FAP 19E Chapter 15 SM

Appendix C

Investments and International Operations

QUESTIONS

1.To be classified as current assets, investments must be (i) capable of being converted into cash quickly and (ii) management must intend to sell the investments as a source of cash to satisfy the needs of current operations (within one year or the operating cycle, whichever is longer).

2.Short-term investments in trading securities are reported on the balance sheet at the (fair) market value of the portfolio of trading securities.

3.The $720 difference between the proceeds ($7,500) and the cost ($6,780) is credited to Gain on Sale of Short-Term Investments and reported in the income statement.

1. The three classes of noninfluential investments in securities are:

a)debt and equity trading securities.

b)debt securities held-to-maturity.

c)debt and equity securities available-for-sale.

The two classes of influential investments in securities are:

a) equity securities giving an investor a significant influence over an investee.

b) equity securities giving an investor control over an investee.

5.To be classified as current assets, investments must be capable of being converted into cash quickly and management must intend to sell the investments as a source of cash to satisfy the needs of current operations. To be classified as longterm, investments must not meet the requirements for short-term investments—not marketable and not intended to be converted into cash. Long-term investments also include funds earmarked for a special purpose, and other assets not used in company operations.

6.Unrealized lossEquity...... ##

Market Adjustment—Available-for-Sale (LT)...... ##

7.The portfolio for investments in available-for-sale securities should be reported on the balance sheet at (fair) market value—this is separated into short- and long-term.

8.The portfolio of long-term investments in debt securities is reported at cost adjusted for amortization of any difference between cost and maturity when the investments are classified as held-to-maturity debt securities.

9.Unrealized holding gains and losses are not reported on the standard income statement for available-for-sale securities. Unrealized gains and losses for these securities are reported in the stockholders’ equity section of the balance sheet. (They can also be reported either in a separate comprehensive income statement or in a combined statement of comprehensive income.)

10.The equity method is used when the investor has a “significant influence” over the investee corporation; i.e., generally when the investor owns 20% or more of the investee's voting stock. The equity method with consolidation is used when the investor has a “controlling influence” over the investee.

11.A company prepares consolidated statements if the company has control over a subsidiary as a result of owning more than 50% of the subsidiary's voting stock.

12A.Two major challenges in accounting for international operations include (1) accounting for sales and purchases that are denominated in a foreign currency, and (2) preparing consolidated financial statements with a foreign subsidiary.

13A.If the foreign exchange rate falls from $1.40 to $1.30 during the time the U.S. company holds a receivable that is denominated in the foreign currency, the U.S. company will incur an exchange loss. The foreign currency unit is worth $1.40 at the time of sale but is worth only $1.30 at the time it is paid to the U.S. company; hence, a loss of $0.10 is incurred for each foreign currency unit owed to the U.S. company.

14A.No. If a sales agreement requires a foreign customer to pay U.S. dollars to the United States seller, the U.S. company is not exposed to the risk of exchange losses or gains.

15.Best Buy reported $33 million in foreign currency adjustments. This is an unrealized loss.

16.Circuit City’s financial statements, including its balance sheet, are all labeled as being consolidated statements.

17.RadioShack had $1.1 million dollars of unrealized losses on securities.

1. Apple’s return on total assets as of September 30, 2006 is ($ millions):

$1,989/ [($17,205 + $11,516)/2] = 13.9%

QUICK STUDIES

Quick Study C-1 (10 minutes)

[Note: This actively managed (for profit) short-term investment in equity securities would be classified as Trading Securities.]

Quick Study C-2 (10 minutes)

1.2009

Dec. 31Unrealized Loss—Equity...... 6,000

Market Adjustment—Available-for-Sale (ST)..6,000

To reflect an unrealized loss in market value

of the available-for-sale securities’ portfolio.

2.Both accounts in part (1) are reported on the balance sheet.

1. The Unrealized Loss is reported as a reduction in the equity section (and in comprehensive income).
2. The credit balance in the Market Adjustment—Available-for-Sale (ST) account is a contra asset account. It reduces the (cost) balance in the Short-Term Investments—Available-for-Sale account to its market value.

3. 2010

Apr. 6Cash...... 27,000

Gain on Sale of Short-Term Investments....2,000

Short-Term Investments—AFS...... 25,000

To record sale of one-fourth of the available-for-sale

securities. (Cost = $100,000 x 1/4)

Quick Study C-3 (10 minutes)

Quick Study C-4 (10 minutes)

Quick Study C-5 (10 minutes)

True: b, d, f, g

Quick Study C-6 (10 minutes)

1.Equity method

2.Current (or short-term)

3.Interest revenue (or interest earned)

4.Parent, subsidiary

5.Market value (or fair value)

Quick Study C-7 (10 minutes)

Quick Study C-8 (10 minutes)

Valuation Method: The (fair) market value method is used to account for this investment in long-term equity securities (AFS portfolio).

2009

Long-Term Investments—AFS (BBE)......

Gain on Sale of Long-Term Investment......

