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CHAPTER 14
QUESTIONS
1. Companies make investments in the securities of another company to provide a
safety cushion of available funds and to
store a temporary excess of cash. Companies also invest in other companies to earn
a return, to secure influence, or to gain control.

tions to determine the present value of
both the principal sum and the annuity.
8. The effective-interest method computes interest revenue by multiplying the effective
interest rate by the carrying value of the investment.
9. When a company does not own more than
50% of a company, other factors may be
considered to determine if control exists.
Such factors include owning a large minority voting interest with no other shareholder
owning a significant block of stock or having a majority voting interest in determining
who is on the company‟s board of directors.
When these other factors exist, then control
may be assumed and consolidation would
be appropriate.

2. FASB ASC Topic 320 applies to many debt
and equity securities. All debt securities
with a readily determinable fair value fall
under its scope. Debt securities that do not
have a readily determinable fair value are
accounted for under the rules outlined in
FASB ASC Topic 310 (Receivables), as
shown in the Expanded Material for this

chapter. Equity securities with a readily determinable fair value that are not accounted
for (1) using the equity method (i.e., greater
than 20% ownership) or (2) as investments
in consolidated subsidiaries are accounted
for using the rules outlined in Topic 320.

10. (a) Factors that may indicate the ability of
a minority-interest investor to exercise
significant influence over an investee‟s
operating and financial policies are as
follows:
1. Representation on the board of directors of the investee.
2. Participation in the policy-making
process.
3. Material intercompany transactions
between investee and investor.
4. Interchange of managerial personnel between investee and investor.
5. Technological dependency of investee on investor.
6. Substantial minority interest of the
investor in an investee whose
shares of stock are widely distributed and not concentrated for control purposes.

3. A security is classified as held to maturity if
the business has the intent and the ability
to hold the security to maturity.
4. To be classified as a trading security, the
security must have a readily determinable
fair value and must be purchased and held
for the purpose of selling it to generate
profits on short-term differences in price.

5. Under the fair value option, a company has
the option to report, at each balance sheet
date, any or all of its financial assets and
liabilities at their fair values on the balance
sheet date. The unrealized gains and
losses from changes in the fair values of financial assets and liabilities accounted for
using the fair value option are reported in
the income statement.

(b) Factors that may indicate the inability of
an investor with more than 20% of a
company‟s stock to exercise significant
influence over an investee‟s operating
and financial policies are as follows:
1. Opposition by the investee, such as
litigation or complaints to governmental regulatory authorities.
2. An agreement between the investor
and the investee under which the

6. The classification of investment securities
under IFRS 9 is essentially the same as the
classification under U.S. GAAP.
7. (a) The stated rate of interest is used to
determine the amount of the annuity to
be received.
(b) The market or effective rate of interest
is used in the present value computa-

597



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Chapter 14

investor surrenders significant rights
as a shareholder.
3. Majority ownership of the investee is
concentrated among a small group
of shareholders who operate the investee without regard to the views
of the investor.
4. The investor needs or wants more
financial information to apply the
equity method than is available to
the investee‟s other shareholders,
tries to obtain the information, and
fails.
5. The investor tries and fails to obtain
representation on the investee‟s
board of directors.
11. A joint venture is accounted for using the
equity method for those partners that own
20% or more and not more than 50% of the
joint venture. For these joint venture partners, the liabilities of the joint venture do
not show up on the balance sheet. Instead,
only the net investment in the joint venture
shows up on the balance sheet. Thus, the
liabilities of the joint venture are “off” the
balance sheet of the partners that account

for the joint venture using the equity method.
12. Under International Financial Reporting
Standards, an “equity method investee” is
called an “associate.”
13. For trading securities and available-for-sale
securities, a market adjustment account is
used on the balance sheet to report the securities at their fair values. Held-to-maturity
securities are reported on the balance
sheet at their amortized cost. For trading
securities, the change in fair value for the
current period is reported on the income
statement. The change in value for available-for-sale securities is reported in the Equity section on the balance sheet.
14. Market Adjustment is a real account used
in valuing investments on the balance
sheet. If the fair value of a security that falls
under the scope of Topic 320 increases,
the market adjustment account will be debited. If the value of the security decreases,
the market adjustment account will be credited. The market adjustment account is
disclosed on the balance sheet either netted against the related securities account or
disclosed separately in addition to the securities account.

15. For “other-than-temporary” declines, the
cost basis of the security should be reduced by crediting the investment account
rather than a market adjustment account. In
addition, the write-down should be recognized as a loss and charged against current
income. The new cost basis for the security
may not be adjusted upward to its original
cost for any subsequent increases in fair
value. However, the market adjustment account may be used to record any subsequent increases.
16. The sale of trading securities during the

year results in the computed unrealized
gain or loss on trading securities being a
combination of unrealized gains and
losses for the year and reversals of cumulative unrealized gains and losses from
prior years for trading securities sold during the year. The same is true with respect
to the computation of unrealized increases
and decreases in value for available-forsale securities.
17. When securities are transferred between
categories, the transfer is accounted for at
the security‟s current fair value. The historical cost of the security is removed from the
books along with any associated market
adjustment. The difference between the
security‟s current fair value and its fair
value on the most recent balance sheet
date is accounted for differently, depending
on the classifications involved in the transfer.
18. If the purchase and sale of the trading securities is determined to be an operating
activity, realized gains on trading securities
are subtracted from net income in computing cash from operating activities (when
the indirect method is used). Realized
losses are added back to net income. The
same is true for unrealized items; unrealized gains on trading securities are subtracted and unrealized losses on trading
securities are added back to net income.
19. Because trading securities, by their very
definition, are held to take advantage of
short-term differences in price, these securities are always classified as current. Heldto-maturity securities are always classified
as long-term unless the security is maturing
in the current period. The major classification problem arises with available-for-sale
securities. These securities can be classi-



