Multiple Choice: Chapter Nine
1. Which of the following categories/methods would be used to account for an investment, where the intent of the investment was primarily for short-term profits?
2. Ace Corporation has a long-term investment in the common stock of another entity. This investment is accounted for as an available-for-sale security. A journal entry to record a $10,000 decline in market value below cost would necessarily involve:
3. Investment in Bonds should be disclosed on the balance sheet.
4. When the contract interest rate for a bond exceeds the effective interest rate of the bond, then:
The price of the bond will be equal to the future cash flow associated with the
b. The bond will be issued at a premium.
c. The bond will be issued at a discount.
d. The face value of the bond will fluctuate over its life.
5. On June 1, Pennell Corporation purchased $100,000 of 9%, 5-year bonds. The bonds are dated June 1, 20X1. The bonds were issued at 96, and pay interest on December 1 and June 1. The entry to record the investment in bonds is:
6. On April 1, 20X1, Collinge Corporation purchased $100,000 of 7%, 5-year bonds dated April 1, 20X1, at 101. Interest is paid on March 31 and September 30. Assuming use of the straight-line amortization method, the proper amount of income to record on September 30, 20X1 is:
7. On January 1, 20X2, Miller Corporation purchased $100,000 of 5%, 10-year bonds dated January 1, 20X2, at 98. Interest is paid on June 30 and December 31 of each year. Assuming use of the straight-line amortization method, the proper amount to report for Investment in Bonds at December 31, 20X3 is:
8. Investor Corporation owns 30% of Investee Corporation. Investee had net earnings of $100,000 during the year and paid dividends of $30,000. Investor's Investment in Investee account contained a $70,000 balance at the beginning of the year. What would be the correct balance of this account at the end of the year?
9. Investor Corporation owns 30% of Investee Corporation. Investee had net earnings of $100,000 during the year and paid dividends of $30,000. Investor's Investment in Investee account contained a $70,000 balance at the beginning of the year. How much dividend income will Investor record?
10. Mega Corporation owns 100% of Wolf Corporation's stock. Mega paid $1,000,000 for its investment. At the time of the initial investment, Wolf had total stockholders' equity of $600,000. All of Wolf's assets and liabilities were carried at amounts that equaled their fair value, except for a building that was undervalued by $100,000. How much goodwill would you anticipate finding in the consolidated balance sheet?
1. a. Trading securities are those that are acquired with intent of buying and selling for near term profits. Available for sale securities is a default category. Held-to-maturity securities (usually debt securities) are those that are purchased with the intent of holding them until they make their final payoff at a future designated maturity date. The equity method is used for those investments where the investor has the ability to exercise significant influence over the investee.
2. a. The journal entry to record the decline in market value below cost involves a debit to Unrealized Gain/Loss -- OCI and a credit to Available for Sale Securities.
3. b. Investment in Bonds are disclosed on the balance at their face amount, minus any unamortized discount or plus any unamortized premium.
4. b. The bond would be issued at a premium because the contract yield is superior to the going rate of interest for similar bonds. The price of the bond will be less than the future cash flow (because of future interest that will be earned). The face value of a bond does not change over time.
5. b. The bonds were purchased at a $4,000 discount. Choice "b" is the only choice which reflects this fact.
6. b. $3,400. The semiannual cash payment for interest is $3,500 ($100,000 X 7% X 6/12); this is reduced by the premium amortization for 6 months of $100 ($100,000 X 101 = $101,000 original investment, or $1,000 of initial premium. The $1,000 is spread over 5 years, or $200 per year and $100 per six months). Amortization of a premium reduces interest income because the investment will only return $100,000 at maturity versus the $101,000 originally invested.
7. b. $98,400. The bond's original investment amount of $98,000 will increase at a linear rate of $200 per year over its 10-year life ($2,000 original discount . spread over 10 years) . Therefore, its carrying value on December 31, 20X3 (two years from January1, 20X2) will be $98,400.
8. b. $91,000. The balance is determined by taking the beginning balance ($70,000), adding the share of income ($100,000 X 30% = $30,000), and subtracting the dividends received ($30,000 X 30% = $9,000).
9. a. $0. Dividends are not recognized as income under the equity method; they are considered to be a return of the investment. The investment income would be $30,000 corresponding to the investor's share of the investee's income -- but it would not be termed dividend income.
10. c. $300,000. The $1,000,000 purchase price is $400,000 in excess of the equity of the subsidiary ($1,000,000 - $600,000 = $400,000). This $400,000 would first be allocated to tangible components that are undervalued ($100,000 to a building). The remaining differential of $300,000 would finally be assigned to goodwill.