Chapter 12

Chapter 12

Investments

QUESTIONS FOR REVIEW OF KEY TOPICS
Investment securities classified as “held-to-maturity,” “available-for-sale,” or

Question 12-1“trading securities.”
Increases and decreases in the market value between the time a debt security is

Question 12-2acquired and the day it matures to a prearranged maturity value are ignored for
securities classified as “held-to-maturity.” These changes aren’t important if sale before maturity isn’t an alternative, which is the case if an investor has the “positive intent and ability” to hold the securities to maturity. The fair value of an equity security is considered “readily determinable” if its Question 12-3selling price (or bid-and-asked quotation) is currently available on a securities exchange. When its fair value is not readily determinable, an investment is carried and reported at cost. Any dividends received are recognized as investment revenue, and a gain or loss is reported only when actually realized through the sale of the investment. For investments to be held for an unspecified period of time, fair value Question 12-4information 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 and 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. The way unrealized holding gains and losses are reported in the financial Question 12-5statements depends on whether the investments are classified as “securities available-for-sale” or as “trading 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. Comprehensive income is a more expansive view of the change in Question 12-6shareholders’ equity than traditional net income. It encompasses all changes in equity from nonowner transactions. So, in addition to net income, comprehensive income includes up to four other changes in equity: Foreign currency translation ad ustments, !et unreali"ed holding gains #losses$ on investments, %nreali"ed pension cost, and &eferred gain or loss from derivatives. Unrealized holding gains or losses on trading securities

Answers to Questions (continued) are reported in the income statement as if they actually had Question 12-7
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
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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 not considered relevant performance measures to be included in earnings. Apparently, the drop in the market price of the stock is an other-than-temporary Question 12-8impairment. 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. 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. When acquired, debt and equity securities are assigned to one of the three Question 12-9reporting classifications – held-to-maturity, available-for-sale, or trading. 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 as a separate component of shareholders’ equity. 3. Into the held-to-maturity category, any unrealized holding gain or loss should be amortized over the remaining time to maturity. Yes. Although a company is not required to report individual amounts for the Question 12-10three categories of investments – held-to-maturity, available-for-sale, or trading – 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. 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. The equity method is used when an investor can’t Answers to Questions (continued) control, but can “significantly influence” the investee. If effective control is absent, the investor still might be able to exercise significant influence over the operating and Question 12-11 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. The equity method, like consolidation, views the investor and investee as a Question 12-12special 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
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12-2 Intermediate Accounting, 3/e

investee as a single investment account. That single investment account is periodically adjusted to reflect the effects of consolidation, without actually consolidating financial statements. The investor should account for dividends from the investee as a reduction in Question 12-13the 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. The equity method attempts to approximate the effects of accounting for the Question 12-14purchase 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 “extra depreciation” the higher fair value would cause. This would equal 40% x $12 million ÷ 10 years = $480,000 each year for ten years. The investment account was decreased by $40,000 (40% x $100,000). Cash Question 12-15increased the same amount. There is no effect on the income statement. When it becomes necessary to change from the equity Answers to Questions (concluded) 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 Question 12-16 then on. The investment account balance when the equity method is discontinued would serve as the new “cost” basis for writing the investment up or down to market value in the next set of financial statements. A 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 Question 12-17 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. These instruments “derive” their values or contractually required cash flows Question 12-18from some other security or index. Since this fund won’t be used within the upcoming operating cycle, it is a Question 12-19noncurrent asset. It should be reported as part of “Investments and funds.” Part of each premium payment the company makes is not used by the Question 12-20insurance company to pay for life insurance coverage, but rather is “invested” on behalf of the insured company in a fixed-income investment. As a result, the periodic insurance premium should not be expensed in its entirety; an appropriate portion should be recorded instead as a noncurrent asset – cash surrender value. When a creditor’s investment in a receivable becomes impaired, due to a Question 12-21troubled debt restructuring or for any other reason, the receivable is remeasured based on the discounted present value of currently expected cash flows at the loan’s original effective rate (regardless of the extent to which expected cash receipts have been reduced). The extent of the impairment is the difference between the carrying amount of the receivable (the present value of the receivable’s cash flows prior to the restructuring) and the present value of the revised cash flows discounted at the loan’s original effective rate. This difference is recorded as a loss at the time the receivable is reduced.
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Solutions Manual, Vol. 1, Chapter 12 12-3

EXERCISES

Exercise 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 40 200

7.2 .8 8.0

Requirement 3 Tanner-UNF reports its investment in the December 31, 2003, balance sheet at its amortized cost – that is, its book value: Investment in bonds............................................ Less: Discount on bond investment ($40 - .8 million) Amortized cost................................................. $240.0 39.2 $200.8

If sale 'efore maturity isn’t an alternative, increases and decreases in the mar(et value 'etween the time a de't security is acquired and the day it matures to a prearranged maturity value are relatively unimportant. For this reason, if an investor has the )positive intent and a'ility* to hold the securities to maturity, investments in de't securities are classified as )held+to+maturity* and reported at amorti"ed cost rather than fair value in the 'alance 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 10.8 240.0

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12-4 Intermediate Accounting, 3/e

November 1

Exercise 12-2
($ in millions)

Cash................................................................. Investment revenue...................................... December 1 Investment in Facsimile Enterprises bonds..... Cash.............................................................

2.4 2.4

30 30

December 31 Investment in U.S. Treasury bills ................... Cash............................................................. December 31 Investment revenue receivable - Convenience bonds ($48 million x 10% x 2/12)........................ Investment revenue receivable - Facsimile Enterprises bonds ($30 million x 12% x 1/12)..... Investment revenue ......................................
Note: Securities held-to-maturity are not adjusted to fair value.

8.9 8.9

0.8 0.3 1.1

Exercise 12-3

Investment in GM common shares Cash ([800 shares x $50] + $1,200) ................................41,200 41,100 100

41,200

Cash ([800 shares x $53] – $1,300)....................... Loss on sale of investments............................. Investment in GM common shares .............

41,200

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Solutions Manual, Vol. 1, Chapter 12 12-5

Requirement 1

Exercise 12-4
($ in 000s)

Unrealized holding loss on investment in Blair, Inc. shares.... Investment in Blair, Inc. shares ($405 - 480).......................... Investment in ANC shares ($480 - 450)..................................... Unrealized holding gain on investment in ANC shares....... Investment in Drake shares ($560 - 480).................................... Unrealized holding gain on investment in Drake shares...... Unrealized holding loss on investment in Aaron Industries shares...................................................... Investment in Aaron Industries shares ($660 - 720)...............