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599

fied as either current or long-term, depending on the intention and assessments of
management.

and the basis on which cost was determined in computing unrealized gains and
losses. Finally, companies should disclose
the change in net unrealized holding gain
or loss on available-for-sale securities that
has been included in stockholders‟ equity
during the period.
Held-to-maturity securities—the aggregate
fair value, gross unrealized holding gains
and gross unrealized holding losses, and
amortized cost basis by major security
type. In addition, the company should disclose information about contractual maturities.
For investment securities reported at fair
value, the magnitude of the fair values determined using Level 1, Level 2, and Level
3 inputs is disclosed.

20. For all securities not classified as trading
and not accounted for using the fair value
option, the cash flow effects of purchases
and sales are reported in the Investing
section of the statement of cash flows. For
securities classified as trading and for securities accounted for using the fair value

option, the purchase and sale of securities
are reported in either the Operating or Investing section, depending on the purpose
for which the securities were acquired.
21. The following additional disclosures for the
different classifications of securities are required:
Trading securities—the change in the net
unrealized holding gain or loss that is included in the income statement.
Available-for-sale securities—the aggregate fair value, gross unrealized holding
gains and gross unrealized holding losses,
and amortized cost basis by major security
type. In addition, for debt securities the
company should disclose information about
contractual maturities. Companies need to
also disclose the proceeds from sales of
available-for-sale securities, the gross unrealized gains and losses on those sales,

‡

Relates to Expanded Material.

‡

22. Topic 320 applies to all debt securities for
which there is a readily determinable fair
value. Thus, most debt securities would fall
under the scope of this pronouncement.
Loans often do not have a readily determinable fair value because they are not
traded on an exchange as are most debt
securities. Thus, the provisions of Topic
320 are not applicable to impaired loans.

FASB ASC Section 310-10-35 addresses
the accounting for the impairment of a loan.


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Chapter 14

PRACTICE EXERCISES
PRACTICE 14–1
1.

PURCHASING DEBT SECURITIES

Asset approach
Feb. 1
Investment in Trading Securities ..................................
Interest Receivable ........................................................
Cash ..........................................................................
Interest Receivable: $100,000  0.08  (1/12) = $667
June 30
Cash ................................................................................
Interest Receivable ..................................................
Interest Revenue ......................................................
Cash: $100,000  0.08  (6/12) = $4,000

2.

100,000

667
100,667

4,000
667
3,333

Revenue approach
Feb. 1
Investment in Trading Securities ..................................
Interest Revenue ............................................................
Cash ..........................................................................
Interest Revenue: $100,000  0.08  (1/12) = $667
June 30
Cash ................................................................................
Interest Revenue ......................................................
Cash: $100,000  0.08  (6/12) = $4,000

PRACTICE 14–2

100,000
667
100,667

4,000
4,000

PURCHASING EQUITY SECURITIES

Investment in Available-for-Sale Securities ......................

Cash ................................................................................

54,000

Investment: 2,000 shares  $27 = $54,000
PRACTICE 14–3

COMPUTING THE VALUE OF DEBT SECURITIES

Business Calculator Keystrokes:
N = 7 years  2 = 14
I = 12/2 = 6
PMT = $100,000  0.08  (6/12) = $4,000
FV = $100,000 (the face value is paid at the end of 7 years)
PV = $81,410

54,000


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601

PRACTICE 14–4
1.

2.

INTEREST REVENUE FOR HELD-TO-MATURITY SECURITIES


Investment in Held-to-Maturity Securities .........................
Cash ................................................................................

25,518

Cash [$20,000  0.10  (6/12)] .............................................
Investment in Held-to-Maturity Securities ...................
Interest Revenue ............................................................

1,000

25,518

107
893

Interest Revenue: $25,518  0.07  (6/12) = $893
3.

Cash .....................................................................................
Investment in Held-to-Maturity Securities ...................
Interest Revenue ............................................................

1,000
111
889

Interest Revenue: ($25,518 – $107)  0.07  (6/12) = $889
PRACTICE 14–5


COST METHOD, EQUITY METHOD, AND CONSOLIDATION

Number of
Total Shares
Shares Owned
of Investee Company Percentage
by Investor Company
Outstanding
Ownership
1.

1,200

10,000

2.

6,000

8,000

75

Consolidation

3.

20,000


55,000

36

Equity method

PRACTICE 14–6

12%

Accounting
Classification
Trading or
available for sale

REVENUE FOR TRADING AND AVAILABLE-FOR-SALE
SECURITIES

Dividends received on trading and available-for-sale securities are both classified as
dividend revenue.
Cash .....................................................................................
Dividend Revenue ..........................................................
Cash: (2,000 shares  $1.75) + (6,000 shares  $0.97) = $9,320

9,320
9,320


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Chapter 14

PRACTICE 14–7

REVENUE FOR EQUITY METHOD SECURITIES

Because Burton owns more than 20% of Company A stock (2,000/8,000 = 25%), the
investment is accounted for using the equity method. Because the purchase price
was equal to Burton’s share of the book value of Company A’s equity, there is no
excess of purchase price over cost basis.
Year 1
Investment in Company A Stock ........................................
Cash ................................................................................
Investment in Company A Stock ........................................
Income from Company A Stock ....................................

