Firms X and Y, similar in all respects, recently bought identical securities. However, X has classified the securities as "held-to-maturity" securities while Y has categorized them as "available-for-sale" securities. Which of the following statements is/are true as a result of this difference?
Answer(s): D
"Available-for-sale" securities are reported at their fair market value on the balance sheet while "held- to- maturity" securities are carried at amortized historical cost. Therefore, the reported assets for X and Y will be different over time. Hence, they will also show different equities because liabilities for the two firms are the same. However, changes in the market value of available-for-sale securities are charged directly to the retained earnings account, without going through the income statement. On the other hand, changes in the market value of "held-to-maturity" securities are not even recognized on financial statements due to historical cost accounting. For both the classifications, interest and dividend payments are attributed to the income. So the income volatility is not affected due to the classification.
The basic asset-liability equation, assets = liabilities + shareholder equity implies:
Answer(s): B
The asset-liability equation has the results of investing activities on the left-hand side as assets. On the right hand side are results of creditor financing (debt) and equity financing.
Under GAAP, when interest rates rise, the carrying value of a long-term bond ________.
Answer(s): A
Long-term debt is recorded at acquisition cost and historical cost accounting does not allow revaluation. Hence, even though the market value of the debt changes due to a change in interest rates, the book value of the debt changes only at the regular amortization schedule, independent of the market changes.
The following is true about liquidating dividends:
The cash dividend account is not affected, and they would not likely occur when making an acquisition.
The best indication of a firm's present and continuing ability to generate favorable cash flows is information about enterprise earnings based on which of the following basis?
Information about an enterprise's earnings based on accrual accounting generally provides a better indication of the firm's present and continuing ability to generate favorable cash flows than would information limited to the financial effects of cash receipts and payments.
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