Deck 12: Reporting and Analyzing Financial Investments

Question 1

If company A accounts for its investment in company B using the equity method, then all of company B's earnings are reported on company A's income statement.

Answer 1

False

Question 2

Under the equity method, if the fair value of the investee company increases, and the increases are deemed other-than-temporary, the book value of the investment on the investor's balance sheet is adjusted upward to reflect in the increase in value.

Answer 2

False

Question 3

An investor company can be considered to have control over the investee company even if it owns less than 50% of the outstanding voting stock of the investee company.

Answer 3

True

Question 4

If investee shares are classified as "available-for-sale" by the investor company, then no significant influence is assumed.

Question 5

IFRS uses the term 'associate' to describe an investment involving significant influence.

Question 6

Financial statements of investee and investor companies can only be consolidated if both companies use the same accounting principles.

Question 7

In addition to the ownership of a sufficient percentage of outstanding common stock, significant influence can result by virtue of legal agreements and technology licensing.

Question 8

Under the equity method, the investment account is adjusted to the fair value of the stock at the end of the period.

Question 9

When a passive investment is sold, the gain (loss) is typically reported in "other" income.

Question 10

Available-for-sale securities are those that management intends to actively trade for profits as market prices fluctuate.

Question 11

Shareholders' equity of the investee company will be same using either equity method accounting or the consolidation accounting method for an investment

Question 12

Goodwill is not amortized, but is tested at least annually and written down to current fair value if found to be impaired, and written up to fair value if the fair value increases.

Question 13

Under equity method accounting, dividends received from the investee are treated as a return on the investment rather than a return of the investment.

Question 14

Companies are only required to disclose quantitative information about derivatives in financial statement notes.

Question 15

Under IFRS, trading and available-for-sale securities are accounted for similar to GAAP.

Question 16

One reason a company makes investments with significant influence is to gain a seat on the board of directors from which it can learn much about the investee company.

Question 17

If Pamela & Lee, Inc. paid $8,000 at book value for its 25% stake in Parkersburg Company, and in the next year total shareholders' equity for Parkersburg Company increases by 75%.
What will Pamela & Lee's interest of Parkersburg's equity be?

A) $ 7,000
B) $ 1,750
C) $ 3,000
D) $14,000

Question 18

If Eve Company buys 26% of Adam Company's stock, and pays $4,000 more than current fair value for these shares, what percentage of Adam Company's shareholder equity belongs to Eve Company?

A) 25%
B) It depends on the dollar value of total shareholders' equity for Adam Company.
C) 35%
D) 26%

Question 19

At what level of investment ownership is significant influence often presumed?

A) Greater than 20% of the voting stock of the investee
B) Between 20% and 50% of the voting stock of the investee
C) Greater than 50% of the voting stock of the investee
D) Greater than 20% of the voting stock or of the fair value of the investee

Question 20

Team Tennis owns 40% of Best Racquets, Inc. and accounts for the investment using the equity method. During the year, Best Racquets reports a net loss of $2,400,000 and pays total dividends of $50,000.
Which of the following describes the change in Team Tennis' investment in Best Racquets during the year?

A) The investment increases by $50,000
B) The investment decreases by $2,450,000
C) The investment decreases by $735,000
D) The investment decreases by $980,000

Question 21

Which of the following statements is true in regards to the cost method?

A) Investments for which no current market values exist must be accounted for using this method
B) Trading investments are reported using the cost method
C) Dividends and interest received are recognized in current income
D) The investment is adjusted to fair value at year end

Question 22

Which of the following statements is not correct concerning the effects on the components of return on equity (ROE) under equity method accounting?

A) Financial leverage is understated
B) Return on equity is affected, because of the noncontrolling interest portion of equity
C) Net operating profit margin is overstated
D) Total asset turnover is understated

Question 23

Which of the following would not be capitalized as an identifiable intangible asset by an investor company when an entire company is acquired?

