term Investments 38,000
b.
Allowance to Adjust Long Term Investment to Market 12,000
Unrealized Loss on Long-Term Investments 12,000
c.
Unrealized Loss on Long-Term Investments 38,000
Allowance to Adjust Long Term Investment to Market 38,000
d.
Unrealized Loss on Long-Term Investments 12,000
Allowance to Adjust Long Term Investment to Market 12,000
35. Orlov Corporation purchased 8,000 shares of Matsey Corporation common stock for $40 per share on
January 1, 2009. Matsey reported net income of $120,000 for 2009 and paid dividends of $42,000
during 2009. As of December 31, 2009, the market value of Matsey Corporation common stock was
$40 per share. Assuming the shares owned by Orlov represent 10 percent of the total outstanding stock
of Matsey, the entry to record the receipt of dividend income in Orlov Corporation’s books is:
a.
Cash 8,000
Dividend Income 8,000
b.
Cash 4,000
Dividend Income 4,000
c.
Cash 4,200
Dividend Income 4,200
d.
Cash 12,000
Dividend Income 12,000
36. Orlov Corporation purchased 22,000 shares of Matsey Corporation common stock for $40 per share on
January 1, 2009. Matsey reported net income of $120,000 for 2009 and paid dividends of $45,000
during 2009. As of December 31, 2009, the market value of Matsey Corporation common stock was
$39 per share. Assuming the shares owned by Orlov represent 10 percent of the total outstanding stock
of Matsey, the year end adjustment entry in Orlov Corporation’s books is:
a.
Cash 22,000
Dividend Income 22,000
b.
Cash 22,000
Long-Term Investments 22,000
c.
Unrealized Loss on Long-term Investments 22,000
Allowance to Adjust Long-Term Investments to Market 22,000
d.
Loss on Long-Term Investments 22,000
Allowance to Adjust Long-Term Investments to Market 22,000
37. Orlov Corporation purchased 8,000 shares of Matsey Corporation common stock for $40 per share on
January 1, 2009. Matsey reported net income of $110,000 for 2009 and paid dividends of $45,000
during 2009. As of December 31, 2009, the market value of Matsey Corporation common stock was
$40 per share. Assuming the shares owned by Orlov represent 30 percent of the total outstanding stock
of Matsey, the entry to record the recognition of income by Orlov Corporation is:
a.
Cash 33,000
Dividend Income 33,000
b.
Investment in Matsey Corporation 110,000
Income, Matsey Corporation Investment 110,000
c.
Investment in Matsey Corporation 33,000
Income, Matsey Corporation Investment 33,000
d.
Investment in Orloy Corporation 33,000
Cash 33,000
38. Orlov Corporation purchased 8,500 shares of Matsey Corporation common stock for $40 per share on
January 1, 2009. Matsey reported net income of $120,000 for 2009 and paid dividends of $45,000
during 2009. As of December 31, 2009, the market value of Matsey Corporation common stock was
$40 per share. Assuming the shares owned by Orlov represent 30 percent of the total outstanding stock
of Matsey, Orlov Corporation should report the long-term investment on December 31, 2009, at a
carrying value of
a.
$362,500.
b.
$376,000.
c.
$353,500.
d.
$340,000.
39. West Corporation purchased 15,000 shares of Luffy Corporation common stock for $60 per share on
January 2, 2009. Luffy Corporation reported net income of $1,500,000 for 2009 and paid dividends of
$300,000 during 2009. Luffy has a total of 50,000 shares of common stock outstanding. The entry that
would be recorded to recognize the income is:
a.
Cash 90,000
Dividend Income 90,000
b.
Investment in Luffy Corporation 450,000
Income, Luffy Corporation Investment 450,000
c.
Dividend Income 450,000