financial accounting tools for business decision making 6e solution manual chapter 12

a The $10 million difference between the carrying amount of $245 million and the fair value of $255 million should be recorded as an unrealized gain and reported in the other revenues an

CHAPTER 12 Reporting and Analyzing Investments

ASSIGNMENT CLASSIFICATION TABLE

Study Objectives Questions

Brief Exercises Exercises

A Problems

B Problems BYP

ASSIGNMENT CHARACTERISTICS TABLE

Problem

Difficulty Level

Time Allotted (min.)

1A Record trading investments; show statement

presentation

Moderate 30-40

2A Record trading investments; show statement

presentation

Moderate 30-40

3A Record trading investments; show statement

presentation

Moderate 30-40

4A Determine valuation of investments; indicate

statement presentation

Moderate 30-40

5A Identify impact of investment transactions Moderate 20-30

7A Record investments; indicate statement presentation Moderate 30-40

*9A Record bond investment; show statement

presentation

Complex 30-40

*10A Record bonds for investor and investee Complex 30-40

1B Record trading investments; show statement

presentation

Moderate 30-40

2B Record trading investments; show statement

presentation

Moderate 30-40

3B Record trading investments; show statement

presentation

Moderate 30-40

4B Determine valuation of investments; indicate

statement presentation

Complex 30-40

5B Identify impact of investment transactions Moderate 20-30

ASSIGNMENT CHARACTERISTICS TABLE (Continued)

Problem

Number Description

Difficulty Level

Time Allotted (min.)

*9B Record bond investment; show statement

presentation

Complex 30-40

*10B Record bonds for investor and investee Complex 30-40

3 (a) This equity investment should be classified as a non-strategic investment as

the company intends to sell its Suncor Energy shares if the need for cash arises

(b) The investment would most likely be classified as a current asset (although judgement must be exercised here) as it was not purchased with the intent of holding it for a long period of time

4 (a) Common shares in a publicly traded company that will be sold within a year

are valued at fair value

(b) Bond investments that will be held until maturity are valued at amortized cost (c) Shares in a private company that do not have a determinable fair value are

valued at cost

5 Realized gains/losses are the differences between fair values and the carrying amounts when the investments are actually sold Unrealized gains/losses are the differences between the fair values and carrying amounts of investments still held or owned by the investor

6 (a) The $10 million difference between the carrying amount of $245 million and

the fair value of $255 million should be recorded as an unrealized gain and reported in the other revenues and expenses section in the income statement

(b) Yes, the answer would be different if the fair value could not be determined

No unrealized gain would be reported and the investment would be valued at cost

Answers to Questions (Continued)

7 (a) The bonds would be shown at their fair value of $1,050,000

(b) The interest revenue earned on the bonds would be reported as other revenue

under other revenue and expenses section of the statement of income

8 The carrying amount of the investment ($130,000) would be compared to the

proceeds ($125,000) The $5,000 difference is a realized loss The realized loss

would be reported on the 2015 income statement in other revenues and expenses

The journal entries to record these transactions (not required) follow:

Unrealized Gain on Trading Investments 15,000

Realized Loss on Trading Investments 5,000

9 Significant influence over an investee may result from representation on the board

of directors, participation in policy-making processes, material inter-company

transactions, interchange of managerial personnel, or technological dependency

An investment (direct or indirect) of 20% or more of the voting shares of an investee

constitutes significant influence, unless there exists evidence to the contrary

However, companies are required to use judgement rather than to blindly follow the

20% guideline For example, 25% ownership in a company that is 75% controlled

by another company would not necessarily indicate significant influence

10 Under the cost model, the carrying amount of the company’s investment is recorded

at cost The investment account is not affected by the earnings of the entity into

which the investment is made The investing company records any dividends

received as investment revenue, leaving the carrying amount (usually cost) of the

investment intact

Under the equity method, the investment is also recorded at cost on the day the

investment is made However, the investment account is increased or decreased by

the investor’s share of the investee company’s profit or loss for the period

respectively The investing company would reduce the carrying amount of its

investment by any dividends received from the investee, since the value of the

latter’s net assets decreases as it declares dividends

Answers to Questions (Continued)

