12sol_7e_final.pdf

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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, 7e, with the following AACSB learning skills:

Questions AACSB Tag Brief Exercises AACSB Tag

12–1 Reflective thinking 12–6 Analytic

12–2 Reflective thinking 12–7 Analytic, Communications 12–3 Reflective thinking 12–8 Analytic, Communications

12–5 Reflective thinking 12–10 Analytic, Communications 12–6 Reflective thinking 12–11 Analytic, Communications 12–7 Reflective thinking 12–12 Analytic, Communications

12–10 Diversity, Reflective thinking 12–15 Analytic 12–11 Diversity, Reflective thinking 12–16 Analytic

12–13 Diversity, Reflective thinking 12–18 Analytic

12–16 Reflective thinking _Exercises

12–19 Reflective thinking 12–3 Communications

12–21 Diversity, Reflective thinking 12–5 Reflective thinking, Analytic

12–22 Reflective thinking 12–6 Communications

12–29 Diversity, Reflective thinking 12–13 Analytic

Chapter 12 INVESTMENTS

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Exercises cont. AACSB Tags 12–24 Analytic 12–25 Analytic 12–26 Analytic 12–27 Analytic 12–28 Analytic 12–29 Analytic 12–30 Analytic 12–31 Analytic CPA/CMA 1 Reflective thinking 2 Reflective thinking 3 Analytic 4 Analytic 5 Reflective thinking 6 Analytic 7 Analytic 8 Analytic

9 Diversity, Reflective thinking 10 Diversity, Reflective thinking 11 Diversity, Reflective thinking 12 Diversity, Reflective thinking 13 Diversity, Reflective thinking

1 Reflective thinking 2 Analytic 3 Reflective thinking Problems 12–1 Analytic 12–2 Analytic 12–3 Analytic, Communications 12–4 Analytic 12–5 Analytic 12–6 Analytic 12–7 Analytic 12–8 Analytic 12–9 Analytic 12–10 Analytic 12–11 Analytic 12–12 Analytic 12–13 Analytic 12–14 Analytic 12–15 Analytic 12–16 Analytic 12–17 Analytic 12–18 Analytic 12–19 Analytic 12–20 Reflective thinking 12–21 Analytic 12–22 Analytic 12–23 Analytic 12–24 Analytic

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Question 12–1

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

Question 12–2

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 a security 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 security to maturity.

Question 12–3

GAAP 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. GAAP requires disclosure of the amount of fair values based on each of these three classes of inputs.

Question 12–4

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.

Question 12–5

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

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Answers to Questions (continued)

Question 12–6

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 nonincome part of comprehensive income is called “other comprehensive income.” Other comprehensive income includes net unrealized holding gains (losses) on AFS investments, and also the noncredit loss component of other-than-temporary impairments of HTM investments.

Question 12–7

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.

Question 12–8

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.

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Question 12–9

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 four 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.

Question 12–10

Under IFRS No. 9, debt investments are accounted for as either amortized cost or FVTPL (“fair value through profit and loss”), while equity investments are accounted for at FVTPL unless the equity is not held for trading and the investor elects at acquisition to account for the investment at FVTOCI (“fair value through other comprehensive income”).

According to U.S. GAAP, the fair value of an equity security is considered readily determinable only if its selling price is currently available on particular securities exchanges or over-the-counter markets. If the fair value of an equity security is not readily determinable, U.S. GAAP uses the cost method. Under IFRS, equity investments typically are measured at fair value, even if they are not listed on an exchange or over-the-counter market. Under IAS No. 39, the cost method only is used if fair value cannot be measured reliably, which occurs when the range of reasonable fair value

estimates is significant and the probability of various estimates within the range cannot be reasonably estimated. Under IFRS No. 9, the cost method is prohibited, although cost can

sometimes be used as an estimate of fair value. Therefore, in general, use of the cost method is less prevalent under IFRS than under U.S. GAAP.

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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, for example, when electing the fair value option for an asset or liability allows a company to avoid the “accounting mismatch” that occurs when some parts of a fair value risk-hedging arrangement are accounted for at fair value and others are not.

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.

