02 - Trading - FVPL

Objective Questions

1. The equity method of accounting is adopted in:
a. Controlling interest.
b. Significant influence.
c. Passive investments.
d. None of the above.

2. In trade date accounting, a liability payable for acquiring the asset will be recorded on:
a. The trade date.
b. The reporting date.
c. The settlement date.
d. All of the above.

3. A broker-dealer who records the transactions on settlement date basis should compute the net capital on:
a. The trade date.
b. The reporting date.
c. The settlement date.
d. Any of the above.

4. The definition of equity security as per FAS 115 does not applies to:
a. Investment companies.
b. Nonprofit organizations.
c. Brokers and dealers in securities.
d. All of the above.

5. The shareholder will recognize the dividend income:
a. On the date of dividend declaration.
b. On the ex-dividend date.
c. At the end of accounting period.
d. None of the above.

6. A shareholder is said to have controlling interest in the company if he holds:
a. Less than 20 percent shares of the investee company.
b. From 20 to 50 percent shares of the investee company.
c. More than 50 percent shares of the investee company.
d. None of the above.

7. Unrealized gains or loss computed for available-for-sale (AFS) securities will be reported as:
a. Income/loss on the income statement.
b. Other comprehensive income.
c. Dividend income.
d. None of the above.

8. For private equity investment, the responsibility of fulfillment of the obligation is vested with:
a. The stock exchange.
b. The broker.
c. The seller.
d. All of the above.

9. If the net holding of any share is negative, then it is referred to as:
a. Available-for-sale (AFS).
b. A long position.
c. A short position.
d. Trading securities.

10. Under the incremental value method, mark-to-market entry is reversed:
a. On T + 2.
b. At the end of the accounting period.
c. On the next valuation date.
d. None of the above.

11. The fair value of securities that are listed and traded through stock exchanges is determined based on:
a. The highest bid price quoted in the exchange for each day.
b. Market quotes at the end of each day.
c. Market quotes at the opening of each day.
d. The forecasted price received from stock broker.
e. The average price of the high and low recorded in the exchange.

12. In private equity investments where the trade is executed over-the-counter, who among the following will be the actual counterparty?
a. The stock exchange in which the stock is listed.
b. The buyer.
c. The seller.
d. The custodian bank.
e. The broker.

13. When the net holding of any given share is shown in negative value, it refers to:
a. Quantity of short position.
b. Loss from long position.
c. Unrealized loss from short position.
d. Quantity of long position.
e. Dividend receivable.

14. For exchange-traded securities, the delivery of the securities either in physical or in electronic form takes place:
a. When the trade is booked.
b. When the broker confirms the receipt of payment.
c. Immediately after the payment is received by the stock exchange.
d. On T + 1.
e. At a predetermined future date.

15. When a company announces a dividend, who among the following is entitled to receive it?
a. An investor listed as holder of stock as of the dividend declaration date.
b. An investor listed as holder of stock as of the ex-dividend date.
c. An investor listed as holder of stock as of the day before ex-dividend date.
d. An investor listed as holder of stock as of the record date.
e. An investor listed as holder of stock as of the dividend payment date.

16. If an investor buys 1,000 shares at $50 and the initial margin is 60 percent and the maintenance margin is 30 percent, he will receive the first marginal call when the stock price falls below:
a. $14.00
b. $21.00
c. $28.57
d. $49.99

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Theory Questions

1. Define equity shares as per the accounting standard FAS 115.

2. How are passive investments classified for accounting purposes?

3. What is readily determinable fair value as per FAS 115?

4. What is the fundamental difference between the trading and available-for-sale classifications of equity investments?

5. When is an investor supposed to have significant influence on the investee company, and what is the method of accounting for such investments?

6. Controlling interest is acquired if an investor holds more than 50 percent—is this statement true? Discuss your answer with examples.

7. What are the main differences between exchange-traded securities and over-the-counter securities?

8. Explain in brief the functions and functioning of stock exchanges.

9. List the various events during the trade life cycle for equity shares that are held as trading, along with the accounting entries to be recorded.

