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17.39. 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.

  1. 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.

  2. 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.

  3. 10-year bonds were purchased this year. The bonds mature at the first of next year.

  4. 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.

  5. 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.

  6. Preferred stock was purchased for its constant dividend. The company is planning to hold the preferred stock for a long time.

E17-2 (Entries for Held-to-Maturity Securities) On January 1, 2010, Jennings Company purchased at par 10% bonds having a maturity value of $300,000. They are dated January 1, 2010, and mature January 1, 2015, with interest receivable December 31 of each year. The bonds are classified in the held-to-maturity category.

Instructions

  1. Prepare the journal entry at the date of the bond purchase.

  2. Prepare the journal entry to record the interest received for 2010.

  3. Prepare the journal entry to record the interest received for 2011.

E17-3 (Entries for Held-to-Maturity Securities) On January 1, 2009, Roosevelt Company purchased 12% bonds, having a maturity value of $500,000, for $537,907.40. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2009, and mature January 1, 2014, with interest receivable December 31 of each year. Roosevelt Company uses the effective-interest method to allocate unamortized discount or premium. The bonds are classified in the held-to-maturity category.

Instructions

  1. Prepare the journal entry at the date of the bond purchase.

  2. Prepare a bond amortization schedule.

  3. Prepare the journal entry to record the interest received and the amortization for 2009.

  4. Prepare the journal entry to record the interest received and the amortization for 2010.

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.



Instructions

  1. Prepare the journal entry at the date of the bond purchase.

  2. Prepare the journal entries to record the interest received and recognition of fair value for 2009.

  3. Prepare the journal entry to record the recognition of fair value for 2010.

E17-5 (Effective-Interest versus Straight-Line Bond Amortization) On January 1, 2010, Morgan Company acquires $300,000 of Nicklaus, Inc., 9% bonds at a price of $278,384. The interest is payable each December 31, and the bonds mature December 31, 2012. The investment will provide Morgan Company a 12% yield. The bonds are classified as held-to-maturity.

Instructions

  1. Prepare a 3-year schedule of interest revenue and bond discount amortization, applying the straight-line method. (Round to nearest dollar.)

  2. Prepare a 3-year schedule of interest revenue and bond discount amortization, applying the effective-interest method. (Round to nearest cent.)

  3. Prepare the journal entry for the interest receipt of December 31, 2011, and the discount amortization under the straight-line method.

  4. Prepare the journal entry for the interest receipt of December 31, 2011, 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 Kinney Company at December 31, 2010, regarding its investments.



Instructions

  1. Prepare the adjusting entry (if any) for 2010, assuming the securities are classified as trading.

  2. Prepare the adjusting entry (if any) for 2010, assuming the securities are classified as available-for-sale.

  3. 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, 2010, Zurich Company provided you with the following information regarding its trading securities.



During 2011, Carolina Company stock was sold for $9,500. The fair value of the stock on December 31, 2011, was: Stargate Corp. stock—$19,300; Vectorman Co. stock—$20,500.

Instructions

  1. Prepare the adjusting journal entry needed on December 31, 2010.

  2. Prepare the journal entry to record the sale of the Carolina Company stock during 2011.

  3. Prepare the adjusting journal entry needed on December 31, 2011.

E17-8 (Available-for-Sale Securities Entries and Reporting) Player 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 $67,000.

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, 2010, the available-for-sale equity portfolio for Wenger, Inc. is as follows.



On January 20, 2011, Wenger, Inc. sold security A for $15,300. The sale proceeds are net of brokerage fees.

Instructions

  1. Prepare the adjusting entry at December 31, 2010, to report the portfolio at fair value.

  2. Show the balance sheet presentation of the investment related accounts at December 31, 2010. (Ignore notes presentation.)

  3. Prepare the journal entry for the 2011 sale of security A.

E17-10 (Comprehensive Income Disclosure) Assume the same information as E17-9 and that Wenger, Inc. reports net income in 2010 of $120,000 and in 2011 of $140,000. Total holding gains (including any realized holding gain or loss) arising during 2011 total $30,000.

Instructions

  1. Prepare a statement of comprehensive income for 2010 starting with net income.

  2. Prepare a statement of comprehensive income for 2011 starting with net income.

E17-11 (Equity Securities Entries) Capriati Corporation made the following cash purchases of securities during 2010, which is the first year in which Capriati invested in securities.

  1. On January 15, purchased 9,000 shares of Gonzalez Company's common stock at $33.50 per share plus commission $1,980.

  2. On April 1, purchased 5,000 shares of Belmont Co.'s common stock at $52.00 per share plus commission $3,370.

  3. On September 10, purchased 7,000 shares of Thep Co.'s preferred stock at $26.50 per share plus commission $4,910.

On May 20, 2010, Capriati sold 3,000 shares of Gonzalez Company's common stock at a market price of $35 per share less brokerage commissions, taxes, and fees of $2,850. The year-end fair values per share were: Gonzalez $30, Belmont $55, and Thep $28. In addition, the chief accountant of Capriati told you that Capriati Corporation plans to hold these securities for the long term but may sell them in order to earn profits from appreciation in prices.

