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中级财务会计英文版第七章课后题答案
Chapter 12 - InvestmentsChapter 12InvestmentsQUESTIONS FOR REVIEW OF KEY TOPICSQuestion 12-1Investment securities are classified as Dheld-to-maturity,‖ Dtrading,‖ or Davailable-for-sale‖ securities.Question 12-2Increases and decreases in the market value between the time a debt security is acquired and the day it matures to a prearranged maturity value are ignored for a security classified as Dheld-to-maturity.‖ These changes aren’t important if sale before maturity isn’t an alternative, which is the case if an investor has the Dpositive intent and ability‖ to hold the security to maturity.Question 12-3GAAP distinguishes between three levels of inputs to fair value determination, with level 1 being readily observable fair values (for example, from a securities exchange), level 2 inputs are other observable amounts (for example, quoted values for similar items, or important inputs like interest rates), and level 3 inputs are unobservable, like the company’s own assumptions. GAAP requires disclosure of the amount of fair values based on each of these three classes of inputs.Question 12-4For investments to be held for an unspecified period of time, fair value information is more relevant than for investments to be held to maturity. Changes in fair values are less relevant if the investment is to be held to maturity because sale at that fair value is not an option. The investor receives the same contracted interest payments for the period held to maturity and the stated principal at maturity, regardless of movements in market values. However, when the investment is of unspecified length, changes in fair values indicate management’s success in deciding when to acquire the investment and when to sell it, as well as the propriety of investing in fixed-rate or variable-rate securities and long-term or short-term securities.Question 12-5The way unrealized holding gains and losses are reported in the financial statements depends on whether the investments are classified as Dsecurities available-for-sale‖ or as Dtrading securities.‖ Securities available-for-sale are reported at fair value, and resulting holding gains and losses are not included in the determination of income for the period. Rather, they are reported as a separate component of shareholders’ equity, as part of other comprehensive income (OCI). (Available-for-sale securities for which the investor has chosen the fair value option are reclassified as trading securities.)12-1Chapter 12 - InvestmentsAnswers to Questions (continued) Question 12-6Comprehensive income is a more expansive view of the change in shareholders’ equity than traditional net income. It encompasses all changes in equity from non-owner transactions. The non-income part of comprehensive income is called DOther comprehensive income.‖ Other comprehensive income includes net unrealized holding gains (losses) on AFS investments, and also the non-credit-loss component of other-than-temporary impairments of HTM investments.Question 12-7Unrealized holding gains or losses on trading securities are reported in the income statement as if they actually had been realized. Trading securities are actively managed in a trading account with the express intent of profiting from short-term market price changes. So, any gains and losses that result from holding securities during market price changes are suitable measures of success or lack of success in achieving that goal. On the other hand, unrealized holding gains or losses on securities available-for-sale are not reported in the income statement. By definition, these securities are not acquired for the purpose of profiting from short-term market price changes, so gains and losses from holding these securities while prices change are less relevant performance measures to be included in earnings.Question 12-8When acquired, debt and equity securities are assigned to one of the three reporting classifications C held-to-maturity, trading, or available-for-sale. The appropriateness of the classification is reassessed at each reporting date. A reclassification should be accounted for as though the security had been sold and immediately reacquired at its fair value. Any unrealized holding gain or loss should be accounted for in a manner consistent with the classification into which the security is being transferred. Specifically, when a security is transferred: 1. Into the trading category, any unrealized holding gain or loss should be recognized in earnings of the reclassification period. 2. Into the available-for-sale category, any unrealized holding gain or loss should be recorded in Other Comprehensive Income, which will then increase Accumulated Other Comprehensive Income in shareholders’ equity. 3. Into the held-to-maturity category, any unrealized holding gain or loss should be amortized over the remaining time to maturity. This would be the case for Western Die-Casting’s investment in the LGB Heating Equipment bonds.12-2Chapter 12 - InvestmentsAnswers to Questions (continued) Question 12-9Yes. Although a company is not required to report individual amounts for the three categories of investments C held-to-maturity, available-for-sale, or trading C on the face of the balance sheet, that information should be presented in the disclosure notes. The following also should be disclosed for each year presented: aggregate fair value, gross realized and unrealized holding gains, gross realized and unrealized holding losses, the change in net unrealized holding gains and losses, and amortized cost basis by major security type. Information about the level of the fair value hierarchy upon which fair values are based should be provided, and more disclosure is necessary with respect to amounts based on level 3 of the fair value hierarchy. In addition, information about maturities should be reported for debt securities, by disclosing the fair value and cost for at least 4 maturity groupings: (a) within 1 year, (b) after 1 year through 5 years, (c) after 5 years through 10 years, and (d) after 10 years.Question 12-10According to U.S. GAAP, the fair value of an equity security is considered readily determinable only if its selling price is currently available on particular securities exchanges or over-the-counter markets. If the fair value of an equity security is not readily determinable, U.S. GAAP uses the cost method. Under IFRS, equity investments typically are measured at fair value, even if they are not listed on an exchange or over-the-counter market. Under IAS No. 39, the cost method only is used if fair value cannot be measured reliably, which occurs when the range of reasonable fair value estimates is significant and the probability of various estimates within the range cannot be reasonably estimated. Under IFRS No. 9, the cost method is prohibited, although cost can sometimes be used as an estimate of fair value. Therefore, in general, use of the cost method is less prevalent under IFRS than under U.S. GAAP.Question 12-11When a company elects the fair value option for held-to-maturity or available-for-sale investments, it simply reclassifies those investments as trading securities and accounts for them in that fashion.Question 12-12U.S. GAAP allows companies complete discretion in electing the fair value option when an investment is made. The only constraint is that the election is irrevocable. IFRS only allows companies to elect the fair value option in specific circumstances, e.g., when electing the fair value option for an asset or liability allows a company to avoid the Daccounting mismatch‖ that occurs when some parts of a fair value risk-hedging arrangement are accounted for at fair value and others are not.12-3Chapter 12 - InvestmentsAnswers to Questions (continued) Question 12-13The equity method is used when an investor can’t control but can Dsignificantly influence‖ the investee. For example, if effective control is absent, the investor still might be able to exercise significant influence over the operating and financial policies of the investee if the investor owns a large percentage