75 75 30 30 80 80 60 60

Requirement 2 None. Holding gains and losses for securities available-for-sale are reported as a component of shareholders’ equity rather than as part of earnings.

Exercise 12-5Requirement 1
Securities “held-to-maturity” are debt securities an investor has the “positive 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 “trading securities.” The IBM shares are neither. They are classified as “available-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 “significant 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 a separate component of shareholders’ equity.

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12-6 Intermediate Accounting, 3/e

Requirement 2 Unrealized holding loss on investments (10,000 shares x [$58 - 60]) Investment in IBM shares ....................................................... Requirement 3 Investment in IBM shares (10,000 shares x [$61 - 58])..................... Unrealized holding loss on investment in IBM shares (from previous adjustment)................................. Unrealized holding gain on investment in IBM shares (difference)....................................................... 30,000 20,000 10,000 20,000 20,000

Note: This entry creates a net gain in a single account. It would be acceptable, but mechanically more cumbersome to leave a $20,000 balance in the loss account and also create a $30,000 gain.

Exercise 12-6Requirement 1
2003

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Solutions Manual, Vol. 1, Chapter 12 12-7

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......................................................................................... December 31 Adjusting entries: Investment in Platinum Gauges shares ....................................... Unrealized holding gain on investments
([$32 x 1 million shares] - $31 million)................................................

31 31

20 20

2 2

1 1

21 20 1

40 40

1 1

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12-8 Intermediate Accounting, 3/e

Unrealized holding loss on investments ([$74 x 500,000 shares] - $40 million).............................................. Investment in LTD preferred shares ....................................... Exercise 12-6 (concluded) 2004 January 23

3 3

($ in millions)

Cash ([1 million shares x 1/2] x $32)................................................ Unrealized holding gain on investments (1/2 amount from adjusting entry)................................ Gain on sale of investments (difference).................................... Investment in Platinum Gauges shares ($32 million balance after adjusting entry x 1/2)..................

16.0 .5 .5 16.0

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Solutions Manual, Vol. 1, Chapter 12 12-9

March 1 Cash ($76 x 500,000 shares)............................................................. Loss on sale of investments (difference)........................................ Unrealized holding loss on investments (from adjusting entry)... Investment in LTD preferred (balance after adjusting entry).........

38 2 3 37

Requirement 2 2003 Income Statement
($ in millions)

Investment revenue (from July 18; Oct. 15).................................$3 Gain on sale of investments (from Oct. 16).................................. 1

Note: Unlike for trading securities, unrealized holding gains and losses are not included in income for securities available-for-sale.

Exercise 12-7Requirement 1

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12-10 Intermediate Accounting, 3/e

Purchase

($ in millions)

Investment in Jackson Industry shares......................................... Cash ........................................................................................
Net income

90 90

No entry
Dividends

Cash (5% x $60 million).................................................................. Investment revenue..................................................................
Adjusting entry

3 3

Investment in Jackson Industry shares ($98 - 90 million)............... Unrealized holding gain on investment in Jackson Industry shares

8 8

Requirement 2 Investment revenue.......................... $3 million

An unrealized holding gain is not included in income for securities availablefor-sale.

Exercise 12-8Requirement 1
2003

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Solutions Manual, Vol. 1, Chapter 12 12-11

December 17 Investment in Grocers’ Supply preferred shares ................. Cash.................................................................................. December 28 Cash...................................................................................... Investment revenue.......................................................... December 31 Investment in Grocers’ Supply preferred shares ................. Unrealized holding gain on investments ([$4 x 100,000 shares] - $350,000)................... 2004

350,000 350,000

2,000 2,000

50,000 50,000

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12-12 Intermediate Accounting, 3/e

January 5 Cash (selling price).................................................................. Loss on investments (to balance)............................................ Investment in Grocers’ Supply preferred shares (balance after adjusting entry)................................. Requirement 2 Balance Sheet (short-term investment): Investment in Grocers’ Supply preferred shares (balance after adjusting entry)............................................. Income Statement: Investment revenue (dividends)........................................... Unrealized holding gain on investments (from adjusting entry).........................................................

395,000 5,000 400,000

$400,000 $ 2,000 50,000

Note: Unlike for securities available-for-sale, unrealized holding gains and losses are included in income for trading securities.

Exercise 12-91.
Security Security Security Security Total A B C E

Investments reported as current assets. $ 910,000 100,000 780,000 490,000 $2,280,000

2. Investments reported as noncurrent assets. Security D $ 915,000 Security F 615,000 $1,530,000

3. Unrealized gain (or loss) component of income before taxes. Trading Securities:
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Solutions Manual, Vol. 1, Chapter 12 12-13

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) $ 5,000

4. Unrealized gain (or loss) component of 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 $95,000

Exercise 12-10Requirement 1
Unrealized holding loss on investment in Yucatan Growers common shares ....................................... Investment in Yucatan Growers common shares ($1,175,000 - 1,200,000).......................................... Requirement 2 Investment in Yucatan Growers common shares ($1,275,000 - 1,200,000)................................................. Unrealized holding loss on investment in Yucatan Growers common shares ................................. Requirement 3 75,000 75,000 25,000 25,000

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12-14 Intermediate Accounting, 3/e

Investment in Yucatan Growers common shares ($1,375,000 - 1,200,000)................................................. Unrealized holding loss on investment in Yucatan Growers common shares (balance).................... Unrealized holding gain on investment in Yucatan Growers common shares (difference).................

175,000 145,000 30,000

Exercise 12-11
2. b

1. b

Exercise 12-12Requirement 1
Purchase

Investment in AMC common shares.................................... Cash ...............................................................................
Net income

480,000 480,000

No entry
Dividends Cash (20% x 400,000 shares x $0.25).........................................

