303020

Question 1

On January 1, year 1, a nonpublic company acquired an equity security investment for $5,000. On December 31, year 1, the fair value of the security was $5,200. On June 30, year 2, when the fair value of the security was $5,750, the company’s management planned to sell the security, and on December 31, year 2, the company did sell it for $5,800. What amount should the company recognize in year 2 net income related to the investment?

$600

$800

$50

$200

Answer 1

$600

The correct answer is $600. To calculate the amount that the company should recognize in year 2 net income related to the investment, consider the changes in fair value and the timing of the sale. One of two approaches can be used to solve the problem.

Simplified approach:

Given:

Fair value on December 31, year 1: $5,200
Sale price on December 31, year 2: $5,800
The acquisition cost and fair value on June 30, year 2 are largely irrelevant. The answer can be solved by examining the change in fair value of the instrument within the fiscal year.

Gain to recognize in year 2 net income = Sale price on December 31, year 2 − Fair value on December 31, year 1
Gain to recognize in year 2 net income = $5,800 (Fair value, year 2 ending) − $5,200 (Fair value, year 1 ending) = $600

Detailed approach:

Given:

Acquisition cost of the equity security investment: $5,000
Fair value on December 31, year 1: $5,200
Sale price on December 31, year 2: $5,800
Step 1: Calculate the change in fair value and recognize any gains or losses between December 31, year 1 and June 30, year 2.

The fair value of the investment increased from $5,200 on December 31, year 1, to $5,750 on June 30, year 2, resulting in an unrealized gain of $550 ($5,750 − $5,200). Since the company’s management planned to sell the security on June 30, year 2, we recognize the “unrealized” gain of $550 in net income up to that point.

Step 2: Calculate the change in fair value and recognize any gains or losses between June 30, year 2, and December 31, year 2.

The fair value increased further to $5,800. During this period, the company sold the investment for $5,800, resulting in a “realized” gain of $50 ($5,800 − $5,750).

Step 3: Recognize the sum of the realized gain and the portion of the unrealized gain up to the sale date:

Amount to recognize in year 2 net income = Realized gain + Unrealized gain (up to sale date)
Amount to recognize in year 2 net income = $50 (Realized gain) + $550 (Unrealized gain) = $600

Question 2

Equity Security

Answer 2

Definition 1: An equity security is any security representing an ownership interest in an entity (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, forward purchase contracts, and call options) or dispose of (for example, put options and forward sale contracts) an ownership interest in an entity at fixed or determinable prices. The term equity security does not include any of the following:

• Written equity options (because they represent obligations of the writer, not investments)
• Cash-settled options on equity securities or options on equity-based indexes (because those instruments do not represent ownership interests in an entity)
• Convertible debt or preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor

Definition 2: An equity security is any security representing an ownership interest in an entity (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, forward purchase contracts, and call options) or dispose of (for example, put options and forward sale contracts) an ownership interest in an entity at fixed or determinable prices. However, the term does not include convertible debt or preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor.

FASB ASC Glossary

Question 3

Fair Value

Answer 3

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date.

Question 4

Net Income

Answer 4

Net income is operating income plus non-operating revenues minus non-operating expenses minus taxes.

Question 5

2252.60

Answer 5

Assume, on the other hand, that the investor held the rights and sold them during the next year (20X2) for $9,300 and that the rights had a market price of $9,400 at the end of the year in which the investor received the rights (20X1). The related entries would be:

Valuation Allowance 4,150
Net Unrealized Holding Gain/Loss–Equity 4,150
To recognize, for balance sheet purposes, the difference at 12/31/X1
between fair market value of $9,400 and cost basis (carrying value)
of $5,250.

Cash 9,300
AFS Securities (Stock Rights) 5,250
Realized Gain 4,050
To record realized gain or loss on sale of stock rights - the difference
between sale price of the rights and the cost basis of the rights.
Assuming that these were the only rights held by Investor Company, since the rights were sold the following adjusting entry would be required at the end of 20X2:

Net Unrealized Holding Gain/Loss–Equity 4,150
Valuation Allowance 4,150
To reverse out at 12/31/X2 the balances in these accounts since
Investor Company no longer owns the rights.

Question 6

FASB ASC 320-10-35-1