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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 investment (as if the book value of the asset were being reduced) by the negative income effect of the “extra depreciation” the higher fair value would cause. This would equal 40% x $12 million ÷ 10 years = $480,000 each year for 10 years.

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

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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 money won’t be used within the upcoming operating cycle, it is a noncurrent asset. It should be reported as part of investments.

Part of each premium payment the company makes is not used by the insurance company to pay for life insurance coverage, but rather is “invested” on behalf of the insured 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.

If the investor intends to sell the investment, or thinks it will be more likely than not that it will be required to sell the investment prior to recovering the impairment, the investor is required to recognize the entire impairment loss in the income statement as an OTT impairment, writing down the investment to fair value in the balance sheet.

Otherwise, the investor considers whether credit losses exist. If there are no credit losses, no impairment loss is recognized. On the other hand, if there are some credit losses, then the investment is written down to fair value in the balance sheet. However, only the credit loss component is recognized in net income. Any noncredit losses are recognized in OCI. In the income statement, the entire impairment loss is shown, and then the amount of noncredit loss is subtracted, leaving only the credit loss reducing net income.

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Answers to Questions (concluded)

If the OTT impairment relates to an equity investment, the entire amount of impairment is recognized in net income. Any previously recorded unrealized losses are reclassified out of AOCI.

If the OTT impairment relates to a debt investment, the accounting is more complicated. First, if the investor intends to sell the investment, or thinks it will be more likely than not that it will be required to sell the investment prior to recovering the impairment, it is required to recognize the entire impairment loss in the income statement as an OTT impairment, writing down the investment to fair value in the balance sheet.

Otherwise, the investor considers whether credit losses exist. If there are no credit losses, no impairment loss is recognized. On the other hand, if there are some credit losses, then the investment is written down to fair value in the balance sheet. However, only the credit loss component is recognized in net income. Any noncredit losses are recognized in OCI. In the income statement, the entire impairment loss is shown, and then the amount of noncredit loss is subtracted, leaving only the credit loss reducing net income.

Given that the decline in shares relates to a new law banning a primary approach used by the company, it likely would be treated as an other-than-temporary impairment. So, when the investment is written down to its fair value, the amount of the write-down should be treated as if it were a realized loss, meaning the loss is included in income for the period. This could require a reclassification adjustment if any unrealized losses were included previously in OCI, just as if the investment was being sold. Subsequent to 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 a separate component of shareholders’ equity, accumulated other comprehensive income.

U.S. GAAP and IFRS differ somewhat. Under IFRS, OTT impairments only are recognized on debt that is classified as HTM to the extent that credit losses exist, so there is no noncredit loss component of OTT impairments under IFRS. OTT impairments are recognized on debt classified as AFS in their entirety, with no distinction made between credit losses and noncredit losses. Also, under IFRS, OTT impairments can be recovered in earnings for debt investments, but not for equity investments. U.S. GAAP does not allow OTT impairments to be recovered in earnings for either

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Supplement Questions for Review of Key Topics

Investment securities are classified as “amortized cost,” “FV-OCI,” or “FV-NI.”

To be accounted for at amortized cost, a debt investment must have the characteristics of “simple” debt: (1) the debt consists primarily of payments that include interest and return of principal, (2) the debt agreement doesn’t allow the debtor to prepay or settle the debt in a manner that provides a loss to the investor, and (3) the debt does not involve derivatives. The debt also must be held for the purpose of collecting contractual cash flows associated with lending or customer financing.

To be accounted for at FV-OCI, a debt investment must have the characteristics of “simple” debt (the debt consists primarily of payments that include interest and return of principal, don’t allow the debtor to prepay or settle the debt in a manner that provides a loss to the investor, and do not involve derivatives). The debt also must be held for the purpose of maximizing investment return by selling it after it has appreciated in value or collecting contractual cash flows, or for managing risk.

First, if the debt investment is “complex,” it is accounted for at FV-NI. The debt investment is complex if it lacks one or more of the characteristics of simple debt (the debt consists primarily of payments that include interest and return of principal, don’t allow the debtor to prepay or settle the debt in a manner that provides a loss to the investor, and do not involve derivatives). The debt investment also is accounted for at FV-NI if it is “simple” and either is held for sale at acquisition or issuance or does not qualify for being accounted for at amortized cost or FV-OCI.

