Chapter 12 Solutions

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AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise and problem in Intermediate Accounting, 5e with the following AACSB learning skills:

Questions AACSB Tags Exercises

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AACSB Tags

12-1 Reflective thinking 12-8 Analytic

12-7 Reflective thinking 12-14 Analytic, Reflective thinking

12-16 Analytic 12-23 Analytic

12-19 Diversity _CPA/CMA

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12-2 Analytic 12-1 Reflective thinking

12-5 Analytic _Problems

12-7 Analytic, Communications 12-2 Analytic

Exercises 12-9 Analytic

12-4 Analytic 12-13 Communications

12-5 Reflective thinking, Analytic 12-14 Reflective thinking

Investment securities are classified as “held-to-maturity,” “trading,” or “available-for-sale” securities.”

Increases and decreases in the market value between the time a debt security is acquired and the day it matures to a prearranged maturity value are ignored for securities classified as “held-to-maturity.” These changes aren’t important if sale before maturity isn’t an alternative, which is the case if an investor has the “positive intent and ability” to hold the securities to maturity.

SFAS No. 157 governs determination of fair value. That Standard distinguishes between three levels of inputs to fair value determination, with level 1 being readily observable fair values (for example, from a securities exchange), level 2 inputs are other observable amounts (for example, quoted values for similar items, or important inputs like interest rates), and level 3 inputs are unobservable, like the company’s own assumptions. SFAS No. 157 requires

QUESTIONS FOR REVIEW OF KEY TOPICS

Question 12-1 Question 12-2

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For investments to be held for an unspecified period of time, fair value information is more relevant than for investments to be held to maturity. Changes in fair values are less relevant if the investment is to be held to maturity because sale at that fair value is not an option. The investor receives the same contracted interest payments for the period held to maturity and the stated principal at maturity, regardless of movements in market values. However, when the investment is of unspecified length, changes in fair values indicate management’s success in deciding when to acquire the investment and when to sell it, as well as the propriety of investing in fixed-rate or variable-rate securities and long-term or short-term securities.

The way unrealized holding gains and losses are reported in the financial statements depends on whether the investments are classified as “securities available-for-sale” or as “trading securities.” Securities available-for-sale are reported at fair value, and resulting holding gains and losses are not included in the determination of income for the period. Rather, they are reported as a separate component of shareholders’ equity, as part of Other comprehensive income. (Available-for-sale securities for which the investor has chosen the fair value option are reclassified as trading securities.)

Comprehensive income is a more expansive view of the change in shareholders’ equity than traditional net income. It encompasses all changes in equity from nonowner transactions. The non-income part of comprehensive income is called “Other comprehensive income.” Other comprehensive income includes net unrealized holding gains (losses) on investments.

Unrealized holding gains or losses on trading securities are reported in the income statement as if they actually had been realized. Trading securities are actively managed in a trading account with the express intent of profiting from short-term market price changes. So, any gains and losses that result from holding securities during market price changes are suitable measures of success or lack of success in achieving that goal.

On the other hand, unrealized holding gains or losses on securities available-for-sale are not reported in the income statement. By definition, these securities are not acquired for the purpose of profiting from short-term market price changes, so gains and losses from holding these securities while prices change are less relevant performance measures to be included in earnings.

Apparently, the drop in the market price of the stock is an other-than-temporary Question 12-4

Answers to Questions (continued)

Question 12-5

Question 12-6

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unrealized gains or losses should be resumed. Therefore, later changes in fair value will be reported as a separate component of shareholders’ equity, accumulated other comprehensive income.

When acquired, debt and equity securities are assigned to one of the three reporting classifications – held-to-maturity, trading, or available-for-sale. The appropriateness of the classification is reassessed at each reporting date. A reclassification should be accounted for as though the security had been sold and immediately reacquired at its fair value. Any unrealized holding gain or loss should be accounted for in a manner consistent with the classification into which the security is being transferred. Specifically, when a security is transferred:

1. Into the trading category, any unrealized holding gain or loss should be recognized in earnings of the reclassification period.

2. Into the available-for-sale category, any unrealized holding gain or loss should be recorded in Other Comprehensive Income, which will then increase Accumulated Other Comprehensive Income in shareholders’ equity.

3. Into the held-to-maturity category, any unrealized holding gain or loss should be amortized over the remaining time to maturity. This would be the case for Western Die-Casting’s investment in the LGB Heating Equipment bonds.

Yes. Although a company is not required to report individual amounts for the three categories of investments – held-to-maturity, available-for-sale, or trading – on the face of the balance sheet, that information should be presented in the disclosure notes. The following also should be disclosed for each year presented: aggregate fair value, gross realized and unrealized holding gains, gross realized and unrealized holding losses, the change in net unrealized holding gains and losses, and amortized cost basis by major security type. Information about the level of the fair value hierarchy upon which fair values are based should be provided, and more disclosure is necessary with respect to amounts based on level 3 of the fair value hierarchy. In addition, information about maturities should be reported for debt securities, by disclosing the fair value and cost for at least 4 maturity groupings: (a) within 1 year, (b) after 1 year through 5 years, (c) after 5 years through 10 years, and (d) after 10 years.

When a company elects the fair value option for held-to-maturity or available-for-sale investments, it simply reclassifies those investments as trading securities and accounts for them in that fashion.

U.S. GAAP allows companies complete discretion in electing the fair value option when an investment is made. The only constraint is that the election is irrevocable. IFRS only allows companies to elect the fair value option in specific circumstances,

Question 12-9

Question 12-10

Question 12-11

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e.g., when a group of financial assets or liabilities are managed on a fair value basis, or to allow more consistent accounting of a hedging arrangement.

The equity method is used when an investor can’t control but can “significantly influence” the investee. For example, if effective control is absent, the investor still might be able to exercise significant influence over the operating and financial policies of the investee if the investor owns a large percentage of the outstanding shares relative to other shareholders. By voting those shares as a block, the investor often can sway decisions in the direction desired. We presume, in the absence of evidence to the contrary, that the investor exercises significant influence over the investee when it owns between 20% and 50% of the investee's voting shares.

The equity method, like consolidation, views the investor and investee as a special type of single entity. By the equity method, though, the investor doesn’t include separate financial statement items of the investee on an item-by-item basis as in consolidation. Rather, by the equity method, the investor reports its equity interest in the investee as a single investment account. That single investment account is periodically adjusted to reflect the effects of consolidation, without actually consolidating financial statements.