20,000 20,000 25,000 25,000

Investment revenue.........................................................
Adjusting entry

Investment in AMC common shares ($505,000 - 480,000)...... Unrealized holding gain on investment in AMC common shares ............................................... Requirement 2

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Solutions Manual, Vol. 1, Chapter 12 12-15

Purchase

Investment in AMC common shares.................................... Cash ...............................................................................
Net income

480,000 480,000 50,000 50,000 20,000 20,000

Investment 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 entry

No entry

Exercise 12-13
Purchase ($ in millions)

Investment in Nursery Supplies shares.................................... Cash ....................................................................................
Net income

56 56

Investment in Nursery Supplies shares (30% x $40 million) ...... Investment revenue..............................................................
Dividends

12 12

Cash (30% x 8 million shares x $1.25)........................................... Investment in Nursery Supplies shares................................
Adjusting entry

3 3

No entry

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12-16 Intermediate Accounting, 3/e

Requirement 1

Exercise 12-14
($ in millions)

Investment in equity securities ($48 million – 31 million)............ Retained earnings (investment revenue from the equity method).

17 17

Requirement 2 Financial statements would be restated to the equity method for each year reported for comparative purposes. The income effect for years prior to those included in the comparative statements is reported in the statement of retained earnings as an adjustment to beginning retained earnings of the earliest year reported. A disclosure note also should describe the change. 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 “cost” basis for writing the investment up or down to market value in the next set of financial statements. There also would be no restatement of prior years, but the change should be described in a disclosure note.

Exercise 12-15See solution to Exercise 21-22.

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Solutions Manual, Vol. 1, Chapter 12 12-17

Purchase

($ in millions)

Exercise 12-16
Investment in Carne Cosmetics shares................................. Cash .................................................................................
Net income

68 68

Investment in Carne Cosmetics shares (25% x $40 million) ... Investment revenue..........................................................
Dividends

10 10

Cash (4 million shares x $1)...................................................... Investment in Carne Cosmetics shares.............................
Depreciation Adjustment

4 4

Investment revenue ($8 million [calculation below‡] ÷ 8 years). Investment in Carne Cosmetics shares............................. ‡Calculations:
Investee Net Assets Net Assets Purchased Difference Attributed to:

1 1

⇓
Cost Fair value: Book value:

⇓
$68

⇓


$224* x 25% = $56

Goodwill:$12 Undervaluation of assets: $8


$192 x 25% = $48 *[$192 + 32] = $224 Adjusting entry

No entry

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12-18 Intermediate Accounting, 3/e

Exercise 12-17Requirement 1

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Solutions Manual, Vol. 1, Chapter 12 12-19

Purchase

($ in millions)

Investment in Lake Construction shares.............................. Cash .................................................................................
Net income

300 300

Investment in Lake Construction shares (20% x $150 million) Investment revenue..........................................................
Dividends

30 30

Cash (20% x $30 million)......................................................... Investment in Lake Construction shares..........................
Adjustment for depreciation

6 6

Investment revenue ($10 million [calculation below‡] ÷ 10 years) Investment in Lake Construction shares..........................

1 1

‡ calculation:
Investee Net Assets Net Assets Purchased Difference Attributed to:

⇓
Cost Fair value:

⇓
$300

⇓


$900 x 20% = $180

Goodwill:

$120


Book value: $800 x 20% = $160

Undervaluation of buildings($10) and land ($10): $20

Requirement 2 a. Investment in Lake Construction shares __________________________________________
($ in millions)

Cost
12-20

300
Intermediate Accounting, 3/e

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Share of income

30

Balance

6 Dividends 1 Depreciation adjustment _________________ 323

Exercise 12-17 (concluded) b. As investment revenue in the income statement. $30 million (share of income) – $1 million (depreciation adjustment) = $29 million c. Among investing activities in the statement of cash flows. $300 million
[Cash dividends received ($6 million) also are reported - as part of operating activities.]

1. b

Exercise 12-18
2. b 3. b

Exercise 12-19Requirement 1
Insurance expense (difference)............................................... Cash surrender value of life insurance ($27,000 – 21,000)...... Cash (2003 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 3,973,000

Exercise 12-20Requirement 1
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Solutions Manual, Vol. 1, Chapter 12 12-21

Insurance expense (difference)........................................ Cash surrender value of life insurance ($4,600 – 2,500). . Cash (premium)..........................................................

22,900 2,100 25,000

Requirement 2 Cash (death benefit)......................................................... Cash surrender value of life insurance (account balance) Gain on life insurance settlement (to balance)............
ANALYSIS

250,000 16,000 234,000

Exercise 12-21
Previous Value:

Accrued interest (10% x $12,000,000) Principal Carrying amount of the receivable
New Value:

$ 1,200,000 12,000,000 $13,200,000
= =

Interest $1 million x 1.73554 * Principal $11 million x 0.82645 ** Present value of the receivable
Loss:

$1,735,540 9,090,950 (10,826,490) $ 2,373,510

* present value of an ordinary annuity of $1: n=2, i=10% ** present value of $1: n=2, i=10% JOURNAL ENTRIES

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12-22 Intermediate Accounting, 3/e

January 1, 2003 Loss on troubled debt restructuring (to balance)............. Accrued interest receivable (account balance)............. Note receivable ($12,000,000 - 10,826,490).................. December 31, 2003 Cash (required by new agreement)..................................... Note receivable (to balance)........................................... Interest revenue (10% x $10,826,490).......................... December 31, 2004 Cash (required by new agreement)..................................... Note receivable (to balance)........................................... Interest revenue (10% x [$10,826,490 + 82,649])........... Cash (required by new agreement)..................................... Note receivable (balance)........................................... 1,000,000 90,861 1,090,861* 11,000,000 11,000,000 1,000,000 82,649 1,082,649 2,373,510 1,200,000 1,173,510

* rounded to amortize the note to $11,000,000 (per schedule below)

Exercise 12-21 (concluded)
Cash Interest by agreement

Amortization Schedule – Not required
Outstanding Balance

Effective Increase in Interest Balance 10% x Outstanding Balance Discount Reduction .10 (10,826,490) = 1,082,649 .10 (10,909,139) = 1,090,861* 2,173,510

1 2

1,000,000 1,000,000
2,000,000 * rounded

82,649 90,861
173,510

10,826,490 10,909,139 11,000,000

ANALYSIS

Exercise 12-22
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Solutions Manual, Vol. 1, Chapter 12 12-23

Previous Value:

Accrued interest (10% x $240,000) Principal Carrying amount of the receivable
New Value:

$ 24,000 240,000 $264,000

$11,555 + 11,555 + 11,555 + 240,000 = $274,665 $274,665 x 0.82645 * =
Loss: * present value of $1: n=2, i=10% JOURNAL ENTRIES