If the investor lacks the ability to significantly influence the investee, an equity investment is accounted for at FV-NI. Nonpublic organizations have a practicability exception with respect to nonmarketable investments, allowing them to account for the investment at cost less any impairments and adjusted for any changes in fair value that are observed from transactions of similar equity.

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BRIEF EXERCISES

Brief Exercise 12–1

(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

Brief Exercise 12–2

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 2013 earnings. When the fair value rises by $7,000 in 2014, that amount is reported in 2014 earnings ($5,000 as a realized gain, and $2,000 as the reversal of the unrealized loss that was recognized in 2013). S&L’s journal entries for these transactions would be:

2013

December 27

Investment in Coca Cola shares ... 875,000

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Brief Exercise 12–2 (concluded)

2014

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 2014 adjusting entry to remove the fair value adjustment associated with the sold securities would be:

December 31

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

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Brief Exercise 12–3

Unlike for trading securities, unrealized holding gains and losses for securities available-for-sale are not included in earnings. S&L reports its $2,000 holding loss in 2013 as other comprehensive income in the statement of comprehensive income. When the fair value rises to $880,000 in 2014, the amount reported in 2014 earnings is the $5,000 gain realized by the sale of the securities. S&L’s journal entries for these transactions would be:

2013

December 27

Cash ... 875,000 December 31

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

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

2014

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 2014 adjusting entry to remove the fair value adjustment associated with the sold securities would be:

December 31

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Brief Exercise 12–4

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:

Net unrealized holding gains and losses–OCI 60,000

Brief Exercise 12–5

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 that 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 course, the equity method isn’t appropriate either because 40,000 shares of FedEx certainly don’t constitute “significant influence.” Investments in securities available-for-sale are reported at fair value.

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Brief Exercise 12–6

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 2013 earnings. When the fair value rises by $7,000 in 2014, that amount is reported in 2014 earnings ($5,000 as a realized gain, and $2,000 as the reversal of the unrealized loss that was recognized in 2013). S&L’s journal entries for these transactions would be:

2013

December 27

Cash ... 875,000 December 31

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

2014

January 3

Gain on investments (to balance) ... 5,000

Investment in Coca Cola shares (account balance) ... 875,000 Assuming no other trading securities, the 2014 adjusting entry to remove the fair value adjustment associated with the sold securities would be:

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Brief Exercise 12–7

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.

Brief Exercise 12–8

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 in the income statement.

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Brief Exercise 12–9

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 15 years.

Brief Exercise 12–10

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 15 years.

Brief Exercise 12–11

The investment would be increased by $12 million. 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.

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

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Brief Exercise 12–12

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 noncurrent asset in the balance sheet.

2013

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 its 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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Brief Exercise 12–13

Because the drop in the market price of stock is considered to be other-than-temporary, LED records the impairment of $450,000 ($4.50 x 100,000 shares) and reclassifies previously recognized unrealized losses of $100,000 ($1.00 x 100,000 shares)as follows:

Other-than-temporary impairment loss—I/S .... 450,000

AFS Investment (Branch) ... 450,000 Fair value adjustment ... 100,000

Net unrealized holding gains and losses—OCI 100,000

In the income statement, the entire $450,000 will be shown as an OTT impairment loss. A $100,000 reclassification adjustment will increase OCI (because the $100,000 decreased OCI and therefore AOCI in a prior period, it must be backed out of OCI and AOCI in the current period). Therefore, the net effect on comprehensive income during the current period will be $350,000.

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Brief Exercise 12–14

LED believes it is more likely than not that it will have to sell the investment before fair value recovers, so the portion of the impairment that consists of credit and noncredit losses is not relevant. LED must recognize the entire OTT impairment in earnings, reducing the carrying value of the LED bonds by crediting a discount on bond investment account. LED records the impairment of $450,000 and reclassifies previously recognized unrealized losses of $100,000 as follows:

Other-than-temporary impairment loss—I/S ... 450,000

Discount on bond investment ... 450,000 Fair value adjustment ... 100,000

In the income statement, the entire $450,000 will be shown as an OTT impairment loss. A $100,000 reclassification adjustment will increase OCI (because the $100,000 decreased OCI and therefore AOCI in a prior period, it must be backed out of OCI and AOCI in the current period). Therefore, the net effect on comprehensive income during the current period will be $350,000.

