In contrast to bonds, equity securities can exist in perpetuity.

Therefore,

they should be valued using the equity valuation model.

they cannot be classified as held-to-maturity.

their unrealized gains and losses should not be reported in financial statements.

they cannot be classified as FV-NI.

Solution

Obviously, if a security has no maturity date, then the classification "Held-to-maturity" is not
appropriate.

Accounting for investments usually requires them to be recognized and measured initially at their fair
value at acquisition. When a financial instrument is measured at fair value, after acquisition changes in
its fair value carrying amount are called unrealized holding gains or losses. The change in value is
unrealized because it has not been converted to cash or a claim to cash—the asset is still held by the
entity. Such gains and losses are only realized when the asset is disposed of. Unrealized holding gains
and losses may be separately identified from realized gains and losses on the financial statements.

Where fair value is used, the unrealized gains and losses are booked either to net income (FV-NI) or to
OCI (FV-OCI.

What is one reason a company might invest in equity instruments and not debt instruments?

to exercise its rights to influence and/or control

for the guaranteed returns

short-term trading for profit

debt instruments are higher risk

Solution

Companies have different motivations for investing in debt and equity instruments issued by other
companies:

One motivation is the returns provided by investments: term deposits (debt securities) provide interest
income while shares in another company (equity securities) provide the opportunity of capital
appreciation. Another differentiating factor is the element of risk: some types of investments provide
guaranteed returns (such as term deposits), while others are riskier (such as investments in shares of
other companies). Other investments (equity investments) are made so that the investor can exercise its
rights to influence or control the operations of the other company, the investee, and are not undertaken
for the short-term.

JT Engineering purchases $400,000 in bonds for $420,000. If JT intends to hold the securities to maturity,
which of the following must it include in the entry to record the investment?

A debit to Bond Investment for $420,000.

A debit to Bond Investment for $420,000 and a credit to Interest Payable for $20,000.

A debit to Bond Investment for $400,000 and a debit to Premium on Bond Investment for $20,000.

A debit to Bond Investment for $420,000 and a credit to Interest Expense for $20,000.

Solution

When the cost model is applied to an investment in debt instruments (and long-term notes and loans
receivable), it is called the amortized cost model. This is because any difference between the acquisition
cost recognized and the face value of the security is amortized over the period to maturity. Recognize
the cost of the investment at the fair value of the debt instrument acquired (or the fair value of what
was given up to acquire it, if a more reliable measure). Amortization of the premium or discount will be
recorded directly against the cost at acquisition to reduce or increase the cost so that by maturity, the
cost will equal the face value of the bond.

Your answer is correct.

Which of the following is a requirement for classifying a security as amortized cost?

The security must not be an equity security.

The ability to hold the security to maturity.

The positive intent to hold the security to maturity.

All of the choices are correct.

Solution

The amortized cost model applies only to investments in debt instruments and long-term notes and
loans receivable. Investments in debt securities accounted for under the amortized cost model are
sometimes called held to maturity investments. This is because any difference between the acquisition
cost recognized and the face value of the security is amortized over the period to maturity. Because the
decision to acquire and hold the investment is usually based on its yield on the date when it is
purchased, the yield rate is also the most appropriate rate to measure periodic income over the term
that the investment is held. To achieve this yield the security must be held until maturity.

Why should investments that are purchased for short-term trading be reported at fair value on the
statement of financial position and any unrealized gains and losses from these securities reported in net
income?

in order to provide existing and prospective shareholders with more relevant information

in order to lower the amount of taxes paid on income

in order to decrease the volatility of capital

in order to simplify the preparation of financial statements

Solution

A held-for-trading security is a debt or equity investment that investors purchase with the intent of
selling within a short period of time, usually less than one year. These securities can generate a profit
from short-term price changes. They are short-term assets, and their accounting reflects that fact; the
value of these investments is reported at fair value, and unrealized gains and/or losses are included as
earnings. This provides benefits for users of financial statements: relevance, reliability and
comparability.

The use of fair value accounting reflects current information regarding the value of assets and liabilities
on the statement of financial position. Prevailing prices are considered to be reliable measures of value.
Further, profits defined on a fair value basis rather than a historical cost basis accelerate the recognition
of gains, particularly in periods of rising asset prices. By reflecting more current information, fair value
accounting is argued to be more relevant for decision making.