The investor should account for dividends from the investee as a reduction in the investment account. Since investment revenue is recognized as the investee earns it, it would be inappropriate to again recognize revenue when earnings are distributed as dividends. Rather, the dividend distribution is considered to be a reduction of the investee’s net assets, indicating that the investor’s ownership interest in those net assets declines proportionately. Question 12-16

The equity method attempts to approximate the effects of accounting for the purchase of the investee as a consolidation. Consolidated financial statements report acquired net assets at their fair values as of the date the investor acquired the investee. The accounting in the consolidated financial statements subsequent to the acquisition date is based on those fair values. So, if Finest had consolidated its acquisition of Penner, Penner’s depreciable assets would have been put on Finest’s balance sheet in their respective asset accounts at their fair value on the date of acquisition and then depreciated over 10 years. Under the equity method, Finest’s investment in Penner is shown in a single investment account. Therefore, for the equity method to approximate consolidation, it would reduce both investment revenue (as if depreciation expense were being recognized) and the

Question 12-13

Question 12-14

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the “extra depreciation” the higher fair value would cause. This would equal 40% x $12 million ÷ 10 years = $480,000 each year for ten years.

The investment account was decreased by $40,000 (40% x $100,000). Cash increased by the same amount. There is no effect on the income statement.

When it becomes necessary to change from the equity method to another method, no adjustment is made to the carrying amount of the investment. The equity method is simply discontinued and the new method is applied from then on. The investment account balance when the equity method is discontinued would serve as the new “cost” basis for writing the investment up or down to fair value in the next set of financial statements.

IFRS require that accounting policies of investees be adjusted to correspond to

those of the investor when applying the equity method. U.S. GAAP has no such requirement. Also, IFRS allow investors to account for a joint venture using either the equity method or “proportionate consolidation,” whereby the investor combines its proportionate share of the investee’s accounts with its own accounts on an item-by-item basis. U.S. GAAP generally requires that the equity method be used to account for joint ventures.

When a company elects the fair value option for a significant-influence investment, that investment is not reclassified as a trading security. Rather, the investment still appears on the balance sheet as a significant-influence investment, but the amount that is accounted for at fair value is indicated on the balance sheet either parenthetically on a single line that includes the total amount of significant-influence investment or on a separate line. As with trading securities, unrealized gains and losses are included in earnings in the period in which they occur.

A financial instrument is: (a) cash, (b) evidence of an ownership interest in an entity, (c) a contract that (1) imposes on one entity an obligation to deliver cash or another financial instrument and (2) conveys to a second entity a right to receive cash or another financial instrument, or (d) a contract that (1) imposes on one entity an obligation to exchange financial instruments on potentially unfavorable terms and (2) conveys to a second entity a right to exchange other financial instruments on potentially favorable terms. Accounts payable, bank loans, and investments in securities are examples.

These instruments “derive” their values or contractually required cash flows from some other security or index.

Since this fund won’t be used within the upcoming operating cycle, it is a noncurrent asset. It should be reported as part of “Investments and funds.”

Part of each premium payment the company makes is not used by the insurance company to pay for life insurance

Question 12-17 Question 12-18 Question 12-19 Question 12-20 Question 12-21 Question 12-22 Question 12-23

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company in a fixed-income investment. As a result, the periodic insurance premium should not be expensed in its entirety; an appropriate portion should be recorded instead as a noncurrent asset – cash surrender value.

When a creditor’s investment in a receivable becomes impaired, due to a troubled debt restructuring or for any other reason, the receivable is re-measured based on the discounted present value of currently expected cash flows at the loan’s original effective rate (regardless of the extent to which expected cash receipts have been reduced). The extent of the impairment is the difference between the carrying amount of the receivable (the present value of the receivable’s cash flows prior to the restructuring) and the present value of the revised cash flows discounted at the loan’s original effective rate. This difference is recorded as a loss at the time the receivable is reduced.

(a) Investment in bonds (face amount) 720,000 Discount on bond investment (difference)... 120,000 Cash (price of bonds)... 600,000

(b)

Cash (1.5% x $720,000)... 10,800 Discount on bond investment (difference)... 1,200

Interest revenue (2% x $600,000)... 12,000

Unlike for securities available-for-sale, unrealized holding gains and losses for trading securities are included in earnings. S&L reports its $2,000 holding loss in 2009 earnings. When the fair value rises by $7,000 in 2010, that

Question 12-25

BRIEF

EXERCISES

Brief Exercise 12-1

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reversal of the unrealized loss that was recognized in 2009). S&L’s journal entries for these transactions would be:

2009

December 27

Investment in Coca Cola shares ... 875,000

Cash... 875,000

December 31

Net unrealized holding gains and losses—I/S... 2,000

Fair value adjustment ($875,000 - 873,000)... 2,000

2010 January 3

Cash (selling price)... 880,000

Gain on investments (to balance)... 5,000 Investment in Coca Cola shares (account balance)... 875,000

Assuming no other trading securities, the 2010 adjusting entry to remove the fair value adjustment associated with the sold securities would be:

December 31

Fair value adjustment (account balance)... 2,000

Net unrealized holding gains and losses—I/S (to balance) 2,000

Unlike for trading securities, unrealized holding gains Brief Exercise 12-2 (concluded)

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in earnings. S&L reports its $2,000 holding loss in 2009 as Other comprehensive income in the statement of comprehensive income. When the fair value rises to $880,000 in 2010, the amount is reported in 2010 earnings is the $5,000 gain realized by the sale of the securities. S&L’s journal entries for these transactions would be:

2009

December 27

Cash... 875,000

December 31

Net unrealized holding gains and losses–OCI... 2,000

2010 January 3

Gain on investments (to balance)... 5,000 Investment in Coca Cola shares (cost)... 875,000

Assuming no other transactions involving securities available-for-sale, the 2010 adjusting entry to remove the fair value adjustment associated with the sold securities would be:

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December 31

Securities available-for-sale are reported at fair value, and resulting holding gains and losses are not included in the determination of net income for the period. Rather, they are reported as “other comprehensive income” in the statement of comprehensive income. The accumulated balance of net holding gains and losses is reported as a separate component of shareholders’ equity, as part of accumulated other comprehensive income. The adjusting entry needed to increase the fair value adjustment from $110,000 to $170,000 is:

Fair value adjustment ($670,000 – 610,000)... 60,000 Net unrealized holding gains and losses–OCI.