11 (a) Under the cost model, the investor has little to no influence over the investee,

due to its relatively small ownership interest Therefore, the only entry the investor would make relative to this investment is to record any cash dividends

it receives from the investee as investment revenue

(b) The equity method is used when the investor exercises significant influence over the investee Consequently, the investor has played a role in the determination of any profit or loss experienced by the investee As the investee earns profit, its value will increase Thus the investor’s carrying amount of its investment in the investee should reflect this reality Consequently, the investor records investment revenue (loss) when the investee reports profit (or loss) and does not wait for the distribution of profit by way of dividends The investment is reduced by the amount of dividends received rather than the dividends being recorded as revenue as is the case with the cost model

12 (a) Trading investments are classified as a current assets under the assumption

that management intends to trade them actively, thereby implying that they will

be sold fairly soon

(b) Investment in associates is classified as long-term investments under the assumption that if an investor has gone to the trouble of obtaining a large enough block of shares to significantly influence the investee, they would want

to hold onto the investment for more than one year

(c) Debt investments held to maturity are classified as long-term investments except in the year of maturity when the securities would be classified as a current asset

13

(a) Unrealized Gain on

Trading Investments

Income Statement Other revenues and

expenses (b) Realized Loss on Trading

Investments

Income Statement Other revenues and

expenses (c) Revenue from Investment

in Associates

Income Statement Other revenues and

expenses

Answers to Questions (Continued)

14 Comprehensive income includes all changes to shareholders’ equity during a period except changes resulting from investments by shareholders and dividends declared Profit is one component of comprehensive income The other component is other comprehensive income, which includes the current period’s unrealized gains/losses

on securities accounted for using the fair value through other comprehensive income model and certain other unrealized gains/losses such as revaluation gains under the revaluation model for property, plant, and equipment that was covered in chapter 9 Profit and other comprehensive income can be reported separately in two statements although the preferred approach is to report both in a single statement known as the statement of comprehensive income

Accumulated other comprehensive income is the cumulative total of each period’s other comprehensive income/loss Just as profit is closed out to retained earnings at the end of the year, other comprehensive income is closed out to accumulated other comprehensive income at the end of the year The changes to accumulated other comprehensive income are reported in the statement of changes in equity, and the ending balance of accumulated other comprehensive income is reported in the shareholders’ equity section of the statement of financial position

15 Profit reported on the income statement is a component of comprehensive income Profit along with other comprehensive income is reported in the statement of comprehensive income (if the company chooses to report both under a single statement) Profit (loss) increases (decreases) retained earnings Other comprehensive income (loss) increases (decreases) accumulated other comprehensive income, which like retained earnings is an equity account Changes

in both retained earnings and accumulated other comprehensive income are reported in the statement of changes in equity Total shareholders’ equity is reported in the statement of financial position (assets = liabilities + shareholders’ equity)

16 (a) Since George Weston Ltd owns 63% of the common shares of Loblaw

Compaines Ltd., it must use the equity method to account for its investment Furthermore, George Weston must consolidate its results with those of Loblaw

by preparing consolidated financial statements

(b) George Weston is the parent since it owns 63% of the voting shares of Loblaw Therefore, Loblaw is a subsidiary of George Weston

(c) Consolidated financial statements should be prepared When consolidated financial statements are prepared, George Weston will eliminate its investment account from its own records and replace this with the specific assets and liabilities of Loblaw The consolidated financial statements would include all of

George Weston’s assets and liabilities at their carrying amount in addition to the assets and liabilities of Loblaw

Answers to Questions (Continued)

*17 The accounting treatment for an investment in bonds is essentially the inverse of the recording required for a bond liability In both cases, the investment is recorded

at its issue price, with any premium or discount netted with the bond account The premium or discount is amortized using the effective interest method, unless the bond is held for trading Debt investments in bonds that are held for trading are re-valued to fair value at year-end, whereas bond liabilities are not because it is extremely rare for them to have been issued for the purposes of trading (because they are liabilities not investments)