(226,997) $ 37,003

January 1, 2003 Loss on troubled debt restructuring (to balance)............. Accrued interest receivable (10% x $240,000)............ Note receivable ($240,000 - $226,997)........................ December 31, 2003 Note receivable (to balance)........................................... Interest revenue (10% x $226,997).............................. December 31, 2004 Note receivable (to balance)........................................... Interest revenue (10% x [$226,997 + 22,700])............... Cash (required by new agreement)..................................... Note receivable (balance)...........................................
* rounded to amortize the note to $274,665 (per schedule below)

37,003 24,000 13,003

22,700 22,700

24,968 24,968* 274,665 274,665

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12-24 Intermediate Accounting, 3/e

Exercise 12-22 (concluded)
Cash Interest by agreement

Amortization Schedule – Not required
Increase in Outstanding Balance Balance Discount Reduction

Effective Interest 10% x Outstanding Balance .10 (226,997) = 22,700 .10 (249,697) = 24,968*

1 2

0 0

22,700 24,968

226,997 249,697 274,665

PROBLEMS
47,668 * rounded 47,668

Problem 12-1Requirement 1
Investment in bonds (face amount)........................ Discount on bond investment (difference)......... Cash (price of bonds).......................................... Requirement 2 Cash (4% x $80 million).......................................... Discount on bond investment (difference)............. Interest revenue (5% x $66).................................... Requirement 3 Cash (4% x $80 million).......................................... Discount on bond investment (difference)............. Interest revenue (5% x [$66 + 0.1]).........................

($ in millions)

80 14 66

3.20 .10 3.30

3.20 .11 3.31

Requirement 4 Fuzzy Monkey reports its investment in the December 31, 2003, balance sheet at its amortized cost – that is, its book value: Investment in bonds............................................................ Less: Discount on bond investment ($14 - .1 - .11 million) $80.00 13.79

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Amortized cost................................................................

$66.21

Increases and decreases in the mar(et value 'etween the time a de't security is acquired and the day it matures to a prearranged maturity value are relatively unimportant if sale 'efore maturity isn’t an alternative. For this reason, if an investor has the )positive intent and a'ility* to hold the securities to maturity, investments in de't securities are classified as )held+to+maturity* and reported at amorti"ed cost rather than fair value in the 'alance sheet.

Problem 12-2Requirement 1
Investment in bonds (face amount)........................ Discount on bond investment (difference)......... Cash (price of bonds).......................................... Requirement 2 Cash (4% x $80 million).......................................... Discount on bond investment (difference)............. Interest revenue (5% x $66).................................... Requirement 3 Cash (4% x $80 million).......................................... Discount on bond investment (difference)............. Interest revenue (5% x [$66 + 0.1]).........................

($ in millions)

80 14 66

3.20 .10 3.30

3.20 .11 3.31

Requirement 4 Fuzzy Monkey reports its investment in the December 31, 2003, balance sheet at its fair value, $70 million in this case. For investments in securities availa'le+ for+sale, changes in mar(et values, and thus mar(et returns, provide an indication of management’s success in deciding when to acquire the investment, when to sell it, whether to invest in fixed+rate or varia'le+rate securities, and whether to invest in long+term or short+term securities. ,o do this, we first need to determine the investment’s amorti"ed cost #or 'oo( value$ at the end of the year: Investment in bonds............................................................ Less: Discount on bond investment ($14 - .1 - .11 million) 13.79 Amortized cost................................................................
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$80.00 $66.21

,hen, to record it a fair value, we increase the investment 'y -./ 0 11.23 4 -5..6 million. An acceptable alternative to increasing (or decreasing) an investment to fair value directly with a debit (or credit) to the investment account itself is to instead debit (or credit) an asset valuation account to adjust the investment account indirectly. This, in fact, would be desirable when adjusting a debt security, like this investment in bonds, so we can continue to amortize its cost separately from fair market adjustments: Investment ad ustment to fair value.................... %nreali"ed holding gain on investments #-./ 0 11.23$ 5..6 5..6

Problem 12-3Requirement 1
2003 February 21 Investment in Distribution Transformers shares ......... Cash.......................................................................... March 18 Cash.............................................................................. Investment revenue................................................... September 1 Investment in American Instruments bonds ................ Cash.......................................................................... October 20 Cash.............................................................................. Investment in Distribution Transformers ............... Gain on sale of investments...................................... November 1 Investment in M&D Corporation shares ..................... Cash.......................................................................... 400,000 400,000

8,000 8,000

900,000 900,000

425,000 400,000 25,000

1,400,000 1,400,000

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December 31 Adjusting entries: Investment revenue receivable..................................... Investment revenue ($900,000 x 10% x 4/12)............... Unrealized holding loss on investments ($850,000 - 900,000) Investment in American Instruments bonds ............ 30,000 30,000 50,000 50,000

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Problem 12-3 (concluded) Investment in M&D Corporation shares Unrealized holding gain on investments ($1,460,000 - 1,400,000)......................... Closing entry: Investment revenue ($8,000 + 30,000)............................. Gain on sale of investments.......................................... Income summary...................................................... 38,000 25,000 63,000 60,000 60,000

Note: Unlike for trading securities, unrealized holding gains and losses are not included in income for securities available-for-sale.

Requirement 2 Balance sheet (short-term investment): Investment revenue receivable............. Investment in American Instruments bonds Investment in M&D Corporation shares Balance sheet (shareholders’ equity): Net unrealized holding gain on investments ($60,000 - 50,000)............. Income statement: Investment revenue ($8,000 + 30,000)........ Gain on sale of investments..................... Requirement 3 2004 $ 30,000 850,000 1,460,000

10,000 $ 38,000 25,000

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January 20 Cash.............................................................................. Unrealized holding gain on investments...................... Gain on sale of investments (to balance).................... Investment in M&D Corporation shares ($1,400,000 + 60,000)...................................... March 1 Cash.............................................................................. Investment revenue receivable................................. Investment revenue...................................................

1,485,000 60,000 85,000 1,460,000 45,000 30,000 15,000

Problem 12-4Requirement 1
2003

December 12 Investment in FF&G Corporation bonds ...................................... Cash.......................................................................................... December 13 Investment in Investment in Ferry common shares ..................... Cash.......................................................................................... December 15 Cash.............................................................................................. Investment in FF&G Corporation bonds .................................. Gain on sale of investments ($12.1 – 12).................................... December 22 Investment in U.S. Treasury bills ................................................. Investment in U.S. Treasury bonds .............................................. Cash..........................................................................................

