143. From time to time, debt and equity securities must be reclassified when conditions and circumstances surrounding the investment change.

Required:

Describe the general accounting procedures for reclassifying securities from one category to another- held to maturity, available for sale, or trading.

Answer: When a security is reclassified between two categories, the security is transferred at fair value on the date of transfer. Any unrealized holding gain or loss at reclassification should be accounted for in a manner consistent with the classification into which the security is being transferred. Reclassifications are quite unusual, so when they occur, footnote disclosures should describe the circumstances that resulted in the transfer.

Learning Objective: 1 Level of Learning: 2

144. Discuss the following questions.

Required:

What securities must be classified within one of the three categories of held to maturity, available for sale, and trading? (Do not describe how to determine how securities are classified among these three categories.) Identify the four primary recording activities related to investments in securities.

Answer:

The three categories listed apply to all investments in debt securities and investments in equity securities with a readily determinable fair value that are not accounted for under the equity method or using consolidation procedures. In other words, equity securities where the investor owns less than 20% of the voting stock are included in one of these three categories. Held to maturity securities must be debt securities. Trading and available for sale securities may be debt or equity securities.

The four major recording activities are:

• recording the purchase;

• recording changes in value of the securities;

• recording interest and dividends; and

• recording the sale of securities

Learning Objective: 5 Level of Learning: 2

145. When an investor owns 20% to 50% of the voting stock of an investee company, the investor is presumed to exercise significant influence over the investee unless there is evidence to the contrary.

Required:

What factors could be evidence of significant influence?

What factors could be evidence of lack of significant influence?

Answer:

Some factors indicating significant influence:

• Representation on the board of directors.

• Material intercompany transactions.

• Participation in the policy setting process of the company.

Some factors indicating lack of significant influence:

• Investor tries and fails to obtain representation on the board of investee.

• Majority ownership is concentrated among a small group of investors.

• Investor is unable to obtain the information necessary to apply the equity method.

Learning Objective: 4 Level of Learning: 2

146. Many corporations own more than 50% of the voting stock in other corporations. Sometimes these affiliated companies operate within the same industry, and many times the companies are in unrelated industries.

Required:

What is the significance of owning more than 50% of the voting common stock of another company?

Answer: When a firm owns more than 50% of the voting stock in another corporation, then consolidation procedures are required. Owning more than 50% of an investee company ensures, in most cases, that the parent company has control of the management decisions of the subsidiary by holding over half of the votes at stockholder meetings. Control involves the presence of two essential characteristics: (1) ability to guide the subsidiary's ongoing activities and (2) ability to derive benefit from that power. This usually means that the corporation can choose several board members and can control policy making.

Learning Objective: 4 Level of Learning: 2