Handout Martin Corporation in Accounting

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Handout Martin Corporation in Accounting Powered By Docstoc
					             Financial Accounting: Assets
                          FA2
                       Module 8

                                  Handouts

                         Investments and
                      Financial instruments


                           Presented by:
                         Laura Dallas, CGA




    Note: this information is prepared from the best information I have available to me.
 Also, please note, that I am human, and I have checked over all details for accuracy as
                                     much as possible.
If there are any discrepancies between the handout documents and the module notes or
           textbook, the module notes & textbook are to be considered correct.




2009/2010                        FA2 Handouts Module 8                        Page 1
                             FA2 Past Exams 2004 – 2009
                                 Module 8 questions
Exam      Question   Marks     Topic                                Subject
2009 06      2         8         8        Accounting for investments
2009 03      6        13         8        Accounting for investments
2008 12      3        10         8        Accounting for investments
2008 06      7        10         8        Accounting for investments
2008 03      8        10         8        Investments and present value calculations
2007 12      5        18         8        Accounting for investments and computing present values
2007 06      4         6         8        Accounting for long-term investments
2006 12      6         9         8        Investments
2006 06      2        11         8        Long-term investments
2005 12      3         9         8        Temporary investments
2005 06      6         8         8        Goodwill, equity method
2005 03      5         5         8        Long-term investments


**NOTE* There were significant GAAP changes in 2006 & 2007 for
investments.

The past exams are in the format from when they were distributed. Be careful
– for certain topics, the solutions for the OLD past exams may NOT be
correct to today’s standards.


The practice exam available is a past exam UPDATED to current materials.




2009/2010                            FA2 Handouts Module 8                                          Page 2
OLD Practice Exam (from 2007 – 2008 course materials)
5       Question 3
                   On January 1, 2004, Gostski Enterprises acquired a 20% ownership in Margo
                   Limited for $698,000 cash. For the year ended December 31, 2004, Margo
                   earned net income of $88,000 and paid cash dividends of $15,000.

                     Required
            2        a.    Assume Gostski adopts the differential reporting option available to it and
                           reports its significant influence investment in Margo on a cost basis.
                           Calculate the investment income to be reported by Gostski for the year
                           ended December 31, 2004.

            3        b.    Assume Gostski uses the equity method to report its significant
                           influence investment in Margo. Calculate the balance in the investment
                           account on December 31, 2004.




6       Question 4
                     Northern Services Limited invests its excess cash in financial instruments
                     which it designates as available-for-sale (AFS). The following information is
                     available for the months of October and November. Northern’s year end is
                     October 31.
                                                           October 31              November 30
                                                        Cost      Fair value      Cost Fair value
                     Shares MM                       $32,000        $30,000         —            —
                     Shares NN                        44,000         45,000    $44,000     $42,000
                     Shares OO                            —              —      25,000       27,000
                     Shares PP                        21,000         20,000     21,000       22,000
                     The investments in shares of MM, NN, and PP were all purchased in October.
                     The investment in shares of MM was sold on November 9 for $29,000, while
                     the investment in shares of OO was purchased on November 22.


                     Required
                     Assuming that Northern does not use an allowance account and that the shares
                     outlined above were its only investments in financial instruments during the
                     year, prepare journal entries for the following:
                     a.     The fair value adjustment on October 31
                     b.     The year-end entry to close out the related income statement account
                     c.     The sale of Investment MM on November 9
                     d.     The fair value adjustment on November 30


