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On January 10, 2005, Box, Inc. purchased marketable equity securities of Knox, Inc. and Scot, Inc. Box classified both securities as a noncurrent available-for-sale investments.
At December 31, 2005, the cost of each investment was greater than its fair market value. The loss on the Knox investment was considered permanent and that on Scot was considered temporary. How should Box report the effects of these investing activities in its 2005 Income Statement?

I. Excess of cost of Knox stock over its market value.

II. Excess of cost of Scot stock over its market value.

A. An unrealized loss equal to I plus II.
B. An unrealized loss equal to I only.
C. A realized loss equal to I only.
D. No Income Statement effect.

C. A realized loss equal to I only.

Permanent losses on securities available-for-sale (SAS) are recognized in earnings as if they were realized.

This is an example of conservatism. If the market value is not expected to recover, a loss is probable and therefore should be recognized in earnings.

This is in contrast to the treatment for temporary losses, which for SAS, are treated as direct reductions to owners' equity. Thus, only the loss in I. (Knox) is recognized in earnings.


At December 31, 2005, Hull Corp. had the following marketable equity securities that were purchased during 2005, its first year of operations:
Cost Market Unrealized gain (loss) Held-for-trading:
Security A $ 90,000 $ 60,000 $(30,000)
Security B 15,000 20,000 5,000
Totals $105,000 $ 80,000 $(25,000)
======== ======== ========
Security Y $ 70,000 $ 80,000 $ 10,000
Security Z 90,000 45,000 (45,000)
Totals $160,000 $ 125,000 $(35,000)
======== ======== ========
All market declines are considered temporary.

Valuation allowances at December 31, 2005 should be established with a corresponding charge against

Income Stockholders' equity
$60,000 $0
$30,000 $45,000
$25,000 $35,000
$25,000 $0

$25,000 $35,000

The $25,000 decline in value (unrealized loss) on trading securities is recognized in earnings for the year. The $35,000 decline in value (unrealized loss) on securities available for sale is recognized in owners' equity, bypassing earnings.

The reason for the difference in accounting treatment is that trading securities are held for short-term price appreciation. If the value of the trading portfolio increases or decreases, that gain or loss should be recognized in earnings consistent with the purpose for holding the investments. Securities available for sale are held for purposes other than short-term price appreciation.

Thus, the increases and decreases in the portfolio market value may not be indicative of the intent of holding the securities. Recognition in earnings each year may cause unwarranted volatility in earnings.


On December 31, 2005, Ott Co. had investments in marketable equity securities as follows:

Cost Market value Lower of cost or market
Man Co. $10,000 $ 8,000 $ 8,000
Kemo, Inc. 9,000 11,000 9,000
Fenn Corp. 11,000 9,000 9,000
$30,000 $28,000 $26,000
====== ====== ======
Ott's December 31, 2005 Balance Sheet should report the marketable equity securities as:

A. $26,000
B. $28,000
C. $29,000
D. $30,000

B. $28,000

Investments in available-for-sale securities are reported at market value under the fair value method ($28,000). The LCM method is no longer applicable to investments.


In year 1, a company reported in other comprehensive income an unrealized holding loss on an investment in available-for-sale securities. During year 2, these securities were sold at a loss equal to the unrealized loss previously recognized. The reclassification adjustment should include which of the following?
A. The unrealized loss should be credited to the investment account.
B. The unrealized loss should be credited to the other comprehensive income account.
C. The unrealized loss should be debited to the other comprehensive income account.
D. The unrealized loss should be credited to beginning retained earnings.

The unrealized loss would be credited to the other comprehensive income account to reclassify the holding loss as a realized loss in the income statement for year 2. For purposes of illustration, assume the available for sale (AFS) securities were originally purchased for $5 and that the loss during year 1 was $1. The related entries would be:
Purchase: DR. AFS Securities $5
CR. Cash $5
Year 1 End: DR. OCI (holding loss) $1
CR. AFS Securities $1
Year 2: DR. Cash $4
CR. AFS Securities $4
DR. Loss on AFS Securities $1 (Income Statement)
CR. OCI (holding loss) $1 (B/S, Accumulated OCI)
The last entry (above) reclassifies the holding loss to recognize a realized loss on sale.



An investor purchased a bond classified as a held-to-maturity investment between interest dates at a discount.
At the purchase date, the carrying amount of the bond is more than the:

Cash paid to seller Face amount of bond
No Yes
No No
Yes No
Yes Yes

Cash paid to seller Face amount of bond
No No

When a bond is purchased at a discount, the price paid is less than face value.

Note: Any cash paid to the seller for accrued interest is debited to interest receivable, not to the bond investment.

Thus, the carrying value is the portion of the total amount paid attributable to the total bond price, exclusive of accrued interest.

The carrying value must be less than the cash paid to the seller, which includes accrued interest.


For a marketable-equity securities portfolio classified as available-for-sale, which of the following amounts should be included in the period's net income?