($ in millions)

12 12

22 22

12.1 12.0 0.1

56 65 121

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December 23 Cash.............................................................................................. Loss on sale of investments ($10 – 11)........................................... Investment in Ferry common shares ($22 x 1/2)......................... December 26 Cash (selling price).......................................................................... Gain on sale of investments ($57 – 56)....................................... Investment in U.S. Treasury bills (balance)................................ December 27 Cash (selling price).......................................................................... Loss on sale of investments ($63 – 65)........................................... Investment in U.S. Treasury bonds (balance)............................. December 28 Cash.............................................................................................. Investment revenue................................................................... Problem 12-4 (concluded) December 31

10 1 11

57 1 56

63 2 65

0.2 0.2

($ in millions)

Adjusting entry: Unrealized holding loss on investments ($10 million - [$22 million x 1/2])................................. Investment in Ferry common shares ........................................ Closing entry: Income summary (to balance).......................................................... Investment revenue ($5 + 0.2 million).............................................. Gain on sale of investments ($8 + 0.1 + 1 million)........................... Loss on sale of investments ($11 + 1 + 2 million)........................ Unrealized holding loss on investments (adjusting entry)............ .7 5.2 9.1 14.0 1.0

1.0 1.0

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Note: Unlike for securities available-for-sale, unrealized holding gains and losses are included in income for trading securities.

Requirement 2
($ in millions)

Balance sheet (short-term investment): Investment in Ferry common shares (balance after adjusting entry) Income statement: Investment revenue (closing entry) Gain on sale of investments (closing entry) Loss on sale of investments (closing entry) Unrealized holding loss on investments (closing entry) Requirement 3 2004 January 2

10.0 5.2 9.1 (14.0) (1.0)

($ in millions)

Cash (selling price).......................................................................... Investment in Ferry common (balance after adjusting entry).......... Gain on sale of investments (difference)..................................... January 5 Investment in Warehouse Designs bonds .................................... Cash..........................................................................................

10.2 10.0 .2

34 34
($ in millions)

Problem 12-5
October 18 Investment in Millwork Ventures preferred shares ...................... Cash..........................................................................................

58 58

October 31

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Cash.............................................................................................. Investment revenue................................................................... November 1 Investment in Holistic Entertainment bonds................................. Cash..........................................................................................

1.5 1.5

18 18

November 1 Cash.............................................................................................. Loss on sale of investments ($28 – 30)........................................... Investment in Kansas Abstractors bonds .................................

28 2 30

December 1 Investment in Household Plastics bonds....................................... Cash..........................................................................................

60 60

December 20 Investment in U.S. Treasury bonds .............................................. Cash..........................................................................................

5.6 5.6

December 21 Investment in NXS common shares ............................................. Cash.......................................................................................... December 23 Cash.............................................................................................. Investment in U.S. Treasury bonds .......................................... Gain on sale of investments ($5.7 – 5.6).....................................

44 44

5.7 5.6 .1

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Problem 12-5 (continued)
($ in millions)

December 29 Cash.............................................................................................. Investment revenue................................................................. December 31 Accrued interest: Investment revenue receivable - Holistic Entertainment ($18 million x 10% x 2/12)....................................... Investment revenue receivable - Household Plastics ($60 million x 12% x 1/12).................................................. Investment revenue ................................................................ Revaluations: Unrealized holding loss on investments ([2 million shares x $27.50] - $58 million)..................... Investment in Millwork Ventures preferred shares ............... Investment in NXS common shares ............................................. Unrealized holding gain on investments ([4 million shares x $11.50] - $44 million)...............
Note: Securities held-to-maturity are not adjusted to fair value.

3 3

0.3 0.6 0.9

3 3 2 2

Closing entry: Unrealized holding gain on investments (NXS)............................. Investment revenue ($3.0 + 1.5 + .9)................................................ Gain on sale of investments (U.S. Treasury bonds)........................... Loss on sale of investments (Kansas Abstractors)...................... Income summary (to balance)................................................... 2.0 5.4 .1 2.0 5.5

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Note: Unlike for securities available-for-sale, unrealized holding gains and losses are included in income for trading securities.

2004 January 7 Cash.............................................................................................. Loss on sale of investments (to balance)......................................... Investment in NXS common shares (after adjusting entry)...........

43 3 46

Problem 12-6Requirement 1
Purchase Investment in Lavery Labeling shares.......................................... Cash ......................................................................................... Net income Investment in Lavery Labeling shares (30% x $160 million) ........... Investment revenue................................................................... Dividends Cash (10 million shares x $2)............................................................. Investment in Lavery Labeling shares...................................... Depreciation adjustment Investment revenue ([$80 million x 30%] ÷ 6 years)......................... Investment in Lavery Labeling shares...................................... 4 4 20 20 48 48
($ in millions)

324 324

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‡Calculations:
Investee Net Assets Net Assets Purchased Difference Attributed to:

⇓
Cost Fair value: Book value:

⇓
$324

⇓


$880* x 30% = $264

Goodwill: Undervaluation of depr. assets:

$60


$800 x 30% = $240

$24

*[$800 + 80] = $880 Adjusting entry No entry Problem 12-6 (concluded) Requirement 2 Purchase Investment in Lavery Labeling shares.......................................... Cash ......................................................................................... Net income No entry Dividends Cash (10 million shares x $2)............................................................. Investment revenue................................................................... Adjusting entry Unrealized holding loss on investments
([10 million shares x $31] – $324 million)................................................. ($ in millions)

324 324

20 20

14 14

Investment in Lavery Labeling shares......................................