The other options do not represent outcomes of the fair value methodology.

On October 18, 2019, Hammons Restaurants purchased 8,000 shares of Bronson Food Distributors for
$30 per share. They classified the investment as FV-NI. On December 6, Hammons sold 2,000 shares for
$35 per share. On December 31, 2019, the market price of Bronson’s shares was $28 per share. What
would Hammons Restaurants report as a gain/(loss) related to their Bronson investment on their
December 31, 2019 income statement?

$(2,000)
$10,000

$(6,000)

$(16,000)

Solution

Hammons will have a realized gain of 2,000 x ($35 – $30) = $10,000. They will also have an unrealized
loss of (8,000 – 2,000) x ($28 – $30) = $12,000. Therefore, they will have a net loss of $12,000 – $10,000
= $2,000.

On January 1, 2019, Partin Enterprises purchased $100,000 of 8%, 5-year bonds from Nemeth Industries
for $104,158, giving an effective interest rate of 7%. They classified the bonds as FV-OCI. Interest on the
bonds is payable on July 1 and January 1, and they use the effective interest method to amortize the
bond premium. On July 1, 2019 and December 31, 2019, Partin Enterprises decreased the FV-OCI
Investments account for the Nemeth bonds by the amortized premiums of $354 and $366, respectively.
If the fair value of the bonds was $106,000 on December 31, 2019, what should Partin report as other
comprehensive income related to the bonds?

$2,562.

$1,842.

$720.

$zero; the entry would be to net income.

Solution

After reducing the carrying value after amortization of the premiums, the bonds would have a book
value of $104,158 – $354 – $366 = $103,438. If the fair value is $106,000, Partin should report
comprehensive income of $106,000 – $103,438 = $2,562.

With FV-OCI securities unrealized holding gains and losses are reported through other comprehensive
income. It is only upon disposal of the security that realized gains and losses are recycled to net income.

On June 30, 2019, Brownlee Insulation received a $4,618 cash dividend from FV-OCI securities they held.
In which account would they record the credit for this transaction?

Other Comprehensive Income

Dividend Revenue

Gain from Investments

Retained Earnings
Solution

Dividend income from FV-OCI equity investments is reported directly in net income as dividend revenue.

Using the incurred loss impairment model, an investment is impaired if its carrying

amount is higher than its estimated realizable value.

Solution

To measure the investment's estimated realizable value under the incurred loss impairment model: find
the highest of the following:

1. present value of the revised amounts and timing of the future cash flows, discounted at the current
market rate, or

2. the amount that would be realized if the asset were sold, or

3. the amount that would be realized if the entity called the financial asset (for instance a loan) and took
any collateral that it had rights to.

The impairment loss is the difference between this amount and the instrument's carrying amount.

Which impairment model is best to use for FV-NI investments?

incurred loss

fair value loss

No model needs to be used.

expected loss

Solution

Under an expected loss impairment model, estimates of future cash flows used to determine the
present value of the investment are made on a continuous basis and do not rely on a triggering event to
occur. So the best impairment model to use for FV-NI investments is the fair value loss model because
FV-NI investments are continually revalued to fair value with all gains and losses booked to net income.

Why does the equity method not use the payment of dividends as its basis for recognizing an investee’s
income?

Payment of dividends is not always proportional to the investee’s net income or net loss and thus does
not truly reflect the investor’s proportional increase or decrease in the investment value.
In years when the investee has a net loss but still pays dividends, recording an increase in revenue based
on dividends fails to account for the true economy of the situation.

In years when the investee does not pay dividends, the investor company would be forced to report
their change in the value of the investment based on changes in fair market value rather than the net
worth of the company.

The investor is financially liable for the investee, and simply recording payment of dividends as a basis
for recognizing income fails to account for this liability.

Solution

One of the benefits of the equity method is that the investor's income statement reports the economics
of the situation: if the associate performs well, the investor's income statement reflects positive
investment income. If the associate incurs losses, the investor's income statement reflects its share of
the loss. Like interest, dividends are a return on the investment and are not reflective of the change in
value of the investment.