*18 Premiums and discounts must be amortized when using the amortized cost model because the amortization of the discount or premium provides the proper matching

of interest revenue to the periods the investment is held and reflects the effective interest rate in the financial statements When using the fair value model for debt securities, the investment is held for a short time and any misstatement of interest caused from not amortizing the discount/premium is not considered material

*19 When the bonds are sold by the investor on the open market, the investor must record the sale The investee is not affected by the sale as an independent third party purchases the bonds on the market, and as such, that transaction is occurring between two investors and has nothing to do with the company that originally issued the debt The liability has not been settled, but rather, the amount of the bonds owing is simply payable to a different investor

BRIEF EXERCISE 12-1

(a) Debt or Equity Investment?

(b) Non-Strategic or Strategic Investment?

(c) Reason for Making the Investment?

1 120-day treasury bill Debt Non-Strategic Interest revenue for

120 days

2 A few common shares of

a small oil company

4 Bonds purchased with a

temporary cash surplus

Debt Non-Strategic Interest revenue

6 Five-year bonds intended

to be held for the entire

term of the bonds

Debt Non-Strategic Interest revenue

over the long term

BRIEF EXERCISE 12-2

(a)

Jan 1 Trading Investments 200,000

Cash 200,000 (b)

July 1 Cash 10,000

Interest Revenue ($200,000 × 10% × 6/12) 10,000 (c)

Dec 31 Interest Receivable 10,000

Interest Revenue ($200,000 × 10% × 6/12) 10,000

Dec 31 Unrealized Loss on Trading Investments 6,000

Trading Investments 6,000 ($200,000 – [$200,000 × 97%])

BRIEF EXERCISE 12-3

2016

Jan 2 Cash 194,000

Trading Investments 194,000 The investment is already carried at fair value so no gain or loss will result on this sale

BRIEF EXERCISE 12-4

(a)

Aug 1 Trading Investments 45,000

Cash 45,000 (b)

Dec 31 Trading Investments 4,000

Unrealized Gain on Trading Investments 4,000

BRIEF EXERCISE 12-5

Feb 1 Cash 47,000

Realized Loss on Trading Investments ……… 2,000 Trading Investments 49,000

BRIEF EXERCISE 12-6

Jan 1 Investment in Associates 400,000

Cash 400,000 Dec 31 Cash (25% × $32,000) 8,000

Dividend Revenue 8,000 Since Rook uses the cost model to account for its investment, the only revenue that Rook should report is its pro-rata share of any dividends declared by Hook, which amounts to

$8,000 (25% × $32,000) This is different from the equity method which records a pro-rata share of profit from Hook and records receipt of dividends as a reduction of the investment account on the statement of financial position

BRIEF EXERCISE 12-8

(a) Significant influence – The balance in the equity investment account at December

31, would be $287,000 The investment would be reported as an investment in associates in long-term investments

Cost of investment $225,000

Add: Share of Dong’s profit (20% × $350,000) 70,000

Less: Dividends received from Dong (20% × $40,000) (8,000)

(b) Without significant influence, the investment would be reported at the fair value of

$275,000 in long-term investments

(c) Under the cost model, the investment would be reported at its purchase price of

$225,000 It would be reported as an investment in associates in long-term

investments.

