P15-15
2010
Jan. 1 Investment in Stock: Ray 45,000
Cash ($15 x 3,000) 45,000
P15-16
1. 2010
Apr. 1 Investment in Stock: Moore 400,000
Cash 400,000
Extraordinary (0.40 x $30,000) 12,000
*Ordinary income is recognized for
9 months because that is the length
of time the investment has been owned.
Extraordinary income is recognized in
full because it was earned in the
third quarter.
P15-16 (continued)
Dec. 31 Investment Income: Ordinary 2,000
Investment in Stock: Moore 2,000
2.
Investment in Stock: Moore
01/01/10 $400,000
08/31/10 $16,000
3. Note to Instructor: This answer requires knowledge about the indirect method
of computing net cash flow from operating activities that was introduced in
Chapter 5, but is discussed more extensively in Chapter 22.
P15-17
(1) 2010
Jan. 1 Investment Loss: Feeley 140,000
15-59
P15-17 (continued)
(2) During
2010 Investment Loss: Feeley 21,000
(3) During
2010 Cash 7,000
Investment in Stock: Holmes
($28,000 x 0.25) 7,000
(4) 2011
Jan. 1 Cash 90,000
P15-18
1. $10,000 dividend revenue for 2010 (10,000 shares x $1.00)
2. $40,000 investment income for 2010 ($400,000 net income x 0.10
ownership)
P15-19
2009
Jan. 1 Prepaid Insurance 16,800
Cash ($4,200 x 4) 16,800
2010
Jan. 1 Prepaid Insurance 16,800
Cash 16,800
2011
Jan. 1 Prepaid Insurance 16,800
Cash 16,800
2012
Jan. 1 Prepaid Insurance 16,800
Cash 16,800
P15-19 (continued)
Jan. 1 Cash 103,850
Cash Surrender Value of
Life Insurance* 518
P15-20
Note to Instructor: This interest rate swap is a fair value hedge.
1. Interest Payment on Loan: December 31, 2010
Interest Rate Swap Payment: December 31, 2010
Fair Values and Gains and Losses: December 31, 2010
15-62
P15-20 (continued)
1. (continued)
A swap derivative liability and loss exist because the 10% current market rate is
higher than the 9% fixed interest rate that Danburg receives on the derivative.
Notes Payable 124,342
d
Gain in Value of Debt 124,342
dPresent value of principal = $5,000,000 x 0.751315 (n=3,
The increase in interest rates decreases the value of the note payable by the
same amount as the increase in the value of the swap derivative liability.
Interest Payment on Loan: December 31, 2011
15-63
P15-20 (continued)
1. (continued)
Fair Values and Gains and Losses: December 31, 2011
Liability from Interest Rate Swap 124,342
A swap derivative asset and gain exist because the 8% current market rate is
lower than the 9% fixed interest rate that Danburg receives on the derivative.
So the company has moved from a $124,342 liability to an $89,164 asset
position.
The decrease in interest rates increases the value of the note payable by the
same amount as the decrease in the value of the swap derivative liability.
2. Income Statement for Year Ending December 31, 2010
Other Items:
P15-20 (continued)
2. (continued)
Balance Sheet, December 31, 2010
Long-Term Liabilities:
Income Statement for Year Ending December 31, 2011
Other Items:
Balance Sheet, December 31, 2011
Long-Term Assets:
ANSWERS TO CASES
C15-1
1. Generally accepted accounting principles deal with investments in debt and marketable
equity securities that are classified as trading, available for sale, or held to maturity.
15-65
C15-1 (continued)
2. Generally accepted accounting principles require a company preparing a classified
balance sheet to group its investments in debt and equity securities into three categories.
3. Realized gains (losses) are those gains (losses) resulting from the sale of an investment in a
debt or equity security when the sales price is more (less) than original cost. Holding gains
4. Realized gains and losses on all investments in equity securities as well as holding gains
and losses on trading securities are included in the Income from Continuing Operations
C15-2
1. The differences between the selling prices and the costs of available-for-sale securities
and held-to-maturity securities are reported as realized gains and losses in the
2. The security in the available for sale category is reclassified to the trading security
3. Each portfolio is reported in the balance sheet at its fair value.
For the trading securities, the change in the fair value of the securities that occurred
during the year is reported in the income statement of the current period. For the
available-for-sale securities, the change in the fair value of the securities is reported as
C15-2 (continued)
4. Gains trading occurs when a company sells available-for-sale securities on which it
recognizes a gain and continues to hold securities on which it would recognize a loss.
Gains trading is only possible on available-for-sale securities (and held-to-maturity
securities) because holding gains and losses on trading securities are included in income.
Students may raise ethical issues, such as:
(a) Conflicts between the interests of different stakeholders–particularly management
C15-3
1. A company invests in debt and equity trading securities for the purpose of selling them in
the near term. Trading generally reflects active and frequent buying and selling to profit
on short-term differences in prices.