of the outstanding shares relative to other shareholders. By voting those shares as a block, the investor often can sway decisions in the direction desired. We presume, in the absence of evidence to the contrary, that the investor exercises significant influence over the investee when it owns between 20% and 50% of the investee's voting shares.Question 12-14The equity method, like consolidation, views the investor and investee as a special type of single entity. By the equity method, though, the investor doesn’t include separate financial statement items of the investee on an item-by-item basis as in consolidation. Rather, by the equity method, the investor reports its equity interest in the investee as a single investment account. That single investment account is periodically adjusted to reflect the effects of consolidation, without actually consolidating financial statements.Question 12-15The investor should account for dividends from the investee as a reduction in the investment account. Since investment revenue is recognized as the investee earns it, it would be inappropriate to again recognize revenue when earnings are distributed as dividends. Rather, the dividend distribution is considered to be a reduction of the investee’s net assets, indicating that the investor’s ownership interest in those net assets declines proportionately.Question 12-16The equity method attempts to approximate the effects of accounting for the purchase of the investee as a consolidation. Consolidated financial statements report acquired net assets at their fair values as of the date the investor acquired the investee. The accounting in the consolidated financial statements subsequent to the acquisition date is based on those fair values. So, if Finest had consolidated its acquisition of Penner, Penner’s depreciable assets would have been put on Finest’s balance sheet in their respective asset accounts at their fair value on the date of acquisition and then depreciated over 10 years. Under the equity method, Finest’s investment in Penner is shown in a single investment account. Therefore, for the equity method to approximate consolidation, it would reduce both investment revenue (as if depreciation expense were being recognized) and the investment (as if the book value of the asset were being reduced) by the negative income effect of the Dextra depreciation‖ the higher fair value would cause. This would equal 40% x $12 million ÷ 10 years = $480,000 each year for ten years.12-4Chapter 12 - InvestmentsAnswers to Questions (continued) Question 12-17The investment account was decreased by $40,000 (40% x $100,000). Cash increased by the same amount. There is no effect on the income statement.Question 12-18When it becomes necessary to change from the equity method to another method, no adjustment is made to the carrying amount of the investment. The equity method is simply discontinued and the new method is applied from then on. The investment account balance when the equity method is discontinued would serve as the new Dcost‖ basis for writing the investment up or down to fair value in the next set of financial statements.Question 12-19IFRS require that accounting policies of investees be adjusted to correspond to those of the investor when applying the equity method. U.S. GAAP has no such requirement. Also, IFRS allow investors to account for a joint venture using either the equity method or Dproportionate consolidation,‖ whereby the investor combines its proportionate share of the investee’s accounts with its own accounts on an item-by-item basis. U.S. GAAP generally requires that the equity method be used to account for joint ventures.Question 12-20When a company elects the fair value option for a significant-influence investment, that investment is not reclassified as a trading security. Rather, the investment still appears in the balance sheet as a significant-influence investment, but the amount that is accounted for at fair value is indicated in the balance sheet either parenthetically on a single line that includes the total amount of significant-influence investment or on a separate line. As with trading securities, unrealized gains and losses are included in earnings in the period in which they occur.Question 12-21A financial instrument is: (a) cash, (b) evidence of an ownership interest in an entity, (c) a contract that (1) imposes on one entity an obligation to deliver cash or another financial instrument and (2) conveys to a second entity a right to receive cash or another financial instrument, or (d) a contract that (1) imposes on one entity an obligation to exchange financial instruments on potentially unfavorable terms and (2) conveys to a second entity a right to exchange other financial instruments on potentially favorable terms. Accounts payable, bank loans, and investments in securities are examples.Question 12-22These instruments Dderive‖ their values or contractually required cash flows from some other security or index.12-5Chapter 12 - InvestmentsAnswers to Questions (continued) Question 12-23Since this money won’t be used within the upcoming operating cycle, it is a noncurrent asset. It should be reported as part of Investments .Question 12-24Part of each premium payment the company makes is not used by the insurance company to pay for life insurance coverage, but rather is Dinvested‖ on behalf of the insured company in a fixed-income investment. As a result, the periodic insurance premium should not be expe an appropriate portion should be recorded instead as a noncurrent asset C cash surrender value.Question 12-25If the investor intends to sell the investment, or thinks it will be more likely than not that it will be required to sell the investment prior to recovering the impairment, the investor is required to recognize the entire impairment loss in the income statement as an OTT impairment, writing down the investment to fair value in the balance sheet. Otherwise, the investor considers whether credit losses exist. If there are no credit losses, no impairment loss is recognized. On the other hand, if there are some credit losses, then the investment is written down to fair value in the balance sheet. However, only the credit loss component is recognized in net income. Any non-credit losses are recognized in OCI. In the income statement, the entire impairment loss is shown, and then the amount of non-credit loss is subtracted, leaving only the credit loss reducing net income.Question 12-26If the OTT impairment relates to an equity investment, the entire amount of impairment is recognized in net income. Any previously recorded unrealized losses are reclassified out of AOCI. If the OTT impairment relates to a debt investment, the accounting is more complicated. First, if the investor intends to sell the investment, or thinks it will be more likely than not that it will be required to sell the investment prior to recovering the impairment, it is required to recognize the entire impairment loss in the income statement as an OTT impairment, writing down the investment to fair value in the balance sheet. Otherwise, the investor considers whether credit losses exist. If there are no credit losses, no impairment loss is recognized. On the other hand, if there are some credit losses, then the investment is written down to fair value in the balance sheet. However, only the credit loss component is recognized in net income. Any non-credit losses are recognized in OCI. In the income statement, the entire impairment loss is shown, and then the amount of non-credit loss is subtracted, leaving only the credit loss reducing net income.12-6Chapter 12 - InvestmentsAnswers to Questions (concluded) Question 12-27Given that the decline in shares relates to a new law banning a primary approach used by the company, it likely would be treated as an other-than-temporary impairment. So, when the investment is written down to its fair value, the amount of the write-down should be treated as if it were a realized loss, meaning the loss is included in income for the period. This could require a reclassification adjustment if any unrealized losses were included previously in OCI, just as if the investment was being sold. Subsequent to the other-than-temporary write-down, the usual treatment of unrealized gains or losses should be resumed. Therefore, later changes in fair value will be reported as a separate component of shareholders’ equity, accumulated other comprehensive income.Question 12-28U.S. GAAP and IFRS differ somewhat. Under IFRS, OTT impairments only are recognized on debt that is classified as HTM to the extent that credit losses exist, so there is no non-credit-loss component of OTT impairments under IFRS. OTT impairments are recognized on debt classified as AFS in their entirety, with no distinction made between credit losses and non-credit losses. Also, under IFRS, OTT impairments can be recovered in earnings for debt investments, but not for equity investments.12-7Chapter 12 - InvestmentsBRIEF EXERCISESBrief Exercise 12-1(a) Investment in bonds (face amount) ....................... Discount on bond investment (difference) ........ Cash (price of bonds) .......................................... (b) Cash (1.5% x $720,000).......................................... Discount on bond investment (difference) ............ Interest revenue (2% x $600,000) ....................... 10,800 1,200 12,000 720,000 120,000 600,000Brief Exercise 12-2Unlike for securities available-for-sale, unrealized holding gains and losses for trading securities are included in earnings. S&L reports its $2,000 holding loss in 2011 earnings. When the fair value rises by $7,000 in 2012, that amount is reported in 2012 earnings ($5000 as a realized gain, and $2000 as the reversal of the unrealized loss that was recognized in 2011). S&L’s journal entries for these transactions would be: 2011 December 27 Investment in Coca Cola shares ......................................... Cash ................................................................................. December 31 Net unrealized holding gains and losses―I/S ..................... Fair value adjustment ($875,000 C 873,000) ........................ 875,000 875,000 2,000 2,00012-8Chapter 12 - InvestmentsBrief Exercise 12-2 (concluded) 2012 January 3 Cash (selling price) ................................................................. Gain on investments (to balance) ....................................... Investment in Coca Cola shares (account balance) ............. 880,000 5,000 875,000Assuming no other trading securities, the 2012 adjusting entry to remove the fair value adjustment associated with the sold securities would be: December 31 Fair value adjustment (account balance) ................................. Net unrealized holding gains and losses―I/S (to balance) 2,000 2,00012-9Chapter 12 - InvestmentsBrief Exercise 12-3Unlike for trading securities, unrealized holding gains and losses for securities available-for-sale are not included in earnings. S&L reports its $2,000 holding loss in 2011 as Other comprehensive income in the statement of comprehensive income. When the fair value rises to $880,000 in 2012, the amount is reported in 2012 earnings is the $5,000 gain realized by the sale of the securities. S&L’s journal entries for these transactions would be: 2011 December 27 Investment in Coca Cola shares ......................................... Cash ................................................................................. December 31 Net unrealized holding gains and lossesCOCI..................... Fair value adjustment ($875,000 C 873,000) ........................ 2012 January 3 Cash (selling price) ................................................................. Gain on investments (to balance) ....................................... Investment in Coca Cola shares (cost).............................. 880,000 5,000 875,000 875,000 875,000 2,000 2,000Assuming no other transactions involving securities available-for-sale, the 2012 adjusting entry to remove the fair value adjustment associated with the sold securities would be: December 31 Fair value adjustment (account balance) ................................. Net unrealized holding gains and lossesCOCI................. 2,000 2,00012-10Chapter 12 - InvestmentsBrief Exercise 12-4Securities available-for-sale are reported at fair value, and resulting holding gains and losses are not included in the determination of net income for the period. Rather, they are reported as Dother comprehensive income‖ in the statement of comprehensive income. The accumulated balance of net holding gains and losses is reported as a separate component of shareholders’ equity, as part of accumulated other comprehensive income. The adjusting entry needed to increase the fair value adjustment from $110,000 to $170,000 is: Fair value adjustment ($670,000 C 610,000) ........... Net unrealized holding gains and lossesCOCI 60,000 60,000Brief Exercise 12-5These are securities available-for-sale and are reported at their fair value, $4,000,000. We know this because securities Dheld -to-maturity‖ are debt securities that an investor has the Dpositive intent and ability‖ to hold to maturity. Actively traded investments in debt or equity securities acquired principally for the purpose of selling them in the near term are classified as Dtrading securities.‖ The FedEx shares have been held for over a year. They are classified as Davailable-for-sale‖ since all investments in debt and equity securities that don’t fit the definitions of the other reporting categories are classified this way. Of course, the equity method isn’t appropriate either because 40,000 shares of FedEx certainly don’t constitute Dsignificant influence.‖ Investments in securities available-for-sale are reported at fair value.12-11Chapter 12 - InvestmentsBrief Exercise 12-6Because S&L elected the fair value option, it would classify this investment as a trading security and account for it in that fashion. Therefore, S&L reports its $2,000 holding loss in 2011 earnings. When the fair value rises by $7,000 in 2012, that amount is reported in 2012 earnings ($5000 as a realized gain, and $2000 as the reversal of the unrealized loss that was recognized in 2011). S&L’s journal entries for these transactions would be: 2011 December 27 Investment in Coca Cola shares ......................................... Cash ................................................................................. December 31 Net unrealized holding gains and losses―I/S ..................... Fair value adjustment ($875,000 C 873,000)................... 2012 January 3 Cash (selling price) ................................................................. Gain on investments (to balance) ....................................... Investment in Coca Cola shares (account balance) ............. 880,000 5,000 875,000 875,000 875,000 2,000 2,000Assuming no other trading securities, the 2012 adjusting entry to remove the fair value adjustment associated with the sold securities would be: December 31 Fair value adjustment (account balance) ................................. Net unrealized holding gains and losses―I/S (to balance) 2,000 2,00012-12Chapter 12 - InvestmentsBrief Exercise 12-7An investor should account for dividends from an investment not accounted for by the equity method as investment revenue. Since Turner holds only 10% of ICA stock, it’s assumed that it does not have significant influence over the company. Turner’s cash increased by $500,000 (10% x $5 million). It also reports $500,000 as investment revenue in the income statement.Brief Exercise 12-8An investor should account for dividends from an equity method investee as a reduction in its investment account. Since investment revenue is recognized as the investee earns it, it would be inappropriate to again recognize revenue when earnings are distributed as dividends. Instead, the dividend distribution is considered to be a reduction of the investee’s net assets, reflecting the fact that the investor’s ownership interest in those net assets declined proportionately. Turner’s cash increased by $2 million (40% x $5 million). Its investment account declined by the same amount. There