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Chapter 10
Investments
Review Questions
1. What is a debt security?
2. What is an equity security?
An equity security represents stock ownership in another company that sometimes pays cash
or stock dividends.
3. Why would a company invest in debt or equity securities?
Two common reasons why a company would invest in debt or equity securities are as
follows:
4. Briefly describe the specific types of debt and equity securities.
The specific types of debt securities are as follows:
4., cont. The specific types of equity securities are as follows:
No significant influence equity investments are equity securities in which the investor
lacks the ability to participate in the decisions of the investee company. No significant
interest investments are reported either as current assets or long-term assets on the
consolidated into the investor’s financial statements.
5. How is the purchase of a held-to-maturity debt security at face value recorded?
6. When disposing of an available-for-sale debt investment, where is the gain or loss on
disposal reported in the financial statements?
A gain or loss on disposal of an available-for-sale debt investment is classified as Other
Income and (Expenses) on the income statement.
8. What method is used for investments in equity securities with more than 50% ownership?
Briefly describe this method.
Consolidation accounting is used by the investing company to account for equity securities
9. What adjustment must be made at the end of the period for trading debt investments and
available-for-sale debt investments?
10. Where on the financial statements is an unrealized holding gain or loss on trading debt
investments reported?
An unrealized holding gain or loss on trading debt investments is classified as other income
and (expenses) on the income statement.
11. Where on the financial statements is an unrealized holding gain or loss on available-for-sale
debt investments reported?
Unrealized holding gains or losses on available-for-sale debt investments are not included in
12. What is comprehensive income, and what does it include?
13. How are held-to-maturity debt investments reported on the financial statements?
Depending on the maturity date, held-to-maturity debt investments are categorized as current
assets or long-term assets on the balance sheet and reported at amortized cost.
14. What does the rate of return on total assets measure, and how is it calculated?
The rate of return on total assets measures the success a company has in using its assets to
earn income.
Short Exercises
S10-1 Identifying why companies invest and classifying investments
Learning Objective 1
Garden Haven has excess cash of $15,000 at the end of the harvesting season. Garden Haven will
need this cash in four months for normal operations.
Requirements
1. What are some reasons why Garden Haven may choose to invest in debt or equity securities?
2. What type of classification would Garden Haven’s investment fall within—short-term or
long-term? Why?
SOLUTION
Requirement 1
S10-2 Accounting for debt investments
Learning Objective 2
On January 1, 2018, the Chaucer’s Restaurant decides to invest in Lake Turner bonds. The bonds
mature on December 31, 2023, and pay interest on June 30 and December 31 at 4% annually.
The market rate of interest was 4% on January 1, 2018, so the $90,000 maturity value bonds sold
for face value. Chaucer’s intends to hold the bonds until December 31, 2023.
Requirements
Requirement 2
S10-3 Accounting for equity investments
Learning Objective 3
On January 1, 2018, Bark Company invests $10,000 in Roots, Inc. stock. Roots pays Bark a $400
dividend on August 1, 2018. Bark sells the Roots’s stock on August 31, 2018, for $10,450.
Assume the investment is categorized as a short-term equity investment and Bark Company does
not have significant influence over Roots, Inc.
Requirements
1. Journalize the transactions for Bark’s investment in Roots’s stock.
2. What was the net effect of the investment on Bark’s net income for the year ended December
31, 2018?
SOLUTION
Requirement 1
Calculations:
Net increase in net
income = Dividend revenue + Gain on disposal
= $400 + $450(a)
= $850
(a) Calculated in Requirement 1.
S10-4 Accounting for equity investments
Learning Objective 3
Farrier has 15,000 shares of voting stock outstanding during 2018 and Bryant has significant
influence over Farrier.
Requirements
1. Identify what type of investment the Farrier stock is for Bryant.
2. Journalize the transactions related to Bryant’s investment in the Farrier stock during 2018.
3. In what category and at what value would Bryant’s report the investment on the December 31,
2018, balance sheet?
SOLUTION
Requirement 2
Requirement 3
S10-5 Accounting for debt investments
Learning Objectives 3, 4
On February 1, 2018, Bell Co. decides to invest excess cash of $16,800 by purchasing a Grant,
Inc. bond at face value. At year-end, December 31, 2018, the fair value of the Grant bond was
$19,600. The investment is categorized as a trading debt investment.
Requirements
1. Journalize the transactions for Bell’s investment in Grant, Inc. for 2018.
2. In what category and at what value would Bell report the asset on the December 31, 2018,
balance sheet? In what account would the market price change in Grant’s bond be reported, if
at all?
3. What was the net effect of the investment on Bell’s net income for the year ended December
31, 2018?
SOLUTION
S10-5, cont.
Requirement 2