54,000
54,000
10,000
10,000

Income from Company A Stock: $40,000  (2,000 shares/8,000 shares) = $10,000
Cash .....................................................................................
Investment in Company A Stock ..................................

3,200
3,200

Cash: $1.60  2,000 shares = $3,200

Year 2
Investment in Company A Stock ........................................
Income from Company A Stock ....................................

12,500
12,500

Income from Company A Stock: $50,000  (2,000 shares/8,000 shares) = $12,500
Cash .....................................................................................
Investment in Company A Stock ..................................

4,000
4,000

Cash: $2.00  2,000 shares = $4,000
PRACTICE 14–8
1.

EQUITY METHOD: EXCESS DEPRECIATION

Underlying fair value of net assets ($82,000  3) ................
Book value of net assets ......................................................
Implied amount of excess value of building .......................

$ 246,000
202,000
$ 44,000

Investor’s interest in net assets ...........................................
Amount of excess building value to be depreciated ..........

Depreciation period ...............................................................
Annual extra depreciation ....................................................


1/3
$ 14,667
÷11 years
$
1,333


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603

PRACTICE 14–8

(Concluded)

Year 1
Investment in Company B Stock ........................................
Cash ................................................................................
Investment in Company B Stock ........................................
Income from Company B Stock ....................................

82,000
82,000
24,000
24,000


Income from Company B Stock: $72,000  (5,000 shares/15,000 shares) = $24,000
Cash .....................................................................................
Investment in Company B Stock ..................................

8,250
8,250

Cash: 5,000 shares  $1.65 = $8,250
Income from Company B Stock .........................................
Investment in Company B Stock ..................................
2.

1,333

Investment in Company B
Purchase

82,000

Income

24,000

Ending
PRACTICE 14–9
1.

1,333


8,250

Dividends

1,333

Extra
Depreciation

96,417
EQUITY METHOD: COST GREATER THAN BOOK VALUE

Underlying fair value of net assets ($100,000/0.25) ...................
Book value of net assets ..............................................................
Implied amount of excess of fair value over book value ...........
Excess fair value identified with:
Inventory ..................................................................................
Building....................................................................................
Goodwill ...................................................................................
Total ...............................................................................................

$ 400,000
300,000
$ 100,000
$

10,000
50,000
40,000
$ 100,000


Investor’s interest in net assets ..................................................

0.25

Amount of excess inventory cost this year ................................

$

2,500

Amount of excess building value to be depreciated ..................
Depreciation period ......................................................................
Annual extra depreciation ............................................................

$ 12,500
÷ 10 years
$
1,250

No extra expense is associated with the goodwill, assuming that it is not impaired during the year.


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Chapter 14

PRACTICE 14–9


(Concluded)

Year 1
Investment in Company C Stock ........................................
Cash ................................................................................
Investment in Company C Stock ........................................
Income from Company C Stock ....................................

100,000
100,000
17,500
17,500

Income from Company C Stock: $70,000  (2,500 shares/10,000 shares) = $17,500
Cash .....................................................................................
Investment in Company C Stock ..................................

5,000
5,000

Cash: 2,500 shares  $2.00 = $5,000
Income from Company C Stock .........................................
Investment in Company C Stock ..................................

3,750
3,750

Extra inventory cost $2,500 + Extra depreciation $1,250 = $3,750
2.


Investment in Company C
Purchase
Income

Ending
PRACTICE 14–10
(a)

(b)

100,000
17,500

5,000

Dividends

3,750

Extra
Expense

108,750
CHANGES IN VALUE: TRADING SECURITIES

Market Adjustment—Trading Securities ...........................
Unrealized Gain on Trading Securities ........................

1,350


Unrealized Loss on Trading Securities .............................
Market Adjustment—Trading Securities ......................

1,250

(c)

$3,000 + $1,350 = $4,350

(d)

$3,000  $1,250 = $1,750

1,350

1,250


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PRACTICE 14–11
(a)

(b)

605

CHANGES IN VALUE: AVAILABLE-FOR-SALE SECURITIES


Market Adjustment—Available-for-Sale Securities ..........
Unrealized Increase/Decrease in
Available-for-Sale Securities .....................................
Unrealized Increase/Decrease in Available-for-Sale
Securities .........................................................................
Market Adjustment—Available-for-Sale Securities .....

(c)

$3,000 + No income impact = $3,000

(d)

$3,000 – No income impact = $3,000

PRACTICE 14–12

No adjusting entry

(b)

No adjusting entry

(c)

$3,000 + No income impact = $3,000

(d)

$3,000 – No income impact = $3,000


No adjusting entry

(b)

No adjusting entry

(c)

$3,000 + No income impact = $3,000

(d)

$3,000 – No income impact = $3,000

1.

2.

1,250
1,250

CHANGES IN VALUE: EQUITY METHOD

(a)

PRACTICE 14–14

1,350


CHANGES IN VALUE: HELD-TO-MATURITY SECURITIES

(a)

PRACTICE 14–13

1,350

SALE OF SECURITIES

Cash (400  $27) ..................................................................
Realized Gain on Trading Securities ............................
Investment SecuritiesTrading (400  $24) ................

