CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsHard
A company holds an investment in another company's equity securities. The fair value of the investment at year-end is $150,000, while its cost was $120,000. The company classifies this investment as 'available-for-sale.' How should the unrealized gain or loss on this investment be reported in the financial statements?
- AAs part of net income.
- BNot recognized until the investment is sold.
- CAs a direct adjustment to retained earnings.
- DAs a component of other comprehensive income (OCI).
Show answer & explanationAnswer & explanation
Correct answer: D. As a component of other comprehensive income (OCI).
For available-for-sale (AFS) debt securities, unrealized gains and losses are recognized in other comprehensive income (OCI) and accumulated in accumulated other comprehensive income (AOCI) in equity. They are not included in net income until the security is sold.
Why the other options are wrong
- A. Unrealized gains/losses for trading securities are reported in net income, not AFS.
- B. Unrealized gains/losses on AFS securities are recognized, just not in net income.
- C. Direct adjustments to retained earnings are rare and not for unrealized gains/losses on AFS securities.
Available-for-Sale (AFS) Securities
Available-for-sale securities are debt securities not classified as trading or held-to-maturity; they are reported at fair value with unrealized gains/losses recognized in other comprehensive income (OCI).
- Reported at fair value on the balance sheet.
- Unrealized gains/losses recognized in OCI.
- Realized gains/losses (upon sale) recognized in net income.
Memory trick: INVESTMENTS are CLASSIFIED, and each class has its own way to treat GAINS and LOSSES.