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CHAPTER 17 Exercises
E17-1 (Investment Classifications) For the following investments identify whether they are:
1. Trading Securities
2. Available-for-Sale Securities
3. Held-to-Maturity Securities
Each case is independent of the other.
a. A bond that will mature in 4 years was bought 1 month ago when the price dropped. As soon as the value
increases, which is expected next month, it will be sold.
b. 10% of the outstanding stock of Farm-Co was purchased. The company is planning on eventually getting a
total of 30% of its outstanding stock.
c. 10-year bonds were purchased this year. The bonds mature at the first of next year.
d. Bonds that will mature in 5 years are purchased. The company would like to hold them until they mature,
but money has been tight recently and they may need to be sold.
e. Preferred stock was purchased for its constant dividend. The company is planning to hold the preferred
stock for a long time.
f. A bond that matures in 10 years was purchased. The company is investing money set aside for an expansion
project planned 10 years from now.
Hint: (LO 1 and LO 3)
E17-2
(Entries for Held-to-Maturity Securities) On January 1, 2006, Dagwood Company purchased at par 12%
bonds having a maturity value of $300,000. They are dated January 1, 2006, and mature January 1, 2011,
with interest receivable December 31 of each year. The bonds are classified in the held-to-maturity
category.
Hint: (LO 2)
Instructions
a. Prepare the journal entry at the date of the bond purchase.
b. Prepare the journal entry to record the interest received for 2006.
c. Prepare the journal entry to record the interest received for 2007.
E17-3 (Entries for Held-to-Maturity Securities) On January 1, 2006, Hi and Lois Company purchased 12% bonds,
having a maturity value of $300,000, for $322,744.44. The bonds provide the bondholders with a 10% yield. They
are dated January 1, 2006, and mature January 1, 2011, with interest receivable December 31 of each year. Hi and
Lois Company uses the effective-interest method to allocate unamortized discount or premium. The bonds are
classified in the held-to-maturity category.
Hint: (LO 2)
Instructions
a.
b.
c.
d.
Prepare the journal entry at the date of the bond purchase.
Prepare a bond amortization schedule.
Prepare the journal entry to record the interest received and the amortization for 2006.
Prepare the journal entry to record the interest received and the amortization for 2007.
E17-4 (Entries for Available-for-Sale Securities) Assume the same information as in E17-3 except that the securities
are classified as available-for-sale. The fair value of the bonds at December 31 of each year-end is as follows.
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2006
$320,500
2009
$310,000
2007
$309,000
2010
$300,000
2008
$308,000
Hint: (LO 2)
Instructions
a. Prepare the journal entry at the date of the bond purchase.
b. Prepare the journal entries to record the interest received and recognition of fair value for 2006.
c. Prepare the journal entry to record the recognition of fair value for 2007.
E17-5
(Effective-Interest versus Straight-Line Bond Amortization) On January 1, 2006, Phantom Company
acquires $200,000 of Spiderman Products, Inc., 9% bonds at a price of $185,589. The interest is payable
each December 31, and the bonds mature December 31, 2008. The investment will provide Phantom
Company a 12% yield. The bonds are classified as held-to-maturity.
Hint: (LO 2)
Instructions
a. Prepare a 3-year schedule of interest revenue and bond discount amortization, applying the straight-line method.
b. Prepare a 3-year schedule of interest revenue and bond discount amortization, applying the effective-interest
method.
c. Prepare the journal entry for the interest receipt of December 31, 2007, and the discount amortization under the
straight-line method.
d. Prepare the journal entry for the interest receipt of December 31, 2007, and the discount amortization under the
effective-interest method.
E17-6 (Entries for Available-for-Sale and Trading Securities) The following information is available for Barkley
Company at December 31, 2007, regarding its investments.
