Question

BE2-11 (L06) Vande Velde Company made three investments during 2017.

(1) It purchased 1,000 shares of Sastre Company, a start-up company. Vande Velde made the investment based on valuation estimates from an internally developed model.

(2) It purchased 2,000 shares of GE stock, which trades on the NYSE.

(3) It invested $10,000 in local development authority bonds. Although these bonds do not trade on an active market, their value closely tracks movements in U.S. Treasury bonds.

Where will Vande Velde report these investments in the fair value hierarchy?

Short answer

(1) Level 3

(2) Level 1

(3) Level 2

Step-by-step solution

Meaning of Investment

Investment refers to the property or asset purchased by an individual or any business entity to earn money from it in the future in the form of interest or dividend etc.

An explanation for part (1)

Level 3 –Level 3 means the unobservable inputs such as the company's data or assumptions of the company. The assumptions are based on the company's internal system but not on the market conditions. In the given statement, Vande Velde has purchased the shares of Sastry company based on the assumptions of the Sastry company.

Hence the correct answer is Level 3.

An explanation for part (2)

Level 1– Level 1 means the observable inputs that have quoted prices for identical assets or liabilities traded in the active markets. These types of shares are traded in the active markets. The company purchased the shares of GE stock, which are traded on the NYSE platform, which gives good returns.

Hence the correct answer is Level 1.

An Explanation for part (3)

Level 2 –Level 2 means the inputs not included in level 1 are observable for the asset or liability that comes directly or indirectly with the help of observable data. The company invested in the bonds closely monitored by the U.S. Treasury bonds.

Hence the correct answer is Level 2.