BRIEF EXERCISE 12-9

Financial Statement Classification

A bond investment that will mature

next year

Statement of financial position

position

Long-term investments Investment of a few hundred

common shares in a large publicly

traded company that is held for

trading purposes

Statement of financial position

Current assets

A bond investment that management

intends to hold for 10 years

Statement of financial position

Long-term investments Realized gain on a trading

investment

Income statement Other revenues and

expenses Unrealized gain on a trading

investment

Income statement Other revenues and

expenses Dividends received from a strategic

investment accounted for using the

equity method

Statement of financial position

Long-term investments

Interest earned on a trading

For investments that are non-strategic and not held for trading, the company can elect to report unrealized gains and losses in other comprehensive income

BRIEF EXERCISE 12-11

SABRE CORPORATION Statement of Financial Position (Partial)

December 31, 2015

Assets Current assets

Trading investments……… $ 29,000

Long-term investments

Long-term investments 435,000 *

Investment in associates 116,800 **

* $435,000 = $275,000 (equity investment in Epee at fair value) + $160,000 (bond

investment held to maturity at amortized cost)

Brookfield’s share of profit from associates would be reported on their income statement

in the other revenues and expenses section The amount would also cause an increase in the investment in associates account in the long-term investments section in the statement of financial position

Dividends received from associates would be reported on the company’s statement of cash flows as a cash inflow as an operating activity or an investing activity The amount would also reduce the investment in associates account on the statement of financial position

The year-end balance of investment in associates would be reported in the statement of financial position in long-term investments

(a) Investor

June 30 Long-Term Investments 138,960

Cash 138,960 Dec 31 Cash ($150,000 × 10% × 6/12) 7,500

Long-Term Investments 838 Interest Revenue ($138,960 × 12% × 6/12) 8,338 (b) Investee

June 30 Cash 138,960

Bonds Payable 138,960 Dec 31 Interest Expense ($138,960 × 12% × 6/12) 8,338

Cash 7,500 Bonds Payable 838

SOLUTIONS TO EXERCISES

EXERCISE 12-1

(a) Debt or Equity

Investment?

(b) Non-Strategic or Strategic Investment?

Non-Neither trading or held to maturity

(a)

July 1 Trading Investments ($700,000 × 106.5%) 745,500

Cash 745,500 (b)

Dec 31 Interest Receivable 35,000

Interest Revenue ($700,000 × 10% × 6/12) 35,000

Adjustment to fair value:

Dec 31 Trading Investments 3,500

Unrealized Gain on Trading Investments 3,500 ($700,000 × 107%) – $745,500

EXERCISE 12-5

(a)

Dec 31 Trading Investments 2,000

Unrealized Gain on Trading Investments 2,000

Other revenues and expenses

Unrealized gain on trading investments $2,000

(c)

Mar 22 Cash 22,000

Realized Gain on Trading Investments 1,000

Trading Investments 21,000

Jan 1 Investment in Associates 192,000

Dec 31 Investment in Associates 60,000

Revenue from Investment in Associates 60,000

31 Investment in Associates 40,000 Revenue from Investment in Associates

($200,000 × 20%) 40,000 (b)

Oct 1 Long-Term Investments 500,000

Cash (200,000 × $2.50) 500,000 Dec 29 Cash ($80,000 × 20%*) 16,000

Dividend Revenue 16,000

31 No entry

* 200,000 shares / 1,000,000 shares

(a)Account

Trading Investments

Investment

in Associates

Purchases of investments during the year 30,000 40,000

Carrying amount of investments sold

Fair value adjustment

Realized Gain on Trading Investments 12,000 Trading Investments 43,000 Cash 3,000

Dividend Revenue 3,000 Trading Investments 7,000

Unrealized Gain on Trading Investments 7,000 Investment in Associates

Investment in Associates 40,000 Cash 40,000

Cash 32,000 Realized Loss on Investment in Associates 10,000 Investment in Associates 42,000 Cash 8,000

Investment in Associates 8,000

EXERCISE 12-8 (Continued)

(b) Continued

Investment in Associates 43,000 Revenue from Investment in Associates 43,000

(c)

Investments in Associates Statement of Financial Position:

Income Statement:

Realized gain on trading investments $12,000

Unrealized gain on trading investments 7,000

EXERCISE 12-9

(a) 100% Cameco Europe – equity method but then investment is eliminated when the subsidiary accounts are consolidated together with those of the parent company