How much influence would an investor company have over the investee company if the investor holds
more than 20% of the investee company’s shares but owns less than 50% of its shares?

controlling

minimal

none

significant

Solution

Although an equity interest of less than 50% of an investee corporation does not give an investor legal
control, it might give an investor significant influence over the investee's strategic policies. To ensure
that the significant influence criterion is applied in a reasonably consistent manner, the standard setters
concluded that an investment (direct or indirect) of 20% or more of the voting shares of another
company should lead to a presumption that, unless there is evidence to the contrary, an investor can
exercise significant influence over an investee.

When a corporation acquires more than 50% voting interest in another corporation, they always have
controlling interest.

True

False
Solution

Control is assumed when the investor owns more than 50% of the voting shares of another company.
This is because it holds a majority of the votes at the board of directors' meetings of the investee
company, and therefore, the investor's management controls all the subsidiary's net assets and
operations.

However, based on the standards' definitions of control, sometimes an entity with less than 50% of the
voting shares can have control, while an entity with more than 50% sometimes may not have control.
Considering complex modern business relationships, standard setters realize that this test is too
artificial, and that determining who really has control is often based on factors other than share
ownership.

A company owns 90% of another company’s outstanding shares. How should the parent company
account for the subsidiary’s income in this situation?

using the cost method

Each of the subsidiary’s revenue and expense items is combined individually with that of the parent
company.

using the fair value method

using the equity method

Solution

When preparing IFRS statements, an investor with subsidiaries is required to present consolidated
financial statements for the group of companies under its control. In other words, the investor
eliminates the investment account and instead reports all the assets and liabilities of the subsidiary on a
line-by-line basis. Under ASPE, this is a permitted, but not required, option.

Your answer is correct.

A reconciliation between the opening and closing balances in the impairment allowance account is
required by

both IFRS and ASPE.

ASPE only.

IFRS only.

neither IFRS nor ASPE.

IFRS requires a reconciliation between opening balances in the impairment allowance and closing
balances.

Consolidated financial statements sometimes cause problems for analysts because the consolidated
income statement includes only the income earned by the subsidiary from the date of acquisition
onward.

True

False

Solution

While consolidated financial statements reflect the combined operations of the economic entity,
important information is lost through aggregating the parent's results with those of its subsidiaries.
Analysts must watch for major acquisitions during the current or previous year. The statement of
financial position contains all the assets of the subsidiary, but the income statement includes only the
income earned by the subsidiary after it was acquired by the parent. Any analysis that looks at
relationships between income and assets has to adjust for major acquisitions in the period(s) being
examined.

IFRS permits three measurement models for investments with no significant influence or control.

Solution

For investments with no significant influence or control, IFRS permits three measurement models:

1. amortized cost (for debt instruments where the business model requires holding to maturity),

2. FV-OCI with no recycling (for certain equity instruments only) and FV-OCI for debt securities with
recycling where the business model includes both holding to maturity and holding for sale (depending
on the security and the circumstances), and

3. FV-NI for everything else.

ASPE permits only two measurement models:

1. FV-NI (for equity investments that trade in an active market, derivatives, and those accounted for
under the fair value option), and

2. cost/amortized cost (everything else).

When comparing the accounting rules for equity investments that are between 20% and 50% of the
investee’s total outstanding common shares, the standards set by ASPE are Choose your answer here

different from

the standards set by IFRS.

Solution

IFRS requires companies with significant influence (between 20% and 50% ownership) to use the equity
model.

ASPE allows an accounting policy choice of the equity method or the cost method. If shares are quoted
in an active market, cannot use cost model; may use FV-NI.

Your answer is correct.

Company A invests in Company B, which gives it contractual rights to declared dividends, voting rights,
and rights to residual assets upon windup of the company. This is an investment in a(n) Choose your
answer here

equity

instrument.

Solution

This is an investment in an equity instrument because shares carry contractual rights to the residual
assets of the entity upon windup, rights to dividends, and voting rights. Company A purchased shares in
Company B.

he type of accounting for debt securities can depend on

management intent and company strategy.

percentage of shares purchased.

the fair value of the investment.

All of the choices are correct.