I. Unrealized temporary losses during the period.

II. Realized gains during the period.

III. Changes in the valuation allowance during the period.

A. III only.
B. II only.
C. I and II.
D. I, II, and III

B. II only.

On available-for-sale securities, only realized gains (from sale or reclassification) are recognized in the period.
These securities are not sold for the purpose of relatively quick sale. Rather, they are held for different purposes and may be held long-term. The unrealized changes in market value are recorded in owners' equity.


On both December 31, 2003 and December 31, 2004, Kopp Co.'s only marketable equity security had the same market value, which was below cost.
Kopp considered the decline in value to be temporary in 2003 but other than temporary in 2004. At the end of both years, the security was classified as a noncurrent available-for-sale investment.

What should be the effects of the determination that the decline was other than temporary on Kopp's 2004 net noncurrent assets and net income?

A. No effect on both net noncurrent assets and net income.
B. No effect on net noncurrent assets and decrease in net income.
C. Decrease in net noncurrent assets and no effect on net income.
D. Decrease in both net noncurrent assets and net income.

B. No effect on net noncurrent assets and decrease in net income.

A permanent decline in the value of an available-for-sale security is recognized as a loss in the Income Statement (whereas nonpermanent declines are treated as reductions in owners' equity).
The security did not change in value during 2004 because the market value had not changed, thus there is no further reduction in assets. The owners' equity account would be reclassified as a loss account; thus, only income is decreased.


On October 1, 2004, Park Co. purchased 200 of the $1,000 face value, 10% bonds of Ott, Inc., for $220,000, including accrued interest of $5,000.
The bonds, which mature on January 1, 2011, pay interest semiannually on January 1 and July 1. Park used the straight-line method of amortization and appropriately recorded the bonds as held-to-maturity.
On Park's December 31, 2005 Balance Sheet, the bonds should be reported at:

A. $215,000
B. $214,400
C. $214,200
D. $212,000

D. $212,000

Held-to-maturity investments in bonds are reported at amortized cost. The discount or premium at purchase is amortized during the term of the bonds so that the carrying value is equal to face value at maturity. This is the amount to be received at maturity.
The purchase price, exclusive of accrued interest, is $215,000 ($220,000-$5,000). Accrued interest is not included in the investment carrying value. The premium paid on the bonds is $15,000 because the face value of the bonds is $200,000 (200 x $1,000). The term of holding the bonds is from October 1, 2004 to January 1, 2011, a period of six years and three months or 75 months. The period from purchase to the December 31, 2005 Balance Sheet is 15 months. Amortization of the premium reduces the investment carrying amount because only face value, which is less than the amount paid for the investment, will be received at maturity.

Therefore, the ending 12/31/05 investment carrying value is $212,000 = $215,000-($15,000/75)15.


On December 29, 2005, BJ Co. sold an equity security investment that had been purchased on January 4, 2004. BJ owned no other marketable equity security.
An unrealized loss was reported in the 2004 Income Statement. A realized gain was reported in the 2005 Income Statement.
Was the marketable equity security classified as available-for-sale (AFS), and did its 2004 market price decline exceed its 2005 market price recovery?

AFS 2004 market price decline exceeded 2005 market price recovery
Yes Yes
Yes No
No Yes
No No

AFS 2004 market price decline exceeded 2005 market price recovery
No No

The security cannot be classified as available-for-sale because the unrealized gains and losses are recognized in the Income Statement. Unrealized gains and losses on available-for-sale securities are recognized in owners' equity, not earnings.

The second part of the question is somewhat ambiguous. The 2004 price decline could exceed or be exceeded by the 2005 price recovery. The loss in the first year is not related in amount and does not constrain the realized gain in the second year.
The way to answer the question is to read the right column heading as implying that the earlier price decline must exceed the later price recovery. With that interpretation, the correct answer is no.

For example, assume a cost of $10 and a market value of $4 at the end of the first year. An unrealized loss of $6 is recognized in earnings. During the second year, the security is sold for $12. A realized gain of $8 is recognized-the increase in the market value from the end of the first year to the sale in the second year. Thus, the market decline in the first year did not exceed the recovery in year two. (It could have exceeded the recovery in year two but there is no requirement that it must.)


When the fair value of an investment in debt securities exceeds its carrying amount, how should each of the following assets be reported at the end of the year?
Held-to-maturity securities Available-for-sale securities
Fair value Carrying amount
Carrying amount Fair value
Carrying amount Carrying amount
Fair Value Fair Value

Carrying amount Fair value

Securities classified as held-to-maturity are reported at amortized cost, which is the carrying amount of the securities. Further, securities classified as available-for-sale are reported at fair value.


On January 2, 2004, Adam Co. purchased, as a long-term investment, 10,000 shares of Mill Corp.'s common stock for $40 a share.
On December 31, 2004, the market price of Mill's stock was $35 a share, reflecting a temporary decline in market price. On December 28, 2005, Adam sold 8,000 shares of Mill stock for $30 a share.

