16 Investments

Learning Objectives

1 Explain how to account for debt investments.

2 Explain how to account for stock investments.

Discuss how debt and stock investments are reported in

3 financial statements.

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 LEARNING Explain how to account for debt
1
OBJECTIVE investments.

Corporations purchase investments in debt or stock

securities generally for one of three reasons.
1. Corporation may have excess cash.

2. Generate earnings from investment income.

3. For strategic reasons.

Illustration 16-1
Temporary investments
and the operating cycle

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 Why Corporations Invest

Question
Pension funds and banks regularly invest in debt and stock
securities to:
a. house excess cash until needed.
b. generate earnings.
c. meet strategic goals.
d. avoid a takeover by disgruntled investors.

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 Accounting for Debt Investments

Investments in government and corporation bonds.

Entries are made to record
1. the acquisition,
2. the interest revenue, and
3. the sale.

RECORDING ACQUISITION OF BONDS

Cost includes all expenditures necessary to acquire
these investments, such as the price paid plus brokerage
fees (commissions), if any.
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 Accounting for Debt Investments

RECORDING BOND INTEREST

Calculate and record interest revenue based upon the
 carrying value of the bond

 times the interest rate

 times the portion of the year the bond is outstanding.

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 Accounting for Debt Investments

RECORDING SALE OF BONDS

 Credit the investment account for the cost of the
bonds.

 Record as a gain or loss

► any difference between the net proceeds from the

sale (sales price less brokerage fees) and

► the cost of the bonds.

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 Accounting for Debt Investments

Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-

year, $1,000 bonds on January 1, 2017, for $50,000. The entry
to record the investment is:

Jan. 1 Debt Investments 50,000

Cash 50,000

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 Accounting for Debt Investments

Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000

bonds on January 1, 2017, for $50,000. The bonds pay interest
annually on January 1. If Kuhl Corporation’s fiscal year ends on
December 31, prepare the entry to accrue interest earned by
December 31.

Dec. 31 Interest Receivable 4,000 *

Interest Revenue 4,000

* ($50,000 x 8% = $4,000)
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 Accounting for Debt Investments

Kuhl reports Interest Receivable as a current asset in the

balance sheet. It reports Interest Revenue under “Other
revenues and gains” in the income statement. Kuhl reports
receipt of the interest on January 1 as follows

Jan. 1 Cash 4,000

Interest Receivable 4,000

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 Accounting for Debt Investments

Assume that Kuhl corporation receives net proceeds of $54,000

on the sale of the Doan Inc. bonds on January 1, 2016, after
receiving the interest due. Prepare the entry to record the sale
of the bonds.

Jan. 1 Cash 54,000

Debt Investments 50,000
Gain on Sale of Debt Investments 4,000

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 Accounting for Debt Investments

Question
An event related to an investment in debt securities that
does not require a journal entry is:
a. acquisition of the debt investment.
b. receipt of interest revenue from the debt investment.
c. a change in the name of the firm issuing the debt
securities.
d. sale of the debt investment.

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 Accounting for Debt Investments

Question
When bonds are sold, the gain or loss on sale is the
difference between the:
a. sales price and the cost of the bonds.
b. net proceeds and the cost of the bonds.
c. sales price and the market value of the bonds.
d. net proceeds and the market value of the bonds.

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 Investor Insight
Hey, I Thought It Was Safe!
It is often stated that bond investments are safer than stock investments. After all, with an
investment in bonds, you are guaranteed return of principal and interest payments over the
life of the bonds. However, here are some other factors you may want to consider:
• In 2013, the value of bonds fell by 2% due to interest rate risk. That is, when interest rates
rise, it makes the yields paid on existing bonds less attractive. As a result, the price of the
existing bond you are holding falls.
• While interest rates are currently low, it is likely that they will increase in the future. If you
hold bonds, there is a real possibility that the value of your bonds will be reduced.
• Credit risk also must be considered. Credit risk means that a company may not be able to
pay back what it borrowed. Former bondholders in companies like General Motors, United
Air Lines, and Eastman Kodak saw their bond values drop substantially when these
companies declared bankruptcy.
An advantage of a bond investment over stock is that if you hold it to maturity, you will
receive your principal and also interest payments over the life of the bond. But if you have to
sell your bond investment before maturity, you may be facing a roller coaster regarding its
value.