How investments are accounted for can depend on the type of instrument, management's intent,
company strategy, and the ability to reliably measure the investment's fair value.

Debt securities, whose prices are normally quoted in an active market, include investments in
government and corporate bonds, convertible debt, and commercial paper. Debt instruments generally
have contractual requirements regarding repayment of principal and payment of interest. Equity
instruments, on the other hand, generally represent ownership interests. There are no ownership
requirements to invest in debt securities. As well the only role that fair value plays in determining the
type of accounting for debt securities is the ability to reliably measure the fair value at acquisition.

Your answer is correct.

A company that has its common shares purchased by another company is called a(n)

lender.

investor.

investee.

owner.

Solution

An investor is a person or organization that puts money into financial plans, property, etc. with the
expectation of achieving a profit. The investee is the person or organization that receives the money.

An investee is a company that has

purchased another company’s bonds.

had its common shares purchased by another company.

had its bonds purchased by another company.

purchased another company’s common shares.

Solution

Companies may invest in common shares of other companies because they want to have a special
relationship with a supplier or customer, such as being able to access certain distribution channels or a
supply of raw materials. Other investments are made so that the investor can exercise its rights to
influence or control the operations of the other company, who is called the investee. The intent with
these strategic investments is usually to establish a long-term operating relationship between the two
entities.

An equity instrument

includes the right to earn interest on the maturity date.

represents the investor as a creditor.

includes rights to the residual assets upon liquidation.

includes the transaction costs in its initial fair value.

Solution

Companies that invest in debt instruments of another entity are creditors of the issuing company. When
a company invests in debt instruments, it usually pays cash upfront and obtains the rights to receive
interest and the return of principal at a later date.

Equity instruments, on the other hand, generally represent ownership interests. When a company
purchases equity instruments, it pays cash upfront and receives various rights, which may include rights
to dividends, voting rights, and rights to residual assets upon liquidation. Accounting for investments
usually requires them to be recognized and measured initially at their fair value at acquisition. For assets
accounted for using a fair value model, it makes more sense to expense the transaction costs because
the fair value of an asset is its market price.

How should an unrealized holding gain on a company’s investments in equity securities be reported in
the current financial statements, if the securities were not purchased for short-term trading?

As a current gain resulting from holding securities.

As a note or parenthetical disclosure only.

As an extraordinary item shown as a direct increase to retained earnings.

As other comprehensive income and included in the equity section of the statement of financial
position.

Solution
At acquisition, the investment is recognized at fair value plus transaction costs. At each reporting date,
the investment is revalued to its current fair value, with the holding gains or losses reported in other
comprehensive income. On disposal, the accumulated holding gains or losses are transferred directly to
retained earnings (equity securities).

ASPE does not allow this method. IFRS 9 allows this method for certain equity investments and debt
securities where the business model is achieved by both holding to maturity and selling (depending on
the investment and circumstances).

Herbst Enterprises purchased equity securities in 2019 and classified them as FV-OCI. They reported an
unrealized gain in 2019 and an additional unrealized gain in 2020. They decide to sell the securities in
2021 for $28,000 more than the fair value recorded in 2020. Based on this, Herbst needs to

report the realized gain as dividend revenue.

report the realized gain under other comprehensive income.

transfer the previously unrealized gains on the securities they sold directly into retained earnings.

restate the 2019 and 2020 financial reports to change the unrealized gains to realized gains.

Solution

At acquisition, a FV-OCI investment is recognized at fair value plus transaction costs. At each reporting
date, the investment is revalued to its current fair value, with the holding gains or losses reported in
other comprehensive income. On disposal, the accumulated holding gains or losses are either recycled
to net income (debt securities) or transferred directly to retained earnings (equity securities).

How are unrealized gains and losses reported on a portfolio of FV-OCI securities?

individually, only

by totals, separated between debt and equity securities

one total for the whole portfolio of investments, only

as one total for the whole portfolio or individually

Quinn is journalizing the unrealized holding losses on securities. In doing so, she enters a debit to
Unrealized Gain or Loss—OCI and a credit to FV-OCI Investments. This entry indicates that the loss was
realized on securities which, when purchased, were classified as
either held for sale or expected to be held to maturity.

held for sale only.

held to maturity only.

neither held for sale nor expected to be held to maturity.