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Problem 12-7Requirement 1
Purchase Investment in Vancouver T&M shares......................................... Cash ......................................................................................... Net income Investment in Vancouver T&M shares (40% x $140 million) .......... Investment revenue................................................................... Dividends Cash (40% x $30 million).................................................................. Investment in Vancouver T&M shares..................................... Inventory adjustment Investment revenue ($5 million x 40%: all sold in 2003)..................... Investment in Vancouver T&M shares..................................... Depreciation adjustment Investment revenue ([$20 million x 40%] ÷ 16 years)........................ Investment in Vancouver T&M shares..................................... .5 .5 2.0 2.0 12.0 12.0 56.0 56.0
($ in millions)

400.0 400.0

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‡Calculations:
Investee Net Assets Net Assets Purchased Difference Attributed to:

⇓
Cost Fair value: inventory plant facilities Book value: * $775 +5 +20

⇓
$400

⇓


$800* x 40% = $320 (5) x 40% (20) x 40% $775 x 40% = $310

Goodwill: Undervaluation of inventory: Undervaluation of plant:

$80 [plug]

 

$2 $8

Problem 12-7 (concluded) Requirement 2 Investment Revenue
#- in millions$

71./ Share of income Inventory &epreciation 9alance 2./ .7 88888888888888888 53.5

Requirement 3

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Investment in Vancouver T&M shares
#- in millions$

Cost Share of income

://./ 71./ 32./ &ividends 2./ Inventory .7 &epreciation 88888888888888888 441.5

9alance

Requirement 4 -:// million cash outflow from investing activities -32 million cash inflow #dividends$ among operating activities

Problem 12-8
Requirement 1 Miller’s management should decide whether it has the ability to exercise significant influence over operating and financial policies of the Marlon Company. Ability to exercise significant influence is presumed for investments of 20 percent or more of voting stock and presumed not to exist for investments of less than 20 percent, other things being equal. Evidence to the contrary should be considered, including participation on the board of directors, technological dependency, material intercompany transactions, or interchange of managerial personnel. Requirement 2 a. Income statement: Investment revenue ($12 million x 1/6) Patent amortization adjustment ($4 million* ÷ 10)
*([$24 million] x 1/6]) ($ in millions)

$2.0 (.4) $1.6
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12-39

b. Balance sheet: Investment in Marlon Company ($19 million + 2 million - 1 million - .4 million) *Investment in Marlon Company
#- in millions$

$19.6*

Cost Share of income

36./ 2./ 3./ &ividends #-1 million x 3; 1$ .: <morti"ation ad ustment 88888888888888888 19.

9alance

c. Statement of cash flows: -36 million cash outflow from investing activities -3 million cash inflow #dividends$ among operating activities

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Problem 12-9
Item Reporting Category __A_ 1. 35% of the nonvoting preferred stock T. Trading securities of American Aircraft Company M. Securities held-to-maturity __M_ 2. Treasury bills to be held-to-maturity A. Securities available-for-sale __M_ 3. Two-year note receivable from affiliate E. Equity method __N_ 4. Accounts receivable C. Consolidation __M_ 5. Treasury bond maturing in one week N. None of these __T_ 6. Common stock held in trading account for immediate resale. __T_ 7. Bonds acquired to profit from short-term differences in price. __E_ 8. 35% of the voting common stock of Computer Storage Devices Company. __C_ 9. 90% of the voting common stock of Affiliated Peripherals, Inc. __A_10. Corporate bonds of Primary Smelting Company to be sold if interest rates fall 1/2%. __A_11. 25% of the voting common stock of Smith Foundries Corporation: 51% family-owned by Smith family; fair value determinable. __E_ 12. 17% of the voting common stock of Shipping Barrels Corporation: Investor’s CEO on the board of directors of Shipping Barrels Corporation.

Problem 12-10Requirement 1
($ in millions)

Land.............................................................................................. Loss on debt restructuring............................................................. Note receivable......................................................................... Accrued interest receivable.......................................................

16 6 20 2

Requirement 2
ANALYSIS

Previous Value: Accrued interest (10% x $20,000,000) Principal Carrying amount of the receivable
Solutions Manual, Vol. 1, Chapter 12

$ 2,000,000 20,000,000 $22,000,000
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12-41

New Value: Interest $1 million x 3.16987 * Principal $15 million x 0.68301 ** Present value of the receivable Loss:

= =

$ 3,169,870 10,245,150 (13,415,020) $ 8,584,980

* present value of an ordinary annuity of $1: n=4, i=10% ** present value of $1: n=4, i=10% JOURNAL ENTRIES

January 1, 2003 Loss on troubled debt restructuring (to balance).................. Accrued interest receivable (10% x $20,000,000)............. Note receivable ($20,000,000 - $13,415,020)..................... December 31, 2003 Cash (required by new agreement).......................................... Note receivable (to balance)................................................. Interest revenue (10% x $13,415,020)............................... December 31, 2004 Cash (required by new agreement).......................................... Note receivable (to balance)................................................. Interest revenue (10% x $13,756,522)............................... Problem 12-10 (continued) December 31, 2005 Cash (required by new agreement).......................................... Note receivable (to balance)................................................. Interest revenue (10% x $14,132,174)............................... 1,000,000 413,217 1,413,217 1,000,000 375,652 1,375,652 1,000,000 341,502 1,341,502 8,584,980 2,000,000 6,584,980

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December 31, 2006 Cash (required by new agreement).......................................... Note receivable (to balance)................................................. Interest revenue (10% x $14,545,391)............................... 1,000,000 454,609 1,454,609*

Cash (required by new agreement).......................................... 15,000,000 Note receivable (balance)................................................ 15,000,000
* rounded to amortize the note to $15,000,000 (per schedule below)

Amortization Schedule – Not required
Cash Interest by agreement Effective Interest 10% x Outstanding Balance .10(13,415,020) = .10(13,756,522) = .10(14,132,174) = .10(14,545,391) = Increase in Balance Discount Reduction Outstanding Balance

13,415,020 1 2 3 4 1,000,000 1,000,000 1,000,000 1,000,000 4,000,000
* rounded

1,341,502 1,375,652 1,413,217 1,454,609* 5,584,980

341,502 375,652 413,217 454,609 1,584,980

Problem 12-10 (continued) Requirement 3
ANALYSIS

Previous Value: Accrued interest (10% x $20,000,000) Principal Carrying amount of the receivable New Value: $27,775,000 x 0.68301 * = Loss:
Solutions Manual, Vol. 1, Chapter 12

$ 2,000,000 20,000,000 $22,000,000 (18,970,603) $ 3,029,397
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12-43

* present value of $1: n=4, i=10% JOURNAL ENTRIES ..

January 1, 2003

Loss on troubled debt restructuring (to balance)..................... Accrued interest receivable (10% x $20,000,000)............. Note receivable ($20,000,000 - 18,970,603)....................... December 31, 2003
..

3,029,397 2,000,000 1,029,397

Note receivable (to balance)................................................. Interest revenue (10% x $18,970,603)............................... December 31, 2004

1,897,060 1,897,060

..