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 DO IT! 1 Debt Investments

Waldo Corporation had the following transactions pertaining to

debt investments.

Jan. 1, 2017 Purchased 30, $1,000 Hillary Co. 10% bonds for
$30,000. Interest is payable annually on January 1.
Dec. 31, 2017 Accrued interest on Hillary Co. bonds in 2017.
Jan. 1, 2018 Received interest on Hillary Co. bonds.
Jan. 1, 2018 Sold 15 Hillary Co. bonds for $14,600.
Dec. 31, 2018 Accrued interest on Hillary Co. bonds in 2018.

Journalize the transactions.

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 DO IT! 1 Debt Investments

Waldo Corporation had the following transactions pertaining to

debt investments.

Jan. 1, 2017 Purchased 30, $1,000 Hillary Co. 10% bonds for
$30,000. Interest is payable annually on January 1.

Journalize the transactions.

July 1 Debt Investments 30,000

(2017) Cash 30,000

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 DO IT! 1 Debt Investments

Waldo Corporation had the following transactions pertaining to

debt investments.

Dec. 31, 2017 Accrued interest on Hillary Co. bonds in 2017.

Jan. 1, 2018 Received interest on Hillary Co. bonds.

Journalize the transactions.

Dec. 31 Interest Receivable 3,000

(2017) Interest Revenue ($30,000 x 10%) 3,000

Jan. 1 Cash 3,000

(2018) Interest Receivable 3,000

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 DO IT! 1 Debt Investments

Waldo Corporation had the following transactions pertaining to

debt investments.

Jan. 1, 2018 Sold 15 Hillary Co. bonds for $14,600.

Dec. 31, 2018 Accrued interest on Hillary Co. bonds in 2018.

Journalize the transactions.

Jan. 1 Cash 14,600

(2018) Loss on Sale of Debt Investments 400
Debt Investments ($30,000 x 15/30) 15,000
Dec. 31 Interest Receivable 1,500
(2018) Interest Revenue 1,500
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 LEARNING Explain how to account for stock
2
OBJECTIVE investments.

Ownership Percentages

0 ------------------20% -------------- 50% -------------------- 100%

No significant Significant Control usually exists
influence influence (50%+ owned)
usually exists usually exists
Investment valued on
Investment Investment parent’s books using Cost
valued using valued using Method or Equity Method
Cost Method Equity Method (investment eliminated in
Consolidation)

The accounting depends on the extent of the investor’s influence over

the operating and financial affairs of the issuing corporation (investee).
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 Accounting for Stock Investments

Holding of Less than 20%

 Companies use the cost method.

 Investment is recorded at cost and revenue recognized

only when cash dividends are received.
 Cost includes all expenditures
necessary to acquire these Helpful Hint
The entries for investments
investments, such as the price in common stock also
apply to investments in
paid plus any brokerage fees
preferred stock.
(commissions), if any.

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 Holding of Less than 20%

RECORDING ACQUISITION OF STOCK

INVESTMENTS
Illustration: On July 1, 2017, Sanchez Corporation acquires 1,000
shares (10% ownership) of Beal Corporation common stock.
Sanchez pays $40 per share. The entry for the purchase is:

July 1 Stock Investments (1,000 x $40) 40,000

Cash 40,000

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 Holding of Less than 20%

RECORDING DIVIDENDS
Illustration: During the time Sanchez owns the stock it makes
entries for any cash dividends received. If Sanchez receives a $2
per share dividend on December 31, the entry is:

Dec. 31 Cash (1,000 x $2) 2,000

Dividend Revenue 2,000

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 Holding of Less than 20%

RECORDING SALE OF STOCK

Illustration: Assume that Sanchez Corporation receives net
proceeds of $39,000 on the sale of its Beal stock on February 10,
2018. Because the stock cost $40,000, Sanchez incurred a loss
of $1,000. The entry to record the sale is:

Feb. 10 Cash 39,000

Loss on Sale of Stock Investments 1,000
Stock Investments 40,000

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 Accounting for Stock Investments

Holding Between 20% and 50%

Equity Method: Investor records the investment at cost
and subsequently adjust the amount each period for the
 proportionate share of the earnings (losses) and

 dividends received.