10,800

Cash (400  $20) ..................................................................
Realized Loss on Trading Securities .................................
Investment SecuritiesTrading (400  $24) ................

8,000
1,600

1,200
9,600

9,600


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Chapter 14

PRACTICE 14–15

SALE OF SECURITIES AND THE MARKET ADJUSTMENT
ACCOUNT

1.

Cash proceeds........................................................................................
– Cost ......................................................................................................
Realized loss ..........................................................................................

$ 9,500
10,000
$ (500)

2.

Cumulative unrealized loss, end of year ($5,800 – $9,000) .................
Cumulative unrealized gain, beginning of year ($26,000 – $19,000)...
Unrealized loss for the year ...................................................................

$ (3,200)
7,000
$ (10,200)

PRACTICE 14–16


TRANSFER BETWEEN CATEGORIES: TO AND FROM TRADING

Security A
Investment Securities—Available for Sale ........................
Market Adjustment—Trading .............................................
Unrealized Gain on Transfer of Securities ...................
Investment Securities—Trading ...................................

5,500
1,000
1,500
5,000

Security B
Investment Securities—Trading .........................................
Unrealized Loss on Transfer of Securities ........................
Market Adjustment—Available for Sale .......................
Investment Securities—Available for Sale...................
PRACTICE 14–17

4,100
3,900
2,000
6,000

TRANSFER BETWEEN CATEGORIES: AVAILABLE FOR SALE

Security A
Investment Securities—Held to Maturity ...........................

Market Adjustment—Available for Sale .............................
Unrealized Increase in Available-for-Sale Securities ..
Investment Securities—Available for Sale...................

8,850
1,100
1,750
8,200

Security B
Investment Securities—Available for Sale ........................
Unrealized Decrease in Available-for-Sale Securities ......
Investment Securities—Held to Maturity .....................

9,450
550
10,000


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PRACTICE 14–18

607

CASH FLOW AND AVAILABLE-FOR-SALE SECURITIES

Realized gain: $470 sales proceeds – $350 cost = $120 realized gain
Unrealized increase: $65 fair value – $50 cost ($400 – $350) = $15 unrealized increase

Net income: $880 + $120 realized gain = $1,000
1. Operating activities:
Net income ....................................................
Less: Realized gain on sale of securities ...

$ 1,000
(120)

$880

2. Investing activities:
Purchase of available-for-sale securities ...
Sale of available-for-sale securities ............

$ (400)
470

$70

PRACTICE 14–19

CASH FLOW AND TRADING SECURITIES

Realized gain: $470 sales proceeds – $350 cost = $120 realized gain
Unrealized gain: $65 fair value – $50 cost ($400 – $350) = $15 unrealized gain
Net income: $880 + $120 realized gain + $15 unrealized gain = $1,015
1. Operating activities:
Net income ........................................................ $ 1,015
Purchase of trading securities ........................
(400)

Sale of trading securities .................................
470
Less: Realized gain on sale of securities .......
(120)
Less: Unrealized gain on sale of securities....
(15)

$950

2. Investing activities:
None
PRACTICE 14–20
1.

DISCLOSURE: COMPUTATION OF TOTAL ECONOMIC GAIN

Mar. 23 Cash (6,000  $41) ...................................................
Realized Gain on Available-for-Sale Securities
Investment Securities—Available for Sale ........
(6,000  $25)

246,000

Dec. 31 Unrealized Decrease in Available-for-Sale Securities 35,000
Market Adjustment—Available for Sale .............

96,000
150,000

35,000


The key with the market adjustment is to get the ending balance in the market adjustment account equal to a $60,000 debit [10,000 shares  ($38  $32)]. This requires
a credit of $35,000 since the balance at the end of last year was a $95,000 debit.


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Chapter 14

PRACTICE 14–20
2.

(Concluded)

The easy way to get the answer is Realized gain $96,000 – Unrealized ―loss‖
$35,000 = $61,000 economic gain. In this case, it doesn’t matter that the unrealized decrease is not recognized in the income statement; it is still an economic
loss.
To prove this, look at the economic value of the portfolio at the beginning of the
year compared to the value of the portfolio plus cash at the end of the year:
Beginning: Cost of $470,000 ($150,000 + $320,000) + $95,000 market
adjustment = $565,000
Ending: $380,000 in stock (10,000  $38) + $246,000 cash = $626,000
The increase is $61,000 ($626,000  $565,000)
‡

PRACTICE 14–21

LOAN IMPAIRMENT: INITIAL MEASUREMENT


Sum of payments to be received:
Maturity value ................................................... $5,000
Annual interest payments (5  $800) ............... 4,000
Total ................................................................ $9,000
The entire $9,000 will be received at the end of the loan term. The loan term is 5
years. However, because 1 year has already elapsed (as of the end of Year 1), the
$9,000 payment will be received after four more years. The present value of this
$9,000 payment is computed as follows:
Business Calculator Keystrokes:
FV = $9,000, N = 4, I = 8% → $6,615
The following journal entry is made to record the loan impairment:
Bad Debt Expense ($10,000 – $6,615) ................................
Allowance for Loan Impairment....................................

3,385
3,385

Before this entry, the carrying amount of the loan was $10,000 because the $800 interest receivable for Year 1 had not been recognized.

‡

Relates to Expanded Material.