is no effect on the income statement.12-13Chapter 12 - InvestmentsBrief Exercise 12-9With the equity method we attempt to approximate the effects of accounting for the purchase of the investee as a consolidation. Consolidated financial statements report acquired net assets at their fair values. Both investment revenue and the investment would be reduced by the negative income effect of the Dextra depreciation‖ the higher fair value would cause. This would equal 30% x $50 million ÷ 15 years = $1 million each year for fifteen years.Brief Exercise 12-10Under proportionate consolidation, Park would have included its portion of Wallis’s depreciable assets in the Park depreciable asset accounts on its consolidated balance sheet. Those depreciable asset accounts would be reduced by the Dextra depreciation‖ the higher fair value would cause. This would equal 50% x $50 million ÷ 15 years = $1.67 million each year for fifteen years.Brief Exercise 12-11The investment would be increased by $12 million. Financial statements would be recast to reflect the equity method for each year reported for comparative purposes. A disclosure note also should describe the change, justify the switch, and indicate its effects on all financial statement items. The answer would not be the same if Pioneer changes from the equity method. Rather, no adjustment is made to the carrying amount of the investment. Instead, the equity method is simply discontinued, and the new method is applied from then on. The balance in the investment account when the equity method is discontinued would serve as the new Dcost‖ basis for writing the investment up or down to market value in the next set of financial statements. There also would be no revision of prior years, but the change should be described in a disclosure note.12-14Chapter 12 - InvestmentsBrief Exercise 12-12Given Turner’s election of the fair value option, it would account for this investment similar to a trading security, while still preserving its classification as a significant-influence investment and showing it as a non-current asset in the balance sheet. 2011 January 2 Investment in ICA Company .............................................. 10,000,000 Cash ................................................................................. 10,000,000 December 30 Cash (40% x $500,000) .......................................................... Investment revenue ......................................................... 200,000 200,000December 31 Fair value adjustment ($11.5M C 10M)................................... 1,500,000 Net unrealized holding gains and losses―I/S (may also labeled DInvestment revenue‖) ....................... 1,500,000 Note: A different approach to reach the same outcome would be for Turner to use equity-method accounting throughout the year, and then at the end of the year make whatever adjustment to fair value is necessary to adjust the investment account to fair value. Under that approach, Turner would recognize 40% of ICA’s $750,000 income ($300,000) as investment income, it would not recognize investment income associated with ICA’s dividend, and it would end up with an Investment account containing $10,100,000 ($10,000,000 + $300,000 C 200,000). Turner then would need to make a fair value adjustment of $1,400,000 ($11,500,000 C 10,100,000) to its ICA investment. So the total amount of income recognized would be $1,700,000 ($300,000 investment income + $1,400,000 unrealized gain). Note that this alternative produces the same total amount of investment income as is produced above, $1,700,000 ($200,000 investment revenue + $1,500,000 unrealized gain).12-15Chapter 12 - InvestmentsBrief Exercise 12-13Because the drop in the market price of stock is considered to be other-than-temporary, LED records the impairment of $450,000 ($4.50 x 100,000 shares) and reclassifies previously recognized unrealized losses of $100,000 ($1.00 x 100,000 shares) as follows: Other-than-temporary impairment loss C I/S .... AFS Investment (Branch) .............................. Fair value adjustment ......................................... Net unrealized holding gains and losses C OCI 450,000 450,000 100,000 100,000In the income statement, the entire $450,000 will be shown as an OTT impairment loss. A $100,000 reclassification adjustment will increase OCI (because the $100,000 decreased OCI and therefore AOCI in a prior period, it must be backed out of OCI and AOCI in the current period). Therefore, the net effect on comprehensive income during the current period will be $350,000.12-16Chapter 12 - InvestmentsBrief Exercise 12-14LED believes it is more likely than not that it will have to sell the investment before fair value recovers, so the portion of the impairment that consists of credit and non-credit losses is not relevant. LED must recognize the entire OTT impairment in earnings, reducing the carrying value of the LED bonds by crediting a discount on bond investment account. LED records the impairment of $450,000 and reclassifies previously recognized unrealized losses of $100,000 as follows: Other-than-temporary impairment loss C I/S .... Discount on bond investment ........................ Fair value adjustment ......................................... Net unrealized holding gains and losses C OCI 450,000 450,000 100,000 100,000In the income statement, the entire $450,000 will be shown as an OTT impairment loss. A $100,000 reclassification adjustment will increase OCI (because the $100,000 decreased OCI and therefore AOCI in a prior period, it must be backed out of OCI and AOCI in the current period). Therefore, the net effect on comprehensive income during the current period will be $350,000.12-17Chapter 12 - InvestmentsBrief Exercise 12-15LED does not intend to sell the investment, and it does not believe it is more likely than not that it will have to sell the investment before fair value recovers, so the portion of the impairment that consists of credit and non-credit losses is relevant. LED must recognize the $200,000 credit loss component of the OTT impairment in earnings, and the $250,000 non-credit-loss component in OCI. LED records the impairment of $450,000 and reclassifies previously recognized unrealized losses of $100,000 as follows: Other-than-temporary impairment loss C I/S .... Discount on bond investment ......................... OTT impairment lossC OCI ................................ Fair value adjustment ..................................... Fair value adjustment ......................................... Net unrealized holding gains and losses C OCI 200,000 200,000 250,000 250,000 100,000 100,000LED still would have to include the entire $450,000 in the income statement before backing out the $250,000 to leave a $200,000 reduction of earnings. The $100,000 reclassification adjustment will increase OCI (because the $100,000 decreased OCI and therefore AOCI in a prior period, it must be backed out of OCI and AOCI in the current period). Therefore, the net effect on comprehensive income will be $350,000 during the current period ($200,000 from net income, $150,000 from OCI).12-18Chapter 12 - InvestmentsBrief Exercise 12-16Wickum would have recorded a journal entry previously that recognized the OTT impairment in earnings and reduced the investment account: Other-than-temporary impairment loss C I/S ..... Discount on debt investment .......................... 500,000 500,000Upon recovery of $300,000 of fair value, Wickum would reverse the impairment by that amount: Discount on debt investment .............................. 300,000 Recovery of other-than-temporary impairment loss C I/S 300,00012-19Chapter 12 - InvestmentsEXERCISESExercise 12-1Requirement 1 Investment in bonds (face amount) ....................... Discount on bond investment (difference) ........ Cash (price of bonds) .......................................... Requirement 2 Cash (3% x $240 million) ....................................... Discount on bond investment (difference) ............ Interest revenue (4% x $200) .............................