If investor’s share of investee’s losses exceeds the carrying amount of the

investment, the investor ordinarily should discontinue applying the equity
method.

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 Holdings Between 20% and 50%

Illustration: Milar Corporation acquires 30% of the common shares

of Beck Company for $120,000 on January 1, 2017. For 2017,
Beck reports net income of $100,000 and paid dividends of
$40,000. Prepare the entries for these transactions.

Jan. 1 Stock Investments 120,000

Cash 120,000

Dec. 31 Stock Investments ($100,000 x 30%) 30,000

Revenue from Stock Investments 30,000

Dec. 31 Cash ($40,000 x 30%) 12,000

Stock Investments 12,000
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 Holdings Between 20% and 50%

Illustration: Milar Corporation acquires 30% of the common shares

of Beck Company for $120,000 on January 1, 2017. For 2017,
Beck reports net income of $100,000 and paid dividends of
$40,000. Prepare the entries for these transactions.

After Milar posts the transactions for the year, its investment
and revenue accounts will show the following.

Illustration 16-4
Investment and revenue
accounts after posting

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 Holdings Between 20% and 50%

Question
Under the equity method, the investor records dividends
received by crediting:

a. Dividend Revenue.

b. Investment Income.

c. Revenue from Investment.

d. Stock Investments.

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 Accounting for Stock Investments

Holdings of More than 50%

Controlling Interest - When one corporation acquires a voting
interest of more than 50 percent in another corporation

 Investor is referred to as the parent.

 Investee is referred to as the subsidiary.

 Investment in the subsidiary is reported on the parent’s

books as a long-term investment.

 Parent generally prepares consolidated financial

statements.

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 Holdings of More than 50%

Consolidated statements indicate the magnitude and scope

of operations of the companies under common control.

Illustration 16-5
Examples of consolidated companies and their subsidiaries

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 Accounting Across the Organization
How Procter & Gamble Accounts for Gillette
Several years ago, Procter & Gamble Company acquired Gillette Company for $53.4
billion. The common stockholders of Procter & Gamble elect the board of directors of
the company, who in turn select the officers and managers of the company. Procter &
Gamble’s board of directors controls the property owned by the corporation, which
includes the common stock of Gillette. Thus, they are in a position to elect the board of
directors of Gillette and, in effect, control its operations. These relationships are
graphically illustrated here.

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 DO IT! 2 Stock Investments

Presented below are two independent situations.

1. Rho Jean Inc. acquired 5% of the 400,000 shares of common
stock of Stillwater Corp. at a total cost of $6 per share on May 18,
2017. On August 30, Stillwater declared and paid a $75,000
dividend. On December 31, Stillwater reported net income of
$244,000 for the year. Prepare all necessary journal entries for
2017.

May 18 Stock Investments (400,000 x 5% x $6) 120,000

Cash 120,000
Aug. 30 Cash 3,750
Dividend Revenue ($75,000 x 5%) 3,750

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 Presented below are two independent situations.
2. Debbie, Inc. obtained significant influence over North Sails by
buying 40% of North Sails’ 60,000 outstanding shares of common
stock at a cost of $12 per share on January 1, 2017. On April 15,
North Sails declared and paid a cash dividend of $45,000. On
December 31, North Sails reported net income of $120,000 for the
year. Prepare all necessary journal entries for 2017.

Jan. 1 Stock Investments (60,000 x 40% x $12) 288,000

Cash 288,000
Apr. 15 Cash 18,000
Stock Investments ($45,000 x 40%) 18,000
Dec. 31 Stock Investments ($120,000 x 40%) 48,000
Revenue from Stock Investments 48,000
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 LEARNING Discuss how debt and stock investments are
3
OBJECTIVE reported in financial statements.

Categories of Securities
Classifications of debt and stock investments:

Debt Investments Equity Investments

Trading Trading

Available-for-sale Available-for-sale

Held-to-maturity

These guidelines apply to all debt securities and all stock investments in
which the holdings are less than 20%.

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 Categories of Securities

TRADING SECURITIES
 Companies hold with intention of selling in a short
period.

