Questions Chapter 17
ANSWERS TO QUESTIONS
The reasons corporations invest in securities are: (1) excess cash not needed for operations and
therefore can be invested, (2) for additional earnings, and (3) strategic reasons.
The cost of an investment in bonds consists of the market price of the bonds plus any brokerage
fees. The cost excludes any accrued interest.
Interest is recorded as it is earned; that is, over the life of the investment in bonds.
Losses and gains on the sale of debt investments are computed by comparing the cost of the
securities to the net proceeds from the sale.
Losses are reported in the income statement under other expenses and losses whereas gains
are reported under other revenues and gains.
Cline Company is incorrect. The gain is the difference between the net proceeds, exclusive of inter-est,
and the cost of the bonds. The correct gain is $3,000 [($45,000 – $2,000) – $40,000].
The cost of an investment in stocks includes all expenditures necessary to acquire the investment.
These expenditures include the actual purchase price plus any commissions or brokerage fees.
Brokerage fees are part of the cost of the investment. Therefore, the entry is:
Whenever the investor's influence on the operating and financial affairs of the investee is sig-
nificant, the equity method should be used. The major factor in determining significant influ-ence
is the percentage of ownership interest held by the investor in the investee. The general guideline
for use of the equity method is 20% or more ownership interest. Companies are required to use
judgment, however, rather than blindly follow the 20% guideline. For example, 25% ownership in
a company that is 75% controlled by another organization would not indicate significant influence.
Revenue is recognized as it is earned by the investee.
Since Marx Corporation uses the equity method, the income reported by Welch Packing ($80,000)
should be multiplied by Marx's ownership interest (25%) and the result ($20,000) should be deb- ited
to Stock Investments and credited to Revenue from Investment in Welch Packing. Also, of the total
dividend declared and paid by Welch ($10,000) Marx will receive 25% or $2,500. This amount should
be debited to Cash and credited to Stock Investments.
Significant influence over an investee may result from representation on the board of directors, par-
ticipation in policy-making processes, material intercompany transactions, interchange of managerial
personnel, or technological dependency. An investment (direct or indirect) of 20% or more of the voting
stock of an investee constitutes significant influence unless there exists evidence to the contrary.