($ in millions)240.0 40.0 200.0 7.2 .8 8.0Requirement 3 Tanner-UNF reports its investment in the December 31, 2011, balance sheet at its amortized cost C that is, its book value: Investment in bonds ............................................ Less: Discount on bond investment ($40 C .8 million) Amortized cost ................................................ $240.0 39.2 $200.8If sale before maturity isn’t an alternative, increases and decreases in the market value between the time a debt security is acquired and the day it matures to a prearranged maturity value are relatively unimportant. For this reason, if an investor has the Dpositive intent and ability‖ to hold the securities to maturity, investments in debt securities are classified as Dheld-to-maturity‖ and reported at amortized cost rather than fair value in the balance sheet. Requirement 4 Cash (proceeds from sale) ....................................... Discount on bond investment (balance, determined above) Loss on sale of investments (to balance)............... Investment in bonds (face amount) ....................($ in millions)190.0 39.2 10.8 240.012-20Chapter 12 - InvestmentsExercise 12-2November 1($ in millions)Cash ................................................................ Investment revenue ..................................... December 1 Investment in Facsimile Enterprises bonds .... Cash............................................................. December 31 Investment in U.S. Treasury bills .................. Cash............................................................. December 31 Investment revenue receivableCConvenience bonds ($48 million x 10% x 2/12) ....................... Investment revenue receivableCFacsimile Enterprises bonds ($30 million x 12% x 1/12) .... Investment revenue ...................................Note: Securities held-to-maturity are not adjusted to fair value.2.4 2.4 30 308.9 8.90.8 0.3 1.1Exercise 12-3Investment in GM common shares ................ Cash ([800 shares x $50] + $1,200) ................... Cash ([800 shares x $53] C $1,300)....................... Loss on sale of investments ............................ Investment in GM common shares ............ 41,200 41,200 41,100 100 41,20012-21Chapter 12 - InvestmentsExercise 12-4Requirement 1 2011 December 17 Investment in Grocers’ Supply preferred shares ................ Cash ................................................................................. December 28 Cash ..................................................................................... Investment revenue .......................................................... December 31 Fair value adjustment .......................................................... Net unrealized holding gains and losses―I/S ([$4 x 100,000 shares] C $350,000) ......................................... 2012 January 5 Cash (selling price) ................................................................. Gain on investments (to balance) ....................................... Investment in Grocers’ Supply preferred shares (account balance)................................................. 395,000 45,000 350,000 350,000 350,000 2,000 2,000 50,000 50,000Assuming no other trading securities, the 2012 adjusting entry to remove the fair value adjustment associated with the sold securities would be: December 31 Net unrealized holding gains and losses―I/S ..................... Fair value adjustment (account balance) ............................. 50,000 50,00012-22Chapter 12 - InvestmentsExercise 12-4 (concluded) Requirement 2 Balance Sheet (short-term investment): Trading securities ................................................... Income Statement: Investment revenue (dividends) .......................................... Net unrealized holding gains and losses (from adjusting entry) $400,000 $ 2,000 50,000Note: Unlike for securities available-for-sale, unrealized holding gains and losses for trading securities are included in income.12-23Chapter 12 - InvestmentsExercise 12-5Requirement 1.Net unrealized holding gains and lossesCOCI Fair value adjustment ($45,000 C 20,000) Requirement 225,000 25,000None. Accumulated net holding gains and losses for securities available-for-sale are reported as a component of shareholders’ equity (in accumulated other comprehensive income), and changes in the balance are reported as other comprehensive income or loss in the statement of comprehensive income rather than as part of earnings. This statement can be reported either (a) as an extension of the income statement, (b) as part of the statement of shareholders’ equity, or (c) as a separate statement in a disclosure note.12-24Chapter 12 - InvestmentsExercise 12-6Requirement 1 Securities Dheld-to-maturity‖ are debt securities that an investor has the Dpositive intent and ability‖ to hold to maturity. Actively traded investments in debt or equity securities acquired principally for the purpose of selling them in the near term are classified as Dtrading securities.‖ The IBM shares are neither. They are classified as Davailable-for-sale‖ since all investments in debt and equity securities that don’t fit the definitions of the other reporting categories are classified this way. Of course, the equity method isn’t appropriate either because 10,000 shares of IBM certainly don’t constitute Dsignificant influence.‖ Investments in securities available-for-sale are reported at fair value, and holding gains or losses are not included in the determination of income for the period. Instead, they are reported as other comprehensive income or loss in the statement of comprehensive income. This statement can be reported either (a) as an additional section of the income statement, (b) as part of the statement of shareholders’ equity, or (c) as a separate statement in a disclosure note. Accumulated net holding gains and losses for securities available-for-sale are reported as a separate component of shareholders’ equity in the balance sheet. Requirement 2 December 31, 2011 Net unrealized holding gains and lossesCOCI (10,000 shares x [$58 C 60]) ......................................................... Fair value adjustment ...........................................................20,000 20,00012-25Chapter 12 - InvestmentsExercise 12-6 (concluded) Requirement 3 December 31, 2012 ($ in 000s) Available-for-Sale Securities IBM shares C Dec. 31, 2012 Cost $600 Fair Value $610 Accumulated Unrealized Gain (Loss) $10Moving from a negative $20 (2011) to a positive $10 (2012) requires an increase of $30:Balance needed in fair value adjustment Existing balance in fair value adjustment: Increase (decrease) needed in fair value adjustment: Fair Value Adjustment $10 ($20) $30--------------------------------------------------------20 0 +10 +30 -----------------------------&Fair value adjustment 10,000 shares x [$61 C 58]) ............................ Net unrealized holding gains and lossesCOCI (-$20 less $10) ...30,000 30,00012-26Chapter 12 - InvestmentsExercise 12-7Requirement 1 2011 March 2($ in millions)Investment in Platinum Gauges, Inc. shares .............................. Cash ......................................................................................... April 12 Investment in Zenith bonds ......................................................... Cash ......................................................................................... July 18 Cash ............................................................................................. Investment revenue .................................................................. October 15 Cash ............................................................................................. Investment revenue .................................................................. October 16 Cash ............................................................................................. Investment in Zenith bonds ..................................................... Gain on sale of investments ..................................................... November 1 Investment in LTD preferred shares ........................................... Cash .........................................................................................31 31 20 20 2 2 1 1 21 20 1 40 4012-27Chapter 12 - InvestmentsExercise 12-7(continued) December 31($ in millions)Available-for-Sale Securities Platinum Gauges, Inc. shares LTD preferred shares Totals* $32 x 1 million shares ** $74 x 500,000 sharesCost $31 40 $71Fair Value $32* 37** $69Accumulated Unrealized Gain (Loss) $1 (3) $(2)Adjusting entry: Net unrealized holding gains and lossesCOCI ($71 C 69)............. Fair value adjustment ($71 C 69) ............................................... 