10. What are corporate actions and what is their impact with regards to accounting?

11. Commissions and other expenses for acquiring the shares are treated as part of the cost of the equity—is this true, and if so, what are the exceptions?

12. What are the differences between trade date accounting and settlement date accounting?

13. What is the reversal journal entry for mark-to-market?

14. Explain the process of FX revaluation and FX translation. What are the differences between the two?

15. What is meant by functional currency and how it is determined?

16. How do you distinguish between capitals gains and currency gains due to fluctuation in foreign exchange rate? Is it mandatory to divulge the two gains separately?

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• Equity securities are represented by ownership shares as common stock or preferred stock, rights to acquire ownership shares such as stock warrants or rights, or call options. The category also includes rights to dispose of ownership in shares by way of put options.
• Equity security is defined in FAS 115 as any security representing an ownership interest in an enterprise (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, and call options) or dispose of (for example, put options) an ownership interest in an enterprise at fixed or determinable prices. However, the term does not include convertible debt or preferred stock that by its terms either must be redeemed by the issuing enterprise or is redeemable at the option of the investor. The definition does not include redeemable preference shares.
• Under the trade date accounting method, both the asset and the liability for the asset purchased are recognized on the date of trade and the payable is derecognized once the payment is made.
• Under the settlement date accounting method, the entire transaction is recognized only on the date of settlement. While FAS 115 is silent as to the date on which the transaction should be recorded, the other levels of U.S. GAAP literature require trade date accounting to be followed for regular-way securities contracts, especially for broker-dealers and investment companies.
• For regular-way contracts, the IASB gives the option to follow either trade date accounting or settlement date accounting, provided that one is followed consistently for purchases and sales of financial assets in the same category. However, the changes in the fair value of the asset should be treated properly depending upon the classification of the asset acquired.
• Investments in equity securities that are purchased and held principally for the purpose of generating gains on resale are classified as trading securities. Investments in equity securities that are not trading securities are classified as available-for-sale (AFS) securities.
• Trading securities are normally held by banks and other financial institutions that engage themselves in active buying and selling of securities with a view to make gains on trading. The mark-to-market process values the securities at market rates, recording the unrealized gains/loss on such securities.
• When the investor invests in equity securities just to utilize the idle cash, without any intention to hold it for a long period or without any intention to generate gains on current resale, then such investments in equity securities are classified as available-for-sale securities.
• Where the investor owns between 20 and 50 percent of the equity of the investee company, then the investor is presumed to have a significant influence in the operating and financial decisions of the investee company.
• When the investor acquires more than 50 percent of the outstanding voting stock of the investee company, then the investor has controlling interest because of its majority ownership of the voting stock. Investments of this nature will necessitate the preparation of consolidated financial statements.
• The currency of the primary economic environment in which the investor operates is the functional currency. The financial accounting records should be maintained in the functional currency and the investor is not free to choose the same. The investor’s investment activities and the currency in which the fund raises money from investors predominantly determine the functional currency. Presentation currency is the currency in which the financial statements are presented to the investors.
• For assets and liabilities, the exchange rate at the balance sheet date is used to translate foreign currency statements into the functional currency.
• For revenues, expenses, gains, and losses, the exchange rate at the dates on which such revenue or expense is recognized is used.
• If the reporting currency is different from the trading currency, then every journal entry recorded is first revalued in the reporting currency, based on the market quote available for the trade currency.
• On the reporting date, all the assets and liabilities of the investor that are designated in foreign currency should be converted into the functional currency based on the official FX conversion rates on the reporting date. This is achieved by the FX revaluation process.
• As per the U.S. GAAP Statement of Position (SOP) 93-4, it is not mandatory to show the capital gains/loss due to change in the market rate of the asset and currency gains/loss due to change in the foreign exchange rate separately, even though the SOP indicates that such separate reporting would provide valuable information to the users of the financial statements.

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