23.3% UEX – equity method

24% GE-Hitachi Global – equity method

All three investments exceed 20% ownership in each corporation Control is exerted over Cameco Europe and significant influence over the other two investees’ operations by Cameco is assumed Other factors should be examined to determine

if significant influence does exist regardless of the percentage of ownership If there

is significant influence, the equity method would be used

(b) Cameco Europe should be consolidated with Cameco’s operations because Cameco is the parent company of a fully owned subsidiary, Cameco Europe

*EXERCISE 12-10

(a) Key inputs: Future value (FV) = $500,000

Market interest rate (i) = 3% (6% × 6/12)

Interest payment (PMT) = $12,500 ($500,000 × 5% × 6/12)

Number of semi-annual periods (n) = 20 (10 years × 2)

Using present value tables

Semi-annual interest payments $500,000 × 2.5% $ 12,500

Present value factor for annuity, 3% for 20 periods × 14.87747

Present value of interest payments 185,968

Present value of $500,000, in 20 periods at 3%

Note to the instructor: Rounding discrepancies may arise depending on whether present

value tables, calculators, or a spreadsheet program is used to determine the present value

(b) Investor

2015

June 30 Long-Term Investments 462,808

Cash 462,808 Dec 31 Cash ($500,000 × 5% × 6/12) 12,500

Long-Term Investments 1,384 Interest Revenue ($462,808 × 6% × 6/12) 13,884

2016

June 30 Cash ($500,000 × 5% × 6/12) 12,500

Long-Term Investments 1,426 Interest Revenue (($462,808 + $1,384) × 6% × 6/12) 13,926

2016

June 30 Interest Expense (($462,808 + $1,384) × 6% × 6/12) 13,926

Cash 12,500 Bonds Payable 1,426 (d) The response to (a) would differ in that the bond purchase would be recorded in a trading investment account The discount would not be amortized; the $12,500 cash receipt of interest would be recorded as interest revenue The bonds carrying amount would be adjusted to the fair value of $465,000 ($500,000 × 93%) at December 31,

2015 An unrealized gain of $2,192 would be reported on the income statement [$465,000 (fair value) – $462,808 (carrying amount) = $2,192]

There would be no changes to how the investee recorded the bonds or interest

Dec 31 Interest Receivable

($60,000 × 9% × 5/12) 2,250 Interest Revenue 2,250

31 Unrealized Loss on Trading Investments

($104,000 – $41,600) – $60,000 2,400 Trading Investments 2,400

(b)

GIVARZ CORPORATION Statement of Financial Position (Partial)

December 31, 2015 Current assets

Interest receivable $ 2,250 Trading investments 60,000

(c)

GIVARZ CORPORATION Income Statement (Partial) Year Ended December 31, 2015

Other revenues and expenses

Interest revenue ($4,500 + $2,250) $6,750 Unrealized loss on trading investments $2,400

Realized loss on trading investments 800 3,200

$3,550

PROBLEM 12-1A

(a) Feb 1 Trading Investments 36,000

PROBLEM 12-2A

(a) (Continued)

Dec 31 Unrealized Loss on Trading Investments

(see below $48,000 – $46,800) 1,200 Trading Investments 1,200

*$36,000 − $12,000 = $24,000

Statement of Financial Position (Partial)

December 31, 2015

Current assets

Trading investments $46,800

Income Statement (Partial) Year Ended December 31, 2015

Other revenues and expenses

Dividend revenue ($1,800 + $1,200) $3,000 Interest revenue 2,100 Realized gain on trading investments 2,000

7,100 Unrealized loss on trading investments $1,200

Realized loss on trading investments 400 1,600

$5,500 Please note that it would not be wrong to combine realized gains and losses for a specific category of investments for presentation purposes

(b) KAKISA FINANCIAL CORPORATION

Statement of Financial Position (Partial)

December 31, 2016

Current assets

Trading investments $35,200

Income Statement (Partial) Year Ended December 31, 2016

Other revenue

Realized gain on trading investments ($1,600 + $100) $1,700 Dividend revenue 1,200

2,900 Other expense

Unrealized loss on trading investments 5,200

(a)

