Accounting for Equity Securities

Summary

This session focuses on accounting for equity investments when ownership is less than 20%. It covers the initial recognition at cost, including brokerage fees, and subsequent accounting for dividends received. The session also discusses year-end valuation adjustments based on fair value, using examples to illustrate unrealized gains and losses. It concludes with a reminder to visit the speaker's website for additional resources and emphasizes the importance of adjusting equity securities to market value, affecting the income statement.

Takeaways

• 📈 Equity investments between 0% and 20% are considered passive for accounting purposes.
• 💼 Initial purchase of equity securities is recognized at cost, including brokerage fees.
• 💵 Cash dividends received from passive investments are recorded as dividend revenue.
• 📊 End-of-year portfolio valuation involves comparing cost to fair value to determine unrealized gains or losses.
• 📉 Unrealized losses reduce the balance sheet value of the investment portfolio.
• 🔗 Fair value adjustments are recorded as a counter asset, affecting the income statement.
• 💻 The instructor emphasizes the importance of understanding how to adjust equity securities to market value.
• 🔄 When selling securities at a loss, the unrealized loss is reversed through fair value adjustment.
• 🔝 Recoveries in security value before sale affect the income statement and require adjustment.
• 🌐 Market recoveries or declines in subsequent years require revaluation and adjustment of the portfolio's fair value.
• 📚 The instructor recommends visiting foreheadlectures.com for additional resources to aid in CPA exam preparation.

Q & A

What is considered a passive investment in terms of equity ownership?

A passive investment in terms of equity ownership is when an investor holds between zero and 20 percent of another company's stocks.

How is the initial purchase of equity securities recognized in accounting?

The initial purchase of equity securities is recognized at cost, which includes the price of the stock plus any brokerage commission and fees related to the purchase.

What is the journal entry for the initial purchase of equity securities?

The journal entry for the initial purchase of equity securities is to debit 'Equity Investment' and credit 'Cash' for the total cost of the investment.

How is a cash dividend received from an equity investment accounted for if the ownership is less than 20 percent?

If the ownership is less than 20 percent, a cash dividend received is accounted for by debiting 'Cash' and crediting 'Dividend Revenue' for the amount of the dividend.

What is the difference in accounting treatment of dividends received when the ownership is more than 20 percent but less than 50 percent?

When the ownership is more than 20 percent but less than 50 percent, the equity method is used to account for dividends received, which is different from the passive investor treatment.

How is the value of an equity portfolio reported at the end of the year if the investor is a passive investor?

The value of an equity portfolio reported at the end of the year for a passive investor is compared to the fair value, and any unrealized gains or losses are recorded.

What is the journal entry to reflect a loss in the value of an equity portfolio for a passive investor?

The journal entry to reflect a loss in the value of an equity portfolio includes crediting 'Fair Value Adjustment' and debiting 'Unrealized Loss' for the amount of the loss.

If an equity security is sold at a loss, how is this transaction recorded in the books?

If an equity security is sold at a loss, the transaction is recorded by debiting 'Cash' for the amount received, debiting 'Fair Value Adjustment' for the loss, and crediting 'Equity Investment' for the cost of the investment.

What is the purpose of the 'Fair Value Adjustment' account in equity security accounting?

The 'Fair Value Adjustment' account is used to record the difference between the cost and the fair value of equity securities, affecting the balance sheet by reducing the portfolio value.

How does the unrealized holding gain or loss account affect the income statement?

The unrealized holding gain or loss account affects the income statement by recording the unrealized gains or losses from the adjustment of equity securities to fair value, which flows through to the income as part of the income statement.

What is the significance of adjusting a portfolio to market for equity securities?

Adjusting a portfolio to market for equity securities is significant as it reflects the current value of the investments, allowing for accurate financial reporting and a true reflection of the investor's financial position.