2009/2010                              FA2 Handouts Module 8                                 Page 3
Practice Exam: (from 2007 – 2008 module notes)
Solutions Question 3 & 4
   5        Question 3
              2        a.         Investment income is $3,000 ($15,000 x 0.20)
               3         b.       Balance in the investment account on December 31, 2004
                                  is:
                                  $698,000 + (0.20 x $88,000) – (0.20 x $15,000) =
                                  $712,600
   6        Question 4
                         a    .   Other comprehensive income
                                  (Unrealized holding loss on AFS securities)..........                   2,000
                                  Investment in NN ....................................................   1,000
                                         Investment in MM.......................................                       2,000
                                         Investment in PP .........................................                    1,000
                         b    .   Accumulated other comprehensive income ...........                      2,000
                                       Other comprehensive income ....................                                 2,000
                         c    .   Cash .................................................................... 29,000
                                  Loss on sale of investments .................................... 3,000
                                         Investment MM*.........................................                      30,000
                                         Accumulated other comprehensive income                                        2,000
                         d    .   Investment OO ....................................................... 2,000
                                  Investment PP* ....................................................... 2,000
                                         Investment NN* ..........................................                     3,000
                                         Other comprehensive income
                                         (Unrealized holding gain on AFS securities)                                   1,000
                      *AFS securities are carried at fair value (FV). Providing that the security was
                      held during the previous period, we must compare the current FV to the last
                      recorded FV (not cost) to determine the required adjustment.




2009/2010                                      FA2 Handouts Module 8                                                 Page 4
June 2005
8         Question 6
             On January 1, 2004, Martin Limited purchased 20,000 of the 50,000 outstanding
             common shares of Purdy Ltd. for $480,000 cash as a long-term investment. At that date,
             the balance sheet of Purdy showed the following book values:
             Assets not subject to amortization                        $ 740,000 1
             Assets subject to amortization                               950,000 2
             Liabilities                                                  700,000
             Common shares                                                500,000
             Retained earnings                                            490,000
1   Market value of assets not subject to amortization is $740,000.
2   Market value of assets subject to amortization is $1,100,000.



              All amortizations are made using the straight-line method with an estimated useful life of 10
              years. Purdy earned net income of $80,000 for the year ended December 31, 2004.
              Goodwill was impaired $10,000 for 2004. Purdy declared and paid cash dividends of
              $9,000 during 2004.

              Required
      2       a. Determine the amount of goodwill purchased on January 1, 2004.

      6       b. Determine the investment income to be recognized in 2004 and the balance in
                 the long-term investment account on December 31, 2004, assuming Martin
                 uses the equity method.




2009/2010                                  FA2 Handouts Module 8                                Page 5
June 2005 Question 6

         Exam Marker Comments

         Question 6 Goodwill, equity method (Level 1)
            Performance on this question was poor. Many students were unable to determine the amount
            of purchased goodwill. A common error was to include dividends in the investment
            income. Some students tried to determine the investment income but did not determine the
            balance in the investment account (or vice versa).



         Solution

8       Question 6
           Source: Lesson 8 (Level 1)

    2       a. Cost of investment                                                      $ 480,000
               Shareholders’ equity
                   Common shares                                   $ 500,000
                   Retained earnings                                490,000
                                                                       $ 990,000
                                                                          × 0.40             396,000
                      Purchase discrepancy                                                  $ 84,000

                  Assets subject to amortization
                        (1,100,000 – 950,000 = 150,000 × 0.40)                               $ 60,000
                      Goodwill                                                                 24,000
                                                                                            $ 84,000




    6       b.)                                                    Investment        Long-Term
                                                                   Income            Investment
                                                                                       Accounts

                  Cost of investment — January 1, 2004                                  $480,000
                  Income — 2004 (0.40 × 80,000)                    $ 32,000               32,000
                  Dividends — 2004 (0.40 × 9,000)                                         (3,600)
                  Amortization — 2004
                  Capital assets (60,000 / 10)                       (6,000)              (6,000)
                  Goodwill impairment (10,000 × 0.40)                (4,000)              (4,000)
                                                                    $ 22,000            $498,400




2009/2010                                 FA2 Handouts Module 8                            Page 6
If held-for-trading:                     If available-for-sale:                      If held-to-maturity:
Securities are recorded at fair value.   Securities are recorded at fair value.      Securities are carried at
                                                                                     amortized cost using the
                                                                                     effective rate method.
Holding gains and losses arising from    Holding gains and losses arising from the   Holding gains and losses are
the change in the market value of        change in the market value of the           recognized and included in net
the securities are recognized in net     securities are recognized in other          income when the asset is sold.
income.                                  comprehensive income.
All transaction costs are expensed       The company should adopt a policy to        The company should adopt a
immediately.                             either                                      policy to either

                                         • Expense all transaction costs             • Expense all transaction costs
                                         immediately;                                immediately;

                                         • Add the transaction cost to the cost of   • Add the transaction cost to
                                         the asset.                                  the cost of the asset.