Securities
Cost
Fair Value
3,000 shares of Myers Corporation Common Stock
$40,000
$48,000
1,000 shares of Cole Incorporated Preferred Stock
25,000
22,000
$65,000
$70,000
Hint: (LO 3)
Instructions
a. Prepare the adjusting entry (if any) for 2007, assuming the securities are classified as trading.
b. Prepare the adjusting entry (if any) for 2007, assuming the securities are classified as available-for-sale.
c. Discuss how the amounts reported in the financial statements are affected by the entries in (a) and (b).
E17-7 (Trading Securities Entries) On December 21, 2006, Bucky Katt Company provided you with the following
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information regarding its trading securities.
December 31, 2006
Cost
Fair
Value
Unrealized Gain
(Loss)
$20,000
$19,000
$(1,000)
Colorado Co. stock
10,000
9,000
(1,000)
Buffaloes Co. stock
20,000
20,600
600
$50,000
$48,600
(1,400)
Investments (Trading)
Clemson Corp. stock
Total of portfolio
Previous securities fair value adjustment
balance
–0–
Securities fair value adjustment—Cr.
$(1,400)
During 2007, Colorado Company stock was sold for $9,400. The fair value of the stock on December 31, 2007,
was: Clemson Corp. stock—$19,100; Buffaloes Co. stock—$20,500.
Hint: (LO 3)
Instructions
a. Prepare the adjusting journal entry needed on December 31, 2006.
b. Prepare the journal entry to record the sale of the Colorado Company stock during 2007.
c. Prepare the adjusting journal entry needed on December 31, 2007.
E17-8 (Available-for-Sale Securities Entries and Reporting) Satchel Corporation purchases equity securities costing
$73,000 and classifies them as available-for-sale securities. At December 31, the fair value of the portfolio is
$65,000.
Hint: (LO 3)
Instructions
Prepare the adjusting entry to report the securities properly. Indicate the statement presentation of the accounts in your
entry.
E17-9 (Available-for-Sale Securities Entries and Financial Statement Presentation) At December 31, 2006, the
available-for-sale equity portfolio for Steffi Graf, Inc. is as follows.
Security
Cost
Fair Value
Unrealized Gain (Loss)
A
$17,500
$15,000
($2,500)
B
12,500
14,000
1,500
C
23,000
25,500
2,500
Total
$53,000
$54,500
1,500
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Previous securities fair value adjustment balance—Dr.
Securities fair value adjustment—Dr.
400
$1,100
On January 20, 2007, Steffi Graf, Inc. sold security A for $15,100. The sale proceeds are net of brokerage fees.
Hint: (LO 3)
Instructions
a. Prepare the adjusting entry at December 31, 2006, to report the portfolio at fair value.
b. Show the balance sheet presentation of the investment related accounts at December 31, 2006. (Ignore notes
presentation.)
c. Prepare the journal entry for the 2007 sale of security A.
E17-10 (Comprehensive Income Disclosure) Assume the same information as E17-9 and that Steffi Graf Inc. reports
net income in 2006 of $120,000 and in 2007 of $140,000. Total holding gains (including any realized holding
gain or loss) arising during 2007 total $40,000.
Hint: (LO 5)
Instructions
a. Prepare a statement of comprehensive income for 2006 starting with net income.
b. Prepare a statement of comprehensive income for 2007 starting with net income.
E17-11 (Equity Securities Entries) Arantxa Corporation made the following cash purchases of securities during 2007,
which is the first year in which Arantxa invested in securities.
1. On January 15, purchased 10,000 shares of Sanchez Company's common stock at $33.50 per share plus
commission $1,980.
2. On April 1, purchased 5,000 shares of Vicario Co.'s common stock at $52.00 per share plus commission
$3,370.
3. On September 10, purchased 7,000 shares of WTA Co.'s preferred stock at $26.50 per share plus
commission $4,910.
On May 20, 2007, Arantxa sold 4,000 shares of Sanchez Company's common stock at a market price of $35 per
share less brokerage commissions, taxes, and fees of $3,850. The year-end fair values per share were: Sanchez
$30, Vicario $55, and WTA $28. In addition, the chief accountant of Arantxa told you that Arantxa Corporation
plans to hold these securities for the long term but may sell them in order to earn profits from appreciation in
prices.