... 60,000

These are securities available-for-sale and are reported at their fair value, $4,000,000. We know this because securities “held-to-maturity” are debt securities an investor has the “positive intent and ability” to hold to maturity. Actively traded investments in debt or equity securities acquired principally for the purpose of selling them in the near term are classified as “trading securities.” The FedEx shares have been held for over a year. They are classified as “available-for-sale” since all investments in debt and equity securities that don’t fit the definitions of the other reporting categories are classified this way. Of

Brief Exercise 12-4

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certainly don’t constitute “significant influence.” Investments in securities available-for-sale are reported at fair value.

Because S&L elected the fair value option, it would classify this investment as a trading security and account for it in that fashion. Therefore, S&L reports its $2,000 holding loss in 2009 earnings. When the fair value rises by $7,000 in 2010, that amount is reported in 2010 earnings ($5000 as a realized gain, and $2000 as the reversal of the unrealized loss that was recognized in 2009). S&L’s journal entries for these transactions would be:

2009

December 27

Cash... 875,000

December 31

2010 January 3

Gain on investments (to balance)... 5,000 Investment in Coca Cola shares (account balance)... 875,000

Assuming no other trading securities, the 2010 adjusting entry to remove the fair

Brief Exercise 12-6

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Net unrealized holding gains and losses—I/S (to balance) 2,000

An investor should account for dividends from an equity method investee as a reduction in its investment account. Since investment revenue is recognized as the investee earns it, it would be inappropriate to again recognize revenue when earnings are distributed as dividends. Instead, the dividend distribution is considered to be a reduction of the investee’s net assets, reflecting the fact that the investor’s ownership interest in those net assets declined proportionately. Turner’s cash increased by $2 million (40% x $5 million). Its investment account declined by the same amount. There is no effect on the income statement.

An investor should account for dividends from an investment not accounted for by the equity method as investment revenue. Since Turner holds only 10% of ICA stock, it’s assumed that it does not have significant influence over the company. Turner’s cash increased by $500,000 (10% x $5 million). It also reports $500,000 as investment revenue in the income statement.

Given Turner’s election of the fair value option, it would account for this investment similar to a trading security, while still preserving its classification as a significant-influence investment and showing it as a non-current asset on the balance sheet.

2009

Brief Exercise 12-7

Brief Exercise 12-8

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January 2

Investment in ICA Company ... 10,000,000 Cash... 10,000,000 December 30 Cash (40% x $500,000) ... 200,000 Investment revenue ... 200,000 December 31

Fair value adjustment ($11.5M - 10M)... 1,500,000

Net unrealized holding gains and losses—I/S

(may also labeled “Investment revenue”)... 1,500,000

Note: A different approach to reach the same outcome would be for Turner to use equity-method accounting throughout the year, and then at the end of the year make whatever adjustment to fair value is necessary to adjust the investment

account to fair value. Under that approach, Turner would recognize 40% of ICA’s $750,000 income ($300,000) as investment income, it would not recognize

investment income associated with ICA’s dividend, and it would end up with an Investment account containing $10,100,000 ($10,000,000 + $300,000 - $200,000). Turner then would need to make a fair value adjustment of $1,400,000

($11,500,000 - $10,100,000) to their ICA investment. So the total amount of income recognized would be $1,700,000 ($300,000 investment income + $1,400,000 unrealized gain). Note that this alternative produces the same total amount of investment income as is produced above, $1,700,000 ($200,000 investment revenue + $1,500,000 unrealized gain).

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With the equity method we attempt to approximate the effects of accounting for the purchase of the investee as a consolidation. Consolidated financial statements report acquired net assets at their fair values. Both investment revenue and the investment would be reduced by the negative income effect of the “extra depreciation” the higher fair value would cause. This would equal 30% x $50 million ÷ 15 years = $1 million each year for fifteen years.

Under proportionate consolidation, Park would have included its portion of Wallis’s depreciable assets in the Park depreciable asset accounts on its consolidated balance sheet. Those depreciable asset accounts would be reduced by the “extra depreciation” the higher fair value would cause. This would equal 50% x $50 million ÷ 15 years = $1.67 million each year for fifteen years.

Because the drop in the market price of stock is considered to be other-than-temporary, LED records the impairment as follows:

Impairment loss ($4.50 x $ 100,000 shares)... 450,000

Investment in Branch Pharmaceuticals... 450,000

The investment is written down to its fair value, and the amount of the write-down should be treated as if it were a realized loss, meaning the loss is included in LED’s earnings for the period. Following the other-than-temporary write-down, the usual treatment of unrealized gains or losses should be resumed. Therefore, later changes in fair value will be reported as other comprehensive income or loss in the statement of comprehensive income.

The investment would be increased by $12 million. Financial statements would be recast to reflect the equity

Brief Exercise 12-10

Brief Exercise 12-11

Brief Exercise 12-12

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should describe the change, justify the switch, and indicate its effects on all financial statement items.

The answer would not be the same if Pioneer changes from the equity method. Rather, no adjustment is made to the carrying amount of the investment. Instead, the equity method is simply discontinued, and the new method is applied from then on. The balance in the investment account when the equity method is discontinued would serve as the new “cost” basis for writing the investment up or down to market value in the next set of financial statements. There also would be no revision of prior years, but the change should be described in a disclosure note.

Requirement 1 ($ in millions)

Investment in bonds (face amount) 240 Discount on bond investment (difference)... 40 Cash (price of bonds)... 200

Requirement 2

Cash (3% x $240 million)... 7.2 Discount on bond investment (difference)... .8

Interest revenue (4% x $200)... 8.0

Requirement 3

Tanner-UNF reports its investment in the December 31, 2009, balance sheet

EXERCISES

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Investment in bonds... $240.0 Less: Discount on bond investment ($40 - .8 million) 39 .2 Amortized cost... $200.8

If sale before maturity isn’t an alternative, increases and decreases in the market value between the time a debt security is acquired and the day it matures to a prearranged maturity value are relatively unimportant. For this reason, if an investor has the “positive intent and ability” to hold the securities to maturity, investments in debt securities are classified as “held-to-maturity” and reported at amortized cost rather than fair value in the balance sheet.

