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Accounting Brief Exercises Chapter 9
Typology: Exercises
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Brief Exercises BE9.1 (LO 1) An icon reads, Finance. Bali Corp. has $10,000 in surplus funds to invest and is considering investing in either Company A or Company B. Company A promises to return the $10,000 original amount invested in three years’ time and pay a 2% annual return on the principal amount. Company B does not promise to repay the original amount invested, but indicates that it is likely that the $10, investment will be worth more than $10,000 if Company B is profitable. Whether Bali will receive an annual return on the investment depends on Company B’s cash flows and whether Company B’s board of directors votes to distribute the cash. A. Identify whether the potential investments are investments in debt or in equity securities. B. Explain how you determined your answer. Solution: (a) The investment in Company A is an investment in a debt security, and the investment in Company B is in an equity security. (b) Bali Corp. is a creditor of Company A because Company A has a contractual obligation or liability to repay the $10,000 borrowed, as well as interest on the borrowed funds. Therefore, Bali has invested in another company’s debt. Company B, on the other hand, does not have an obligation (and therefore does not have a liability) to either repay the funds Bali invested or to provide a return to Bali on those funds. Instead, Bali has taken on the risk of a residual shareholder by profiting if Company B does well and losing if Company B does not do well. This is an equity interest in Company B.