Chapter 15, Problem 1QC

To determine

Concept introduction:

Classification of Investments:

The investments are classified on the basis of the two factors to be considered –

1. Intent of the company

2. Length of time for which it will be held.

The three categories for investments are –

i. Trading investments

The debt and equity securities investments will be classified as trading securities if they are purchased with an intention to be sold in a short time of their purchase. Suppose, 3 months or 4 months i.e. held with an intention to be sold in a short period.

ii. Available-for-sale investments

The debt and equity securities investments will be classified as available-for-sale investments if they are purchased with an intention to be sold in a longer time period say, more than a year. By default all the investments are classified as available-for-sale investments.

iii. Held-to-Maturity

Held-to-maturity investments are the investments that are purchased with an intention to be held till maturity. When a purchase is made with an intent that it will be held till maturity, it will be classified as held-to-maturity investment.

How the investment will be classified.

Explanation of Solution

The correct answer to the question will be –

b. No significant influence equity investment

This can be explained as, it is given in the question that the investment represents 5 % of the voting stock and it will be held for three months, thus it is satisfying the conditions for trading investments. The trading investments do not have significant influence equity investment as it represents 5 % of the voting stock,

Thus, No significant influence equity investment or trading investment is the correct option for the given situation.

The other options can be discussed as under –

Option a, significant influence equity investment –

Significant influence investments are the investment when the voting stock purchased is more than 20%. But in the given situation only 5 % of the voting stock has been purchased.

Option c, held-to-maturity investments –

As discussed above, held-to-maturity investments are the investments that are purchased with an intention to be held till maturity. When a purchase is made with an intent that it will be held till maturity, it will be classified as held-to-maturity investment

In the given situation the investment is purchased with be sold within a period of 3 months. Thus, this is also an incorrect option.

Option d, controlling interest equity investment

When the voting stock purchased is more than 50 %, it will be treated as controlling interest equity investment. It is given in the question that the investment represents 5 % of the voting stock, thus, this option will also be treated as incorrect choice.

Thus, from the above discussion it can be concluded that, the correct option will be b. No significant equity investment or trading investment as it will sold within a period of three months.