2012 January 232 2($ in millions)Cash ([1 million shares x 1/2] x $32) ................................................ Gain on sale of investments (difference) ................................... Investment in Platinum Gauges shares ($31 million cost x 1/2)...................................................16.0 0.5 15.5March 1 Cash ($76 x 500,000 shares) ............................................................. 38 Loss on sale of investments (difference)........................................ 2 Investment in LTD preferred (cost) .......................................... 40 Note: As part of the process of recording the normal, period-end fair value adjusting entry at 12/31/2012, Construction would debit Fair value adjustment and credit Net unrealized gains and losses―OCI for the $2.5 million associated with the sold investments to remove their effects from the financial statements. (Construction sold only half the Platinum investments so only half of the Platinum fair value adjustment should be removed. The 2.5 amount comes from 3.0 LTD - 0.5 Platinum.)12-28Chapter 12 - InvestmentsExercise 12-7 (concluded) Requirement 2 2011 Income Statement($ in millions)Investment revenue (from July 18; Oct. 15) ..................................... Gain on sale of investments (from Oct. 16) .................................... Other comprehensive income:* Net unrealized holding gains and losses on investments** .$3 1 $2** Assuming Construction Forms chooses to report Other comprehensive income as anadditional section of the income statement. Alternatively, it can report this (a) as part of the statement of shareholders’ equity or (b) as a separate statement in a disclosure note.Note: Unlike for trading securities, unrealized holding gains and losses are not included in income for securities available-for-sale. Rather, they are included in other comprehensive income, and accumulated in shareholders’ equity i n accumulated other comprehensive income.12-29Chapter 12 - InvestmentsExercise 12-8Requirement 1Purchase ($ in millions)Investment in Jackson Industry shares ........................................ Cash ........................................................................................Net income90 90No entryDividends Cash (5% x $60 million) ..................................................................3 3 8 8Investment revenue ..................................................................Adjusting entryFair value adjustment ($98 C 90 million) ........................................ Net unrealized holding gains and lossesCOCI.........................Requirement 2 Investment revenue .......................... $3 millionNote: An unrealized holding gain is not included in income for securities available-for-sale. Rather, it is included in other comprehensive income, and accumulated in shareholders’ equity in accumulated other comprehensive income.12-30Chapter 12 - InvestmentsExercise 12-91. Investments reported as current assets. Security A $ 910,000 Security B 100,000 Security C 780,000 Security E 490,000 Total $2,280,000 2. Investments reported as noncurrent assets. Security D $ 915,000 Security F 615,000 $1,530,0003. Unrealized gain (or loss) component of income before taxes. Trading Securities: Cost Security Totals A B $ 900,000 105,000 $1,005,000 Fair value $ 910,000 100,000 $1,010,000 Unrealized gain (loss) $10,000 (5,000) $ 5,0004. Unrealized gain (or loss) component of AOCI in shareholders’ equity. Securities Available-for-Sale: Cost Security Totals C D $ 700,000 900,000 $1,600,000 Fair value $ 780,000 915,000 $1,695,000 Unrealized gain (loss) $80,000 15,000 $95,00012-31Chapter 12 - InvestmentsExercise 12-10Requirement 1 ($ in 000s) Available-for-Sale Securities IBM shares C Dec. 31, 2011 Cost $1,345 Fair Value $1,175 Accumulated Unrealized Gain (Loss) $(170)Moving from a negative $145 (Jan.1) to a negative $170 requires a reduction of $25:Balance needed in fair value adjustment Existing balance in fair value adjustment: Increase (decrease) needed in fair value adjustment: --------------------------------------------------------170 -145 0 &---------------- C 25 Fair Value Adjustment ($170) ($145) ($ 25)Net unrealized holding gains and lossesCOCI........................ Fair value adjustment ($1,175,000 C 1,200,000) ...................25,000 25,00012-32Chapter 12 - InvestmentsExercise 12-10 (continued) Requirement 2 ($ in 000s) Available-for-Sale Securities IBM shares C Dec. 31, 2011 Cost $1,345 Fair Value $1,275 Accumulated Unrealized Gain (Loss) $(70)Fair Value Adjustment ($ 70) ($145) $ 75Moving from a negative $145 (Jan.1) to a negative $70 requires an increase of $75:Balance needed in fair value adjustment Existing balance in fair value adjustment: Increase (decrease) needed in fair value adjustment:-------------------------------------------------------------------------------------------145 -70 0 +75 ----------------------&Fair value adjustment ($1,275,000 C 1,200,000) ....................... Net unrealized holding gains and lossesCOCI .................75,000 75,00012-33Chapter 12 - InvestmentsExercise 12-10 (concluded) Requirement 3 ($ in 000s) Available-for-Sale Securities IBM shares C Dec. 31, 2011 Cost $1,345 Fair Value $1,375 Accumulated Unrealized Gain (Loss) $30Fair Value Adjustment $ 30 ($145) $175Moving from a negative $145 (Jan.1) to a positive $30 requires an increase of $175:Balance needed in fair value adjustment Existing balance in fair value adjustment: Increase (decrease) needed in fair value adjustment:-------------------------------------------------------------------------------------------145 -70 0 +30 +175 --------------------------------------------------------&Fair value adjustment ($1,375,000 C 1,200,000) ........................ Net unrealized holding gains and lossesCOCI .................175,000 175,00012-34Chapter 12 - InvestmentsExercise 12-11Requirement 1 The sale of the A Corporation shares decreased Harlon’s pretax earnings by $5 million. The purchase of the C Corporation shares had no effect on Harlon’s 2012 earnings (because the shares are classified as available-for-sale investments, any unrealized gains or losses occurring after purchase during 2012 would not affect 2012 earnings). Here are the entries used to record those two transactions: June 1, 2012 Cash Loss on sale of investments (difference) Investment in A Corporation shares (cost) September 12, 2012 Investment in C Corporation shares Cash($ in millions)15 5 20 15 1512-35Chapter 12 - InvestmentsExercise 12-11 (concluded) Requirement 2 Harlon’s securities available-for-sale portfolio should be reported in its 2012 balance sheet at its fair value of $101 million: December 31, 2012($ in millions) Cost, Dec. 31 Securities Available-for-Sale