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609

‡


PRACTICE 14–22

LOAN IMPAIRMENT: SUBSEQUENT INTEREST REVENUE

An amortization schedule for the annual interest revenue amount is as follows:
Payment
End of Year 1
Year 2
Year 3
Year 4
Year 5

$

0
0
0
(9,000)

Interest (8%)
$529
572
617
667

Principal
$ 529
572
617

8,333

Balance
$6,615
7,144
7,716
8,333
0

Year 2
Allowance for Loan Impairment .........................................
Interest Revenue ............................................................

529

Year 3
Allowance for Loan Impairment .........................................
Interest Revenue ............................................................

572

Year 4
Allowance for Loan Impairment .........................................
Interest Revenue ............................................................

617

Year 5
Allowance for Loan Impairment .........................................
Interest Revenue ............................................................


667

Cash .....................................................................................
Allowance for Loan Impairment .........................................
Loan Receivable ............................................................

‡

Relates to Expanded Material.

529

572

617

667
9,000
1,000
10,000


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Chapter 14

EXERCISES
14–23.

(a) Investment in Trading Securities—Treasury Bonds .............
Interest Revenue ......................................................................
Cash.....................................................................................
To record purchase of $55,000 of U.S. Treasury 6%
bonds.
*1.02  $55,000 = $56,100

56,100*
1,400
57,500

(b) Investment in Available-for-Sale Securities—Dulce Co. ......
Cash.....................................................................................
To record purchase of 2,100 shares of Dulce Co.
common stock.

140,700

(c) Cash ..........................................................................................
Interest Revenue.................................................................
To record receipt of semiannual interest on U.S.
Treasury 6% bonds ($55,000  0.03).

1,650

(d) Cash ..........................................................................................
Investment in Available-for-Sale Securities—
Dulce Co. ..........................................................................
Realized Gain on Sale of Securities ..................................
To record sale of 400 shares of Dulce Co. stock.

*400 shares at $81 per share = $32,400
†
(400/2,100)  $140,700 = $26,800

32,400*

140,700

1,650

26,800†
5,600

(e) Cash ..........................................................................................
20,380*
Realized Loss on Sale of Securities .......................................
200
Investment in Trading Securities—Treasury Bonds ........
Interest Revenue.................................................................
To record sale of $20,000 worth of U.S. Treasury 6%
bonds.
*$20,000  1.01 = $20,200; $20,200 + $180 accrued interest = $20,380
†
($20,000/$55,000)  $56,100 = $20,400 (rounded)
(f) Investment in Trading Securities—Certificate of Deposit .....
Cash.....................................................................................
To record purchase of an $18,000, 6-month certificate
of deposit.

20,400†

180

18,000
18,000


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611

14–24.
1. Investment in Trading Securities—Gimli ...............................
Investment in Trading Securities—Treasury Bonds .............
Investment in Available-for-Sale Securities—Legolas ..........
Investment in Available-for-Sale Securities—Glorfindel.......
Investment in Held-to-Maturity Securities—Mirkwood..........
Cash.....................................................................................
To record the purchase of securities during January.

9,000
11,000
22,000
42,500
24,000

2. Cash ..........................................................................................
Interest Revenue.................................................................
Dividend Revenue ..............................................................
To record the receipt of interest and dividend

revenue during the year.

5,390

3. Cash ..........................................................................................
Realized Loss on Sale of Securities .......................................
Investment in Trading Securities—Gimli ..........................
To record sale of 200 shares of Gimli stock;
purchased at $18 per share, sold at $17 per share.
Cash ..........................................................................................
Investment in Available-for-Sale Securities—
Glorfindel..........................................................................
Realized Gain on Sale of Securities ..................................
To record sale of 250 shares of Glorfindel stock;
purchased at $17 per share, sold at $19 per share.

3,400
200

108,500

3,630
1,760

3,600

4,750
4,250
500


14–25.
(a)

(b)

(c)
(d)

(e)

Equity Method with Consolidation. Even though RV Insurance Company is a
nonhomogeneous operation, it should be consolidated because it is a majorityowned subsidiary.
Cost Method (Available for Sale). Buy Right has 10% ownership (20,000/200,000
shares) with no additional information to suggest that significant influence can
be exercised.
Cost Method (Available for Sale). Super Tire holds nonvoting preferred stock.
The cost method is used for investments in preferred stock.
Cost Method (Trading or Available for Sale). While Takeover Company owns
30% (15,000/50,000 shares) of Western’s common stock, it has been unable to
obtain representation on Western’s board of directors. Takeover does not have
significant influence and so must use the cost method. The securities would
probably not be classified as trading unless Takeover is in the business of regularly making such investments in order to generate short-term trading profits.
Equity Method. Espino has 40% (50,000/125,000 shares) ownership and presumably can exercise significant influence, even though it does not have a controlling interest in Independent Mining.


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612

Chapter 14


14–26.
1. Available for Sale
Jan. 10 Investment in Available-for-Sale Securities—
Kennedy Company Stock ....................................
Cash .....................................................................
To record investment in 12,000 shares of
Kennedy Company common stock.
Dec. 31 Cash .........................................................................
Dividend Revenue ...............................................
To record dividend received from Kennedy
Company for 2013 ($0.55  12,000 shares).
31

Unrealized Increase/Decrease in Value of
Available-for-Sale Securities ...............................
Market Adjustment—Available-for-Sale
Securities ..........................................................
To record decline in fair value of Kennedy
Company stock ($9  12,000 shares).

