 Hello and welcome to this session in which you would look at investments in equity securities. Specifically, we're going to be focusing on when we purchase between zero and 20% of other company stocks, whether you own one or 99%. Once you buy equity, it means you are an owner of the business. However, your degree of ownership will determine how you account for that investment. So as long as you own between zero and 20%, for accounting purposes, you are considered a passive investor, although in the real world, even if you own 5%, you could be considered a large shareholder. But for purpose of accounting, you need more than 20%. How do we report these investments? Once we have zero to 20%, we report the investment at fair value. And this is basically the big picture. I will discuss those topics in prior recording the slide. But in this session, I will focus specifically on this passive investor. So holding less than 20%, how do we recognize the initial purchase? Well, we recognize the initial purchase just like any other asset purchase at cost, which will include the price of the security, the price of the stock you are buying, plus any brokerage commission and fees related to that purchase. It gets added to the cost. So as an example, on January 15, 20X5, Adam purchased three securities, each represent less than 20% of the company's total stocks. And here are the three stocks we bought. We invested 200,000 in economic integration, 415,000 in Best Software Inc., and 145,000 in EMC robotics. In total, we invested 760,000. The journal entry will be debit equity investment, 760 and credit cash, 760. So this is the basic journal entry. Now we're going to assume on December 6, 20X5, Adam received cash dividend of 3,250 from Best Software. How do we account for cash dividend? If we receive this money, assuming we own less than 20%, we debit cash, 3,250, we credit dividend revenue, 3,250. Now I want you to remember this point. Remember, we own less than 20%. In the next session, we are going to be looking at the scenario where we own more than 20%, but less than 50%, so between 20 to 50%. When we receive dividend, the transaction will be treated differently. This is where we're going to be using the equity method. So I want to point this out because I don't want you to think that every time the company receives dividend, you debit cash, credit dividend revenue. Yes, you're going to always debit cash if you receive cash, but you might have to credit something else if the ownership is more than 20%. Again, we'll keep this for the next recording. Let's take a look at the value of our portfolio at the end of the year. December 31st, 20x5. Well, we have the cost of each security, which are right here. We paid 760,000. Then we have to compare the cost of the securities to the fair value. So this is the cost. This is how much we paid for this. And we saw the journal entry. This is how much these securities are worth today. Well, actually we didn't do very well. Economic integration. We have an unrealized loss of 30,000. Best software ink went up 10,000. And AMC went from 145 to 120. We lost 25,000. Overall, we have a total loss of 45,000 in our portfolio. Now, this is a year one portfolio adjustment. Therefore, we have no previous fair value adjustment. Well, how do we prepare the journal entry to reflect a loss of 45,000? Before we look at the journal entry, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course. You might have one. I don't replace your accounting course. I'm a useful addition. I can help you do better in your courses, in your CPA preparation. My motto is saving CPA candidate and accounting student one at a time. How? I provide you lectures, resources, multiple choice, true, false, that's going to help you understand the material better. My CPA resources are aligned with your Becker, Wiley, Roger, Gleam, or your CPA review course. For the CPA exam, I give you access to 1,500 previously released AI CPA questions in their original format, how they appeared on the exam, plus detailed solution by Professor Farhat. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation. Like this recording, share it with others. It helps me tremendously. Connect with me on Instagram. I'm trying to grow my Instagram followers, Facebook, Twitter, and Reddit. So now we need to adjust our investment to market. Well, here's what we need to learn. And this is basically the same strategy that we used when we adjusted debt securities. Here we are dealing with equity securities. When we adjust our portfolio to market, we have two accounts that we need to know how to deal with. And those two accounts, one of them is called Fair Value Adjustment. That's one account. And the other account, whatever we debit here, we have to credit another account called unrealized gain slash loss in this ghost to income. Simply put, when we adjust equity securities, the adjustment goes to income. So if we debited this account, we credit this account. If we credited this account, we're going to debit this account. So those are the two accounts that's used. Now, I'm going to tell you the rules once again, just like as if I never mentioned them in the prior recordings. Okay, for some of you, this might be boring because I mentioned them a few times when we dealt with available for sale securities. And when I went over trading securities for that, but I'm going to have to do it again because I cannot assume that you guys viewed those recordings. So how do you adjust? Well, here's what's going to happen. You look at your total portfolio loss or gain. Here we have a loss of 45,000. Okay, why? Well, we didn't do very well. Here we go. 45,000. If we have a loss, it means we're supposed to have a credit balance of that amount. So the credit balance on fair value adjustment should be 45,000. This is the balance. And if it's a credit, it's a loss. Okay, so the fair value, let me write it up here. Fair value. If it's a loss, it's a credit balance. The balance is credit, not the entry. The entry could be debit, could be credit, but the balance should be credit. Now let's start with fair value. Well, how do I make an account go from 0 to 45,000? I'm going to have to credit this account 45,000. This is the entry. I will make the balance 45,000. Again, what did I say? Whatever I do in the fair value, I will have to do a corresponding in the unrealized gain. Therefore, I'm going to debit unrealized loss for this matter because it's a loss of 45,000. And therefore, my balance is 45,000. And here's the entry to adjust my portfolio to market. Remember, unrealized holding gain loss, which is this account here is an income statement account. Now 45,000 