BRIEF EXERCISES
Brief Exercise 12–1
(a)
Investment in bonds (face amount) .......................
Discount on bond investment (difference) ........
Cash (price of bonds) ..........................................
720,000
Cash (1.5% x $720,000)..........................................
Discount on bond investment (difference) ............
Interest revenue (2% x $600,000) .......................
10,800
1,200
120,000
600,000
(b)
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 .........................................
Cash .................................................................................
875,000
December 31
Net unrealized holding gains and losses—I/S .....................
Fair value adjustment ($875,000 – 873,000) ........................
2,000
875,000
2,000
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Solutions Manual, Vol. 1, Chapter 12
12–11
Brief Exercise 12–2 (concluded)
2014
January 3
Cash (selling price) ..................................................................
Gain on investments (to balance)........................................
Investment in Coca Cola shares (account balance) .............
880,000
5,000
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) ..................................
Net unrealized holding gains and losses—I/S (to balance)
2,000
2,000
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12–12
Intermediate Accounting, 7e
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
Investment in Coca Cola shares .........................................
Cash .................................................................................
875,000
December 31
Net unrealized holding gains and losses–OCI.....................
Fair value adjustment ($875,000 – 873,000) ........................
2,000
875,000
2,000
2014
January 3
Cash (selling price) .................................................................
Gain on investments (to balance) .......................................
Investment in Coca Cola shares (cost)..............................
880,000
5,000
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
Fair value adjustment (account balance) .................................
Net unrealized holding gains and losses–OCI.................
2,000
2,000
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Solutions Manual, Vol. 1, Chapter 12
12–13
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:
Fair value adjustment ($670,000 – 610,000) ...........
Net unrealized holding gains and losses–OCI
60,000
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.
© The McGraw-Hill Companies, Inc., 2013
12–14
Intermediate Accounting, 7e
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
Investment in Coca Cola shares .........................................
Cash .................................................................................
875,000
December 31
Net unrealized holding gains and losses—I/S .....................
Fair value adjustment ($875,000 – 873,000)...................
2,000
875,000
2,000
2014
January 3
Cash (selling price) .................................................................
Gain on investments (to balance) .......................................
Investment in Coca Cola shares (account balance) .............
880,000
5,000
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) .................................
Net unrealized holding gains and losses—I/S (to balance)
2,000
2,000
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Solutions Manual, Vol. 1, Chapter 12
12–15
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.
© The McGraw-Hill Companies, Inc., 2013
12–16
Intermediate Accounting, 7e
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
would serve as the new “cost” basis for writing the investment up or down to market
value in the next set of financial statements. There also would be no revision of
prior years, but the change should be described in a disclosure note.
© The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol. 1, Chapter 12
12–17
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) ...........................................................
Investment revenue .........................................................
200,000
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).
© The McGraw-Hill Companies, Inc., 2013
12–18
Intermediate Accounting, 7e
Brief Exercise 12–13
Because the drop in the market price of stock is considered to be other-thantemporary, 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 ....
AFS Investment (Branch) ..............................
450,000
Fair value adjustment .........................................
Net unrealized holding gains and losses—OCI
100,000
100,000
450,000
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.
© The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol. 1, Chapter 12
12–19
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 .....
Discount on bond investment .........................
450,000
Fair value adjustment ..........................................
Net unrealized holding gains and losses—OCI
100,000
100,000
450,000
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.
© The McGraw-Hill Companies, Inc., 2013
12–20
Intermediate Accounting, 7e
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:
Other-than-temporary impairment loss—I/S ....
Discount on bond investment .........................
200,000
OTT impairment loss—OCI ...............................
Fair value adjustment .....................................
250,000
Fair value adjustment .........................................
Net unrealized holding gains and losses—OCI
100,000
100,000
200,000
250,000
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).
© The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol. 1, Chapter 12
12–21
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 ......
Discount on debt investment ..........................
500,000
500,000
Upon recovery of $300,000 of fair value, Wickum would reverse the impairment
by that amount:
Discount on debt investment ...............................
300,000
Recovery of other-than-temporary impairment loss—I/S
300,000
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12–22
Intermediate Accounting, 7e
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.
Brief Exercise 12–20
Barrett would account for the equity at FV-NI because the equity investment does
not qualify for the equity method. Therefore, Fowler would report the equity in the
balance sheet as an investment of $80,000 and would include the $20,000 decrease in
fair value in net income as a loss. The fact that Barrett expects the fair value to
recover prior to sale is not relevant.
© The McGraw-Hill Companies, Inc., 2013
Solutions Manual, Vol. 1, Chapter 12
12–23