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    Distinguish between a debt security and an equity security.

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    Please see attached file for format of the table.

    A. Distinguish between a debt security and an equity security.

    B. What are the main distinctions between a traditional financial instrument and a derivative financial instrument?

    C. For the following investments identify whether they are:

    Trading Securities
    Available-for-Sale Securities
    Held-to-Maturity Securities

    Each case is independent of the other.
    1. A bond that will mature in 4 years was bought 1 month ago when the price dropped. As soon as the value increases, which is expected next month, it will be sold.
    2. 10% of the outstanding stock of Farm-Co was purchased. The company is planning on eventually getting a total of 30% of its outstanding stock.
    3. 10-year bonds were purchased this year. The bonds mature at the first of next year.
    4. Bonds that will mature in 5 years are purchased. The company would like to hold them until they mature, but money has been tight recently and they may need to be sold.
    5. Preferred stock was purchased for its constant dividend. The company is planning to hold the preferred stock for a long time.
    6. A bond that matures in 10 years was purchased. The company is investing money set aside for an expansion project planned 10 years from now.

    D. (Trading Securities Entries) On December 21, 2006, Bucky Katt Company provided you with the following information regarding its trading securities.

    December 31, 2006
    Investments (Trading) Cost Fair Value Unrealized Gain (Loss)
    Clemson Corp. stock $20,000 $19,000 $(1,000)
    Colorado Co. stock 10,000 9,000 (1,000)
    Buffaloes Co. stock 20,000 20,600 600
    Total of portfolio $50,000 $48,600 (1,400)
    Previous securities fair value adjustment balance â?"0â?"
    Securities fair value adjustmentâ?"Cr. $(1,400)

    During 2007, Colorado Company stock was sold for $9,400. The fair value of the stock on December 31, 2007, was: Clemson Corp. stockâ?"$19,100; Buffaloes Co. stockâ?"$20,500.

    Instructions
    1. Prepare the adjusting journal entry needed on December 31, 2006.
    2. Prepare the journal entry to record the sale of the Colorado Company stock during 2007.
    3. Prepare the adjusting journal entry needed on December 31, 2007.

    E. (Journal Entries for Fair Value and Equity Methods)

    Situation 1
    Conchita Cosmetics acquired 10% of the 200,000 shares of common stock of Martinez Fashion at a total cost of $13 per share on March 18, 2007. On June 30, Martinez declared and paid a $75,000 cash dividend. On December 31, Martinez reported net income of $122,000 for the year. At December 31, the market price of Martinez Fashion was $15 per share. The securities are classified as available-for-sale.

    Situation 2
    Monica, Inc. obtained significant influence over Seles Corporation by buying 30% of Seles's 30,000 outstanding shares of common stock at a total cost of $9 per share on January 1, 2007. On June 15, Seles declared and paid a cash dividend of $36,000. On December 31, Seles reported a net income of $85,000 for the year.
    Instructions: Prepare all necessary journal entries in 2007 for both situations.

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    Solution Preview

    Solution file is attached for journal entries.

    A. Distinguish between a debt security and an equity security.

    When a company needs to raise additional capital (for investments or other purposes), the company either raises the capital through debt or equity financing, which is also called raising capital through debt security, or through equity security. When the company raises capital (money) through debt security, they do so by taking out bank loans, and by using notes to secure the money. When the company uses equity financing, they typically buy back a portion of their stock ...

    Solution Summary

    Distinguish between a debt security and an equity security.

    B. What are the main distinctions between a traditional financial instrument and a derivative financial instrument?

    C. For the following investments identify whether they are:

    Trading Securities
    Available-for-Sale Securities
    Held-to-Maturity Securities

    Each case is independent of the other.
    1. A bond that will mature in 4 years was bought 1 month ago when the price dropped. As soon as the value increases, which is expected next month, it will be sold.
    2. 10% of the outstanding stock of Farm-Co was purchased. The company is planning on eventually getting a total of 30% of its outstanding stock.
    3. 10-year bonds were purchased this year. The bonds mature at the first of next year.
    4. Bonds that will mature in 5 years are purchased. The company would like to hold them until they mature, but money has been tight recently and they may need to be sold.
    5. Preferred stock was purchased for its constant dividend. The company is planning to hold the preferred stock for a long time.
    6. A bond that matures in 10 years was purchased. The company is investing money set aside for an expansion project planned 10 years from now.

    D. (Trading Securities Entries) On December 21, 2006, Bucky Katt Company provided you with the following information regarding its trading securities.

    December 31, 2006
    Investments (Trading) Cost Fair Value Unrealized Gain (Loss)
    Clemson Corp. stock $20,000 $19,000 $(1,000)
    Colorado Co. stock 10,000 9,000 (1,000)
    Buffaloes Co. stock 20,000 20,600 600
    Total of portfolio $50,000 $48,600 (1,400)
    Previous securities fair value adjustment balance â?"0â?"
    Securities fair value adjustmentâ?"Cr. $(1,400)

    During 2007, Colorado Company stock was sold for $9,400. The fair value of the stock on December 31, 2007, was: Clemson Corp. stockâ?"$19,100; Buffaloes Co. stockâ?"$20,500.

    Instructions
    1. Prepare the adjusting journal entry needed on December 31, 2006.
    2. Prepare the journal entry to record the sale of the Colorado Company stock during 2007.
    3. Prepare the adjusting journal entry needed on December 31, 2007.

    E. (Journal Entries for Fair Value and Equity Methods)

    Situation 1
    Conchita Cosmetics acquired 10% of the 200,000 shares of common stock of Martinez Fashion at a total cost of $13 per share on March 18, 2007. On June 30, Martinez declared and paid a $75,000 cash dividend. On December 31, Martinez reported net income of $122,000 for the year. At December 31, the market price of Martinez Fashion was $15 per share. The securities are classified as available-for-sale.

    Situation 2
    Monica, Inc. obtained significant influence over Seles Corporation by buying 30% of Seles's 30,000 outstanding shares of common stock at a total cost of $9 per share on January 1, 2007. On June 15, Seles declared and paid a cash dividend of $36,000. On December 31, Seles reported a net income of $85,000 for the year.
    Instructions: Prepare all necessary journal entries in 2007 for both situations.

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