Note receivable (to balance)................................................. Interest revenue (10% x [$18,970,603 + 1,897,060])............ December 31, 2005

2,086,766 2,086,766

..

Note receivable (to balance)................................................. Interest revenue (10% x balance [see schedule]).................. December 31, 2006

2,295,443 2,295,443

..

Note receivable (to balance)................................................. Interest revenue (10% x balance [see schedule])..................

2,525,128 2,525,128*

Cash (required by new agreement).......................................... 27,775,000 Note receivable (balance)................................................ 27,775,000
* rounded to amortize the note to $27,775,000 (per schedule below)

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Problem 12-10 (concluded)
Cash Interest by agreement

Amortization Schedule – Not required
Outstanding Balance

Effective Increase in Interest Balance 10% x Outstanding Balance Discount Reduction .10 (18,970,603) .10 (20,867,663) .10 (22,954,429) .10 (25,249,872)

18,970,603 1 2 3 4 0 0 0 0
* rounded

= 1,897,060 = 2,086,766 = 2,295,443 = 2,525,128* 8,804,397

1,897,060 2,086,766 2,295,443 2,525,128 8,804,397

CASES
Real World Case 12-1
Requirement 1 December 31, 2000 Cost Unrealized holding gains Fair value Requirement 2 December 31, 2000 Investment in securities..................................................... Unrealized holding gain on investments (given)............. Requirement 3
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($ in millions)

$13 53 $66

($ in millions)

53 53

!o, this does not imply that the securities involved had not previously 'een written up a'ove the original -3: million cost. =olding gains and losses from securities availa'le+ for+sale are included in earnings when they are reali"ed 'y selling the securities. >hen Sprint’s securities were sold, the fair value of the shares had risen -6/ million since the investment was acquired. Five million dollars of that rise occurred prior to 3666, 'ut wasn’t recogni"ed in prior earnings 'ecause it wasn’t yet reali"ed 'y selling the investment. !ow, the entire -6/ million gain is recogni"ed in 3666 when it is actually reali"ed:
#- in millions$

Cash #given$........................................................................ %nreali"ed holding gain on investments #-3// 0 3: million$. Investment in securities #fair value at last reporting date$..... @ain on sale of investments #given$.................................

3/: ?1 3// 6/

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Research Case 12-2
[Note: This case encourages the student to reference actual annual reports.]

The footnote that describes an investment in securities “available-for-sale” may be headed by any one of a variety of captions or subsumed within another disclosure note. Likewise, the caption by which the investments are reported in the balance sheet can be reported separately as one of several asset titles or included within another asset caption. They will be reported as current or noncurrent assets depending on the intent of management regarding the timing of their eventual sale. Realized gains or losses are reported in the income statement if any of these securities were sold during any year reported. Investments in securities available-for-sale are reported at fair value. Unrealized holding gains and losses from retaining securities during periods of price change are not included in the determination of income for the period. Rather, they are accumulated and reported as a separate component of shareholders’ equity. This means an unrealized holding gain would increase shareholders’ equity and an unrealized holding loss would decrease shareholders’ equity. Because unrealized gains or losses cause changes in shareholders’ equity, those changes are reported in the statement of shareholders’ equity. [Some companies may not provide a statement of shareholders’ equity and may provide a statement of retained earnings instead. Unrealized gains or losses have no effect on retained earnings.] In the balance sheet, unrealized gains or losses may be reported under that title, as “other” shareholders’ equity, or some different caption. By definition, securities available-for-sale 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 not considered relevant performance measures to be included in earnings. Cash outflows from acquiring these investments or inflows from selling them are reported as investing activities in the company’s comparative statements of cash flows. Whether they are specifically identifiable depends on the degree of detail the company uses in reporting its cash flows. Information on investing activities assists investors and creditors by indicating the direction the company is directing its funds. A disclosure note may provide information not available in the financial statements, in part dependent on how much information the financial statements provide. Often the footnote will indicate the cost of the securities.
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Integrating Case 12-3
SFAS 115, “Accounting For Certain Investments in Debt and Equity Securities,” follows a “mixed” approach to transition to the new standard. It calls for either a current approach or a prospective approach. Certain investments that previously were reported at lower of cost or market were required by the new Standard to be reported instead at their fair values. Fair values were not to be reported retroactively, but only from the effective date of the Standard forward. However, the cumulative income effect of holding gains and losses created in years before the change are reported by either a current approach or a prospective approach. For securities classified as “available-for-sale” unrealized holding gains and losses are reported as an adjustment to shareholders’ equity as of the beginning of the year of adoption. Unrealized holding gains and losses for securities classified as “trading securities” are reported in earnings of the year of adoption as the cumulative effect of a change in accounting principle. Pro forma effects are not reported.

Trueblood Accounting Case 12-4
A solution and extensive discussion materials accompany each case in the Deloitte & Touche Trueblood Case Study Series. These are available to instructors at: www.us.deloitte.com;rmt'cs//;

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12-48 Intermediate Accounting, 3/e

International Case 12-5
As stated in Renault’s disclosure note, France, like the United States, uses the “equity method.” However, unlike in the U.S., changes in the net assets of equity method investees are not reported in net income. Instead, investment revenue consists of dividends received. Another difference relates to non-equity investments. These are valued at the lower of cost or fair market value. In the U.S., they are classified as trading, availablefor-sale, or held-to-maturity. Trading and available-for-sale securities are reported at fair value; held-to-maturity at amortized cost.

Research Case 12-6
Answers to the questions will, of course, vary because students will research financial statements of different companies. The responses should identify securities held that are classified as trading securities, available-for-sale, or held-to-maturity. Although a company is not required to report individual amounts for the three categories of investments – held-tomaturity, available-for-sale, or trading – on the face of the balance sheet, that information should be presented in the disclosure notes. If securities available-forsale are held, there may be unrealized gains or losses reported in the shareholders’ equity section of the balance sheet. 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 a separate component of shareholders’ equity. Unlike for securities available-for-sale, unrealized holding gains and losses are included in income for trading securities. There may also be gains or losses from the sale of investments during the year. There also will likely be investment revenue (dividends or interest) in the income statement. The statement of cash flows will report acquisitions or disposals of investments as investing activities. Investment revenue is an operating activity.

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Real World Case 12-7
Requirement 1 The 2001 balance sheet reports the following two current and two noncurrent asset categories: !""1 C%AAB!, <SSB,S: Cash and cash equivalents Short+term investments OTHER ASSETS: Investments in de't and equity securities Investments in associated companies -61,///,/// -3?/,///,/// -556,///,/// -222,///,/// -2,23/,///,/// -3,272,///,/// -7,///,/// -:65,///,/// !"""

