2.1 Multiple Choice Questions

1 Copyright © 2015 Pearson Education, Inc.Advanced Accounting, 12e (Beams et al.) Chapter 2 Stock Investments — Investor Accounting and Reporting

2.1 Multiple Choice Questions

1) What method of accounting will generally be used when one company purchases less than 20% of the outstanding stock of another company?

• Only the fair value method may be used.
• Only the equity method may be used.
• Either the fair value method or the equity method may be used, depending upon the relationship

between the companies.

• Neither the fair value method nor the equity method may be used, regardless of the level of

ownership.

Answer: C

Objective: LO1

Difficulty: Easy

2) What method of accounting will generally be used when one company purchases between 20% to 50% of the outstanding stock of another company?

• Only the fair value method may be used.
• Only the equity method may be used.
• The GAAP prescribed the equity method may be used.
• Neither the fair value method nor the equity method may be used, regardless of the level of

ownership.

Answer: C

Objective: LO1

Difficulty: Easy

3) Which one of the following items, originally recorded in the Investment in Falcon Co. account under the equity method, would not be systematically used to reduce investment income on a periodic basis?

• Amortization expense of goodwill
• Depreciation expense on the excess fair value attributed to machinery
• Amortization expense on the excess fair value attributed to lease agreements
• Interest expense on the excess fair value attributed to long-term bonds payable

Answer: A

Objective: LO5

Difficulty: Moderate

Advanced Accounting 12th Edition Beams Test Bank Visit TestBankDeal.com to get complete for all chapters

2 Copyright © 2015 Pearson Education, Inc.4) Which one of the following statements is correct for an investor company?

• The balance in the Investment in Osprey Co. account can be reduced to represent a decline in the fair

market value of the investment, but will not be adjusted if the fair market value increases.

• Under the equity method, the balance in the Investment in Osprey Co. account can be negative if the

investee corporation operates at a loss.

• Once the balance in the Investment in Osprey Co. is reduced to zero, it will not be reduced any further.
• Under the equity method, the balance in the Investment in Osprey Co. account will increase when

cash dividends are received.

Answer: C

Objective: LO2

Difficulty: Moderate

5) Pinkerton Inc. owns 10% of Sable Company. In the most recent year, Sable had net earnings of $40,000 and paid dividends of $6,000. Pinkerton's accountant mistakenly assumed Pinkerton had considerable influence over Sable and used the equity method instead of the cost method. What is the impact on the investment account and net earnings, respectively?

• By using the equity method, the accountant has understated the investment account and overstated

the net earnings.

• By using the equity method, the accountant has overstated the investment account and understated the

net earnings.

• By using the equity method, the accountant has understated the investment account and understated

the net earnings.

• By using the equity method, the accountant has overstated the investment account and overstated the

net earnings.

Answer: D

Objective: LO3

Difficulty: Moderate

6) Griffon Incorporated holds a 30% ownership in Duck Corporation. Griffon should use the equity method under which of the following circumstances?

• Griffon has surrendered significant stockholder rights by agreement between Griffon and Duck.
• Griffon has been unable to secure a position on the Duck Corporation's Board of Directors.
• Griffon has inadequate or untimely information to apply the equity method.
• The ownership of Duck Corporation is diverse.

Answer: D

Objective: LO1

Difficulty: Easy

7) Pond Corporation uses the fair value method of accounting for its investment in Swan Company.Which one of the following events would affect the Investment in Swan Co. account?

• Investee losses
• Investee dividend payments
• An increase in the investee's share price from last period
• All of the above would affect the Investment in Swan Co. account.

Answer: C

Objective: LO2

Difficulty: Easy

3 Copyright © 2015 Pearson Education, Inc.8) Sadie Corporation's stockholders' equity at December 31, 2013 included the following:

6% Preferred stock, $10 par value $1,000,000 Common stock, $1 par value 10,000,000 Other paid-in capital—common 4,000,000 Retained earnings 4,000,000

$19,000,000

Pilga Corporation purchased a 30% interest in Sadie's common stock from other shareholders on January 1, 2014 for $5,800,000. What was the book value of Pilga's investment in Sadie on January 1, 2014?

A) $5,400,000

B) $5,700,000

C) $7,120,000

D) $7,440,000

Answer: A

Explanation: A)

Total stockholders' equity $19,000,000

Less: preferred equity (1,000,000)

Equals: common equity 18,000,000

× Pilga's percentage × 30% Book value of Pilga investment $5,400,000

Objective: LO5

Difficulty: Moderate

4 Copyright © 2015 Pearson Education, Inc.9) Jabiru Corporation purchased a 20% interest in Fish Company common stock on January 1, 2013 for $300,000. This investment was accounted for using the complete equity method and the correct balance in the Investment in Fish account on December 31, 2015 was $440,000. The original excess purchase transaction included $60,000 for a patent amortized at a rate of $6,000 per year. In 2016, Fish Corporation had net income of $4,000 per month earned uniformly throughout the year and paid $20,000 of dividends in May. If Jabiru sold one-half of its investment in Fish on August 1, 2016 for $500,000, how much gain was recognized on this transaction?

A) $278,950

B) $280,000

C) $280,950

D) $282,000

Answer: C

Explanation: C)

Dec 31, 2015 investment balance $440,000

Jabiru's interest in Fish's income from Jan 1-July 31:

($4,000 × 7 months × 20%) = 5,600

Less: Dividends ($20,000 × 20%) = (4,000)

Less: Seven months of patent amortization:

$500 × 7 = (3,500)

Investment account balance at July 31, 2016 $438,100

Amount received from sale: $500,000

Book value of one-half interest (219,050) Gain on sale $280,950

Objective: LO5

Difficulty: Moderate

10) An investor uses the cost method of accounting for its investment in common stock. During the current year, the investor received $25,000 in dividends, an amount that exceeded the investor's share of the investee company's undistributed income since the investment was acquired. The investor should report dividend income of what amount?

A) $25,000

• $25,000 less the amount in excess of its share of undistributed income since the investment was

acquired

• $25,000 less the amount that is not in excess of its share of undistributed income since the investment

was acquired

• None of the above is correct.

Answer: A

Objective: LO3

Difficulty: Easy