 Trading means frequent buying and selling.

 Reported at fair value.

 Changes from cost are reported in the income

statement as unrealized gains or losses.

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 Categories of Securities

Question
Marketable securities bought and held primarily for sale
in the near term are classified as:

a. available-for-sale securities.

b. held-to-maturity securities.

c. stock securities.

d. trading securities

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 TRADING SECURITIES

Illustration: Cost and fair values for investments of

Pace Corporation classified as trading securities on
Illustration 16-7
December 31, 2017. Valuation of trading
securities

The adjusting entry for Pace Corporation is:

Dec. 31 Fair Value Adjustment—Trading 7,000

Unrealized Gain—Income 7,000

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 Categories of Securities

AVAILABLE-FOR-SALE SECURITIES
 Held with the intent of selling sometime in the future.

 Classified as current assets or as long-term assets,

depending on the intent of management.

 Reported at fair value.

 Changes from cost are reported in stockholders’

equity as unrealized gains or losses.

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 AVAILABLE-FOR-SALE SECURITIES

Illustration: Assume that Ingrao Corporation has two

Illustration 16-8
securities that it classifies as available-for-sale. Valuation of available-
for-sale securities

The adjusting entry is:

Dec. 31 Unrealized Gain or Loss—Equity 9,537

Fair Value Adjustment—AFS 9,537

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 Categories of Securities

Question
An unrealized loss on available-for-sale securities is:

a. reported under Other Expenses and Losses in the

income statement.

b. closed-out at the end of the accounting period.

c. reported as a separate component of stockholders'

equity.

d. deducted from the cost of the investment.

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 Investor Insight
Can Fair Value Be Unfair?
The FASB is considering proposals for how to account for financial
instruments. The FASB at one time proposed that loans and receivables
be accounted for at their fair value (the amount they could currently be
sold for), as are most investments. The FASB believes that this would
provide a more accurate view of a company’s financial position. It might
be especially useful as an early warning when a bank is in trouble
because of poor-quality loans. But, banks argue that fair values are
difficult to estimate accurately. They are also concerned that volatile fair
values could cause large swings in a bank’s reported net income.
Source: David Reilly, “Bank Face a Mark-to-Market Challenge,” Wall Street
Journal Online (March 15, 2010).

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 Trading and Available-for-Sale
DO IT! 3a Securities

Some of Powderhorn Corporation’s investment securities are classified

as trading securities and some are classified as available-for-sale. The
cost and fair value of each category at December 31, 2017, are shown
below.
Unrealized
Cost Fair Value Gain (Loss)
Trading securities $93,600 $94,900 $1,300
Available-for-sale securities $48,800 $51,400 $2,600
At December 31, 2016, the Fair Value Adjustment—Trading account had
a debit balance of $9,200, and the Fair Value Adjustment—Available-for-
Sale account had a credit balance of $5,750. Prepare the required
journal entries for each group of securities for December 31, 2017.

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 Trading and Available-for-Sale
DO IT! 3a Securities

Unrealized
Cost Fair Value Gain (Loss)
Trading securities $93,600 $94,900 $1,300
Available-for-sale securities $48,800 $51,400 $2,600
At December 31, 2016, the Fair Value Adjustment—Trading account had
a debit balance of $9,200, and the Fair Value Adjustment—Available-for-
Sale account had a credit balance of $5,750. Prepare the required
journal entries for each group of securities for December 31, 2017.
Trading securities:

Unrealized Loss—Income ($9,200-$1,300) 7,900*

Fair Value Adjustment—Trading 7,900
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 Trading and Available-for-Sale
DO IT! 3a Securities

Unrealized
Cost Fair Value Gain (Loss)
Trading securities $93,600 $94,900 $1,300
Available-for-sale securities $48,800 $51,400 $2,600
At December 31, 2016, the Fair Value Adjustment—Trading account had
a debit balance of $9,200, and the Fair Value Adjustment—Available-for-
Sale account had a credit balance of $5,750. Prepare the required
journal entries for each group of securities for December 31, 2017.
Available-for-Sale securities:

Fair Value Adjustment—Available-for-Sale 8,350**

Unrealized Gain or Loss—Equity 8,350
16-42 **$5,750 + $2,600 LO 3
 Balance Sheet Presentation

SHORT-TERM INVESTMENTS
Also called marketable securities, are securities held by a
company that are

(1) readily marketable and

(2) intended to be converted into cash within the next year or

operating cycle, whichever is longer.