Instructions

  1. Prepare the journal entries to record the above three security purchases.

  2. Prepare the journal entry for the security sale on May 20.

  3. Compute the unrealized gains or losses and prepare the adjusting entries for Capriati on December 31, 2010.

E17-12 (Journal Entries for Fair Value and Equity Methods) Presented below are two independent situations.

Situation 1

Hatcher Cosmetics acquired 10% of the 200,000 shares of common stock of Ramirez Fashion at a total cost of $14 per share on March 18, 2010. On June 30, Ramirez declared and paid a $75,000 cash dividend. On December 31, Ramirez reported net income of $122,000 for the year. At December 31, the market price of Ramirez Fashion was $15 per share. The securities are classified as available-for-sale.

Situation 2

Holmes, Inc. obtained significant influence over Nadal Corporation by buying 25% of Nadal's 30,000 outstanding shares of common stock at a total cost of $9 per share on January 1, 2010. On June 15, Nadal declared and paid a cash dividend of $36,000. On December 31, Nadal reported a net income of $85,000 for the year.

Instructions

Prepare all necessary journal entries in 2010 for both situations.

E17-13 (Equity Method) Gator Co. invested $1,000,000 in Demo Co. for 25% of its outstanding stock. Demo Co. pays out 40% of net income in dividends each year.

Instructions

Use the information in the following T-account for the investment in Demo to answer the following questions.



  1. How much was Gator Co.'s share of Demo Co.'s net income for the year?

  2. How much was Gator Co.'s share of Demo Co.'s dividends for the year?

  3. What was Demo Co.'s total net income for the year?

  4. What was Demo Co.'s total dividends for the year?

E17-14 (Equity Investment—Trading) Feiner Co. had purchased 300 shares of Guttman Co. for $40 each this year and classified the investment as a trading security. Feiner Co. sold 100 shares of the stock for $43 each. At year end the price per share of the Guttman Co. stock had dropped to $35.

Instructions

Prepare the journal entries for these transactions and any year-end adjustments.

E17-15 (Equity Investments—Trading) Swanson Company has the following securities in its trading portfolio of securities on December 31, 2010.



All of the securities were purchased in 2010.

In 2011, Swanson completed the following securities transactions.



Swanson Company's portfolio of trading securities appeared as follows on December 31, 2011.



Instructions

Prepare the general journal entries for Swanson Company for:

  1. The 2010 adjusting entry.

  2. The sale of the Parker stock.

  3. The purchase of the McDowell stock.

  4. The 2011 adjusting entry for the trading portfolio.

E17-16 (Fair Value and Equity Method Compared) Gregory Inc. acquired 20% of the outstanding common stock of Handerson Inc. on December 31, 2010. The purchase price was $1,250,000 for 50,000 shares. Handerson Inc. declared and paid an $0.80 per share cash dividend on June 30 and on December 31, 2011. Handerson reported net income of $730,000 for 2011. The fair value of Handerson's stock was $27 per share at December 31, 2011.

Instructions

  1. Prepare the journal entries for Gregory Inc. for 2010 and 2011, assuming that Gregory cannot exercise significant influence over Handerson. The securities should be classified as available-for-sale.

  2. Prepare the journal entries for Gregory Inc. for 2010 and 2011, assuming that Gregory can exercise significant influence over Handerson.

  3. At what amount is the investment in securities reported on the balance sheet under each of these methods at December 31, 2011? What is the total net income reported in 2011 under each of these methods?

E17-17 (Equity Method) On January 1, 2010, Meredith Corporation purchased 25% of the common shares of Pirates Company for $200,000. During the year, Pirates earned net income of $80,000 and paid dividends of $20,000.

Instructions

Prepare the entries for Meredith to record the purchase and any additional entries related to this investment in Pirates Company in 2010.

E17-18 (Impairment of Debt Securities) Cairo Corporation has municipal bonds classified as available-for-sale at December 31, 2010. These bonds have a par value of $800,000, an amortized cost of $800,000, and a fair value of $740,000. The unrealized loss of $60,000 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.

Instructions

  1. Prepare the journal entry to recognize the impairment.

  2. What is the new cost basis of the municipal bonds? Given that the maturity value of the bonds is $800,000, should Cairo Corporation amortize the difference between the carrying amount and the maturity value over the life of the bonds?

  3. At December 31, 2011, the fair value of the municipal bonds is $760,000. Prepare the entry (if any) to record this information.

E17-19 (Fair Value Measurement) Presented below is information related to the purchases of common stock by Lilly Company during 2010.



Instructions

  1. What entry would Lilly make at December 31, 2010, to record the investment in Arroyo Company stock if it chooses to report this security using the fair value option?

  2. What entry would Lilly make at December 31, 2010, to record the investment in Lee Corporation, assuming that Lilly wants to classify this security as available-for-sale? This security is the only available-for-sale security that Lilly presently owns.

  3. What entry would Lilly make at December 31, 2010, to record the investment in Woods Inc., assuming that Lilly wants to classify this investment as a trading security?

