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Self Study Quiz 17 With Answers

Self Study Quiz 17 With Answers

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Chapter 17 Self-Study Quiz with Answers
ANALYSIS OF MULTIPLE-CHOICE TYPE QUESTIONS
1.(L.O. 1) An investor purchased bonds with a face amount of $100,000 betweeninterest payment dates. The investor purchased the bonds at 102, paid incidentalcosts of $1,500, and paid accrued interest for three months of $2,500. Theamount to record as the cost of this long-term investment in bonds is:a.$100,000.b.$102,000.c.$103,500.d.$106,000.Explanation:The cost is determined as follows:Purchase price (102% x $100,000 par)$ 102,000Incidental costs to acquire1,500Total acquisition cost of investment$ 103.500The cost of an investment includes its purchase price and all incidental costs to acquirethe item, such as brokerage commissions and taxes. Any accrued interest is to berecorded by a debit to Interest Receivable or by a debit to Interest Revenue; it is
not
anelement of the investment’s cost. Accrued interest increases the cash outlay to acquirean investment but does not increase the investment’s cost. (Solution
=
c.)2.(L.O. 1) Refer to the facts in Question I above. The amount of cash outlayrequired toacquire the investment is:a.$100,000.b.$102,000.c.$103,500.d.$106,000.Explanation:The amount of cash required to acquire the investment is determined asfollows:Purchase price (102% x $100,000 par)
$
102,000Incidental costs to acquire1,500Total acquisition cost of investment103,500Accrued interest for three months2,500Total cash required to acquire investment$~106 ~,QQQ(Solution
=
d.)3.(L.O. 1) When an investor’s accounting period ends on a date that does notcoincide with an interest receipt date for bonds held as an investment, theinvestor must:a.make an adjusting entry to debit Interest Receivable and to credit InterestRevenue for the amount of interest accrued since the last interest receiptdate.b.notify the issuer and request that a special payment be made for theappropriate portion of the interest period.c.make an adjusting entry to debit Interest Receivable and to credit InterestRevenue for the total amount of interest to be received at the next interestreceipt date.d.do nothing special and ignore the fact that the accounting period does not
 
coincide with the bond’s interest period.
Approach:
Think of the requirements of the accrual basis of accounting: revenues areto be recognized when they are earned and expenses are to be recognized (recordedand reported) when they are incurred. Interest is earned by the passage of time and isusually collected after the time period for which it pertains. Thus, to comply with therevenue recognition principle, an adjusting entry is necessary to record the accruedrevenue (revenue earned but not yet received). (Solution
=
a.)4.(L.a. 1) The market value of Security A exceeds its cost, and the market value oSecurity B is less than its cost at a balance sheet date. Both securities are heldas investments in debt securities; Security A is classified as trading and SecurityB is classified as available-for-sale. How should each of these assets be reportedon thebalance sheet?SecurityASecurity Ba.Market valueMarket valueb.Amortized costAmortized costc.Amortized costMarket valued.Market valueAmortized cost
Approach and
Explanation: Mentally review the accounting requirements for debtsecurities. They are summarized in Illustration 17-I. Investments in debt and equitysecurities classified as trading or available-for-sale are to be reported at fair value.Market value, if one is available, is used as a measure of fair value. Investments in debtsecurities classified as held-to-maturity are to be reported at amortized cost. (Solution=a.)5.(L.a. 1) At December 31, 2006, Bithlo Corporation reported the following for itsportfolio of investment in marketable debt securities:Investment in bonds, at cost
$
400,000Less securities fair value adjustment39,000$361 .000At December 31, 2007 the market value of the portfolio was $389,000. The costremained at $400,000. Under what circumstances would Bithlo report a $28,000credit on its income statement for 2007 as a result of the increase in the marketprice of the investment in 2007?a.When the security is classified in the trading category.b.When the security is classified in the available-for-sale category.c.When the security is classified in the held-to-maturity category.d.No circumstances would call for such a credit of $28,000 on the 2007income statement.Approach and Explanation: Quickly review the guidelines in accounting for aninvestment in debt securities; they are:Trading category: Report at fair value on the balance sheet. Changes in fair valueare reported on the income statement.Available-for-sale category: Report at fair value on the balance sheet. Changes infair value are reflected in a separate component of stockholders’ equity rather than as a component of income.Held-to-maturity category: Report at amortized cost on the balance sheet.Changes in fair value are ignored. (Solution
=
a.)
 
6.(L.O. 3) ABC Studios holds four available-for-sale equity securities at December 31,2007. They are all classified as long-term investments. All securities werepurchased in2007. The portfolio of securities appears as follows at December 31, 2007:CostMarket ValueDifferenceBarbara Walters Corp.$100,000
$
80,000 $(20,000)Harry Reasoner Corp.220,000230,000 10,000David Brinkley Corp. 210,000150,000 (60,000)Hugh Downs Corp. 140,000145,000 5,000Totals$670.000$605,000 $(65.000)Assuming the decline in the market value of David Brinkley Corp. stock isconsidered to be other than temporary, the amounts of realized loss andunrealized loss to report as a component of net income for the year endingDecember 31, 2007 are:
Realized LossUnrealized Loss
a.$60,000$5,000b.$60,000$0c.$0$65,000d.$0$60,000Explanation: A decline in fair value that is other than temporary is referred to as an
impairment.
Regardless of the category in which the security is classified, the securityis written down to fair value. The amount of the writedown is accounted for as
a
realizedloss and, therefore, included in net income. The fair value at the date of writedown isused as a new cost basis for the security. Temporary changes in the fair value of securities in the available-for-sale category are reflected as a component of other comprehensive income and in a separate stockholders’ equity account rather than acomponent of net income. Thus, the $60,000 reduction in market value of David BrinkleyCorp. stock is recorded as an impairment (charge to the income statement as a realizedloss) and the remaining net unrealized loss [($20,000)
+
$10,000
+
$5,000
=
($5,000)] isreported as a component of other comprehensive income and as a separate componentof stockholders’ equity and not a component of net income. (Solution =b.)TIPIf the same facts above were for securities classified in the tradingcategory, the answer would be nau because the temporary changes ui fair value of a trading portfolio are recognized as an element of net income7.(L.O. 3) During 2006, Colquitt Company purchased 4,000 shares of EichneCorp. common stock for $63,000 as an available-for-sale investment. The fair value of these shares was $60,000 at December 31, 2006. Colquitt sold all of theEichner stock for $17 per share on December 3, 2007, incurring $2,800 inbrokerage commissions. Colquitt Company should report a realized gain on thesale of stock in 2007 of:a.$8,000.b.$5,200.c.$5,000.d.$2,200.
Explanation:
The gain is computed as follows:Selling price ($17 x 4,000 shares)
$
68,000Cost of salecommissions(2,800)Net proceeds (or net selling price)65,200Cost63,000Realized gain on sale$ 2,200(Solution
=
d.)

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