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Brief Exercise 12–15

LED does not intend to sell the investment, and it does not believe it is more likely than not that it will have to sell the investment before fair value recovers, so the portion of the impairment that consists of credit and noncredit losses is relevant. LED must recognize the $200,000 credit loss component of the OTT impairment in earnings, and the $250,000 noncredit loss component in OCI. LED records the impairment of $450,000 and reclassifies previously recognized unrealized losses of $100,000 as follows:

Discount on bond investment ... 200,000 OTT impairment loss—OCI ... 250,000

Fair value adjustment ... 250,000 Fair value adjustment ... 100,000

LED still would have to include the entire $450,000 in the income statement before backing out the $250,000 to leave a $200,000 reduction of earnings. The $100,000 reclassification adjustment will increase OCI (because the $100,000 decreased OCI and therefore AOCI in a prior period, it must be backed out of OCI and AOCI in the current period). Therefore, the net effect on comprehensive income will be $350,000 during the current period ($200,000 from net income, $150,000 from OCI).

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Brief Exercise 12–16

Wickum would have recorded a journal entry previously that recognized the OTT impairment in earnings and reduced the investment account:

Other-than-temporary impairment loss—I/S ... 500,000

Discount on debt investment ... 500,000

Upon recovery of $300,000 of fair value, Wickum would reverse the impairment by that amount:

Discount on debt investment ... 300,000

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SUPPLEMENT BRIEF EXERCISES

Brief Exercise 12–17

Lemp would account for the bond investment at FV-OCI because it has the characteristics of “simple” debt and is held for purposes of investment. Therefore, Lemp would report the bond in the balance sheet as an investment of $900 and include the $100 decline in fair value in OCI as a loss.

Brief Exercise 12–18

Fowler would account for the note at FV-NI because it has the characteristics of “simple” debt and Fowler is holding it for sale. Therefore, Fowler would report the note in the balance sheet as an investment of $80,000 and include the $5,000 increase in fair value in net income as a gain.

Brief Exercise 12–19

Fowler would account for the note at amortized cost, because it has the characteristics of “simple” debt and Fowler intends to hold it until it matures. Therefore, Fowler would report the note in the balance sheet as an investment of $75,000, and would not include the $5,000 increase in fair value in either OCI or net income.

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Exercise 12–1

Requirement 1 ($ in millions)

Investment in bonds (face amount) ... 240.0

Discount on bond investment (difference) ... 40.0 Cash (price of bonds) ... 200.0 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, 2013, balance sheet at its amortized cost—that is, its book value:

Investment in bonds ... $240.0 Less: Discount on bond investment ($40 – 0.8 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

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Exercise 12–2

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 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.

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Exercise 12–3

Requirement 2

The specific citation that specifies the circumstances and conditions under which it is appropriate to account for investments as held-to-maturity is FASB ACS 320–10–25– 4: “Investments—Debt and Equity Securities—Overall—Recognition

—Circumstances Not Consistent with Held-to-Maturity Classification.” Requirement 3

FASB ACS 320–10–25–4 reads as follows:

“An entity shall not classify a debt security as held-to-maturity if the entity has the intent to hold the security for only an indefinite period. Consequently, a debt security shall not, for example, be classified as held-to-maturity if the entity anticipates that the security would be available to be sold in response to any of the following

circumstances:

a. Changes in market interest rates and related changes in the security's prepayment risk

b. Needs for liquidity (for example, due to the withdrawal of deposits,

increased demand for loans, surrender of insurance policies, or payment of insurance claims)

c. Changes in the availability of and the yield on alternative investments d. Changes in funding sources and terms

e. Changes in foreign currency risk.”

Exercise 12–4

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

(27)

Exercise 12–5

Requirement 1

2013

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

2014

January 5

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

shares (account balance) ... 350,000 Assuming no other trading securities, the 2014 adjusting entry to remove the fair value adjustment associated with the sold securities would be:

December 31

(28)

Exercise 12–5 (concluded) 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.