went to the income statement of losses. Fair value adjustment is a balance sheet account. It's a counter asset. It reduces my portfolio of securities. Now let's take a look at the second scenario. Let's assume Adam Company sold all the securities in economic integration. By the way, Adam Company is the company that owns these securities. Sold economic integration, this investment here for 175,000. So during 20x5, at 20x6, during 20x6, what we did, the fair value of it went up 5,000. We decided to get rid of this investment. And we sold it for 175. So initially we bought it at 200,000. Now we sold it for 175. What do we have to do? So I'm going to break down this instruction for you step by step. Because in most CPA review courses and most textbook, they don't do this detailed explanation. So I'm going to have to go through it. Here's what's going to happen. Let's think about it for a moment. You purchase the investment for 200,000. Notice right here when we purchase it initially. And you end up selling it for 175. What does that mean? It means you have a total loss. You got it of 25,000. Now of this total loss, you already recorded 30,000 of this total loss right here. Do you see here? I'm just 30,000. Well, if my total loss is 25, already recorded 30,000 of losses. But this stock recovered 5,000 before I sold it. Remember I sold it for 175. So it recovered 5,000. So the first thing I'm going to do, I'm going to do a fair value adjustment and increase my fair value and report $5,000 of income for that increase in the economic integration. What I did, I increased the value of economic integration by 5,000. Therefore, in 20x5, I recorded 30,000 of losses. In 20x6, I recovered 5. You got it. My total loss is 25,000. So this is the first thing I did. So now as far as the income statement is concerned, I'm just identifying my actual loss of 25,000. Now I received money. They paid me 175,000. Let's do the journal entry. I'm going to debit cash 175,000, debit fair value adjustment 25, and get root of the investment. I removed the investment for 200,000. I debit my cash 75,000. And the fair value adjustment is debited 25,000. And this is the fair value adjustment, is the net loss. But I wanted to show you this in two separate journal entries because most CPA review courses, they don't show it to you. They tell you you have to remove the adjustment from fair value, but I'm just showing you in detail how you would do it. So this is how you will record the adjustment. Obviously, I can combine those two, simply put. I don't have to have too fair value. If I want to do the adjustment, I will do it in one shot. Simply put, what I can do, I can basically make this fair value adjustment equal to 30,000. Why? Because I can combine this entry and I can have an unrealized holding gain of 5,000, which will give me the same thing if I want to combine those two. I just showed it to you separately, so you understand how we did this. Now, most CPA, the reason why they don't go over it in detail really on the CPA exam, they don't really test you at this level. And also in your intermediate accounting, they don't go down to that level. But nevertheless, I wanted to do so. Now, let's assume for the sake of simplicity, Adam did not sell any securities in 20x5. So we did not sell Economic Integration Forum. Now we need to take a look at our portfolio in 20x6 and make an adjustment. Remember, before we start, our fair value adjustment is 45,000 from 20x6. This is the value from 20x6. And let's do the unrealized holding gain, loss, income. We had in that account 45,000 as well. This is from the prior year. Now we look at our portfolio, and it seems in 20x6 the market recovered. Economic integration went up to 210,000. We have a gain on it. Best software went up to 430. We have 15,000 gain on it. EMC robotics went from 145 to 146. We have 1,000 gain on it. So notice what happened between 20x5 and 20x6. Our portfolio went from a loss of 45 to a gain of 26. Again, what I'm going to do, I'm going to show you the line, the number line. And here's where we were. In 20x5, the market wasn't doing well, and we were at negative 45,000. In 20x6, the market recovered, and our investment, now they are at a gain of 26,000. Remember what I said in the prior recording? Sorry, but I always say this, but I'm going to explain it to you now. When you move on the number line to the right, it means you are doing better. We moved from negative 45 to positive 26. Well, how many units are you moving from the left to the right? You have to move 71,000 units. Therefore, you debit. Fair value adjustment, 71,000, because in fair value, because you have a gain, your balance should be 26. This should be your balance. Well, to go from credit 45 to debit 26, I have to debit this account 71,000. For every corresponding debit to fair value, I will credit the unrealized gain. So now, unrealized gain will have a balance of 26, and those two should match. So I will debit fair value, credit, unrealized holding gain, or loss of 71,000. Therefore, now my portfolio is adjusted. Now, let me just show you another example of what's going to happen in 20x7. So I'm just going to make up some numbers. In 20x7, the cost, I'm going to keep the same portfolio. I'm going to keep the same portfolio. My total cost, I'm going to keep it 760 to keep it simple. And my fair value happens to be 762,000. My total portfolio. What happened is in 20x7, I have a $2,000 gain. What does that mean? Well, I still have a gain, but here's what happened to my portfolio. It went from 26,000. I'm going to move them back to 2,000 gain, 2K gain. What do I have to do? Well, under those circumstances, I'm moving to the left. I'm still positive, but I'm moving to the left. What I would do is I will debit. First of all, what does that mean? It means I have to have a balance now of 2,000. I have to have a balance of 2,000 debit. It's still a gain. What do I have to do then? I have to move. I have to credit this account to 24,000 to make this 2,000, the balance 2,000. And if I credited this, I have to debit this 24,000 to make the balance here only 2,000 credit unrealized gain. Therefore, I debit unrealized gain income, gain loss income of 24,000. And I credit fair value adjustment 24,000. This will be the entry. So I just basically the reverse of this, but it's for 24,000 to reflect 2,000 gain and 2,000 debit and fair value adjustment. It's very important that you understand how you adjust your portfolio to market. What should you do now? Go to farhatlectures.com, register. Start to work multiple choice questions and you will be fine. Good luck. 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