A) Trademarks
B) Customer relationships
C) Patents
D) Currency translation adjustments

Question 24

Which of the following is correct about goodwill impairment?

A) The fair value of the investee company is compared with the fair value of the investor's equity investment account.
B) If the fair value is less than the investment balance, the investment is deemed impaired.
C) If the book value is less than the investment balance, the investment is deemed impaired.
D) The future expected cash flows of the investment are compared with the book value of the investment.

Question 25

When the fair value of a company's portfolio of available-for-sale equity securities is lower than its book value, how should the difference be handled?

A) Written off as an impairment
B) Recorded as a liability on the company's balance sheet
C) Recorded as an expense on the company's income statement
D) Deducted from the investment account
E) Added to stockholders' equity of the investor

Question 26

Thomas C. Company holds a 15% equity investment in Kayak Zone. Fred W. Company holds a 30% of Kayak Zone's stock. On November 1, 2016, Kayak Zone declares and pays dividends to its stockholders.
How will the dividend affect each company's investment account?

A)
B)
C)
D)

Question 27

GAAP identifies three levels of influence/control. Which level of influence/control would a company use if it was investing in a company that gave it 15% of the outstanding voting stock?

A) Passive
B) Significant Influence
C) Control
D) Market-level

Question 28

When equity method accounting is used for an investment, which component of ROE will always be understated?

A) Net profit margin
B) Total asset turnover
C) Financial leverage
D) Return on equity

Question 29

Which of the following statements is not true for fair value method accounting?

A) The investment account is recorded at current fair value
B) Interim changes in fair value may or may not affect income depending on classification
C) Dividends are not reported as income but instead are treated as a return of the capital invested
D) Used when an investor company owns less than 20% of the acquired company
E) Uses current fair value to report investments that are active and have published prices each time a balance sheet is created

Question 30

Brahtz Brothers owns 100% of Schweinfurt Company. At year-end, Schweinfurt owes Brahtz Brothers $52,000. If a consolidated balance sheet is prepared at year-end, how is the $52,000 handled?

A) The $52,000 is eliminated on the consolidated balance sheet
B) The $52,000 is reported as goodwill on the consolidated balance sheet
C) The $52,000 is amortized as an intangible asset on the consolidated balance sheet
D) The $52,000 is shown as an unearned revenue on the consolidated balance sheet

Question 31

At what amount is a derivative contract reported?

A) At book value
B) At historical cost
C) At fair value
D) At the average of book and fair value

Question 32

Which of the following is not an example of the ability to exercise significant influence over an investee?

A) Technological dependency
B) Material intercompany transactions
C) Interchange of managerial personnel
D) Clearly determinable fair market value

Question 33

Under the equity method, which of the following does not cause a decrease in the investment account?

A) The losses of the investee
B) Dividends paid by the investee
C) Declines in the fair value of the investment
D) All of the choices would decrease the investment account

Question 34

Which will be accounted for differently from GAAP under the proposed IFRS?

A) Trading securities
B) Available-for-sale securities
C) Equity method investments
D) None of the above

Question 35

Lion Company purchases an investment in Africa Preserve Company at the purchase price of $6 million cash. This represents 25% of the book value of Africa Preserve. During the year, Africa Preserve reports net income of $1,200,000 and pays cash dividends of $100,000. At the end of the year, the fair value of Lion's investment is $6.4 million.
A. At what amount is the investment reported on Lion's balance sheet at year-end?
B. What amount of income from investments does Lion report? Explain.
C. Prepare journal entries to record the transactions for Lion Company.

Question 36

The following is from the financial statement footnotes from Perfect Container Retailers:
As of December 31, 2016, the Company's marketable securities approximated the fair market values of the securities and the unrealized gains and losses on these securities were not significant. As of September 30, 2016, the Company had recorded an unrealized gain of approximately $4.6 million in other comprehensive income on its investment in a certain private company. In 2017, the Company sold this investment in its entirety and realized a gain on the sale of $5.8 million.
A. How did Perfect Container classify these marketable securities? How do you know?
B. How did the unrealized gain of $4.6 million affect Perfect Container's 2016 net income?