Fair Value, Dec. 31 A Corporation shares B Corporation bonds C Corporation shares D Industries shares Totals$20 35 na 45 $100na $35 15 45 $95$14 35 na 46 $95na $ 37 14 50 $101In 2011, Harlon would have had a net unrealized loss of $5 (cost of $100 C fair value of $95). Moving from a negative $5 (2011) to a positive $6 requires an increase of $11:Fair Value Adjustment Allowance $ 6 (5) $11Balance needed in fair value adjustment Existing balance in fair value adjustment: Increase (decrease) needed in fair value adjustment:---------------------------------------------------------5 0 +6+11 -----------------------------&Fair value adjustment ($5 credit to $6 debit) Net unrealized holding gains and lossesCOCI11 11The adjustment has no effect on earnings. Unlike for trading securities, unrealized holding gains and losses are not included in income for securities available-for-sale. Rather, they are included in other comprehensive income, and accumulated in shareholders’ equity in accumulated other comprehensive income.12-36Chapter 12 - InvestmentsExercise 12-12Requirement 1 The investment would be accounted for as an available-for-sale investment:PurchaseInvestment in AMC common shares ................................... Cash ...............................................................................Net income480,000 480,000No entryDividends Cash (20% x 400,000 shares x $0.25) ........................................20,000 20,000 25,000 25,000Investment revenue.........................................................Adjusting entryFair value adjustment ($505,000 C 480,000)............................ Net unrealized holding gains and lossesCOCI ............... Requirement 2The investment would be accounted for using the equity method:PurchaseInvestment in AMC common shares ................................... Cash ...............................................................................Net income480,000 480,000 50,000 50,000 20,000 20,000Investment in AMC common shares (20% x $250,000) ........ Investment revenue.........................................................Dividends Cash (20% x 400,000 shares x $0.25) ........................................Investment in AMC common shares ..............................Adjusting entryNo entry12-37Chapter 12 - InvestmentsExercise 12-13Purchase ($ in millions)Investment in Nursery Supplies shares ................................... Cash ....................................................................................Net income56 56 12 12 3 3Investment in Nursery Supplies shares (30% x $40 million) ..... Investment revenue ..............................................................Dividends Cash (30% x 8 million shares x $1.25) ...........................................Investment in Nursery Supplies shares ...............................Adjusting entryNo entryExercise 12-14Requirement 1($ in millions)Investment in equity securities ($48 million C 31 million) ........... Retained earnings (investment revenue from the equity method) .17 17Requirement 2 Financial statements would be recast to reflect the equity method for each year reported for comparative purposes. A disclosure note also should describe the change, justify the switch, and indicate its effects on all financial statement items. Requirement 3 When a company changes from the equity method, no adjustment is made to the carrying amount of the investment. Instead, the equity method is simply discontinued, and the new method is applied from then on. The balance in the investment account when the equity method is discontinued would serve as the new Dcost‖ basis for writing the investment up or down to fair value in the next set of financial statements. There also would be no revision of prior years, but the change should be described in a disclosure note.12-38Chapter 12 - InvestmentsExercise 12-15Requirement 1: Error discovered before the books are adjusted or closed in 2011. The journal entry the company made is: Cash ............................................................. Investments .............................................. The journal entry the company should have made is: Cash ............................................................. Investments .............................................. Gain on sale of investments ($100,000 C 80,000) 100,000 80,000 20,000 100,000 100,000Therefore, to get from what was done to what should have been done, the following entry is needed: Investments ($100,000 C 80,000) ..................... Gain on sale of investments ..................... Requirement 2: Error not discovered until early 2012. Investments ($100,000 C 80,000) ..................... Retained earnings .................................... 20,000 20,000 20,000 20,00012-39Chapter 12 - InvestmentsExercise 12-16Purchase ($ in millions)Investment in Carne Cosmetics shares ................................ Cash ................................................................................Net income68 68 10 10 4 4 1 1Investment in Carne Cosmetics shares (25% x $40 million) .. Investment revenue ..........................................................Dividends Cash (4 million shares x $1) .....................................................Investment in Carne Cosmetics shares ............................Depreciation AdjustmentInvestment revenue ($8 million [calculation below?] ÷8 years) . Investment in Carne Cosmetics shares ............................ ?Calculations:Investee Net Assets Net Assets Purchased Difference Attributed to:?Cost Fair value: Book value:?$68??$224* x 25% = $56Goodwill:$12 Undervaluation of assets: $8?$192 x 25% = $48 *[$192 + 32] = $224 Adjusting entryNo entry to adjust for changes in fair value as this investment is accounted for under the equity method.12-40Chapter 12 - InvestmentsExercise 12-17Requirement 1Purchase ($ in millions)Investment in Lake Construction shares ............................. Cash ................................................................................Net income300 300 30 30 6 6 1 1Investment in Lake Construction shares (20% x $150 million) Investment revenue ..........................................................Dividends Cash (20% x $30 million) ........................................................Investment in Lake Construction shares .........................Adjustment for depreciationInvestment revenue ($10 million [calculation below?] ÷10 years) Investment in Lake Construction shares ......................... ? calculation:Investee Net Assets Net Assets Purchased Difference Attributed to:?Cost Fair value:?$300??$900 x 20% = $180Goodwill:$120Book value:$800 x 20% = $160?Undervaluation of buildings ($10) and land ($10): $20Requirement 2 a. Investment in Lake Construction shares ________________________________________($ in millions)Cost 300 Share of income 30 6 Dividends 1 Depreciation adjustment _________________ 323Balance12-41Chapter 12 - InvestmentsExercise 12-17 (concluded)b. As investment revenue in the income statement. $30 million (share of income) C $1 million (depreciation adjustment) = $29 million c. Among investing activities in the statement of cash flows. $294 million12-42Chapter 12 - InvestmentsExercise 12-18Requirement 1 First we need to identify the amount of difference between book value and fair value associated with goodwill, buildings and land:Investee Net Assets Net Assets Purchased Difference Attributed to:?Cost Fair value:?$750??$900 x 50% = $450Goodwill:$300Book value:$800 x 50% = $400?Undervaluation of buildings ($25) and land ($25): $50a.January 1, 2011 effect on Buildings Because half of the fair value of Lake’s individual net assets are buildings, and Lake would be consolidated with Cameron, Cameron’s Buildings account would increase by 1/2 x $450 = $225 million. January 1, 2011 effect on Land Because half of the fair value of Lake’s individual net assets is land, and Lake would be consolidated with Cameron, Cameron’s Land account would increase by 1/2 x $450 = $225 million. January 1, 2011 effect on Goodwill Because Lake would be consolidated with Cameron, Cameron’s Goodwill account would increase by $300 million. January 1, 2011 effect on Equity method investments Because Lake would be consolidated with Cameron, there would be no effect of this investment on Cameron’s Equity method investment account.b.c.d.12-43Chapter 12 - InvestmentsExercise 12-18 (concluded) Requirement 2 a. December 31, 2011 effect on Buildings Because half of the fair value of Lake’s individual net assets are buildings, and Lake would be consolidated with Cameron, Cameron’s Buildings account would increase by 1/2 x $450 = $225 million. Cameron would depreciate those buildings over their remaining 10 year life, so Lake would recognize $22.5 million of depreciation expense per year ($225 million ÷10 years). Therefore, at December 31, 2011, the buildings associated with the Lake investment would have a carrying value of $202.5 million ($225 million cost - $22.5 million accumulated depreciation). b. December 31, 2011 effect on Land Land is not amortized, so its carrying value would not change from its value on January 1, 2011. December 31, 2011 effect on Goodwill Goodwill is not amortized, so its carrying value would not change from its value on January 1, 2011. December 31, 2011 effect on Equity method investments Because Lake would be consolidated with Cameron, there would be no effect of this investment on Cameron’s Equity method investment account at December 31, 2011.c.d.Requirement 3 The effect of the investment on Cameron’s December 31, 2011 retained earnings would not differ between the equity method and proportionate consolidation treatments. Under the equity method, Cameron would recognize investment revenue based on its share of Lake’s net income, while under proportionate consolidation, Cameron would include its share of Lake’s revenue and expenses on those lines of the consolidated income statement. Regardless, the same total amount would be included in Cameron’s net income and closed to Cameron’s retained earnings.12-44Chapter 12 - InvestmentsExercise 12-19Requirement 1 Electing the fair value option for held-to-maturity securities simply requires reclassifying those securities as trading securities. Therefore, this investment would be classified as a trading security on Tanner-UNF’s balance sheet. Requirement 2 Investment in bonds (face amount) ....................... Discount on bond investment (difference) ........ Cash (price of bonds) .......................................... Requirement 3 Cash (3% x $240 million) ....................................... Discount on bond investment (difference) ............ Interest revenue (4% x $200) .................................. Requirement 4 The carrying value of the bonds is $240 C ($40 C $0.8) = $200.8. Therefore, to adjust to fair value of $210, Tanner-UNF would need the following journal entry: Fair value adjustment ......................................... Net unrealized holding gains and losses―I/S ($210 C 200.8) Requirement 5 Tanner-UNF reports its investment in the December 31, 2011, balance sheet at fair value of $210 million. Requirement 6 Cash (proceeds from sale) ....................................... Loss on sale of investments (to balance)............... Discount on bond investment (account balance) .... Investment in bonds (account balance)...............($ in millions) ($ in millions)240 40 200 7.2 .8 8.09.2 9.2190.0 10.8 39.2 240.0Assuming no other trading securities, the 2012 adjusting entry would be: Net unrealized holding gains and losses―I/S .... 9.2 Fair value adjustment (account balance) ........... 9.212-45Chapter 12 - InvestmentsExercise 12-20Requirement 1 Electing the fair value option for available-for-sale securities simply requires reclassifying those securities as trading securities. Therefore, this investment would be classified as a trading security on Sanborn’s balance sheet. Requirement 2Purchase ($ in millions)Investment in Jackson Industry shares ........................................ Cash ........................................................................................Net income90 90No entryDividends Cash (5% x $60 million) ..................................................................3 3 8 8Investment revenue ..................................................................Adjusting entryFair value adjustment ($98 C 90 million) ........................................ Net unrealized holding gains and losses―I/S .........................Requirement 3 Investment revenue (dividends) .......................................... Net unrealized holding gains and losses (from adjusting entry) Total effect on 2011 net income before taxes $ 3,000 8,000 11,00012-46Chapter 12 - InvestmentsExercise 12-21Requirement 1 Electing the fair value option for significant-influence investments requires use of the same basic accounting approach that is used for trading securities. However, the investments will still be classified as significant-influence investments and shown either on the same line of the balance sheet as equity-method investments (but with the amount at fair value indicated parenthetically) or on a separate line of the balance sheet. Requirement 2Purchase ($ in millions)Investment in Nursery Supplies shares ................................... Cash ....................................................................................Net income56 56No entry.Dividends Cash (30% x 8 million shares x $1.25) ...........................................3 3 4 4Investment revenue ..............................................................Adjusting entry ...................................................................................... Net unrealized holding gains and losses―I/S ($56 C 52 million)Fair value adjustment ..........................................................12-47Chapter 12 - InvestmentsNote: A different approach to reach the same outcome would be for Florists to use equity-method accounting throughout the year, and then at the end of the year make whatever adjustment to fair value is necessary to adjust the investment account to fair value. Under that approach, Florists would recognize 30% of Nursery’s $40 million of income ($12 million) as investment income, it would not recognize investment income associated with Nursery’s dividend, and would end up with an Investment account containing $65 ($56 million + $12 million C $3 million). The company would need to make a fair value adjustment of $13 million ($65 million C 52 million). So the total amount of loss recognized would be $1 million ($12 million investment income C $13 million unrealized loss). Note that this alternative produces the same total amount of investment loss as is produced above: $1 million ($3 million investment revenue C $4 million unrealized loss).Exercise 12-22Requirement 1 Insurance expense (difference)............................................... Cash surrender value of life insurance ($27,000 C 21,000) ..... Cash (2011 premium) .......................................................... Requirement 2 Cash (death benefit) ........................................................ Cash surrender value of life insurance (account balance) Gain on life insurance settlement (to balance) ........... 64,000 6,000 70,000 4,000,000 27,000 3,973,000Exercise 12-23Requirement 1 Insurance expense (difference)....................................... Cash surrender value of life insurance ($4,600 C 2,500) .. Cash (premium) .......................................................... Requirement 2 Cash (death benefit) ........................................................ Cash surrender value of life insurance (account balance) Gain on life insurance settlement (to balance) ........... 250,000 16,000 234,000 22,900 2,100 25,00012-48Chapter 12 - InvestmentsExercise 12-24Requirement 1 Bloom believes it is more likely than not it will have to sell the investment before fair value recovers, so the portion of the impairment that consists of credit and non-credit losses is not relevant. Bloom must recognize the entire OTT impairment in earnings as follows: Other-than-temporary impairment loss C I/S .... Discount on bond investment ......................... 400,000 400,000On the income statement, the entire $400,000 will be shown as an OTT impairment loss. Requirement 2 Bloom does not plan to sell the investment, and does not believe it is more likely than not that it will have to sell the investment before fair value recovers, so the portion of the impairment that consists of credit and non-credit losses is relevant. Bloom must recognize the $250,000 of credit losses as an OTT impairment in earnings, and the other $150,000 as a reduction of OCI, as follows: Other-than-temporary impairment loss C I/S .... Discount on bond investment ......................... OTT impairment loss C OCI .............................. Fair value adjustment C Non-credit loss ......... 250,000 250,000 150,000 150,000On the income statement, the entire $400,000 will be shown as an OTT impairment l