CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingMedium
A publicly traded company, Alpha Corp., is preparing its financial statements for the year ended December 31, Year 1. Alpha Corp. holds an equity investment in Beta Co. with a carrying amount of $500,000. Alpha Corp. does not have significant influence over Beta Co. The fair value of the investment at year-end is $450,000. Alpha Corp. elected the fair value option for this investment. Which of the following statements is true regarding the accounting for this investment at year-end?
- AThe investment will be written down to its fair value, and no gain or loss will be recognized.
- BThe investment will remain at its carrying amount of $500,000, as the loss is not yet realized.
- CAn unrealized loss of $50,000 will be recognized in net income.
- DAn unrealized loss of $50,000 will be recognized in Other Comprehensive Income.
Show answer & explanationAnswer & explanation
Correct answer: C. An unrealized loss of $50,000 will be recognized in net income.
When the fair value option is elected for an equity investment where the investor does not have significant influence, changes in fair value are recognized in net income. This applies to both unrealized gains and losses.
Why the other options are wrong
- A. A write-down implies impairment, but with the fair value option, all changes are recognized as gain/loss.
- B. The fair value option requires the investment to be reported at fair value, and changes are recognized.
- D. Unrealized gains/losses for available-for-sale debt securities or certain equity investments not electing the fair value option go to OCI.
Fair Value Option (Equity Investments)
An accounting election that allows companies to report certain financial assets and liabilities at fair value, with changes in fair value recognized in earnings.
- Election is irrevocable for the specified item.
- Changes in fair value are recognized in net income.
- Simplifies accounting by eliminating complex hedge accounting or impairment rules.
Memory trick: Fair Value Option: All Roads Lead to Income.