Solution

Under the current IFRS, FV-OCI with no recycling can be used for certain equity instruments only and FV-
OCI for debt securities with recycling can be used where the business model includes both holding to
maturity and holding for sale (depending on the security and the circumstances), FV-OCI does not exist
under ASPE.

When journalizing an unrealized holding loss on FV-OCI debt securities, how and where should a
company record the loss?

as a debit to Unrealized Gain or Loss—OCI and a debit to FV-OCI Investments

as a debit to Unrealized Gain or Loss—OCI and a credit to FV-OCI Investments

as a credit to Unrealized Gain or Loss—OCI and a credit to FV-OCI Investments

as a credit to Unrealized Gain or Loss—OCI and a debit to FV-OCI Investments

Solution

At each reporting date, the carrying amount of each FV-OCI investment is remeasured and adjusted to
its current fair value. As the name of the model implies, the changes in fair value—the holding gains and
losses—are recognized in other comprehensive income net of income tax.

A holding loss means the fair value of the investment is lower than the carrying value. An entry needs to
be made to decrease the carrying value of the investment, or a credit to FV-OCI Investments. The offset
is to the other comprehensive income account: Unrealized Gain or Loss--OCI.

Which of the following IFRS requirements came about due to the increased volatility of capital
introduced by recognizing gains and losses on assets but not liabilities?

recording unrealized holding gains and losses on securities that are available for sale as net income
rather than other comprehensive income
accounting for securities that are expected to be held to maturity at fair value rather than amortized
value

accounting for securities that are expected to be held to maturity at amortized value rather than fair
value

recording unrealized holding gains and losses on securities that are available for sale as other
comprehensive income rather than net income

Solution

When unrealized gains or unrealized losses are recognized in income it affects the net income of the
Company, even though the gains and losses have not been "earned". Any gains would increase net
income which means they also increase earnings per share and retained earnings. Unfortunately, in a
volatile market, gains would likely be temporary with net income overstated during that time. As net
income is often used to measure performance, by reporting results in other comprehensive income it
removes any unearned revenues from net income.

On January 1, 2019, Bravo Industries purchased $900,000 of 8% bonds from RL Enterprises. The bonds
are classified as FV-OCI. Bravo paid $937,422 for the bonds, which will mature January 1, 2024. Interest
on the bonds is payable each July 1 and January 1. The effective interest rate on the bonds is 7%. On
December 31, 2019, the fair value of the bonds was $954,000. How much other comprehensive income
should Bravo report?

$6,480.

$16,578.

$0.

$23,058.

Solution

The fair value increased by ($954,000 - $937,422) = $16,578. In the FV-OCI model, interest and
amortization are recognized directly in net income, not in OCI.

Which of the following is true of debt securities that are accounted for by recognizing unrealized holding
gains or losses as other comprehensive income?

They can be classified as securities held to maturity only.

They can be classified as both held to maturity and held for sale securities.

They can be classified as securities held for sale only.

Solution

Under IFRS, FV-OCI for debt securities with recycling is used where the business model includes both
holding to maturity and holding for sale securities (depending on the security and the circumstances).

The failure by a bond issuer to make scheduled payments on time is a Type your answer here

trigger

event that might indicate to the bondholder that the bond is impaired.

Solution

To recognize an incurred loss impairment, entities look for objective evidence that there has been a
significant adverse change in the period in the expected amount of future cash flows, or in the timing of
those cash flows. These events are called trigger events or loss events. Examples of situations that might
indicate impairment include the fact that the entity that issued the debt or equity instrument: is
experiencing significant financial difficulties; has defaulted on, or is late making, interest or principal
payments; is likely to undergo a major financial reorganization or enter bankruptcy; or is in a market
that is experiencing significant negative economic change.

Using the expected loss impairment model, how overdue must a principal or interest payment be before
it can be concluded that the investment carries a significantly increased credit risk?

30 days

6 months

one year

60 days

Solution

As a general rule, there is a significant increase in credit risk when principal or interest payments are
more than 30 days past due (unless the entity has evidence to the contrary). Credit risk may also have
increased significantly even before the debtor defaults on payments. Factors to consider include
decreased sales, profit, or cash flows, worsening economy, breach of covenants, and risk of default.