E17-20 (Fair Value Measurement Issues) Assume the same information as in E17-19 for Lilly Company. In addition, assume that the investment in the Woods Inc. stock was sold during 2011 for $195,000. At December 31, 2011, the following information relates to its two remaining investments of common stock.



Net income before any security gains and losses for 2011 was $905,000.

Instructions

  1. Compute the amount of net income or net loss that Lilly should report for 2011, taking into consideration Lilly's security transactions for 2011.

  2. Prepare the journal entry to record unrealized gain or loss related to the investment in Arroyo Company stock at December 31, 2011.

E17-21 (Fair Value Option) Presented below is selected information related to the financial instruments of Dawson Company at December 31, 2010. This is Dawson Company's first year of operations.



Instructions

  1. Dawson elects to use the fair value option whenever possible. Assuming that Dawson's net income is $100,000 in 2010 before reporting any securities gains or losses, determine Dawson's net income for 2010.

  2. Record the journal entry, if any, necessary at December 31, 2010, to record the fair value option for the bonds payable.

*E17-22 (Derivative Transaction) On January 2, 2010, 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, 2010 (the intrinsic value is therefore $0). On March 31, 2010, the market price for Merchant stock is $53 per share, and the time value of the option is $200.

Instructions

  1. Prepare the journal entry to record the purchase of the call option on January 2, 2010.

  2. Prepare the journal entry(ies) to recognize the change in the fair value of the call option as of March 31, 2010.

  3. What was the effect on net income of entering into the derivative transaction for the period January 2 to March 31, 2010? (Ignore tax effects.)

*E17-23 (Fair Value Hedge) On January 2, 2010, 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, 2010, 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, 2010.

Instructions

  1. Compute the net interest expense to be reported for this note and related swap transaction as of June 30, 2010.

  2. Compute the net interest expense to be reported for this note and related swap transaction as of December 31, 2010.

*E17-24 (Cash Flow Hedge) On January 2, 2010, Parton Company issues a 5-year, $10,000,000 note at LIBOR, with interest paid annually. The variable rate is reset at the end of each year. The LIBOR rate for the first year is 5.8%.

Parton Company decides it prefers fixed-rate financing and wants to lock in a rate of 6%. As a result, Parton enters into an interest rate swap to pay 6% fixed and receive LIBOR based on $10 million. The variable rate is reset to 6.6% on January 2, 2011.

Instructions

  1. Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2010.

  2. Compute the net interest expense to be reported for this note and related swap transactions as of December 31, 2011.

*E17-25 (Fair Value Hedge) Sarazan Company issues a 4-year, 7.5% fixed-rate interest only, nonprepayable $1,000,000 note payable on December 31, 2010. 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 2011 and that Sarazan received $13,000 as an adjustment to interest expense for the settlement at December 31, 2011. The loss related to the debt (due to interest rate changes) was $48,000. The value of the swap contract increased $48,000.

Instructions

  1. Prepare the journal entry to record the payment of interest expense on December 31, 2011.

  2. Prepare the journal entry to record the receipt of the swap settlement on December 31, 2011.

  3. Prepare the journal entry to record the change in the fair value of the swap contract on December 31, 2011.

  4. Prepare the journal entry to record the change in the fair value of the debt on December 31, 2011.

*E17-26 (Call Option) On August 15, 2010. 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. (Market price of an Outkast share is $40.) The option expires on January 31, 2011. The following data are available with respect to the call option.

DateMarket Price of Counting Crows SharesTime Value of Call Option
September 30, 2010$48 per share$180
December 31, 2010$46 per share65
January 15, 2011$47 per share30


Instructions

Prepare the journal entries for Outkast for the following dates.

  1. Investment in call option on Counting Crows shares on August 15, 2010.

  2. September 30, 2010—Outkast prepares financial statements.

  3. December 31, 2010—Outkast prepares financial statements.

  4. January 15, 2011—Outkast settles the call option on the Counting Crows shares.

*E17-27 (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 October 2010, for clubs that will be shipped in the holiday shopping season. 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, 2010, Hart enters into a titanium futures contract and designates this futures contract as 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 right and the obligation to purchase titanium at a price of $500 per ounce. The price will be good until the contract expires on November 30, 2010.

Assume the following data with respect to the price of the call options and the titanium inventory purchase.

DateSpot Price for November Delivery
May 1, 2010$500 per ounce
June 30, 2010520 per ounce
September 30, 2011525 per ounce


Instructions

Present the journal entries for the following dates/transactions.

  1. May 1, 2010—Inception of futures contract, no premium paid.

  2. June 30, 2010—Hart prepares financial statements.

  3. September 30, 2010—Hart prepares financial statements.

  4. October 5, 2010—Hart purchases 200 ounces of titanium at $525 per ounce and settles the futures contract.

  5. December 15, 2010—Hart sells clubs containing titanium purchased in October 2010 for $250,000. The cost of the finished goods inventory is $140,000.

  6. Indicate the amount(s) reported in the income statement related to the futures contract and the inventory transactions on December 31, 2010.

See the book's companion website, www.wiley.com/college/kieso, for a set of B Exercises.


  

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