(29)

Exercise 12–6

The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is:

1. Unrealized holding gains for trading securities should be included in earnings: FASB ACS 320–10–35–1a: “Investments—Debt and Equity Securities—

Overall—Subsequent Measurement—General.”

2. Under the equity method, the investor accounts for its share of the earnings or losses of the investee in the periods they are reported by the investee in its financial statements: FASB ACS 323–10–35–4: “Investments—Equity Method and Joint Ventures—Overall—Subsequent Measurement—General.”

3. Transfers of securities between categories shall be accounted for at fair value: FASB ACS 320–10–35–10: “Investments—Debt and Equity Securities—

Overall—Subsequent Measurement—General.”

4. Disclosures for available-for-sale securities should include total losses for securities that have net losses included in accumulated other comprehensive income: FASB ACS 320–10–50–2: “Investments—Debt and Equity

(30)

Exercise 12–7

Requirement 1

.

Fair value adjustment ($45,000 – 20,000) 25,000 Requirement 2

None. Accumulated net holding gains and losses for securities available-for-sale are reported as a component of shareholders’ equity (in accumulated other comprehensive income), and changes in the balance are reported as other comprehensive income or loss in the statement of comprehensive income rather than as part of earnings. This statement can be reported either (a) as a combined statement of comprehensive income that includes net income and other comprehensive income, or (b) as a separate statement of comprehensive income.

(31)

Exercise 12–8

Requirement 1

Securities “held-to-maturity” are debt securities that 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 a combined statement of comprehensive income that includes net income and other comprehensive income, or (b) as a separate statement of comprehensive income. 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, 2013

Net unrealized holding gains and losses—OCI

(10,000 shares x [$58 – 60]) ... 20,000

(32)

Exercise 12–8 (concluded) Requirement 3

December 31, 2014

Accumulated

($ in 000s) Unrealized

Available-for-Sale Securities Cost Fair Value Gain (Loss) IBM shares – Dec. 31, 2014 $600 $610 $10

Moving from a negative $20 (2013) to a positive $10 (2014) 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 – 10) .... 30,000

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

(33)

Exercise 12–9

Requirement 1

2013

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

(34)

Exercise 12–9(continued) December 31

Accumulated

($ in millions) Unrealized

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

2014

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 12/31/2014, Construction would debit fair value adjustment and credit net unrealized gains and losses—OCI for the $2.5 million associated with the sold

investments to remove their effects from the financial statements. (Construction sold only half the Platinum investments so only half of the Platinum fair value adjustment should be removed. The 2.5 amount comes from 3.0 LTD – 0.5 Platinum.)

(35)

2013 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 * 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.

** Assuming Construction Forms chooses to report other comprehensive income in a combined statement of comprehensive income that includes net income and other comprehensive income.

(36)

Exercise 12–10

Requirement 1

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

Requirement 2

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.

(37)

Exercise 12–11

1. Investments reported as current assets. Security A $ 910,000

Security B 100,000

Security C 780,000

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:

(38)

Exercise 12–12

Requirement 1

Accumulated

IBM shares—Dec. 31, 2013 $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

Net unrealized holding gains and losses—OCI ... 25,000

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

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)

(39)

Exercise 12–12 (continued) Requirement 2

Accumulated

IBM shares—Dec. 31, 2013 $1,345 $1,275 $(70)

Moving from a negative $145 (Jan.1) to a negative $70 requires an increase of $75:

---

– 145 – 70 0

+75 --->

Fair Value

Adjustment

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

(40)

Accumulated

IBM shares—Dec. 31, 2013 $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

Balance needed in fair value adjustment $ 30

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

(41)

Exercise 12–13

Requirement 1

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 2014 earnings (because the shares are classified as available-for-sale investments, any unrealized gains or losses occurring after purchase during 2014 would not affect 2014 earnings). Here are the entries used to record those two transactions:

June 1, 2014 ($ in millions)

Cash 15

Loss on sale of investments (difference) 5

Investment in A Corporation shares(cost) 20 September 12, 2014

Investment in C Corporation shares 15

(42)

Harlon’s securities available-for-sale portfolio should be reported in its 2014 balance sheet at its fair value of $101 million:

December 31, 2014

($ in millions) Cost, Dec. 31 Fair Value, Dec. 31 Securities Available-for-Sale 2013 2014 2013 2014 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 2013, Harlon would have had a net unrealized loss of $5 (cost of $100 – fair value of $95). Moving from a negative $5 (2013) to a positive $6 requires an increase of $11:

---

– 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

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

(43)

Exercise 12–14

Requirement 1

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

Net unrealized holding gains and losses–OCI ... 25,000 Requirement 2

The investment would be accounted for using the equity method: Purchase

Investment in AMC common shares ... 480,000

Cash ... 480,000 Net income

(44)

Exercise 12–15

Purchase ($ in millions) Investment in Nursery Supplies shares ... 56

Cash ... 56 Net income

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

Investment revenue ... 12 Dividends

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

Investment in Nursery Supplies shares ... 3 Adjusting entry

No entry

Exercise 12–16

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.

(45)

Exercise 12–17

Requirement 1: Error discovered before the books are adjusted or closed in 2013.

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 2014.

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

(46)

Exercise 12–18

Purchase ($ in millions) Investment in Carne Cosmetics shares ... 68

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

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

*[$192 + 32] = $224

Adjusting entry

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

(47)

Exercise 12–19

Requirement 1

Purchase ($ in millions) Investment in Lake Construction shares ... 300

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

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

Book value: $800 x 20% = $160 of buildings ($10) and land ($10): $20

Requirement 2

(48)

Exercise 12–19 (concluded)

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 operating activities 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.]

(49)

Exercise 12–20

Requirement 1

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

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, 2013 effect on Buildings

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.

b. January 1, 2013 effect on Land

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.

c. January 1, 2013 effect on Goodwill

(50)

a. December 31, 2013 effect on Buildings

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, 2013, the buildings associated with the Lake investment would have a carrying value of $202.5 million ($225 million cost – 22.5 million accumulated depreciation).

b. December 31, 2013 effect on Land

Land is not amortized, so its carrying value would not change from its value on January 1, 2013.

c. December 31, 2013 effect on Goodwill

Goodwill is not amortized, so its carrying value would not change from its value on January 1, 2013.

d. December 31, 2013 effect on Equity method investments

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, 2013.

Requirement 3

The effect of the investment on Cameron’s December 31, 2013, 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

(51)

Exercise 12–21

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

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

Interest revenue (4% x $200) ... 8.0 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, 2013, balance sheet at fair value of $210 million.

(52)

Exercise 12–22

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

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—I/S ... 8

Requirement 3

Investment revenue (dividends)... $ 3,000 Net unrealized holding gains and losses (from adjusting entry) 8,000 Total effect on 2013 net income before taxes 11,000

(53)

Exercise 12–23

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 equitymethod investments (but with the amount at fair value indicated parenthetically) or on a separate line of the balance sheet.

Requirement 2

Purchase ($ in millions) Investment in Nursery Supplies shares ... 56

No entry. 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

(54)

Exercise 12–24

Requirement 1

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

Cash (2013 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

Exercise 12–25

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

(55)

Exercise 12–26

Requirement 1

Bloom believes it is more likely than not it will have to sell the investment before fair value recovers, so the portion of the impairment that consists of credit and noncredit losses is not relevant. Bloom must recognize the entire OTT impairment in earnings as follows:

Discount on bond investment ... 400,000 In the income statement, the entire $400,000 will be shown as an OTT impairment loss.

Requirement 2

Bloom does not plan to sell the investment, and does not believe it is more likely than not that it will have to sell the investment before fair value recovers, so the portion of the impairment that consists of credit and noncredit losses is relevant. Bloom must recognize the $250,000 of credit losses as an OTT impairment in earnings, and the other $150,000 as a reduction of OCI, as follows:

Discount on bond investment ... 250,000 OTT impairment loss—OCI ... 150,000

Fair value adjustment—Noncredit loss ... 150,000 In the income statement, the entire $400,000 will be shown as an OTT impairment loss, then the amount of noncredit loss is subtracted to leave only the credit loss

(56)

Bloom does not plan to sell the investment, and does not believe it is more likely than not that Bloom will have to sell the investment before fair value recovers, but the entire impairment consists of noncredit losses, so Bloom does not record any OTT impairment.