E. INVESTMENTS - 1. FINANCIAL ASSETS Equity Securities

Question 1

_{E. INVESTMENTS}

_{<u>1. FINANCIAL ASSETS AT FAIR VALUE</u>}

Equity Securities

Define:

Answer 1

Equity securities—Securities that represent ownership interest or the right to acquire or dispose of ownership interest.

Includes:

• common stock,
• preferred stock (except redeemable preferred stock),
• stock warrants,
• call options/rights,
• put options.

Excludes:

• debt securities (including convertible debt),
• redeemable preferred stock,
• written equity options,
• cash settled options, and
• treasury stock.

Question 2

_{E. INVESTMENTS}

_{<u>1. FINANCIAL ASSETS AT FAIR VALUE</u>}

Decision Tree

Equity Security

Answer 2

Is investment a Debt or Equity Security?

If Equity, then is FV readily determinable?

Yes -

• recognize at FV (balance sheet)
• Unrealized gains and losses (net income)

No -

• recognize at Cost (balance sheet)
• Impairment loss and observable price changes (net income)

Question 3

_{E. INVESTMENTS}

_{<u>1. FINANCIAL ASSETS AT FAIR VALUE</u>}

Equity Securities

Fair Value or Cost?

Answer 3

For Equity Securities:

All equity securities are required to be recorded at fair value when fair value can be readily determined (see exceptions below).

Dividends from equity securities are included in net income.

Exceptions to carrying equity securities at fair value:

Investments in equity securities will be carried at fair value unless:

1. There is significant influence over the investee and the equity method is used
2. The investment will be consolidated and therefore eliminated
3. The fair value of the investment cannot be readily determined. In this case, the investment will be recorded at cost and adjusted for any impairments

Question 4

_{E. INVESTMENTS}

_{<u>1. FINANCIAL ASSETS AT FAIR VALUE</u>}

Equity Securities

Fair Value Treatment

Answer 4

For Equity Securities at Fair Value

Recognize:

• Investment (FV)
• Cash (at purchase)
• Unrealized Gain or Loss
• Dividend Income
• Cash (at sale)
• Realized Gain or Loss on Sale

Equity Securities Example:

ABC purchased 10 shares of XYZ for $1,000.

Journal entry at purchase:

Investment in XYZ $1,000

Cash $1,000

At the balance sheet date if the fair value of the XYZ shares is now $1,250:

Investment in XYZ $250

Unrealized gain $250

If ABC received dividends of $50 on their XYZ investment:

Cash $50

Dividend income $50

At the next balance sheet date if XYZ investment is now worth $950:

Unrealized loss $300

Investment in XYZ $300

When the XYZ shares are actually sold for $900:

Cash $900

Realized loss $50

Investment in XYZ $950

Question 5

_{E. INVESTMENTS}

_{<u>1. FINANCIAL ASSETS AT FAIR VALUE</u>}

Equity Securities at Cost

Answer 5

Equity Securities at Cost

If the fair value of the securities cannot be readily determined, then the investor would record the investment at cost.

Any dividends received would be included in net income.

Such investments would be evaluated for impairment based on any of the following factors:

• If there’s been a downturn in the earnings performance, credit rating, business outlook of the investee, or concerns about the ability of the investee to continue as a going concern
• If there’s been a downturn in the economic, regulatory, or market conditions the investee operates in.

If it is determined the assets are impaired, the impairment loss is equal to the carrying value of the investment less the determined fair value.

In other words, carrying value – fair value = the impairment loss.

Recognize:

Investment (cost)

Cash (at purchase)

Dividend Income

Impairment (BV - FV)

Cash (at sale)

Realized Gain or Loss (at sale)