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Chapter 12: Q28. (page 610)

What is meant by the term “underlying” as it relates to derivative financial instruments.

Short Answer

Expert verified

Underlying is a special rate that helps determine the price of the derivative.

Step by step solution

01

Definition of derivative financial instruments

Derivative instruments are the instruments that change their prices according to the change in financial instruments’ price, credit risk, etc.

02

Underlying term

Underlying includes various items like security price, index of prices or rate, interest rate, etc. The price of the derivative financial instruments is the sum of all underlying expenses and face value after this amount is multiplied by the number of shares to find the net amount of the derivative contract. If there are any changes in the derivatives, it also affects the price of the derivative instrument.

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Most popular questions from this chapter

What are the two main characteristics of intangible assets?

Recently, a group of university students decided to incorporate for the purposes of selling a process to recycle the waste product from manufacturing cheese. Some of the initial costs involved were legal fees and office expenses incurred in starting the business, state incorporation fees, and stamp taxes. One student wishes to charge these costs against revenue in the current period. Another wishes to defer these costs and amortize them in the future. Which student is correct?

Question: (Accounting for Franchise, Patents, and Trademark) Information concerning Sandro Corporation’s intangible assets is as follows.

On January 1, 2017, Sandro signed an agreement to operate as a franchisee of Hsian Copy Service, Inc. for an initial franchise fee of \(75,000. Of this amount, \)15,000 was paid when the agreement was signed, and the balance is payable in 4 annual payments of \(15,000 each, beginning January 1, 2018. The agreement provides that the down payment is not refundable and no future services are required of the franchisor. The present value at January 1, 2017, of the 4 annual payments discounted at 14% (the implicit rate for a loan of this type) is \)43,700. The agreement also provides that 5% of the revenue from the franchise must be paid to the franchisor annually. Sandro’s revenue from the franchise for 2017 was \(900,000. Sandro estimates the useful life of the franchise to be 10 years. (Hint: You may want to refer to Chapter 18 to determine the proper accounting treatment for the franchise fee and payments.)
Sandro incurred \)65,000 of experimental and development costs in its laboratory to develop a patent that was granted on January 2, 2017. Legal fees and other costs associated with registration of the patent totaled \(17,600. Sandro estimates that the useful life of the patent will be 8 years.
A trademark was purchased from Shanghai Company for \)36,000 on July 1, 2014. Expenditures for successful litigation in defense of the trademark totaling $10,200 were paid on July 1, 2017. Sandro estimates that the useful life of the trademark will be 20 years from the date of acquisition.

Instructions

Prepare a schedule showing the intangible assets section of Sandro’s balance sheet at December 31, 2017. Show supporting computations in good form.

Prepare a schedule showing all expenses resulting from the transactions that would appear on Sandro’s income statement for the year ended December 31, 2017. Show supporting computations in good form.

: As a new intern for the local branch office of a national brokerage firm, you are excited to get an assignment that allows you to use your accounting expertise. Your supervisor provides you with the spreadsheet below, which contains data for the most recent quarter for three companies that the firm has been recommending to its clients as “buys.” Each of the companies’ returns on assets has outperformed their industry cohorts in the past. But, given recent challenges in their markets, there is concern that the companies may experience operating challenges and lower earnings. (All numbers in millions, except return on assets.)

A	B	C	D	E
Company	Fair Value of Company	Book Value (Net Assets)	Carrying Value of Goodwill	Return on Assets
Sprint Nextel	\(36,361	\)51,271	$30,718	3.5%
Washington Mutual	11,742	23,941	9,062	2.4
E* Trade Financial	1,639	4,104	2,035	5.6

Instructions

The fair value for each of these companies is lower than the corresponding book value. What implications does this have for each company’s future prospects?
To date, none of these companies has recorded goodwill impairments. Your supervisor suspects that they will need to record impairments in the near future, but he is unsure about the goodwill impairment rules. Is it likely that these companies will recognize impairments? Explain.
Estimate the amount of goodwill impairment for each company and prepare the journal entry to record the impairment. For each company, you may assume that the book value less the carrying value of the goodwill approximates the fair value of the company’s net assets.
Discuss the effects of your entries in part (c) on your evaluation of these companies based on the return on assets ratio.

Explain how to account for the impairment of held-to-maturity debt security.

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