Hint: (LO 3)
Instructions
a. Prepare the journal entries to record the above three security purchases.
b. Prepare the journal entry for the security sale on May 20.
c. Compute the unrealized gains or losses and prepare the adjusting entries for Arantxa on December 31, 2007.
E17-12 (Journal Entries for Fair Value and Equity Methods) Presented are two independent situations.
Situation 1
Conchita Cosmetics acquired 10% of the 200,000 shares of common stock of Martinez Fashion at a total cost of
$13 per share on March 18, 2007. On June 30, Martinez declared and paid a $75,000 cash dividend. On
December 31, Martinez reported net income of $122,000 for the year. At December 31, the market price of
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Martinez Fashion was $15 per share. The securities are classified as available-for-sale.
Situation 2
Monica, Inc. obtained significant influence over Seles Corporation by buying 30% of Seles's 30,000 outstanding
shares of common stock at a total cost of $9 per share on January 1, 2007. On June 15, Seles declared and paid a
cash dividend of $36,000. On December 31, Seles reported a net income of $85,000 for the year.
Hint: (LO 3 and LO 4)
Instructions
Prepare all necessary journal entries in 2007 for both situations.
E17-13 (Equity Method) Parent Co. invested $1,000,000 in Sub Co. for 25% of its outstanding stock. Sub Co. pays out
40% of net income in dividends each year.
Hint: (LO 4)
Instructions
Use the information in the following T-account for the investment in Sub to answer the following questions.
Investment in Sub Co.
1,000,000
110,000
44,000
a.
b.
c.
d.
How much was Parent Co.'s share of Sub Co.'s net income for the year?
How much was Parent Co.'s share of Sub Co.'s dividends for the year?
What was Sub Co.'s total net income for the year?
What was Sub Co.'s total dividends for the year?
E17-14 (Equity Investment—Trading) Oregon Co. had purchased 200 shares of Washington Co. for $40 each this year
and classified the investment as a trading security. Oregon Co. sold 100 shares of the stock for $45 each. At year
end the price per share of the Washington Co. stock had dropped to $35.
Hint: (LO 3)
Instructions
Prepare the journal entries for these transactions and any year-end adjustments.
E17-15 (Equity Investments—Trading) Kenseth Company has the following securities in its trading portfolio of
securities on December 31, 2006.
Investments (Trading)
Cost
Fair Value
1,500 shares of Gordon, Inc., Common
$ 73,500
$ 69,000
5,000 shares of Wallace Corp., Common
180,000
175,000
60,000
61,600
400 shares of Martin, Inc., Preferred
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$313,500
$305,600
All of the securities were purchased in 2006.
In 2007, Kenseth completed the following securities transactions.
March 1
Sold the 1,500 shares of Gordon, Inc., Common, @ $45 less fees of $1,200.
April 1
Bought 700 shares of Earnhart Corp., Common, @ $75 plus fees of $1,300.
Kenseth Company's portfolio of trading securities appeared as follows on December 31, 2007.
Investments (Trading)
Cost
Fair Value
5,000 shares of Wallace Corp., Common
$180,000
$175,000
700 shares of Earnhart Corp., Common
53,800
50,400
400 shares of Martin, Inc., Preferred
60,000
58,000
$293,800
$283,400
Hint: (LO 3)
Instructions
Prepare the general journal entries for Kenseth Company for:
a.
b.
c.
d.
The 2006 adjusting entry.
The sale of the Gordon stock.
The purchase of the Earnhart stock.
The 2007 adjusting entry for the trading portfolio.
E17-16 (Fair Value and Equity Method Compared) Jaycie Phelps Inc. acquired 20% of the outstanding common stock
of Theresa Kulikowski Inc. on December 31, 2006. The purchase price was $1,200,000 for 50,000 shares.