Investments that do not meet both Helpful Hint

criteria are classified as long-term
investments.
Trading securities are always
classified as short-term.
Available-for-sale securities
can be either short-term or
long-term.

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 Presentation of Realized and Unrealized
Gain or Loss

Illustration 16-10
Nonoperating items
related to investments

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 Realized and Unrealized Gain or Loss

Unrealized gains or losses on available-for-sale securities are

reported as a separate component of stockholders’ equity.

Illustration 16-11
Unrealized loss in stockholders’
equity section

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 Classified Balance Sheet Illustration 16-12
Classified balance sheet
(Partial Statement)

PACE CORPORATION
Balance Sheet
December 31, 2017

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 Classified Balance Sheet Illustration 16-12
Classified balance sheet
(Partial Statement)

PACE CORPORATION
Balance Sheet
December 31, 2017

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 A Look at IFRS

LEARNING Compare the accounting for investments under

OBJECTIVE
4 GAAP and IFRS.

Key Points
Similarities

 The basic accounting entries to record the acquisition of debt

securities, the receipt of interest, and the sale of debt securities are
the same under IFRS and GAAP.

 The basic accounting entries to record the acquisition of stock

investments, the receipt of dividends, and the sale of stock securities
are the same under IFRS and GAAP.

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 A Look at IFRS

Key Points
 Both IFRS and GAAP use the same criteria to determine whether the
equity method of accounting should be used—that is, significant
influence with a general guide of over 20% ownership, IFRS uses
the term associate investment rather than equity investment to
describe its investment under the equity method.

 Equity investments are generally recorded and reported at fair value

under IFRS. Equity investments do not have a fixed interest or
principal payment schedule and therefore cannot be accounted for at
amortized cost. In general, equity investments are valued at fair
value, with all gains and losses reported in income, similar to GAAP.

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 A Look at IFRS

Key Points
 Unrealized gains and losses related to available-for-sale securities
are reported in other comprehensive income under GAAP and IFRS.
These gains and losses that accumulate are then reported in the
balance sheet.

Differences

 Under IFRS, both the investor and an associate company should

follow the same accounting policies. As a result, in order to prepare
financial information, adjustments are made to the associate’s
policies to conform to the investor’s books. GAAP does not have that
requirement.

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 A Look at IFRS

Key Points
Differences

 In general, IFRS requires that companies determine how to measure

their financial assets based on two criteria:
 The company’s business model for managing their financial assets;
and
 The contractual cash flow characteristics of the financial asset.

If a company has (1) a business model whose objective is to hold

assets in order to collect contractual cash flows and (2) the
contractual terms of the financial asset gives specified dates to cash
flows that are solely payments of principal and interest on the
principal amount outstanding, then the company should use cost.
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 A Look at IFRS

Looking to the Future

As indicated earlier, the IASB has issued a new revised IFRS which
deals with the accounting issues related to investment securities. The
FASB is now in the final process of issuing a new standard in this
area. It is likely that some differences will continue to exist between the
IFRS and the FASB regarding investments.

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 A Look at IFRS

IFRS Self-Test Questions

The following asset is not considered a financial asset
under IFRS:

a) trading securities.

b) held-for-collection securities.

c) equity securities.

d) inventories.

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 A Look at IFRS

IFRS Self-Test Questions

Under IFRS, the equity method of accounting for long-term
investments in common stock should be used when the
investor has significant influence over an investee and owns:

a) between 20% and 50% of the investee’s common stock.

b) 30% or more of the investee’s common stock.

c) more than 50% of the investee’s common stock.

d) less than 20% of the investee’s common stock.

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 A Look at IFRS

IFRS Self-Test Questions

Under IFRS, unrealized loss on trading investments should be
reported:
a) as part of other comprehensive loss reducing net income.
b) on the income statement reducing net income.
c) as part of other comprehensive loss not affecting net
income.
d) directly to stockholders’ equity bypassing the income
statement.

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 Copyright

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