Question 37

On January 1, Snowbird acquired common stock of A-Basin Company. At the time of acquisition, the book value and the fair value of A-Basin's net assets were $200 million. During the current year, A-Basin earned $80 million and declared dividends of $10 million.
Indicate the amount shown for Investment in A-Basin on Snowbird's balance sheet on December 31 and the amount of income Snowbird would report for the year related to its investment under the assumption that Snowbird did the following:
A. Paid $60 million for a 20-percent interest in A-Basin and classifies the investment as held-to-maturity. The fair value of A-Basin on December 31 was $240 million.
B. Paid $80 million for a 35-percent interest in A-Basin and uses the equity method.

Question 38

Truck Company purchases an investment in Equipment Products, Inc. at a purchase price of $900,000, representing 15% of the book value of Equipment Products. During the year, Equipment Products reports a net income of $300,000 and pays cash dividends of $80,000. The fair value of Truck Company's investment at the end of the year is $1,600,000.
A. Using the fair value method, at what amount is the investment account reported at the end of the year?
B. How would fair value changes be treated if the marketable securities are classified as available-for-sale investments?
C. How would fair value changes be treated if the marketable securities are classified as trading investments?
D. How are dividends and gains/losses on security sales treated for trading and available-for-sale securities?

Question 39

On January 1, Barnyard Corporation acquired common stock of Fresh Hay Corporation. At the time of acquisition, the book value and the fair value of Fresh Hay Corporation's net assets were $1 billion. During the year, Fresh Hay Corporation earned $480 million and declared dividends of $160 million. The fair value of the shares increased by 10 percent during the year.
How much income would Barnyard Corporation report for the year related to its investment under the assumption that it:
A. Paid $150 million for 15 percent of the common stock and uses the fair value method (classified as available-for-sale) to account for its investment in Fresh Hay Corporation.
B. Paid $300 million for 30 percent of the common stock and uses the equity method to account for its investment in Fresh Hay Corporation.

Question 40

Newman Corporation purchases an investment in Paul, Inc. at a purchase price of $6 million cash, representing 25% of the book value of Paul, Inc. During the year, Paul, Inc. reports net income of $700,000 and pays $120,000 of cash dividends. At the end of the year, the fair value of Newman's investment is $6.4 million.
A. What is the year-end balance of the equity investment account?
B. What amount of equity earnings would be reported by Newman Corporation?
C. How are dividends treated in equity method accounting? What amount in dividends is reported?
D. What is the amount of the unrealized gain or loss to be reported for the year?

Question 41

Investor C has $160,000 in assets (including the investment in Investee N), $30,000 in liabilities, and $130,000 in equity. Investor C purchased 100% of Investee N, which has $60,000 in assets, $16,000 in liabilities, and $44,000 in equity on the date of acquisition.
What will the assets, liabilities, and equity be on the consolidated balance sheet immediately following the acquisition?

Question 42

Investor P has $160,000 in assets (including the investment account at $22,000) and $36,000 in equity. Investor P purchased (at book value) 100% of Investee G, which has $30,000 in assets and $8,000 in liabilities.
What will the assets, liabilities, and equity be on the consolidated balance sheet?

Question 43

On December 31, 2015, East Company acquired 45% of Yellow Company's common stock for $3.0 million. In 2016, the fair value of East's investment in Yellow Company increased to $3.7 million. On December 31, 2016, Yellow declared net income of $800,000. It also paid its stockholders a dividend of 20% of its 2016 income.
A. How would you classify East Company's investment in Yellow Company? Explain.
B. What will East report on its income statement for the investment in Yellow for 2016?
C. What will be the ending balance of East's Investment account on December 31, 2016?