2. The classification of an asset in each category is primarily one of management intent,
although classification will often be affected by the industry in which the company
operates. Trading securities generally will be purchased by financial institutions such as
15-67
C15-4 (AICPA adapted solution)
1. The equity method of accounting for an investment in the voting stock of another
company is called for under generally accepted accounting principles when the investor
can, or is presumed to be able to, exercise significant influence over the investee by virtue
2. The initial investment using the equity method is recorded at the actual cost paid. This
amount is adjusted for several reasons. The first adjustment is for the investor’s
proportionate amount of investee earnings that represents an increase in the investment
3. Earnings under the equity method are recognized as earned by the investee. This amount
is the investor’s proportionate amount of the earnings reported by the investee, whether or
not paid in dividends. If the net earnings of the investee include extraordinary items, these
C15-5 (AICPA adapted solution)
1. Walker’s investment portfolio of available-for-sale securities is accounted for at fair value,
with the increase in fair value at the beginning of the year reported as a positive
component of accumulated other comprehensive income in stockholders’ equity. At the
C15-5 (continued)
2. Due to the size of its investment, i.e., over twenty percent of the outstanding voting stock
of Sipe, Walker is presumed to be able to exercise significant influence over Sipe.
Therefore, Walker uses the equity method of accounting for its investment in Sipe.
Walker reports the purchase of the stock of Sipe as a long-term investment, and initially
C15-6 (AICPA adapted solution)
1. a. Houston reports the cash dividends received during the year on the available-for-sale
securities as dividend revenue in the income statement.
2. Houston reports the portfolio of available-for-sale securities as a noncurrent asset in its
balance sheet. The portfolio is presented at fair value. The amount by which the
3. Houston uses the equity method of accounting for its forty percent investment in the
outstanding voting stock of Joy. The equity method is appropriate when the company
15-69
C15-7 (AICPA adapted solution)
Situation I. If the fair value of an available-for-sale debt security declines below cost and
the decline in value is considered to be other than temporary, the cost of the security is
Situation II. In the case of a statement of financial position that does not classify assets
There is no effect on earnings.
Situation III. If there is a change in the classification of a security from available for sale to
Situation IV. According to the facts given, the portfolio consists of one security that had
decreased in fair value in a prior year and has appreciated to a fair value in excess of
C15-8 (AICPA adapted solution)
When Herbert increased its investment in Broome common stock from 10 percent to 25
percent, Herbert obtained the presumed ability to exercise significant influence over
1. Record 10 percent of all reported earnings since the date of purchase as increases in
the investment.
15-70
C15-8 (continued)
4. “Reverse” the cumulative adjustment of cost to fair value.
The change in the amount shown in the investment is reflected in retained earnings in a
manner consistent with the accounting for a step-by-step acquisition of a subsidiary.
Starting with the current period and for subsequent periods, Herbert reports its investment
in Broome at an amount arrived at in the following manner:
1. Record 25 percent of all reported earnings (or losses) as an increase (or decrease) in
the investment.
C15-9 (AICPA adapted solution)
1. (a) For the available-for-sale equity securities portfolio, the difference between the selling
price and the cost is a realized gain or loss that is included in the net income for the
(b) Victoria accounts for both the trading and available for sale equity securities portfolios
at their fair values, determined at the balance sheet date. The amount by which the
aggregate cost of the portfolio exceeds the fair value is accounted for directly in the
15-71
C15-9 (continued)
2. Victoria accounts for the disposition prior to their maturity of the long-term bonds called by
3. Victoria reports the purchase price of the additional similar bonds as investment in held-to-
maturity debt securities–a noncurrent asset–and the two months’ accrued interest as a
C15-10 (amounts in millions)
3. The notes do not clearly discuss this issue (p. 74 and p. 91). Presumably, the company has
cost method investments because it does not have significant influence over those
investments (i.e., less than 20% ownership) and the shares do not trade on a market.
4. The effects would be material (p. 67, 79, and 82).
C15-11
Note to Instructor: This case does not have a definitive answer. From a financial reporting
perspective, GAAP is identified and summarized. From an ethical perspective, various
issues are raised for discussion purposes.
From a financial reporting perspective, the first issue involves “gains trading.” Obviously,
the company can sell either security and under GAAP would report the gain or loss in
From an ethical perspective, the first issue involves whether gains trading may be
considered appropriate. The primary stakeholders are the company’s current and
potential stockholders and creditors. The advantage of selling the investment in
Company Z is that it appears that the price of the “dog” is unlikely to rise and may
continue to fall. In contrast, Company X’s shares may well be expected to increase.
Therefore, the rational decision would be to sell Company Z’s shares and thereby increase