For the year ended December 31, 2005, Adam should report a loss on disposal of long-term investment of:

A. $100,000
B. $90,000
C. $80,000
D. $40,000

C. $80,000

The realized loss on the sale of available-for-sale securities is the decline in market value since the acquisition of the securities sold. The $80,000 loss equals 8,000($40-$30). The loss to the beginning of 2005 is unrealized and recorded in owners' equity.


On January 1 of the current year, Barton Co. paid $900,000 to purchase two-year, 8%, $1,000,000 face value bonds that were issued by another publicly-traded corporation. Barton plans to sell the bonds in the first quarter of the following year. The fair value of the bonds at the end of the current year was $1,020,000. At what amount should Barton report the bonds in its balance sheet at the end of the current year?
A. $900,000
B. $950,000
C. $1,000,000
D. $1,020,000

D. $1,020,000

For investments in debt securities other than those intended to be held to maturity, the fair value method is applied. $1,020,000 is the fair value of the investment in bonds and is the appropriate amount for reporting the investment.


This question has been adapted from the original AICPA question.

On January 1, 2004, Purl Corp. purchased, as a long-term investment, $500,000 face value Shaw, Inc. 8% bonds for $456,200. The bonds were purchased to yield 10% interest. Purl has the positive intent and ability to hold the bonds until maturity on January 1, 2010. The bonds pay interest annually on January 1, and Purl uses the interest method of amortization.
What amount (rounded to nearest $100) should Purl report on its December 31, 2005 Balance Sheet for this long-term investment?

A. $468,000
B. $466,200
C. $461,800
D. $456,200

A held-to-maturity (HTM) investment purchased at a discount increases in value as maturity approaches, at which time the book value of the investment must be the face value of the investment. During the life of an HTM investment the investor carries and reports the investment at amortized cost.

The interest and amortization entries for the two years 2004 and 2005 lead to the correct ending balance at December 31, 2005 are:

December 31, 2004:

Interest receivable .08($500,000) 40,000
Investment in HTM bonds 5,620
Interest revenue .10($456,200)

December 31, 2005:

Interest receivable .08($500,000)
Investment in HTM bonds
Interest revenue .10($456,200 + $5,620)

Thus, the ending investment balance at December 31, 2005 is $456,200 + $5,620 + $6,182 = $468,002, or $468,000 (rounded to the nearest $100 as required by the problem).


At the end of year one, Lane Co. held trading securities that cost $86,000 that had a year-end market value of $92,000. During year two, all of these securities were sold for $104,500. At the end of year two, Lane had acquired additional trading securities that cost $73,000 that had a year-end market value of $71,000. What is the impact of these stock activities on Lane's year two Income Statement?
A. Loss of $2,000.
B. Gain of $10,500.
C. Gain of $16,500.
D. Gain of $18,500

B. Gain of $10,500

* reduce the value by the market value at the end of 04

At the end of year one, Lane wrote the trading securities up to their fair value of $92,000. At sale, the gain recognized is, therefore, $104,500-$92,000=$12,500.
In addition, Lane had an unrealized holding loss of $73,000-$71,000=$2,000.
Together, the net impact on Lane's Income Statement is $12,500-$2,000=$10,500 gain.


Jent Corp. purchased bonds at a discount of $10,000. Jent classified the bonds as available-for-sale and subsequently sold them at a premium of $14,000. At the time of the sale, $2,000 of the discount had been amortized.
What amount should Jent report as gain on the sale of bonds?

A. $12,000
B. $22,000
C. $24,000
D. $26,000

B. $22,000

The book value at the date of sale was $8,000 below face value ($10,000 original discount-$2,000 amortization). The market value of the bonds at date of sale was $14,000 above face value ($14,000 premium). Thus, the difference between the price of the bonds at sale and the book value was $22,000 ($8,000 + $14,000). That difference is the gain on sale.


On July 1, 2004, York Co. purchased, as a held-to-maturity investment, $1,000,000 of Park, Inc.'s 8% bonds for $946,000, including accrued interest of $40,000.
The bonds were purchased to yield 10% interest. The bonds mature on January 1, 2011 and pay interest annually on January 1. York uses the effective interest method of amortization.

In its December 31, 2004 Balance Sheet, what amount should York report as investment in bonds?

A. $911,300
B. $916,600
C. $953,300
D. $960,600

A. $911,300

Initial investment cost: $946,000-$40,000 =
Interest revenue for 2004: $906,000(.10)(1/2 year) = $45,300
Less cash interest for 6 months: $1,000,000(.08)(1/2) = (40,000)
Equals amortization of discount (increases investment)
Investment in bonds balance at the end of 2004
The initial investment cost or balance excludes accrued interest. The bonds were purchased at the halfway point in the interest period. York must pay for 1/2 a year's interest, and will receive a full year's interest on January 1, 2005. The interest revenue for the year is based on the effective yield of 10%. The difference between interest revenue and the cash interest earned for the second half of 2004 is the growth in the value of the bond over time.

The book value of the bond investment at maturity will be $1,000,000. Thus, the discount amortization increases the investment carrying value each year until it reaches $1,000,000.