CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsHard
A company holds an investment in another entity's equity securities. The company intends to hold the securities for capital appreciation and does not have significant influence over the investee. The fair value of the securities increased by $50,000 during the year. What is the impact of this fair value change on the company's financial statements if the securities are classified as equity investments without readily determinable fair value?
- AA $50,000 unrealized gain is reported in Other Comprehensive Income (OCI).
- BA $50,000 unrealized gain is reported in Net Income.
- CNo gain or loss is reported until the asset is sold, and the investment is carried at cost less impairment.
- DNo gain or loss is reported, but the investment is adjusted to fair value.
Show answer & explanationAnswer & explanation
Correct answer: C. No gain or loss is reported until the asset is sold, and the investment is carried at cost less impairment.
For equity investments without readily determinable fair value, the investment is initially measured at cost. Subsequent measurement is at cost less impairment, plus or minus observable price changes for identical or similar investments of the same issuer. Fair value changes are recognized in earnings only upon sale or impairment, not as unrealized gains or losses in OCI or net income.
Why the other options are wrong
- A. This would be true for Available-for-Sale (AFS) debt securities, not for equity investments without readily determinable fair value.
- B. This would be true for Trading securities or equity investments for which the fair value option has been elected, not for equity investments without readily determinable fair value.
- D. While the investment may be adjusted for observable price changes, a general fair value increase is not reported as a gain until sale under this classification.
Equity Investments without Readily Determinable Fair Value
Equity investments for which a fair value is not readily available, typically private company stock or certain limited partnership interests.
- Initially measured at cost.
- Subsequent measurement is cost less impairment, plus or minus observable price changes.
- Gains/losses recognized in earnings only upon sale or impairment.
Memory trick: Equity's Path: Influence, Market, or Just Hold Fast.