2. Equity Method
Jan. 10 Investment in Kennedy Company Stock ...............
Cash .....................................................................
To record investment in 12,000 shares of
Kennedy Company common stock.
Dec. 31

31

600,000

600,000

6,600
6,600

108,000
108,000

600,000
600,000

Investment in Kennedy Company Stock ...............
45,000
Income from Investment in Kennedy
Company Stock ................................................
To record proportionate share of Kennedy
Company’s earnings for 2013 (25%  $180,000).
Cash .........................................................................
Investment in Kennedy Company Stock ...........
To record dividend received from Kennedy
Company for 2013 ($0.55  12,000 shares).

6,600

Investment in Beta Co. Stock .......................................
Cash ............................................................................
To record purchase of 25% interest in Beta Co.
common stock ($12  20,000 shares).

240,000


45,000

6,600

14–27.
2012
Jan. 1

240,000


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613

14–27. (Concluded)
Dec. 31

31

2013
Dec. 31

31

Investment in Beta Co. Stock .......................................
88,000
Income from Investment in Beta Co. Stock ..............

To record 25% share of income (0.25  $360,000 =
$90,000 less amortization of $2,000*).
*Underlying fair value of net assets ($240,000/0.25) ...................
Book value of net assets ..............................................................
Broadcast license .........................................................................
Investor’s interest in net assets ..................................................
Amount of license to be amortized .............................................
Amortization period ......................................................................
Annual amortization ....................................................................
Cash ...............................................................................
32,000
Investment in Beta Co. Stock ....................................
To record receipt of dividend ($1.60  20,000 shares).
Investment in Beta Co. Stock .......................................
95,500
Income from Investment in Beta Co. Stock ..............
To record 25% share of income (0.25  $390,000 =
$97,500 less amortization of $2,000).
Cash ...............................................................................
40,000
Investment in Beta Co. Stock ....................................
To record receipt of dividend ($2.00  20,000 shares).

88,000

$ 960,000
800,000
$ 160,000

0.25

$ 40,000
÷
20
$ 2,000
32,000

95,500

40,000

14–28.
Investment in Old Farms Co. Stock ...........................................
Cash ..........................................................................................
To record the purchase of 40% of the outstanding
common stock of Old Farms Co.

128,000

Investment in Old Farms Co. Stock..............................................
Income from Investment in Old Farms Co. Stock ..................
To report 40% of the net income reported by Old
Farms Co. (0.40  $80,000).

32,000

Cash ................................................................................................
Investment in Old Farms Co. Stock ........................................
To record the receipt of $20,000 in dividends from
Old Farms Co. (0.40  $50,000).


20,000

128,000

32,000

20,000


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Chapter 14

14–28. (Concluded)
Income from Investment in Old Farms Co. Stock .......................
Investment in Old Farms Co. Stock ........................................
To amortize the differential associated with the
equipment and buildings as follows:

Equipment ...
Buildings .....

Fair
Value
$100,000
80,000

Book
Value

$60,000
50,000

5,000
5,000

40% of
Remaining
Difference Difference
Life
$40,000
$16,000
4 years
30,000
12,000
12 years

Amount
Amortized
$4,000
1,000

14–29.
1. Investment in Held-to-Maturity Securities ..............................
Cash ......................................................................................
To record the purchase of the debt security whose
value is computed as follows:
Using present value tables:
$ 30,000  19.7928 = $593,784
600,000  0.2083 =

124,980
$718,764

718,764
718,764

Using a business calculator:
PMT = $30,000, FV = $600,000, N = 40, I = 4%  $718,757
Note that the amount in this entry would be the same regardless of whether this
security was classified as trading, available for sale, or held to maturity.
2. Cash ..........................................................................................
Investment in Held-to-Maturity Securities..........................
Interest Revenue ..................................................................
To record the cash received for the first interest
payment and to recognize interest revenue.
*$718,764  0.04 = $28,751; $30,000 – $28,751 = $1,249

30,000

Cash ..........................................................................................
30,000
Investment in Held-to-Maturity Securities..........................
Interest Revenue ..................................................................
To record the cash received for the second interest
payment and to recognize interest revenue.
*($718,764 – $1,249)  0.04 = $28,701; $30,000 – $28,701 = $1,299

1,249*
28,751*


1,299*
28,701*


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Chapter 14

615

14–30.
1. Amortization Schedule:

Interest
Payment

Interest
Received
(0.04 
$100,000)

Interest
Revenue (0.05
 Carrying
Value)

Discount
Amortization

1
2

3
4
5
6
7
8
9
10

$4,000
4,000
4,000
4,000
4,000
4,000
4,000
4,000
4,000
4,000

$4,614
4,645
4,677
4,711
4,746
4,784
4,823
4,864
4,907
4,952


$614
645
677
711
746
784
823
864
907
952

Unamortized
Discount
$7,723
7,109
6,464
5,787
5,076
4,330
3,546
2,723
1,859
952
0

Bond
Carrying
Value
$ 92,277

92,891
93,536
94,213
94,924
95,670
96,454
97,277
98,141
99,048
100,000

2. Journal Entries:
July 1 Cash ................................................................................
Investment in Held-to-Maturity Securities ....................
Interest Revenue ........................................................

4,000
614

Dec. 31 Cash ................................................................................
Investment in Held-to-Maturity Securities ....................
Interest Revenue ........................................................