Kulikowski Inc. declared and paid an $0.85 per share cash dividend on June 30 and on December 31, 2007.
Kulikowski reported net income of $730,000 for 2007. The fair value of Kulikowski's stock was $27 per share at
December 31, 2007.
Hint: (LO 3 and LO 4)
Instructions
a. Prepare the journal entries for Jaycie Phelps Inc. for 2006 and 2007, assuming that Phelps cannot exercise
significant influence over Kulikowski. The securities should be classified as available-for-sale.
b. Prepare the journal entries for Jaycie Phelps Inc. for 2006 and 2007, assuming that Phelps can exercise significant
influence over Kulikowski.
c. At what amount is the investment in securities reported on the balance sheet under each of these methods at
December 31, 2007? What is the total net income reported in 2007 under each of these methods?
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E17-17 (Equity Method) On January 1, 2007, Pennington Corporation purchased 30% of the common shares of
Edwards Company for $180,000. During the year, Edwards earned net income of $80,000 and paid dividends of
$20,000.
Hint: (LO 4)
Instructions
Prepare the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards
Company in 2007.
E17-18 (Impairment of Debt Securities) Hagar Corporation has municipal bonds classified as available-for-sale at
December 31, 2006. These bonds have a par value of $800,000, an amortized cost of $800,000, and a fair value
of $720,000. The unrealized loss of $80,000 previously recognized as other comprehensive income and as a
separate component of stockholders' equity is now determined to be other than temporary. That is, the company
believes that impairment accounting is now appropriate for these bonds.
Hint: (LO 6)
Instructions
a. Prepare the journal entry to recognize the impairment.
b. What is the new cost basis of the municipal bonds? Given that the maturity value of the bonds is $800,000, should
Hagar Corporation amortize the difference between the carrying amount and the maturity value over the life of the
bonds?
c. At December 31, 2007, the fair value of the municipal bonds is $760,000. Prepare the entry (if any) to record this
information.
*E17-19 (Call Option) On January 2, 2007, Jones Company purchases a call option for $300 on Merchant common
stock. The call option gives Jones the option to buy 1,000 shares of Merchant at a strike price of $50 per share.
The market price of a Merchant share is $50 on January 2, 2007 (the intrinsic value is therefore $0). On March
31, 2007, the market price for Merchant stock is $53 per share, and the time value of the option is $200.
Hint: (LO 10)
Instructions
a. Prepare the journal entry to record the purchase of the call option on January 2, 2007.
b. Prepare the journal entry(ies) to recognize the change in the fair value of the call option as of March 31, 2007.
c. What was the effect on net income of entering into the derivative transaction for the period January 2 to March 31,
2007?
*E17-20 (Call Option) On August 15, 2006, Outkast Co. invested idle cash by purchasing a call option on Counting
Crows Inc. common shares for $360. The notional value of the call option is 400 shares, and the option price is
$40. The option expires on January 31, 2007. The following data are available with respect to the call option.
Market Price of Counting Crows
Shares
Time Value of Call
Option
September 30,
2006
$48 per share
$180
December 31,
2006
$46 per share
65
January 15, 2007
$47 per share
30
Date
Hint: (LO 10)
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Instructions
Prepare the journal entries for Outkast for the following dates.
a.
b.
c.
d.
Investment in call option on Counting Crows shares on August 15, 2006.
September 30, 2006—Outkast prepares financial statements.
December 31, 2006—Outkast prepares financial statements.
January 15, 2007—Outkast settles the call option on the Counting Crows shares.
*E17-21 (Put and Call Options) On February 15, 2007, Derek Co. invested idle cash by purchasing a put option on Lee
Corp. common shares for $160. The notional value of the put option is 300 shares, and the option price is $50.
The option expires on July 31, 2007. The following data are available with respect to the put option.
Date
Market Price of Lee Shares
Time Value of Put Option
March 31, 2007
$40 per share
$70
June 30, 2007
$42 per share
30
July 15, 2007
$39 per share
20
Hint: (LO 10)
Instructions
Prepare the journal entries for Derek Co. for the following dates.
a.
b.
c.
d.
e.
