Investments
Hard Practice Test
Financial Accounting
Investments
Hard Practice Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. Which of the following is correct?
a. holding gains related to investments accounted for under the fair market value method are always reported on the income statement
b. holding gains related to investments accounted for under the fair market value method are always reported on the balance sheet
c. unrealized holding gains related to investments accounted for using the equity method are not recorded until the investment is sold
d. dividend revenue is recorded when using the equity method
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C. Changes in fair market value are not recorded at the end of each period using the equity method. All unrecorded appreciation/depreciation is recorded when the investment is sold. The equity method records dividends received as a reduction to the investment. Holding gains under the fair market method are reported on the balance sheet or the income statement, depending on how long management intends to hold the investment and the type of investment (stocks or bonds).
2. When accounting for a passive investment
a. dividends received reduce the investment account
b. the ownership interest grants significant influence
c. unrealized holding gains are never recorded
d. none of the above
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D. A passive investment is one where significant influence does not exist (b.) and the fair market value method is used. Changes in fair market value are recorded (c.) and dividends received are recorded as dividend revenue (a.)
3. When using the fair market value method, an increase in income is recognized when
a. profits are earned by the company invested in
b. dividends are declared
c. the market value changes for an investment in a bond held long term
d. the market value changes and the investor has significant influence
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B. The fair market value method recognized income when dividends are declared (receivable) and fair market value increases for a security held short-term (c.)
(a.) is recorded when using the equity method.
4. Investors report securities on the balance sheet at fair market value if
a. the security is held long term with no significant influence
b. there is a reliable fair market value and no significant influence
c. there is significant influence
d. Both a. & b.
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D. Investors using the fair market value method report investments at fair market value on the balance sheet. The fair market value method is used when there is no significant influence and there is a reliable fair market value. Equity method securities (significant influence) are typically held long term and are not reported at fair market value.
5. The investor reports the appreciation in fair value of an equity investment as
a. a realized gain on sale in the period of sale only
b. always to unrealized gain on the balance sheet
c. always to unrealized gain on the income statement
d. not enough information to determine
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D. How appreciation is accounted for is first determined by whether or not the investor has significant influence. If there is no significant influence, the change in fair market value (appreciation) is reported either on the income statement or the balance sheet depending on the classification (trading or available for sale). Securities owned with significant influence can also appreciate in market value and the appreciation is not reported.
6. Selling an equity method investment for more than original cost always results in
a. a realized gain
b. a realized loss
c. an unrealized gain
d. not enough information to determine
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D. Historical cost is adjusted for profits and losses, dividends, and the difference in fair market value and book value. The adjusted cost of an equity method investment may be less than cash received (gain) or higher (loss). The original historical cost is no longer relevant when determining the gain or loss when the investment is sold.
7. When the fair value of an equity investment is not reliable and there is no significant influence, the investment should be reported at
a. historical cost
b. fair market value
c. cost adjusted for % of profits and dividends
d. amortized cost
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A. When there is no significant influence the equity method is not used and (c) is not done. When fair market value is not reliable, the investment remains at historical cost. Amortized cost relates only to bonds. (d.)
8. When an equity security is reported using the cost method, gains and losses are reported
a. when the fair market value changes
b. when dividends are received
c. when the investment is sold
d. when the investors share of the investee’s profits is recorded
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C. The cost method is used when there is no significant influence and there is no reliable fair market value. The cost method does not adjust to fair market value and the investment balance remains at historical cost until it is sold. When the investment is sold a realized gain or loss on sale will occur. (d.) occurs with the equity method.
9. Cash flows related to purchasing and selling long-term investments are reported on the
a. balance sheet
b. income statement
c. cash flow statement
d. statement of stockholder’s equity
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C. The amount of cash paid to purchase and received from selling an investment is reported in the investing activities section of the cash flow statement. The gain or loss on the sale is not a cash flow and is reported on the income statement. The statement of stockholder’s equity reports transactions that occur directly with owners of the company.
10. An available for sale security is
a. a debt security with the intent to hold for more than one year and less than to maturity
b. a debt security with the intent to hold until the investor repays the entire amount owed to the investor
c. a security that cannot be sold during the current year
d. one the company intends to sell as soon as it can find a buyer
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A. Available for sale securities are investments in bonds the investor intends to hold for more than one year and less than to maturity. Management’s intend is to hold the bond for more than one year; however, the accounting method does not prevent the company from selling should the intent change.
11. On January 1st of the prior year, the company purchased 10,000 shares (20%) of Old, Corp. for $20 per share. Old Corp. reported a loss of $100,000 during the prior year and profits of $20,000 during the current. Old Corp. paid total dividends of $10,000 per share at the end of both years. The market value of Old Corp. was $15 per share at the end of the prior year and $13 per share at the end of the current year.
A. Record the required journal entries for both years for the company related to the investment given there is significant influence.
B. Record the required journal entries for both years for the company related to the investment given there is no significant influence.
C. What will the investor report on the balance sheet and the income statement at the end of the current year under the equity method and the fair market value method?
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A.
Investment 200,000
Cash 200,000
Prior Year:
Investment Expense 20,000
Investment 20,000
($100,000 loss x 20% owned)
Cash 2,000
Investment 2,000
($10,000 x 20%)
total dividend x % owned
Current Year:
Investment 4,000
Investment Revenue 4,000
($20,000 profit x 20% owned)
Cash 2,000
Investment 2,000
($10,000 x 20%)
B.