4,000
645

4,614

4,645


14–31.
This debt security’s book value following the second interest payment is $93,536
(from amortization table). The journal entries to adjust the security to fair value under
differing assumptions are as follows:
1. Trading Security:
Market Adjustment—Trading Securities ................................
2,964*
Unrealized Gain on Trading Securities ..............................
To record unrealized increase in fair value of security.
Increase is recognized on the income statement.
*Fair value less book value = $96,500 – $93,536 = $2,964 unrealized gain.

2,964


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616

Chapter 14

14–31. (Concluded)
2. Available-for-Sale Security:
Market Adjustment—Available-for-Sale Securities ...............
Unrealized Increase/Decrease in Value of Availablefor-Sale Securities ............................................................
To record unrealized increase in fair value of security.
Increase is recognized in Stockholders’ Equity section.

2,964
2,964


3. For held-to-maturity securities, increases and decreases in value are not
recognized.
14–32.
1.

Security
A
B
C
Total

Cost
$ 65,000
100,000
220,000
$385,000

Fair Value (12/31/2013)
$ 75,000
54,000
226,000
$355,000

A loss of $30,000 ($385,000 – $355,000) would be recognized, reducing net income to $257,000 ($287,000 – $30,000).
2.

Security
A
B
C

Total

Cost
$ 65,000
100,000
220,000
$385,000

Fair Value (12/31/2013)
$ 75,000
95,000
226,000
$396,000

If the fair value of security B were $95,000, net income would be increased by
$11,000 ($396,000 – $385,000). Net income would be reported at $298,000
($287,000 + $11,000).
14–33.
1. Unrealized Loss on Trading Securities ........................................ 2,000*
Market Adjustment—Trading Securities ..................................
2,000
To record the decrease in fair value of trading
securities.
*Historical cost less fair value = $69,000 – $67,000 = $2,000 decline in fair value.
2. Cash ................................................................................................ 17,000
Trading Securities—Bizzare Corp. ...........................................
Realized Gain on Sale of Securities .........................................
To record sale of one-half of Bizzare Corp. common
stock.


15,500
1,500


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Chapter 14

617

14–33. (Concluded)
3. (a)

(b)

(c)

Unrealized Loss on Trading Securities ................................ 1,500
Market Adjustment—Trading Securities ..........................
To record additional decline in value of trading
securities from cost of $53,500 to fair value of
$50,000, $2,000 having already been recognized.
Market Adjustment—Trading Securities .............................. 1,000
Unrealized Gain on Trading Securities ............................
To record increase in value of trading securities,
reflecting previous decline of $2,000 with cost
now $53,500 and fair value $52,500.
Market Adjustment—Trading Securities ........................
Unrealized Gain on Trading Securities ......................
To record increase in value of trading securities
above cost of $53,500 to fair value of $56,000, also

reflecting the previous decline of $2,000.

1,500

1,000

4,500
4,500

14–34.
1. Unrealized Loss on Trading Securities ..................................
Market Adjustment—Trading Securities ...........................
To record the decline in value of trading securities
from cost of $26,000 to fair value of $22,000.
Unrealized Increase/Decrease in Value of Available-forSale Securities .......................................................................
Market Adjustment—Available-for-Sale Securities ..........
To record decline in value of available-for-sale
securities from cost of $32,000 to fair value of $30,000.

4,000
4,000

2,000
2,000

No entry to adjust held-to-maturity securities to fair value.
2. Reported net income ............................................................... $100,000
Less: Unrealized loss on trading securities...........................
(4,000)
Adjusted net income ................................................................ $ 96,000

(Note: The decrease in value of available-for-sale securities is not reflected in
net income.)


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618

Chapter 14

14–35.
1. In 2012, the historical cost of the trading securities exceeds the fair value by
$5,000 ($51,000 – $46,000). Thus, income for 2012 would be reduced by $5,000.
Unrealized Loss on Trading Securities ..................................
Market Adjustment—Trading Securities ............................

5,000
5,000

In 2013, the fair value of the securities exceeds historical cost by $2,300. With an
existing balance in the market adjustment account of $5,000 (credit), an adjustment would be made to income for $7,300 to obtain the desired $2,300 debit balance in the market adjustment account.
Market Adjustment—Trading Securities ................................
Unrealized Gain on Trading Securities ..............................

7,300
7,300

2. If the decline in the fair value of a security is believed to be other than temporary,
the loss is recognized in income in the current period and the cost of the security
is adjusted.
Unrealized Loss on Trading Securities ..................................

6,700
Investment in Trading Securities—Sonoma ......................
To record the other-than-temporary decline in value of the
Sonoma security.
Market Adjustment—Trading Securities ................................
Unrealized Gain on Trading Securities ..............................
To adjust market adjustment account from previous
$5,000 credit balance (as of 12/31/2012) to desired
debit balance of $9,000 [$53,300 fair value less
$44,300 ($15,000 + $24,000 + $5,300) adjusted cost].

6,700

14,000
14,000

14–36.
1. Market Adjustment—Trading Securities ................................
Unrealized Gain on Trading Securities ..............................
To record increase in value of trading securities
from cost of $23,000 to fair value of $31,000.

8,000

2. Investment in Available-for-Sale Securities—Security B ......
Unrealized Loss on Transfer of Securities .............................
Market Adjustment—Trading Securities ............................
Investment in Trading Securities—Security B ...................
To reclassify security as available for sale at current
fair value of $16,500 and to remove historical cost of

trading security ($15,000) and associated market
adjustment. Unrealized loss represents difference
between fair value at the beginning of the period
and fair value on date of transfer.