Question 44

Consider companies with the pre-acquisition balance sheets presented below. Macro Investor Company purchases 100% of Micro Investee Company's stock at book value by exchanging newly issued common stock. Complete the columns for Investor's post-acquisition balance sheet and the Consolidated Company post-acquisition balance sheet.

Question 45

Raymundo Corp. owns 100% of Indiana Group, Inc.'s stock. Raymundo Corp. prepares consolidated financial statements. Data from the annual reports of the two companies are:
A. How much of the $3,000,000 consolidated sales reported by Raymundo Corp. is from operations of Indiana Group?
B. How much of the $800,000 consolidated net income reported by Raymundo Corp. is from operations of Indiana Group?

Question 46

Brick Company had the following transactions and adjustment related to a stock investment.
Prepare the journal entries to record these transactions.

Question 47

The 2016 annual report of Major Bank Corp includes the following footnote related to its available-for-sale securities:
A. What amount will Major Bank report for available-for-sale equity securities on the balance sheet? Explain.
B. How do unrealized gains arise on these available-for-sale equity securities?
C. How do these unrealized gains affect Major Bank's 2016 income statement?
D. How do these unrealized gains affect Major Bank's' 2016 balance sheet?

Question 48

Following is a portion of the investments footnote from Red Barron Life Insurance's 2016 annual report. Investment earnings are a crucial component of the financial performance of insurance companies such as Red Barron Life Insurance, and investments comprise a large part of Red Barron's assets. Red Barron accounts for its bond investments as available-for-sale securities.
A. What amount does Red Barron report for bond investments on its balance sheets for 2016?
B. What are the net unrealized gains (losses) for 2016? How did these unrealized gains (losses) affect the company's reported income in 2016?
C. What is the difference between realized and unrealized gains and losses? Are realized gains and losses treated differently in the income statement than unrealized gains and losses?

Question 49

Following is a portion of the investments footnote from Athletic Supply's 2016 annual report.
A. At what amount does Athletic Supply report its available-for-sale securities on its balance sheets for 2016 and 2015?
B. How does Athletic Supply account for its trading securities? How does the accounting differ from their accounting method for available-for-sale?
C. What are the net unrealized gains (losses) for 2016 and 2015? How did these unrealized gains (losses) affect the company's reported income in 2016 and 2015?
D. What is the difference between realized and unrealized gains and losses? Are realized gains and losses treated differently in the income statement than unrealized gains and losses for the available-for-sale securities?

Question 50

See the Future Corporation reported the following in its 2016 annual report regarding acquisition of Mountain Microchips:
Acquisition of Mountain Microchips, Inc.
On January31, 2016 we completed our acquisition of Mountain Microchips, Inc., a provider of hardware systems, software and services, by means of a merger of one of our wholly owned subsidiaries with and into Mountain such that Mountain became a wholly owned subsidiary of See the Future. We acquired Mountain to, among other things, expand our product offerings by adding Mountain's existing hardware systems business and broadening our software and services offerings. We have included the financial results of Mountain in our consolidated financial statements from the date of acquisition.
A. Of the total assets acquired, what portion is allocated to tangible assets and what portion to intangible assets?
B. Are Mountain's assets (both tangible and intangible) reported on the consolidated balance sheet at the book value or at the fair market value on the date of the acquisition? Explain.
C. Explain how the intangible assets are valued at the time of the acquisition.
D. How are the tangible and intangible assets accounted for subsequent to the acquisition?

Question 51

The following is from footnotes from the Mega Power, Inc. 2016 annual report (in millions):
The following table summarizes the changes in the carrying amount of goodwill for 2016 and 2015:
Intangible assets that have finite useful lives are amortized over their estimated useful lives. The following table summarizes our other intangible assets with finite useful lives that are subject to amortization:
Amortization expense for software and other intangibles totaled $128 million, $114 million and $138 million for the years ended December 31, 2016, 2015, and 2014, respectively. Internal and external software costs (excluding those related to research, re-engineering and training), trademarks and patents are amortized generally over a three to 12 year period. The following table represents the projected amortization expense of our intangible assets, assuming no further acquisitions or dispositions.