Investment 200,000
Cash 200,000
Prior Year:
Unrealized Holding G/L – IS 50,000
Fair Value Adjustment 50,000
($5 drop x 10,000 shares)
Cash 2,000
Dividend Income 2,000
Current Year:
Unrealized Holding G/L – IS 20,000
Fair Value Adjustment 20,000
($2 drop x 10,000 shares)
Cash 2,000
Dividend Income 2,000
C. Equity Method
Balance Sheet
Investment $180,000 see below
Income Statement
Investment Revenue $4,000
Fair Market Value Method
Balance Sheet
Investment $130,000
Income Statement
Unrealized Holding Loss ($20,000)
Dividend Income $ 2,000
Equity Method Investment balance =
200,000 – 20,000 – 2,000 + 4,000 – 2000 = 180,000
12. Dell Corporation bought 14,000 shares of Bequik Corp. for $20 per share on May 1, 20X1. The fair market value of a share of Bequik was $21 on December 31, 20X1 and $18 on December 31, 20X2. Bequik paid dividends of $0.50 per share on December 31st of each year. Dell Corporation sold 8,000 shares for $27 each on March 31, 20X3.
1. Prepare all required journal entries related to the investment on 12/31/20X1.
2. Prepare all required journal entries related to the investment on 12/31/20X2.
3. Prepare the required journal entry(s) related to the investment on March 31, 20X3.
4. What will Dell Corporation report on the income statement for the year ended December 31, 20X1?
5. What will Dell Corporation report on the balance sheet related to this investment on December 31, 20X1?
Check Your Answer
A. 1.
Investment 280,000
Cash 280,000
Fair Value Adjustment 14,000
Unrealized Holding G/L – IS 14,000
Cash 7,000
Dividend Income 7,000
A. 2.
Unrealized Holding G/L – IS 42,000
Fair Value Adjustment 42,000
Cash 7,000
Dividend Income 7,000
A.3.
Fair Value Adjustment 126,000
Unrealized Holding G/L – IS 126,000
($27-$18 = $9 x 14,000)
Cash 216,000
Investment 160,000
Fair Value Adjustment 56,000
(280,000 cost x 57% rounded)
(98,000 balance x 57% rounded)
Sold 8,000 of 14,000 shares = 57% rounded
Fair Value Adjustment is
14,000 – 42,000 + 126,000 = 98,000 balance
A.4.
Unrealized Gain 14,000
Dividend Income 7,000
A.5.
Investment 280,000
Fair Value Adjustment 14,000
Investment at FMV 294,000
13. The company purchased bonds of Jack Co. at the beginning of the year for a cost of $210,000. Fair market value at the end of year one was $223,000. The company earned $7,400 interest and received $7,800 interest during year one.
A. Record all journal entries related to the investment for the first year given the company intends to hold the bonds to maturity.
B. Record all journal entries related to the investment for the first year given the company intends to hold the bonds to for three years.
C. State the line items and amounts the investor will report on the financial statements at the end of the first year given the company intends to hold the bonds to maturity and for three years.
Check Your Answer
A.
Investment 210,000
Cash 210,000
Cash 7,800
Investment in Bond 400
Interest Revenue 7,400
No Adjustment to FMV
B.
Investment 210,000
Cash 210,000
Cash 7,800
Investment in Bond 400
Interest Revenue 7,400
Fair Value Adjustment 13,400
Unrealized Holding G/L – OE 13,400
(210,000 – 400 = 209,600 adjusted cost
– 223,000 FMV = 13,400 adjustment
C.
| Held to Maturity | Fair Market Value – LT | |
| Investment | 209,600 | 223,000 |
| Interest Revenue | 7,400 | 7,400 |
| Unrealized H Gain | 0 | 13,400 |
14. At the beginning of year 1, the company purchased 10,000 shares of common stock (20%) of Bright, Inc. for $200,000. The company’s intent was to hold long term at the end of year one and then short term at the end of year 2. At the beginning of year 3, the company obtained significant influence. Information related to Bright, Co. for the 3 years follows:
| Year 1 | Year 2 | Year 3 | |
| Net Income | 200,000 | (300,000) | 250,000 |
| Dividends Paid | 5,000 | 1,000 | 10,000 |
| Assets FMV > BV (10 year life) | 80,000 | 90,000 | (50,000) |
| FMV of stock price 12/31 | $22 | $25 | $35 |
A. Record the entries related to the investment for all 3 years.
Check Your Answer
Year 1:
Fair Value Adjustment 20,000
Unrealized Holding G/L – IS 20,000
Cash 1,000
Dividend Income 1,000
(20% x total dividends of $5,000)
Year 2:
Fair Value Adjustment 30,000
Unrealized Holding G/L – IS 30,000
Cash 200
Dividend Income 200
(20% x total dividends of $1,000)
Year 3: Significant Influence
Investment 50,000
Investment Revenue 50,000
(250,000 x 20%)
Cash 2,000
Investment 2,000
(10,000 x 20%)
Investment Expense 1,600
Investment 1,600
80,000 x 20% = 16,000 / 10 years = 1,600
Only the difference at the time of purchase to gain significant influence is relevant