Cash (proceeds from sale)... 190.0

Discount on bond investment (balance, determined above) 39.2 Loss on sale of investments (to balance)... 10.8

Investment in bonds (face amount)... 240.0

November 1 ($ in millions)

Cash... 2.4

Investment revenue... 2.4

December 1

Investment in Facsimile Enterprises bonds... 30

Cash... 30

December 31

Investment in U.S. Treasury bills ... 8.9

Cash... 8.9

Exercise 12-2

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December 31

Investment revenue receivable - Convenience

bonds ($48 million x 10% x 2/12)... 0.8 Investment revenue receivable - Facsimile

Enterprises bonds ($30 million x 12% x 1/12)... 0.3

Investment revenue ... 1.1 Note: Securities held-to-maturity are not adjusted to fair value.

Investment in GM common shares 41,200 Cash ([800 shares x $50] + $1,200)

...41,200

Cash ([800 shares x $53] – $1,300)... 41,100 Loss on sale of investments... 100

Investment in GM common shares ... 41,200

Requirement 1

.

Net unrealized holding gains and losses–OCI 25,000 Fair value adjustment ($45,000 – 20,000) 25,000

Requirement 2

None. Accumulated net holding gains and losses for securities available-for-sale

Exercise 12-3

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rather than as part of earnings. This statement can be reported either (a) as an

extension of the income statement, (b) as part of the statement of shareholders’ equity, or (c) as a separate statement in a disclosure note.

Requirement 1

Securities “held-to-maturity” are debt securities an investor has the “positive intent and ability” to hold to maturity. Actively traded investments in debt or

equity securities acquired principally for the purpose of selling them in the near term are classified as “trading securities.” The IBM shares are neither. They are classified as “available-for-sale” since all investments in debt and equity securities that don’t fit the definitions of the other reporting categories are classified this way. Of course, the equity method isn’t appropriate either because 10,000 shares of IBM certainly don’t constitute “significant influence.”

Investments in securities available-for-sale are reported at fair value, and holding gains or losses are not included in the determination of income for the period. Instead, they are reported as other comprehensive income or loss in the statement of comprehensive income. This statement can be reported either (a) as an

additional section of the income statement, (b) as part of the statement of shareholders’ equity, or (c) as a separate statement in a disclosure note. Accumulated net holding gains and losses for securities available-for-sale are reported as a separate component of shareholders’ equity in the balance sheet.

Requirement 2

December 31, 2009

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Net unrealized holding gains and losses–OCI

(10,000 shares x [$58 - 60]) ... 20,000 Fair value adjustment...

20,000

Requirement 3 December 31, 2010

Accumulated

($ in 000s) Unrealized

Available-for-Sale Securities Cost Fair Value Gain (Loss) IBM shares – Dec. 31, 2010 $600 $610 $10

Moving from a negative $20 (2009) to a positive $10 (2010) requires an increase of $30:

---20 0 +10

+30 --->

Fair value adjustment 10,000 shares x [$61 - 58])... 30,000 Net unrealized holding gains and losses–OCI (-$20 less $10)....

30,000

Exercise 12-5 (concluded)

Fair Value Adjustment

Balance needed in fair value adjustment $10 Existing balance in fair value adjustment: ($20) Increase (decrease) needed in fair value adjustment: $30

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Requirement 1 2009

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March 2

($ in millions)

Investment in Platinum Gauges, Inc. shares ... 31 Cash... 31

April 12

Investment in Zenith bonds... 20 Cash... 20 July 18 Cash... 2 Investment revenue... 2 October 15 Cash... 1 Investment revenue... 1 October 16 Cash... 21 Investment in Zenith bonds... 20 Gain on sale of investments... 1

November 1

Investment in LTD preferred shares ... 40 Cash... 40

December 31

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Available-for-Sale Securities Cost Fair Value Gain (Loss)

Platinum Gauges, Inc. shares $31 $32* $1

LTD preferred shares 40 37** (3 )

Totals $71 $69 $(2)

* $32 x 1 million shares ** $74 x 500,000 shares

Adjusting entry:

Net unrealized holding gains and losses–OCI ($71 – 69)... 2 Fair value adjustment ($71 – 69)... 2

2010

January 23

($ in millions)

Cash _{([1 million shares x 1/2] x $32)}... 16.0 Gain on sale of investments (difference)... 0.5 Investment in Platinum Gauges

shares ($31 million cost x 1/2)... 15.5

March 1

Cash ($76 x 500,000 shares)... 38 Loss on sale of investments (difference)... 2

Investment in LTD preferred (cost)... 40

Note: As part of the process of recording the normal, period-end fair value adjusting entry at 12/31/2010, Construction would debit Fair value adjustment

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and credit Net unrealized gains and losses—OCI for the $2 million associated with the sold investments to remove their effects from the financial statements.

Requirement 2

2009 Income Statement ($ in millions)

Investment revenue (from July 18; Oct. 15)... $3 Gain on sale of investments (from Oct. 16)... 1

Other comprehensive income:*

Net unrealized holding gains and losses on investments**... $2

* Assuming Construction Forms chooses to report Other comprehensive income as an additional section of the income statement. Alternatively, it can report this (a) as part of the statement of shareholders’ equity or (b) as a separate statement in a disclosure note.

Note: Unlike for trading securities, unrealized holding gains and losses are not included in income for securities available-for-sale. Rather, they are included in other comprehensive income, and accumulated in shareholders’ equity in accumulated other comprehensive income.

Requirement 1

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Purchase ($ in millions)

Investment in Jackson Industry shares... 90 Cash ... 90 Net income No entry Dividends Cash (5% x $60 million)... 3 Investment revenue... 3 Adjusting entry

Fair value adjustment ($98 - 90 million)... 8

Net unrealized holding gains and losses–OCI... 8

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Investment revenue... $3 million

Note: An unrealized holding gain is not included in income for securities available-for-sale. Rather, it is included in other comprehensive income, and accumulated in shareholders’ equity in accumulated other

comprehensive income.

Requirement 1 2009

December 17

Investment in Grocers’ Supply preferred shares ... 350,000

Cash... 350,000

December 28

Cash... 2,000

Investment revenue... 2,000

December 31

Fair value adjustment... 50,000

Net unrealized holding gains and losses—I/S

([$4 x 100,000 shares] - $350,000)... 50,000

2010

January 5

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Gain on investments (to balance)... 45,000 Investment in Grocers’ Supply preferred

shares (account balance)... 350,000

Assuming no other trading securities, the 2010 adjusting entry to remove the fair value adjustment associated with the sold securities would be:

December 31

Requirement 2 Balance Sheet (short-term investment):

Trading securities... $400,000

Income Statement:

Investment revenue (dividends)... $ 2,000 Net unrealized holding gains and losses (from adjusting entry) 50,000

Note: Unlike for securities available-for-sale, unrealized holding gains and losses for trading securities are included in income.

