CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingHard
A company is preparing its financial statements for the year ended December 31, Year 1. On January 1, Year 1, the company purchased an investment in another entity's equity securities for $100,000. The investment does not give the company significant influence or control. At December 31, Year 1, the fair value of the investment is $90,000. There were no sales or purchases of this investment during the year. The company elected the fair value option for this investment. What amount of gain or loss should the company recognize in its Year 1 income statement related to this investment?
- A$90,000 gain
- B$0
- C$10,000 gain
- D$10,000 loss
Show answer & explanationAnswer & explanation
Correct answer: D. $10,000 loss
When the fair value option is elected for an equity investment where there is no significant influence or control, all changes in fair value are recognized in net income. The investment decreased in value from $100,000 to $90,000, resulting in a $10,000 loss recognized in net income.
Why the other options are wrong
- A. This is incorrect; it implies a gain from the full fair value, not the change in fair value.
- B. This would be true if the investment was accounted for under the cost method (for non-marketable securities) or if it was an AFS debt security where changes were in OCI (and fair value option not taken).
- C. This suggests a gain, but the fair value decreased. It also doesn't consider the fair value option.
Fair Value Option (Equity Investments)
For equity investments without significant influence, electing the fair value option means all changes in fair value are recognized in net income, bypassing OCI.
- This option is irrevocable for the specific investment.
- Applies to investments where the investor does not have significant influence or control.
- Contrasts with default treatment for equity investments (unless AFS), where changes are in OCI.
Memory trick: Influence dictates, Fair Value can change path.