Under GAAP for goodwill, we have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value as a basis for determining whether it is necessary to perform an annual two-step goodwill impairment test. The two-step impairment test is now only required if an entity determines through this qualitative analysis that it is more likely than not that the fair value of the reporting unit is less than its carrying value. In addition, carrying value of goodwill must be tested for impairment on an interim basis in certain circumstances where impairment may be indicated. When we are required or opt to perform the two-step impairment test, the fair value of each reporting unit is estimated by discounting the after tax future cash flows less requirements for working capital and fixed asset additions. Our reporting units are generally defined as one level below an operating segment. However, there were two situations where we have aggregated two or more components which share similar economic characteristics and thus are aggregated into a single reporting unit for testing purposes. These two situations are described further below. This analysis has resulted in the following reporting units for our goodwill testing:
●Within our Components segment, emission solutions and filtration have been aggregated into a single reporting unit.
●Also within our Components segment, our turbo technologies business is considered a separate reporting unit.
●Within our Power Generation segment, our generator technologies business is considered a separate reporting unit.
●Within our Engine segment, our new and recon parts business is considered a separate reporting unit. This reporting unit is in the business of selling new parts and remanufacturing and reconditioning engines and certain engine components.
●Our Distribution segment is considered a single reporting unit as it is managed geographically and all regions share similar economic characteristics and provide similar products and services.
No other reporting units have goodwill. Our valuation method requires us to make projections of revenue, operating expenses, working capital investment and fixed asset additions for the reporting units over a multi-year period. Additionally, management must estimate a weighted-average cost of capital, which reflects a market rate, for each reporting unit for use as a discount rate. The discounted cash flows are compared to the carrying value of the reporting unit and, if less than the carrying value, a separate valuation of the goodwill is required to determine if an impairment loss has occurred. In addition, we also perform a sensitivity analysis to determine how much our forecasts can fluctuate before the fair value of a reporting unit would be lower than its carrying amount. We performed the required procedures as of the end of our fiscal third quarter and determined that our goodwill was not impaired. At December 31, 2016, our recorded goodwill was $890 million, approximately 90 percent of which resided in the emission solutions plus filtration reporting unit. For this reporting unit, the fair value of the reporting unit exceeded its carrying value by a substantial margin. Changes in our projections or estimates, a deterioration of our operating results and the related cash flow effect or a significant increase in the discount rate could decrease the estimated fair value of our reporting units and result in a future impairment of goodwill.
A. How much goodwill did Mega Power, Inc. report on its 2016 balance sheet? How much accumulated amortization was included in that amount? Explain.
B. How much impairment charge relating to goodwill did Mega Power, Inc. report in 2016 and what was the reason for this?
C. What was the value of intangible assets on Mega Power, Inc.'s 2016 balance sheet? How much accumulated amortization was included in that amount?

Question 52

Why do corporations undertake intercorporate investments? How might our understanding of these reasons influence our analysis of such investments?

Question 53

Companies are required to disclose both qualitative and quantitative information about the potential risks underlying derivatives.
A. In general, what types of qualitative information must be disclosed?
B. Explain the reporting of quantitative information in financial statements that relates to derivatives.

Question 54

Refuse Disposal Inc. reports the following in the 2016 Form 10-K (in millions):
A. Why does Refuse Disposal's income statement deduct its share of net losses of the unconsolidated entities?
B. Explain the reconciling item on Refuse Disposal's statement of cash flow that adds back equity in net losses of unconsolidated entities.

Question 55

Explain the standards which determine if an investor company will report its investment in an investee company using the equity method vs. consolidation. Why might the investor company prefer the equity method?

Question 56

What is meant by significant influence? Describe situations in which you believe a company has significant influence over the operations of another company. How is significant influence in investments accounted for?