1. Investments reported as current assets.

Security A $ 910,000

Security B 100,000

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Security E 490,000 Total $2,280,000

2. Investments reported as noncurrent assets.

Security D $ 915,000 Security F 615,000 $1,530,000

3. Unrealized gain (or loss) component of income before taxes. Trading Securities:

Cost Fair value Unrealized

gain (loss)

Security A $ 900,000 $ 910,000 $10,000

B 105,000 100,000 (5,000 )

Totals $1,005,000 $1,010,000 $ 5,000

4. Unrealized gain (or loss) component of AOCI in shareholders’ equity. Securities Available-for-Sale:

Cost Fair value Unrealized

gain (loss)

Security C $ 700,000 $ 780,000 $80,000

D 900,000 915,000 15,000

Totals $1,600,000 $1,695,000 $95,000

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($ in 000s) Unrealized Available-for-Sale Securities Cost Fair Value Gain (Loss) IBM shares – Dec. 31, 2009 $1,345 $1,175 $(170)

Moving from a negative $145 (Jan.1) to a negative $170 requires a reduction of $25:

---170 -145 0

<--- - 25

Fair value adjustment ($1,175,000 - 1,200,000)... 25,000

Requirement 2

Accumulated

Available-for-Sale Securities Cost Fair Value Gain (Loss) IBM shares – Dec. 31, 2009 $1,345 $1,275 $(70)

Moving from a negative $145 (Jan.1) to a negative $70 requires an increase of $75: --145 -70 0 Fair Value Adjustment

Balance needed in fair value adjustment ($170) Existing balance in fair value adjustment: ($145) Increase (decrease) needed in fair value adjustment: ($ 25)

Exercise 12-10 (continued)

Balance needed in fair value adjustment ($ 70) Existing balance in fair value adjustment: ($145) Increase (decrease) needed in fair value adjustment: $ 75

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+75 --->

Fair value adjustment ($1,275,000 - 1,200,000) ... 75,000

Requirement 3

Accumulated

Available-for-Sale Securities Cost Fair Value Gain (Loss) IBM shares – Dec. 31, 2009 $1,345 $1,375 $30

Moving from a negative $145 (Jan.1) to a positive $30 requires an increase of $175:

--145 -70 0 +30

+175 --->

Fair value adjustment ($1,375,000 - 1,200,000) ... 175,000

Requirement 1

Balance needed in fair value adjustment $ 30 Existing balance in fair value adjustment: ($145) Increase (decrease) needed in fair value adjustment: $175

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The sale of the A Corporation shares decreased Harlon’s pretax earnings by $5 million. The purchase of the C Corporation shares had no effect on Harlon’s 2010 earnings (because the shares are classified as available-for-sale investments, any unrealized gains or losses occurring after purchase during 2010 would not affect 2010 earnings). Here are the entries used to record those two transactions:

June 1, 2010 ($ in millions)

Cash 15

Loss on sale of investments (difference) 5

Investment in A Corporation shares(cost) 20

September 12, 2010

Investment in C Corporation shares 15

Cash 15

Requirement 2

Harlon’s securities available-for-sale portfolio should be reported in its 2010 balance sheet at its fair value of $101 million:

December 31, 2010

($ in millions) Cost, Dec. 31 Fair Value, Dec. 31 Securities Available-for-Sale 2009 2010 2009 2010 A Corporation shares $20 na $14 na B Corporation bonds 35 $35 35 $ 37 C Corporation shares na 15 na 14 D Industries shares 45 45 46 50 Totals $100 $95 $95 $101

In 2009, Harlon would have had a net unrealized loss of $5 (cost of $100 – fair value of $95). Moving from a negative $5 (2009) to a positive $6 requires an increase of $11:

(31)

---5 0 +6

+11 --->

Fair value adjustment ($5credit to $6debit) 11

Net unrealized holding gains and losses–OCI 11

The adjustment has no effect on earnings. Unlike for trading securities, unrealized holding gains and losses are not included in income for securities available-for-sale. Rather, they are included in other comprehensive income, and accumulated in shareholders’ equity in accumulated other

comprehensive income.

Requirement 1

The investment would be accounted for as an available-for-sale investment: Fair Value Adjustment

Allowance

Balance needed in fair value adjustment $ 6 Existing balance in fair value adjustment: (5) Increase (decrease) needed in fair value adjustment: $11

(32)

Purchase

Investment in AMC common shares... 480,000

Cash ... 480,000 Net income No entry Dividends Cash (20% x 400,000 shares x $0.25)... 20,000 Investment revenue... 20,000 Adjusting entry

Requirement 2

(33)

Purchase

Investment in AMC common shares... 480,000

Cash ... 480,000 Net income

Investment in AMC common shares (20% x $250,000) ... 50,000

Investment revenue... 50,000 Dividends

Cash (20% x 400,000 shares x $0.25)... 20,000

Investment in AMC common shares... 20,000 Adjusting entry

No entry

Investment in Nursery Supplies shares... 56

Cash ... 56

Net income

Investment in Nursery Supplies shares (30% x $40 million) ... 12

Investment revenue... 12

Exercise 12-13

(34)

Dividends

Cash (30% x 8 million shares x $1.25)... 3

Adjusting entry No entry

Requirement 1

($ in millions)

Investment in equity securities ($48 million – 31 million)... 17

Retained earnings (investment revenue from the equity method). 17

Requirement 2

Financial statements would be recast to reflect the equity method for each year reported for comparative purposes. A disclosure note also should describe the change, justify the switch, and indicate its effects on all financial statement items.

Requirement 3

When a company changes from the equity method, no adjustment is made to the carrying amount of the investment. Instead, the equity method is simply discontinued, and the new method is applied from then on. The balance in the investment account when the equity method is discontinued would serve as the new “cost” basis for writing the investment up or down to fair value in the next set of financial statements. There also would be no revision of prior years, but the change should be described in a disclosure note.

(35)

Requirement 1: Error discovered before the books are adjusted or closed in 2009.

The journal entry the company made is:

Cash... 100,000

Investments... 100,000 The journal entry the company should have made is:

Cash... 100,000

Investments... 80,000 Gain on sale of investments ($100,000 – 80,000) 20,000

Therefore, to get from what was done to what should have been done, the following entry is needed:

Investments ($100,000 – 80,000)... 20,000

Gain on sale of investments... 20,000

Requirement 2: Error not discovered until early 2010.