Debt Securities Quantity

Government of Canada

Equity Securities Quantity

on the income statement

The equity securities would be carried at fair value of $482,000 The portfolio of equity securities would be classified as a current asset An unrealized gain of

$47,000 ($482,000 – $435,000) would appear under other revenues and expenses

on the company’s income statement

PROBLEM 12-4A

Expenses and Losses Profit

(b) Under IFRS, Lai could have accounted for the bonds using the fair value through

profit or loss model and the following transaction would change:

Statement of Financial Position Income Statement Assets Liabilities

Shareholders’

Equity

Revenues and Gains

Expenses and Losses Profit

(c) Under ASPE, using the cost model to account for investment in associates is an

allowed alternative if the fair value of the investment is not known Under these

circumstances, the following transactions would change:

Statement of Financial Position Income Statement Assets Liabilities

Shareholders’

Equity

Revenues and Gains

Expenses and Losses Profit

PROBLEM 12-5A

(a) No significant influence

Jan 1 Long-Term Investments 1,800,000

Cash 1,800,000 Mar 15 Cash (100,000 × $0.50) 50,000

Dividend Revenue 50,000 June 15 Cash (100,000 × $0.50) 50,000

Jan 1 Investment in Associates 1,800,000

Cash 1,800,000 Mar 15 Cash (100,000 × $0.50) 50,000

Investment in Associates 50,000 June 15 Cash (100,000 × $0.50) 50,000

Investment in Associates 50,000

Sept 15 Cash (100,000 × $0.50) 50,000

Investment in Associates 50,000 Dec 15 Cash (100,000 × $0.50) 50,000

Investment in Associates 50,000

PROBLEM 12-6A

PROBLEM 12-6A (Continued)

(c) Several factors should be examined to determine whether one company can exercise significant influence over another Although an ownership interest of 20%

or more implies significant influence, this is just a rule of thumb Other factors should be taken into consideration One factor would be the presence of a member

of the investor’s management on the investee’s board of directors A second factor

to be considered would be whether or not the investor influences the investee’s policy-making process Third, the presence of material transactions between the investor and investee might indicate significant influence Fourth, there is an exchange of managerial personnel Fifth, the investor is providing key technical information to the investee Another consideration is the distribution of the investee’s common shares That is, are the investee’s shares widely held or owned

by relatively few shareholders? If someone owns 20% of the outstanding shares and none of the shareholders holding the other 80% owns more than 1% of the shares there is probably significant influence, but if there is only one other shareholder who owns 80%, there may not be significant influence

(d) Cost model

Jan 1 Long-Term Investments 1,800,000

Cash 1,800,000 Mar 15 Cash (100,000 × $0.50) 50,000

Dividend Revenue 50,000 June 15 Cash (100,000 × $0.50) 50,000

Dividend Revenue 50,000 Sept 15 Cash (100,000 × $0.50) 50,000

Dividend Revenue 50,000

Dec 15 Cash (100,000 × $0.50) 50,000

Dividend Revenue 50,000

PROBLEM 12-6A (Continued)

(e) ASPE is a set of standards developed for use primarily by private companies Private companies are more likely to invest in other private companies and the shares of such companies do not trade actively on public stock exchanges It is therefore more common for private companies to have difficulty reporting investments at fair value because such values are not readily obtained So, if fair value cannot be determined, ASPE allows the use of the cost method Under ASPE, companies can choose to use the cost model rather than the equity method to account for investments subject to significant influence if the fair value of the shares

is not known Private companies often have few users and the information provided

by the equity method may not relevant

(f)

No Significant Influence

Significant Influence Cost Model

(a) Under situation 1, it is unlikely that significant influence has been achieved as the percentage of Hat’s total shares outstanding that is held by CT Inc is too low at 12.5% (25,000 ÷ 200,000 = 12.5% ownership)

Situation 1 Statement of Financial Position:

Long-term investments:

30 Investment in Associates 201,250 Revenue from Investment in Associates

($575,000 × 35%) 201,250

PROBLEM 12-7A