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Chapter 12: Q29. (page 610)

What are the main distinctions between a traditional financial instrument and a derivative financial instrument?

Short Answer

Expert verified

There are many differences between a traditional financial instrument and a derivative financial instrument. Some of the differences are payment of cost, disclosure of risk, etc.

Step by step solution

01

Definition of financial instrument.

The financial instruments are those assets that have the trading feature and those assets that can be expressed in the form of capital.

02

Difference between traditional financial instruments and derivative financial instruments

The difference between the traditional financial instrument and derivative financial instruments are as follows:

Traditional Financial Instruments

Derivative financial instrument

Cost

The traditional financial instrument includes the full cost payment.

The derivative financial market requires less amount of investment.

Risk Disclosure

In the traditional, all risks related to ownership of the instrument are exposed.

In a derivative instrument, all the risks related to the owner are not exposed.

Realization of Profit

In this, the investor realizes his profit only if he has ownership of that instrument.

On the other hand, there is no requirement for realizing a profit.

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Most popular questions from this chapter

Merck and Johnson & Johnson

Question: Merck & Co., Inc. and Johnson & Johnson are two leading producers of healthcare products. Each has considerable assets, and each expends considerable funds each year toward the development of new products. The development of a new healthcare product is often very expensive, and risky. New products frequently must undergo considerable testing before approval for distribution to the public. For example, it took Johnson & Johnson 4 years and \(200 million to develop its 1-DAY ACUVUE contact lenses. Below are some basic data compiled from the financial statements of these two companies.

(all dollars in millions)

Johnson & Johnson

Merck

Total assets

\)53,317

\(42,573

Total revenue

47,348

22,939

Net income

8,509

5,813

Research and development expense

5,203

4,010

Intangible assets

11,842

2,765

Instructions

  1. What kinds of intangible assets might a healthcare products company have? Does the composition of these intangibles matter to investors—that is, would it be perceived differently if all of Merck’s intangibles were goodwill than if all of its intangibles were patents?
  2. Suppose the president of Merck has come to you for advice. He has noted that by eliminating research and development expenditures the company could have reported \)4 billion more in net income. He is frustrated because much of the research never results in a product, or the products take years to develop. He says shareholders are eager for higher returns, so he is considering eliminating research and development expenditures for at least a couple of years. What would you advise?
  3. The notes to Merck’s financial statements note that Merck has goodwill of $1.1 billion. Where does recorded goodwill come from? Is it necessarily a good thing to have a lot of goodwill on a company’s books?

On January 1, 2017, Dagwood Company purchased at par 6%

bonds having a maturity value of $300,000. They are dated January 1, 2017, and mature January 1, 2022, with interest received

on January 1 of each year. The bonds are classified in the held-to-maturity category.

Instructions

(a) Prepare the journal entry at the date of the bond purchase.

(b) Prepare the journal entry to record the interest revenue on December 31, 2017.

(c) Prepare the journal entry to record the interest received on January 1, 2018.

In examining financial statements, financial analysts often write off goodwill immediately. Comment on this procedure.

Use the information provided in BE12-7. Assume that the fair value of the division is estimated to be \(750,000 and the implied goodwill is \)350,000. Prepare Waters’ journal entry, if necessary, to record impairment of the goodwill.

Research and development activities may include (a) personnel costs, (b) materials and equipment costs, and (c) indirect costs. What is the recommended accounting treatment for these three types of R&D costs?
See all solutions

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