2007/2008                                     FA2 Handouts Module 8                                        Page 7
                                    Definitions – Module 8

Available-for-sale investment
An investment that is not classified as a control, joint venture, significant influence, held-to-
   maturity or trading investment; the catch-all category of investment
Consolidation
combining the financial statements of a parent company and its subsidiary(ies); fair value on
   acquisition is established and intercompany transactions are eliminated
Control
the continuing power to determine the strategic policies of an investee without the cooperation of
    other shareholders
Controlled investment
the investment in a controlled subsidiary; normally consolidated for financial reporting
Cost method of accounting for investments
investments are recorded at cost and revenue is recorded as time passes (interest) or as declared
    (dividends). Interest income includes premium or discount amortization
Discount
a difference between the issuance price (or cost) and the maturity value of a debt security where
    the maturity value is higher
Downstream profits
intercompany profits on transactions between an investor company and investee where the
    parent records the profit
Effective interest method
a measure of interest expense or revenue over the life of a financial instrument not issued at par;
   measures expense or revenue as a constant rate over the term of the financial instrument
Equity method of accounting for investments
investments are initially recorded at cost, and revenue is recorded as the investor’s appropriate
    share of earnings, increasing the investment account; dividends received reduce the
    investment account
Fair value
as fair market value
Fair value method of accounting for investments
Investments are initially recorded at cost, but adjusted to fair value at each reporting date.
   Realized gains and losses are included in income; unrealized amounts are included in income
   (trading investments) or in other comprehensive income (available-for-sale investments)
Held-to-maturity investments
Those investments that have a defined maturity date, fixed or determinable payments, and for
   which there is positive intent to hold to maturity
Joint venture
an investment resulting in a contractual arrangement whereby two or more venturers jointly
    control an economic activity; the joint venture is subject to joint control by the joint venturers
Non-controlling interest (minority interest)
when a company controls a subsidiary but does not own 100% of the voting shares, it still
   includes 100% of the net assets and net income in the consolidated financial statements; the
   non-controlling interest in earnings is the portion of the subsidiary’s earnings that accrue to
   the other, minority shareholders; the non-controlling interest in net assets—a balance sheet
   credit—is the portion of net assets that represent the minority shareholders’ share


2007/2008                               FA2 Handouts Module 8                                 Page 8
Other comprehensive income
amounts that are not included in determining net income but that also do not represent
   investment or disinvestment by owners; examples include unrealized gains and losses on
   held-for-sale assets
Parent company
a corporation that controls one or more other corporations through ownership of a majority of the
    shares, carrying the right to elect at least a majority of the Board of Directors
Passive investment
an intercorporate investment in which the investor cannot significantly influence or control the
    operations of the investee company
Proportionate consolidation
combining the financial statements of an investor company and a joint venture enterprise; only
   the investor’s proportionate share of the financial elements of the joint venture are included
Realized holding gain
increase in fair value of an asset while held, realized through sale
Significant influence investment
an investment representing ownership interest to the extent that the investor can affect strategic
    operating, investing, and/or financing policies of the investee
Strategic investment
An investment in another company for strategic purposes; usually conveys control or significant
   influence or is a joint venture
Subsidiary company
an investee company in which the investor company (the parent) controls the investee, usually by
    having the right to appoint a majority of the Board of Directors and/or holding in excess of
    50% of the voting shares
Temporary investment
an investment in debt or equity securities that can be liquidated quickly and is intended by
    management as a short-term use of cash
Trading investment
an investment designated by management as held for trading; part of a portfolio managed for
    short-term profit or acquired principally for immediate resale. Financial institutions are the
    major holders of trading investments
Unrealized holding gain
increase in fair value of an asset while held; unrealized because asset is not yet sold
Unremitted earnings
when accounting for a significant influence investment, the difference between the investor’s
   cumulative share of an investee’s net income and the cumulative dividends actually received
Upstream profits
intercompany profits on transactions between an investor company and investee where the
    investee records the profit




2007/2008                              FA2 Handouts Module 8                                 Page 9

				
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