Investments ($100,000 – 80,000)... 20,000

Retained earnings... 20,000

(36)

Investment in Carne Cosmetics shares. 68 Cash ... 68

Net income

Investment in Carne Cosmetics shares (25% x $40 million) ... 10 Investment revenue... 10

Dividends

Cash (4 million shares x $1)... 4 Investment in Carne Cosmetics shares... 4

Depreciation Adjustment

Investment revenue ($8 million [calculation below‡] ÷ 8 years).. 1 Investment in Carne Cosmetics shares... 1

‡_{Calculations:}

Investee Net Assets Difference Net Assets Purchased Attributed to:

⇓ ⇓ ⇓

Cost $68



Goodwill:$12 Fair value: $224* x 25% = $56



Undervaluation Book value: $192 x 25% = $48 of assets: $8

Exercise 12-16

(37)

*[$192 + 32] = $224

Adjusting entry

No entry to adjust for changes in fair value as this investment is accounted for under the equity method.

Requirement 1

(38)

Investment in Lake Construction shares... 300 Cash ... 300

Net income

Investment in Lake Construction shares (20% x $150 million) 30 Investment revenue... 30

Dividends

Cash (20% x $30 million)... 6 Investment in Lake Construction shares... 6

Adjustment for depreciation

Investment revenue ($10 million [calculation below‡] ÷ 10 years) 1 Investment in Lake Construction shares... 1

‡_calculation:

Investee Net Assets Difference

Net Assets Purchased Attributed to:

⇓ ⇓ ⇓

Cost $300



Goodwill: $120

Fair value: $900 x 20% = $180



Undervaluation

(39)

Requirement 2

a. Investment in Lake Construction shares

__________________________________________ ($ in millions) Cost 300 Share of income 30 6 Dividends 1 Depreciation adjustment _________________ Balance 323

b. As investment revenue in the income statement.

$30 million (share of income) – $1 million (depreciation adjustment) =

$29 million

c. Among investing activities in the statement of cash flows. $300 million

[Cash dividends received ($6 million) also are reported - as part of operating activities. If Cameron reports cash flows using the indirect method, the operations section of its statement of cash flows would include an adjustment of ($23 million) to get from the net income figure that includes $29 million of revenue to a cash flow number that should only include $6 million of cash flow.]

(40)

Requirement 1

Investee Net Assets Difference

Net Assets Purchased Attributed to:

⇓ ⇓ ⇓

Cost $750



Goodwill: $300

Fair value: $900 x 50% = $450



Undervaluation

Book value: $800 x 50% = $400 of buildings ($25) and land ($25): $50

a. January 1, 2009 effect on Buildings

b. January 1, 2009 effect on Land

c. January 1, 2009 effect on Goodwill

d. January 1, 2009 effect on Equity method investments

Exercise 12-18

First we need to identify the amount of difference between book value and fair value associated with goodwill, buildings and land:

Because half of the fair value of Lake’s individual net assets are buildings, and Lake would be consolidated with Cameron, Cameron’s Buildings account would increase by 1/2 x $450 = $225 million.

Because half of the fair value of Lake’s individual net assets is land, and Lake would be consolidated with Cameron, Cameron’s Land account would increase by 1/2 x $450 = $225 million.

Because Lake would be consolidated with Cameron, Cameron’s Goodwill account would increase by $300 million.

(41)

Requirement 2

a. December 31, 2009 effect on Buildings

b. December 31, 2009 effect on Land

c. December 31, 2009 effect on Goodwill

d. December 31, 2009 effect on Equity method investments

Requirement 3

Because Lake would be consolidated with Cameron, there would be no effect of this investment on Cameron’s Equity method investment account.

Because half of the fair value of Lake’s individual net assets are buildings, and Lake would be consolidated with Cameron, Cameron’s Buildings account would increase by 1/2 x $450 = $225 million. Cameron would depreciate those buildings over their remaining 10 year life, so Lake would recognize $22.5 million of depreciation expense per year ($225 million ÷ 10 years). Therefore, at December 31, 2009, the buildings associated with the Lake investment would have a carrying value of $202.5 million ($225 million cost - $22.5 million accumulated depreciation).

Land is not amortized, so its carrying value would not change from its value on January 1, 2009.

Goodwill is not amortized, so its carrying value would not change from its value on January 1, 2009.

Because Lake would be consolidated with Cameron, there would be no effect of this investment on Cameron’s Equity method investment account at December 31,

(42)

Requirement 1

Electing the fair value option for held-to-maturity securities simply requires reclassifying those securities as trading securities. Therefore, this investment would be classified as a trading security on Tanner-UNF’s balance sheet.

Investment in bonds (face amount)... 240

Discount on bond investment (difference)... 40 Cash (price of bonds)... 200

Requirement 3

The effect of the investment on Cameron’s December 31, 2009 retained earnings would not differ between the equity method and proportionate consolidation treatments. Under the equity method, Cameron would recognize investment revenue based on its share of Lake’s net income, while under proportionate consolidation, Cameron would include its share of Lake’s revenue and expenses on those lines of the consolidated income statement. Regardless, the same total amount would be included in Cameron’s net income and closed to Cameron’s retained earnings.

(43)

Requirement 4

The carrying value of the bonds is $240 – ($40 – $0.8) = $200.8. Therefore, to adjust to fair value of $210, Tanner-UNF would need the following journal entry:

Fair value adjustment... 9.2

Net unrealized holding gains and losses—I/S ($210 – 200.8) 9.2

Requirement 5

Tanner-UNF reports its investment in the December 31, 2009, balance sheet at fair value of $210 million.

Cash (proceeds from sale)... 190.0 Loss on sale of investments (to balance)... 10.8 Discount on bond investment (account balance)... 39.2

Investment in bonds (account balance)... 240.0

Assuming no other trading securities, the 2010 adjusting entry would be: Net unrealized holding gains and losses—I/S... 9.2

(44)

Requirement 1

Electing the fair value option for available-for-sale securities simply requires reclassifying those securities as trading securities. Therefore, this investment would be classified as a trading security on Sanborn’s balance sheet.