In the summary of significant accounting policies (Note 1), Delta describes its policy regarding investments classified as "cash equivalents." It is consistent with the way most companies classify "cash equivalents." CASH AND CASH EQUIVALENTS -- We classify shortterm, highly liquid investments with original maturities of three months or less as cash and cash equivalents. These investments are stated at cost, which approximates fair value. Case 12-7 (continued) Delta (in Note 3) describes its accounting policy for its available-for-sale securities in keeping with SFAS 115: Preferred Stock is accounted for as an available-for-sale debt security. In accordance with SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities," the Series B Preferred Stock and the priceline common stock are recorded at fair market value in investments in debt and equity securities on our Consolidated Balance Sheets. Delta's equity investment in SkyWest, Inc., the parent company of SkyWest Airlines, was classified as an available-for-sale equity security under SFAS 115. The fair value of this investment was $179 million at December 31,
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2000. During 2001, we sold our equity interest in SkyWest, Inc. for $125 million and recorded a pretax gain of $111 million in our 2001 Consolidated Statements of Operations. Investments in Associated Companies (note 1) – We use the equity method to account for our 40% ownership interest in WORLDSPAN, L.P. (Worldspan), a computer reservations system partnership. Our equity earnings from this investment totaled $19 million in 2001, $59 million in 2000 and $30 million in 1999. We also received cash dividends of $70 million in 2001, $32 million in 2000 and $100 million in 1999 related to our investment in Worldspan. We account for our 18% ownership interest in Orbitz, LLC, an on-line travel agency, under the equity method. We accounted for our investments in Comair Holdings and ASA Holdings under the equity method until November 22, 1999 and April 1, 1999, respectively. (This is consistent with accounting for investments over which the investor has significant influence by the equity method.) Case 12-7 (continued) Requirement 2 Investments in securities available-for-sale are reported at fair value. Unrealized holding gains and losses from retaining securities during periods of price change are not included in the determination of income for the period. Rather, they are accumulated and reported as a separate component of shareholders’ equity. This means an unrealized holding gain would increase shareholders’ equity and an unrealized holding loss would decrease shareholders’ equity. Because unrealized gains or losses cause changes in shareholders’ equity, those changes are reported in the statement of shareholders’ equity. [Some companies may not provide a statement of shareholders’ equity and may provide a statement of retained earnings instead. Unrealized gains or losses have no effect on retained earnings.] In the balance sheet, unrealized gains or losses may be reported under that title, as "other" shareholders’ equity, or some different caption. By definition, securities available© The McGraw-Hill Companies, Inc., 200 4
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for-sale 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 not considered relevant performance measures to be included in earnings. Gross unrealized holding gains and losses of Delta are reflected as adjustments to "Accumulated other comprehensive income," net of related income taxes. Realized gains or losses are reported in the income statement if any of these securities were sold during any year reported.

Case 12-7 (continued) Requirement 3 Investments accounted for using the equity method mainly are described in the note: Investments in Associated Companies (note 1) – We use the equity method to account for our 40% ownership interest in WORLDSPAN, L.P. (Worldspan), a computer reservations system partnership. Our equity earnings from this investment totaled $19 million in 2001, $59 million in 2000 and $30 million in 1999. We also received cash dividends of $70 million in 2001, $32 million in 2000 and $100 million in 1999 related to our investment in Worldspan. We account for our 18% ownership interest in Orbitz, LLC, an on-line travel agency, under the equity method. We accounted for our investments in Comair Holdings and ASA Holdings under the equity method until November 22, 1999 and April 1, 1999, respectively. (This is consistent with accounting for investments over which the investor has significant influence by the equity method.)

Requirement 4 Delta reported equity earnings in these investments totaling $19 million in fiscal 2001, $59 million in fiscal 2000, and $30 million in fiscal 1999. These amounts are included in
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"Miscellaneous income (expense), net" in the Consolidated Statements of Income. Delta reported gains from the sale of investments of $127 million in 2001, $301 million in 2000, and $927 million in 1999. Unrealized holding gains and losses from availablefor-sale securities are not reported in the income statement.

Case 12-7 (concluded) Requirement 5 Cash outflows from acquiring these investments or inflows from selling them are reported as investing activities in the company’s comparative statements of cash flows. Whether they are specifically identifiable depends on the degree of dissagregation the company uses in reporting its cash flows. Information on investing activities assists investors and creditors by indicating the direction the company is directing its funds. Delta's Statement of Cash Flows reports: Increase (decrease) in short-term investments, net.

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Real World Case 12-8
Requirement 1 The note indicates Unrealized holding gains during 2000 in the amount of $531 million. This is not the amount Microsoft would include as a separate component of shareholders’ equity. Actually, the balance sheet amount is the Accumulated net unrealized holding gains. That is, over time, there have been, presumably, both unrealized gains and losses. This is the net, accumulated amount. The 2000 amount in the disclosure note is the 2000 addition to the accumulated amount. Requirement 2 Aeclassification ad ustment for gains included in net income refers to unreali"ed holding gains that occurred in periods prior to the period in which the securities are sold. =olding gains and losses from securities availa'le+for+sale are included in earnings when they are reali"ed 'y selling the securities. >hen Cicrosoft sold securities in 2///, the entire increase in the fair value of the shares since the investment was acquired was included in earnings. ,he portion of that rise that occurred prior to 2///, 'ut wasn’t recogni"ed in prior earnings 'ecause it wasn’t yet reali"ed 'y selling the investment, is what Cicrosoft refers to as it reclassification ad ustment. ,hat would 'e the de'it to %nreali"ed holding gains when the entire gain is recogni"ed in 2/// when it is actually reali"ed. Requirement 3 In addition to net income, comprehensive income includes up to four other changes in equity: !et unreali"ed holding gains #losses$ on investments, Foreign currency translation ad ustments, %nreali"ed pension cost, and &eferred gain or loss from derivatives. ,wo of these + !et unreali"ed holding gains #losses$ on investments and Foreign currency translation ad ustments 0 are specifically mentioned in Cicrosoft’s disclosure note, so potentially, )other* refers to either or 'oth of the remaining two + %nreali"ed pension cost and &eferred gain or loss from derivatives.

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