Your answer is correct.

True

False

Solution

Under an expected loss impairment model, estimates of future cash flows used to determine the
present value of the investment are made on a continuous basis and do not rely on a triggering event to
occur. This model provides more objective information because the assessment of a trigger or loss event
can be very subjective.

BeeJay Company has purchased a $500,000 bond issued by TeePee Inc., at par. BeeJay carries the bond
at cost and estimates that they might eventually collect only 90% of the bond’s face value. Although
there has been no significant increase in credit risk, there is a 1% chance that TeePee will default during
the coming year. What impairment loss will BeeJay record using the expected loss impairment model?

$500

Nothing

$5,000

$50,000

Solution

Under IFRS 9, a company must determine whether the credit risk has significantly increased. If not, then
a 12-month time frame can be used for assessing defaults. Otherwise, it must consider defaults over the
lifetime of the investment. The company must also consider a probability-weighted range of outcomes.
So the impairment loss would be $500,000 x (1.0 - 0.9) x 1% = $500.

Your answer is correct.

Which of the following statements regarding impairment models is true?

The incurred loss model is used under ASPE; the expected loss model is used under IFRS 9; and the fair
value loss model is used under both ASPE and IFRS.

All three impairment models are used under both ASPE and IFRS 9.
The expected loss model is used under ASPE; the incurred loss model is used under IFRS; and the fair
value loss model is used under both ASPE and IFRS.

The expected loss model is used under ASPE; the fair value loss model is used under IFRS; and the
incurred loss model is used under both ASPE and IFRS 9.

Solution

Models used under ASPE

Incurred loss: Used for all investments measured at cost/amortized cost.

Reduce carrying value to the higher of the discounted cash flow (discounted using the current market
interest rate) and net realizable value (either through sale or by exercising the entity's rights to
collateral).

May use an allowance account or reduce carrying value directly.

Impairment losses may be reversed.

Fair value loss: Used for all investments accounted for as FV-NI.

No need to do a separate impairment test because the assets are continually revalued to fair value with
gains and losses booked to net income.

Models used under IFRS

Expected loss: Used for all investments carried at cost/amortized cost as well as debt investments
carried at FV-OCI.

Must determine whether the credit risk has significantly increased. If not, use a 12-month time frame for
assessing defaults. Otherwise, consider defaults over the lifetime of the investment.

Must consider a probability-weighted range of outcomes and the time value of money using the
historical rate.

Based on information that is reasonable, supportable and available without undue cost.

Fair value loss: Used for all investments accounted for as FV-NI.

No need to do a separate impairment test because the assets are continually revalued to fair value with
gains and losses booked to net income.

Impairment losses on equity investments accounted for at FV-OCI are not recycled to net income so
impairment testing is not done.
If a corporation reports its investments in equity securities by recognizing unrealized holding gains or
losses as other comprehensive income and dividends in net income, the securities are likely

securities in which the company has holdings of between 20% and 50%.

FV-OCI securities in which the company has holdings of less than 20%.

securities in which the company has holdings of more than 50%.

FV-NI securities in which the company has holdings of less than 20%.

Solution

At initial recognition an entity may designate an investment in an equity instrument as FV-OCI, unless
the asset is held for trading. Under this option, only qualifying dividends are recognized in profit and
loss. Changes in fair value are recognized in OCI and never reclassified to profit and loss. This applies to
equity investments where there is no significant influence or control.

If an FV-OCI debt security is purchased at a discount, which of the following should be included in the
entry to record the amortization of the discount?

a debit to the Discount on Investments account

a credit to FV-OCI Investments

a debit to FV-OCI Investments

a debit to Interest Income

Solution

If a debt security is purchased at a discount, the initial entry to record the purchase would record the
investment as a debit to FV-OCI Investments at the discounted value (there is no Discount on
Investments account). Subsequently, at every interest entry, the amortization amount would be added
to the carrying amount to bring it to face value at maturity. Therefore, the entry would include a debit
to FV-OCI Investments.

A discount causes the effective interest rate to be higher than the stated rate, so the interest revenue is
more than the interest received--a debit to Interest Income would reduce it.

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