16,500
1,500

8,000

3,000
15,000


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619

14–37.
1. Market Adjustment—Trading Securities ................................
Unrealized Gain on Trading Securities ..............................
To record increase in value of trading securities from
cost of $9,000 to fair value of $10,000.
Unrealized Increase/Decrease in Value of Available-forSale Securities .....................................................................
Market Adjustment—Available-for-Sale Securities ........
To record decline in value of available-for-sale
securities from cost of $23,000 to fair value of $20,000.

1,000

1,000

3,000
3,000

2. Investment in Available-for-Sale Securities—Security B ......
Market Adjustment—Trading Securities ................................
Unrealized Loss on Transfer of Securities .............................
Investment in Trading Securities—Security B .................
To reclassify security B as available for sale at
current fair value ($5,500), remove historical cost
($7,000) of trading security, remove associated
market adjustment, and record change in value
since balance sheet date ($500).

5,500
1,000
500

3. Investment in Trading Securities—Security C .......................
Market Adjustment—Available-for-Sale Securities ...............
Unrealized Loss on Transfer of Securities .............................
Unrealized Increase/Decrease in Value of Availablefor-Sale Securities ...........................................................
Investment in Available-for-Sale Securities—
Security C .........................................................................
To reclassify security C as a trading security at its
fair value ($17,000), remove previous adjustments
as a result of changing values, and to recognize on
the income statement the difference between
historical cost and current fair value ($1,000).


17,000
2,000
1,000

7,000

2,000
18,000

14–38.
2012
Dec. 31 Market Adjustment—Available-for-Sale Securities ....
Unrealized Increase/Decrease in Value of
Available-for-Sale Securities ...................................
To record increase in market adjustment account
from $0 to $6,200.
Unrealized Loss on Trading Securities .......................
Market Adjustment—Trading Securities
To record decrease in market adjustment
account from $0 to ($1,800).

6,200
6,200

1,800
1,800


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620

Chapter 14

14–38. (Concluded)
2013
Dec. 31 Unrealized Increase/Decrease in Value of
Available-for-Sale Securities
......................
Market Adjustment—Available-for-Sale Securities
To record decline in market adjustment
account from $6,200 to $4,600.
Market Adjustment—Trading Securities .....................
Unrealized Gain on Trading Securities ...................
To record increase in market adjustment
account from ($1,800) to $300.
2014
Dec. 31 Unrealized Increase/Decrease in Value of
Available-for-Sale Securities ........................................
Market Adjustment—Available-for-Sale Securities
To record decline in market adjustment account
from $4,600 to ($800).

1,600
1,600

2,100
2,100

5,400

5,400

Market Adjustment—Trading Securities .....................
Unrealized Gain on Trading Securities ...................
To record increase in market adjustment
account from $300 to $1,550.

1,250

Unrealized Loss on Trading Securities ...............................
Market Adjustment—Trading Securities ........................
To record decrease in value of trading securities
from cost of $26,000 to fair value of $22,000.

4,000

1,250

14–39.
1.

4,000

Market Adjustment—Available-for-Sale Securities ............
2,000
Unrealized Increase/Decrease in Value of Availablefor-Sale Securities ........................................................
To record increase in value of available-for-sale
securities from cost of $41,000 to fair value of $43,000.
2.


Cash .......................................................................................
Realized Loss on Sale of Securities ....................................
Investment in Trading Securities—Security A ..............
To record sale of one-half of security A.

8,000
1,000

Cash .......................................................................................
Realized Gain on Sale of Securities ...............................
Investment in Available-for-Sale Securities—
Security D ......................................................................
To record sale of one-half of security D.

15,000

2,000

9,000

3,000
12,000


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621

14–39. (Concluded)

3.

Market Adjustment—Trading Securities .............................
6,000
Unrealized Gain on Trading Securities ..........................
To record increase in value of trading securities
from cost of $17,000 to fair value of $19,000 and also to
reflect the previous recognized decline of $4,000.
Unrealized Increase/Decrease in Value of Availablefor-Sale Securities ..............................................................
Market Adjustment—Available-for-Sale Securities .......
To adjust available-for-sale securities from cost of
$29,000 to fair value of $30,000 while reflecting
previously recognized increase of $2,000.

6,000

1,000
1,000

14–40.
a. Because aggregate fair value is less than aggregate cost, an unrealized loss of
$35,000 will be shown in the income statement. However, because no cash is involved, this $35,000 will be added back to net income in computing net cash from
operations in the statement of cash flows.
b. The $50,000 cash payment for trading securities will be reflected as an increase in
the balance of trading securities and deducted in the cash from the Operating
Activities section of the statement of cash flows. The $70,000 purchase of
available-for-sale securities will be disclosed as a cash outflow in the Investing
Activities section of the statement of cash flows.
c. The $62,000 received from the sale of trading securities will be reflected in the
Operating section of the statement of cash flows. The $22,000 realized gain is

subtracted in order to avoid double counting because the gain is already included
in net income.
d. Because aggregate fair value is greater than aggregate cost, an unrealized gain of
$20,000 will be shown in the income statement. However, because no cash is involved, this $20,000 will be subtracted from net income in computing net cash
from operations in the statement of cash flows.
14–41.
Available for sale:
Realized gain: $470 sales proceeds – $150 cost = $320 realized gain
Unrealized decrease: $460 fair value – $750 cost ($900 – $150) = $290 unrealized decrease