Quick Study C-9 (10 minutes)

Quick Study C-10 (10 minutes)

2.Each of the accounts used in the entry for (1) would be reported on the balance sheet. The unrealized loss of $23,000 is a reduction in equity. When the Market Adjustment account contains a credit balance as shown here, it serves as a contra asset account. This results in the reporting of the asset (long-term investment) at its market value.

Quick Study C-11 (10 minutes)

Return on total assets =

This ratio provides information to evaluate a company's profitability (efficiency) in using its available assets.

Quick Study C-12 (10 minutes)

Return on Total Assets = Profit margin x Total asset turnover

= x

Component analysis is useful as it allows the determination of whether the return on assets is achieved primarily due to profitability or efficiency of assetusage (or a balanced combination of both). Component analysis often is more useful when computed and examined over a period of several years and when comparisons are made with competitors.

Quick Study C-13A (10 minutes)

Date of Sale

Sales......

Date of Payment

Quick Study C-14A (10 minutes)

EXERCISES

Exercise C-1 (25 minutes)

Feb. 15

Cash......

Exercise C-2 (20 minutes)

2.The accounts in part (1) are reported on different financial statements.

1. The $9,000 debit balance in the Market Adjustment—Trading account is an adjunct asset account in the balance sheet. It increases the balance of the Short-Term Investment—Trading account to the securities’ market value of $85,000.
2. The Unrealized Gain of $9,000 is reported in the Other Revenues and Gains section of the income statement.

Exercise C-3 (15 minutes)

Unrealized

Available-for-Sale PortfolioCost MarketGain (Loss)

Verrizano Corporation bonds payable...... $ 81,400$ 92,000

Porter Corporation notes payable...... 54,90047,928

Laverne Company common stock...... 100,500 96,480

$236,800$236,408$(392)

Exercise C-4 (30 minutes)

2009

Exercise C-5 (15 minutes)

Computation of Market Adjustment

Exercise C-6 (15 minutes)

Computation of Market Adjustment

Exercise C-7 (30 minutes)

2007

Exercise C-8 (15 minutes)

1.Classification of Investments in Securities

a.The Beeman Company bonds are a long-term investment in held-to-maturity debt securities.

b.The Baybridge stock is a long-term investment in equity securities where the investor has a significant influence over the investee.

c.The Carroll stock is a long-term investment in available-for-sale equity securities.

d.The Newtech stock is a long-term investment in available-for-sale equity securities.

e.Since the Flock stock is marketable and is held as an investment of cash available for operations, it is a current asset.

2.Market Adjustment entry at December 31, 2009

Exercise C-9 (30 minutes)

2009

*Kareen’s investment equals 40% of Altus’ stock (55,000/137,500). Kareen should use the equity method to account for its investment.

Dec. 31

Exercise C-10 (15 minutes)

2009 return on total assets 2010 return on total assets

= 14.3% = 10.9%

Interstate Industries appears to be less efficient in the use of its total assets in 2010 than in 2009 as suggested by the decline in return on total assets from 14.3% to 10.9%. However, without additional information, it is not possible to determine whether Interstate is within the normal range as compared to similar companies. In addition, conditions may exist that explain the apparent decline in efficiency between 2009 and 2010. For example, Interstate may have increased its investment in plant assets in 2010 in anticipation of increased production and sales in 2011. Or, its competitors’ returns may have fallen even more than that of Interstate’s returns.

Exercise C-11A (25 minutes)

*Original measure = (20,000 x $2.0325)=$40,650

Year-end measure = (20,000 x $2.0292)= 40,584

Loss for the period =$ 66

2010

*Year-end measure = (20,000 x $2.0292)=$40,584

Final measure = (20,000 x $2.0340)= 40,680

Gain for the period =$ 96

Exercise C-12A (25 minutes)

Note — The combined net gain for all four quarters equals:

$3,570 ($765 + $935 - $1,445 + $3,315).

This amount also equals the difference between the number of dollars finally received ($82,790) and the initial measure of the account receivable ($79,220). In addition, this amount equals the number of pesos (850,000) owed by the customer times the change in the exchange rate ($0.0042) between the beginning rate ($0.0932) and the ending rate ($0.0974).

PROBLEM SET A

Problem C-1A (60 minutes)

Part 1

Cash......

Gain on Sale of Short-Term Investments..

Cash......

Cash......

Problem C-1A (Concluded)

Cash......

Part 2 (Adjusting entry at Dec. 31, 2011)

* Market adjustment computations

Problem C-2A (40 minutes)

Part 1

Problem C-2A (Continued)

Part 2

Comparison of Cost and Market Values for AFS Portfolio

Unrealized

Cost Market Gain (Loss)

Gem Co.(4,000 x $29.75) + 220a...... $119,220

4,000 x $32.00...... $ 128,000

PepsiCo(4,000 x $47.75) + 410b...... 191,410

4,000 x $45.00...... 180,000

Xerox(2,000 x $19.75) + 490c...... 39,990