Requirement 2

Investment in Jackson Industry shares... 90 Cash ... 90 Net income No entry Dividends Cash (5% x $60 million)... 3 Investment revenue... 3 Adjusting entry

Fair value adjustment ($98 - 90 million)... 8 Net unrealized holding gains and losses—I/S... 8

Exercise 12-20

(45)

Requirement 3

Investment revenue (dividends)... $ 3,000

Net unrealized holding gains and losses (from adjusting entry) 8,000 Total effect on 2009 net income before taxes

11,000

Requirement 1

Electing the fair value option for significant-influence investments requires use of the same basic accounting approach that is used for trading securities. However, the investments will still be classified as significant-influence investments and shown either on the same line of the balance sheet as equity-method investments (but with the amount at fair value indicated parenthetically) or on a separate line of the balance sheet.

Requirement 2

Cash ... 56

Net income No entry.

Exercise 12-21

(46)

Dividends

Cash (30% x 8 million shares x $1.25)... 3

Investment revenue... 3 Adjusting entry...

Net unrealized holding gains and losses—I/S ($56 - 52 million)4

Fair value adjustment... 4

Note: A different approach to reach the same outcome would be for Florists to use equity-method accounting throughout the year, and then at the end of the year make whatever adjustment to fair value is necessary to adjust the investment account to fair value. Under that approach, Florists would recognize 30% of Nursery’s $40 million of income ($12 million) as investment income, it would not recognize investment income associated with Nursery’s dividend, and would end up with an Investment account containing $65 ($56 million + $12 million – $3 million). The company would need to make a fair value adjustment of $13 million ($65 million – 52 million). So the total amount of loss recognized would be $1 million ($12 million investment income – $13 million unrealized loss). Note that this alternative produces the same total amount of investment loss as is

produced above: $1 million ($3 million investment revenue – $4 million unrealized loss).

(47)

Requirement 1

Insurance expense (difference)... 64,000 Cash surrender valueof life insurance ($27,000 – 21,000)... 6,000

Cash (2009 premium)... 70,000

Requirement 2

Cash (death benefit)... 4,000,000

Cash surrender valueof life insurance (account balance) 27,000 Gain on life insurance settlement (to balance)... 3,973,000

Requirement 1

Insurance expense (difference)... 22,900 Cash surrender valueof life insurance ($4,600 – 2,500). . 2,100

Cash (premium)... 25,000

Requirement 2

Cash (death benefit)... 250,000

Cash surrender valueof life insurance (account balance) 16,000

Gain on life insurance settlement (to balance)... 234,000

ANALYSIS Previous Value:

Accrued 2008 interest (10% x $12,000,000) $ 1,200,000

Principal 12,000,000

Carrying amount of the receivable $13,200,000

Exercise 12-22

Exercise 12-23

(48)

New Value:

Interest $1 million x 1.73554 * ₌ _$1,735,540 Principal $11 million x 0.82645 ** ₌ _9,090,950

Present value of the receivable (10,826,490 )

Loss: $ 2,373,510

* _{present value of an ordinary annuity of $1: n=2, i=10% (from Table 4)} ** present value of $1: n=2, i=10% (from Table 2)

JOURNAL ENTRIES January 1, 2009

Loss on troubled debt restructuring (to balance)... 2,373,510

Accrued interest receivable (account balance)... 1,200,000 Note receivable ($12,000,000 - 10,826,490)... 1,173,510

December 31, 2009

Cash (required by new agreement)... 1,000,000 Note receivable (to balance)... 82,649

Interest revenue (10% x $10,826,490)... 1,082,649

December 31, 2010

Cash (required by new agreement)... 1,000,000 Note receivable (to balance)... 90,861

Interest revenue (10% x [$10,826,490 + 82,649])... 1,090,861* Cash (required by new agreement)... 11,000,000

(49)

Amortization Schedule – Not required

Cash Effective Increase in Outstanding

Interest Interest Balance Balance

by agreement 10% x Outstanding Balance Discount Reduction

10,826,490 1 1,000,000 .10 (10,826,490) = 1,082,649 82,649 10,909,139 2 1,000,000 .10 (10,909,139) = 1,090,861* 90,861 11,000,000 2,000,000 2,173,510 173,510 * rounded ANALYSIS Previous Value: Accrued 2008 interest (10% x $240,000)$ 24,000 Principal 240,000

Carrying amount of the receivable $264,000 New Value:

$11,555 + 11,555 + 11,555 + 240,000 = $274,665

$274,665 x 0.82645 * ₌ _(226,997₎

Loss: $ 37,003

* _{present value of $1: n=2, i=10% (from Table 2)} JOURNAL ENTRIES Exercise 12-24 (concluded)

(50)

January 1, 2009

Loss on troubled debt restructuring (to balance)... 37,003

Accrued interest receivable (10% x $240,000)... 24,000

Note receivable ($240,000 - 226,997)... 13,003

December 31, 2009

Note receivable (to balance)... 22,700

Interest revenue (10% x $226,997)... 22,700

December 31, 2010

Note receivable (to balance)... 24,968

Interest revenue (10% x [$226,997 + 22,700])... 24,968* Cash (required by new agreement)... 274,665

Note receivable (balance)... 274,665

(51)

Amortization Schedule – Not required

Cash Effective Increase in Outstanding

Interest Interest Balance Balance

by agreement 10% x Outstanding Balance Discount Reduction

226,997 1 0 .10 (226,997) = 22,700 22,700 249,697 2 0 .10 (249,697) = 24,968* 24,968 274,665 47,668 47,668 * rounded 1. d.

Sales price (2,000 shares x $14) $28,000 Less: Brokerage commission (1,400)

Net Proceeds $26,600

Less: Cost of investment (31,500)

Realized loss on trading security $(4,900)

If these securities had been categorized as available-for-sale, the total loss of $4,900 would have been recognized in net income. The prior year's unrealized holding loss would not have been included (recognized) in earnings (net income), but rather would have been reported as an element of other comprehensive income. A reclassification adjustment for the unrealized holding loss ($2,000) would also be included in other comprehensive income to remove it from the Exercise 12-25 (concluded)

CPA / CMA REVIEW

QUESTIONS

(52)

Note: The question asks for realized loss. This is defined as the net cash proceeds

from sale minus the original cost of the investment. That realized loss was

recognized over two accounting periods: Year 4 (unrealized loss) and

Year 5 (realized, due to sale). Be careful when answering these questions: watch for the difference between loss realized and loss recognized.

(53)

CPA Review Questions (continued)

2. a. Marketable equity securities (equity securities with readily determinable fair

values) are categorized as either trading securities (which are classified as current assets) or available-for-sale securities (which are classified as current or noncurrent assets), as appropriate. Because Lark’s investments are long-term, they are categorized as available-for-sale securities.