February 15, 2007—Investment in put option on Lee shares.
March 31, 2007—Derek prepares financial statements.
June 30, 2007—Derek prepares financial statements.
July 6, 2007—Derek settles the put option on the Lee shares.
Repeat the requirements for (a) through (d), assuming that instead of purchasing a put option, Derek purchased a
call option.
E17-22 (Cash Flow Hedge) Hart Golf Co. uses titanium in the production of its specialty drivers. Hart anticipates that it
will need to purchase 200 ounces of titanium in November 2007, for clubs that will be shipped in the spring and
summer of 2008. However, if the price of titanium increases, this will increase the cost to produce the clubs,
which will result in lower profit margins.
To hedge the risk of increased titanium prices, on May 1, 2007, Hart enters into a titanium futures contract and
designates this futures contract as a cash flow hedge of the anticipated titanium purchase. The notional amount of
the contract is 200 ounces, and the terms of the contract give Hart the option to purchase titanium at a price of
$500 per ounce. The price will be good until the contract expires on November 30, 2007.
Assume the following data with respect to the price of the call options and the titanium inventory purchase.
Date
May 1, 2007
Spot Price for November Delivery
$500 per ounce
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June 30, 2007
520 per ounce
September 30, 2007
525 per ounce
Hint: (LO 11)
Instructions
Present the journal entries for the following dates/transactions.
May 1, 2007—Inception of futures contract, no premium paid.
June 30, 2007—Hart prepares financial statements.
September 30, 2007—Hart prepares financial statements.
October 5, 2007—Hart purchases 200 ounces of titanium at $525 per ounce and settles the futures contract.
December 15, 2007—Hart sells clubs containing titanium purchased in October 2006 for $250,000. The cost of the
finished goods inventory is $140,000.
f. Indicate the amount(s) reported in the income statement related to the futures contract and the inventory
transactions on December 31, 2007.
a.
b.
c.
d.
e.
*E17-23 (Fair Value Hedge) On January 2, 2007, MacCloud Co. issued a 4-year, $100,000 note at 6% fixed interest,
interest payable semiannually. MacCloud now wants to change the note to a variable-rate note.
As a result, on January 2, 2007, MacCloud Co. enters into an interest rate swap where it agrees to receive 6%
fixed and pay LIBOR of 5.7% for the first 6 months on $100,000. At each 6-month period, the variable rate will
be reset. The variable rate is reset to 6.7% on June 30, 2007.
Hint: (LO 11)
Instructions
a. Compute the net interest expense to be reported for this note and related swap transaction as of June 30, 2007.
b. Compute the net interest expense to be reported for this note and related swap transaction as of December 31,
2007.
*E17-24 (Fair Value Hedge) Sarazan Company issues a 4-year, 7.5% fixed-rate interest only, nonprepayable $1,000,000
note payable on December 31, 2006. It decides to change the interest rate from a fixed rate to variable rate and
enters into a swap agreement with M&S Corp. The swap agreement specifies that Sarazan will receive a fixed
rate at 7.5% and pay variable with settlement dates that match the interest payments on the debt. Assume that
interest rates have declined during 2007 and that Sarazan received $13,000 as an adjustment to interest expense
for the settlement at December 31, 2007. The loss related to the debt (due to interest rate changes) was $48,000.
The value of the swap contract increased $48,000.
Hint: (LO 11)
Instructions
a.
b.
c.
d.
Prepare the journal entry to record the payment of interest expense on December 31, 2007.
Prepare the journal entry to record the receipt of the swap settlement on December 31, 2007.
Prepare the journal entry to record the change in the fair value of the swap contract on December 31, 2007.
Prepare the journal entry to record the change in the fair value of the debt on December 31, 2007.
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See the book's website, www.wiley.com/college/kieso, for Additional Exercises.
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