Available-for-sale securities are reported at fair value with unrealized holding gains and losses reported in other comprehensive income and included in the balance of accumulated other comprehensive income reported in equity. The unrealized holding gain included in other

comprehensive income for 2009 would be $60,000 ($240,000 current fair value vs. $180,000 prior period fair value). The net unrealized holding gain, included in the accumulated other comprehensive income as of December 31, 2009 is $40,000 ($60,000 current period unrealized holding gain less $20,000 prior period unrealized holding loss). Alternative calculation shown below.

Net unrealized holding gains at December 31, 2009:

Fair value at December 31, 2009 $240,000

Cost (200,000 )

Net unrealized holding gain $ 40,000

3. d. $116,250.

LT investments in marketable equity securities at fair value $ 96,450 Plus: Net unrealized holding gains and losses on

long-term marketable equity securities 19,800 Cost of LT investments in marketable equity securities $116,250

(54)

Unrealized holding gains and losses on the non-current portfolio of

investments in marketable equity securities (categorized as available-for-sale securities) are reported in other comprehensive income and included in the balance of accumulated other comprehensive income reported in

(55)

CPA Review Questions (continued)

4. d. Since the decline in value occurred in 2008, the available-for-sale security

was reduced to fair value with a related unrealized holding loss reported in other comprehensive income in 2008. In 2009, the asset continues to be carried at the same net value but the unrealized holding loss in accumulated other comprehensive income is removed and recognized as a loss in the determination of net income since the decline is considered to be permanent. The recognition of the loss (write-down to fair value) establishes a new cost basis which will not be changed for subsequent recoveries in fair value. However, subsequent unrealized holding gains and losses will be reported in other comprehensive income.

5. d. Neither a change in fair value of investee's common stock nor cash dividends

from investee affect the investor's reported investment income (equity in earnings of investee) under the equity method. Under the equity method, cash dividends would be charged against (reduce) the investment account and have no effect on income. A change in the fair value of the investee's common stock would not be recorded under the equity method unless the change were judged a permanent and substantial decline, and then the decline would be charged to a loss account rather than investment income. FAS #115 does not apply to investments accounted for under the equity method.

6. c. The entries should have been:

Investment in affiliate (40% x 20,000) 8,000 Equity in earnings of affiliate 8,000

Cash (40% x $5,000) 2,000

(56)

By erroneously recognizing the $2000 dividend as revenue, retained earnings are overstated. The dividends should have been booked as a reduction of the investment; thus the investment is overstated.

(57)

CPA Review Questions (concluded)

7. b. Under the equity method, the investor should reflect adjustments which

would be made in consolidation, based on the investor's percentage ownership, if such adjustment (eliminations) can be recorded between investment income and the investment account. The fair value of the FIFO inventory in excess of the carrying value would reduce net income of the investee, therefore, the investor would charge investment income and credit the investment account to reflect the decrease in income. The fair value of the land in excess of its carrying value would not affect income as it is not a depreciable asset. No adjustment would be made relative to the land.

8. a. $435,000. The equity method of accounting for investments in common

stock should be used if the investor has significant influence over the

operating and financial policies of the investee. Well Company's significant influence is demonstrated by its officers being a majority of the investees' board of directors.

Original cost of investment $400,000

Add: Share of income subsequent to acquisition

10% x $500,000 50,000

Less: Dividend of investee

10% x $150,000 (15,000)

$435,000

1. c. According to SFAS 115, available-for-sale

securities are investments in debt securities that are not classified as held-to-maturity or trading securities and in equity

securities with readily determinable fair values that are not classified as trading

CMA Exam Questions

(58)

2. b. Available-for-sale securities include (1) equity securities with readily

determinable fair values that are not classified as trading securities and (2) debt securities that are not classified as held-to-maturity or trading securities.

Unrealized holding gains and losses are measured by the difference between the amortized cost and fair value, excluded from earnings, and reported in other comprehensive income. The balance is reported net of the tax effect (ignored in this question). Thus, the difference at May 31, year 3 is $8,005 ($643,500 fair value – $635,495 amortized cost). This unrealized gain is reported as a credit to accumulated other comprehensive income.

3. d. Debt securities that the company has the positive intent and ability to hold to

maturity are classified as held-to-maturity. Held-to-maturity securities are reported at amortized cost. Under the provisions of SFAS 115, any unrealized gains or losses are not recognized.

Requirement 2

PROBLEMS

(59)

Requirement 3

Interest revenue (5% x [$66 + 0.1])... 3.31

Requirement 4

Fuzzy Monkey reports its investment in the December 31, 2009, balance sheet at its amortized cost – that is, its book value:

Investment in bonds... $80.00 Less: Discount on bond investment ($14 –.1 –.11 million) 13 .79

Amortized cost... $66.21

Increases and decreases in the fair value between the time a debt security is acquired and the day it matures to a prearranged maturity value are relatively unimportant if sale before maturity isn’t an alternative. For this reason, if an investor has the “positive intent and ability” to hold the securities to maturity, investments in debt securities are classified as “held-to-maturity” and reported at amortized cost rather than fair value in the balance sheet.

Requirement 5

Fuzzy Monkey’s 2009 statement of cash flows would be affected as follows:

Operating cash flows: Cash inflow from interest of $3.2 + $3.2 = $6.4. (Note: if Fuzzy Monkey prepares an indirect method statement of cash flows, it would have interest revenue of $3.30 + $3.31 = $6.61 included in net income, so would have to include an adjustment of $6.4 – $6.61 = ($0.21) to get from net income to cash from operations.)

Investing cash flows: Cash outflow from purchasing

(60)

Requirement 2

Cash (4% x $80 million)... 3.20

Discount on bond investment (difference)... .10

Requirement 3

Interest revenue (5% x [$66 + 0.1])... 3.31

Requirement 4

Fuzzy Monkey reports its investment in the December 31, 2009, balance sheet at its fair value, $70 million in this case. For investments in trading

securities, changes in market values, and thus market returns, provide an indication of management’s success in deciding when to acquire the investment, when to sell it, whether to invest in fixed-rate or variable-rate securities, and whether to invest in long-term or short-term securities. To do this, we first need to determine the investment’s amortized cost (or book value) at the end of the year:

Investment in bonds... $80.00 Less: Discount on bond investment ($14 –.10 –.11 million) 13 .79 Amortized cost... $66.21

Then, to record it at fair value, we increase the investment by $70 – 66.21 = $3.79 million: