 Hello and welcome to this session in which you would look at the fair value option for notes receivable So we have two topics here that are there are connected together One is notes receivable, which you have to have a good understanding of notes receivable The second topic is fair value fair value is an important topic in accounting especially for gap because many items many assets and many liabilities are reported at fair value So understanding fair value is critical for your success whether you are an accounting student Whether you are a practitioner or if you are taking the CPA exam If you are any of those farhat-lectures.com can help you understand fair value and notes receivable better I don't replace your CPA review course. I'm a useful addition to your CPA review course I explained the theory behind the concept so you Understand the material better which in turn you can take advantage of your CPA review course Which in turn you can do better to pass the exam your risk is one month of subscription You give it a try you try it. You like it. You keep it. You don't you cancel your return is passing the exam So the risk return, I believe it's pretty straightforward If not for anything take a look at my website to find out how well or not well your university doing on the CPA exam I do have a list of courses for other accounting courses advanced accounting Taxation governmental Integral auditing so on and so forth also my supplement or review courses are aligned with your backer Roger gleam Wiley so you can switch back and forth real easily between my material and your CPA review course If you have not connected with me only then please do so take a look at my LinkedIn Recommendation like this recording share it with other connect with me on Instagram Facebook Twitter and Reddit So let's talk about the fair value option for notes receivable So the first thing you want to know is it's an option What does an option mean? It means you can choose so companies can choose to report notes receivable at fair value for any particular? Instrument for a specific instrument. They don't have to do it for older notes receivable They can choose one to any of them and they can report it at fair value now. Hold on a second We know what notes receivable is we should know what notes receivable is if we're going chronologically But what is fair value and why can we report notes receivable at fair value? So what is fair value fair value and what is when you can report increases or decreases as? unrealized gains and losses and specifically for notes receivable in the income statement. What does that mean? It means I'm going to give you a personal example. Let's assume you purchase a home Okay, you purchase a home and you paid for that home a 200 and 90 thousand dollar a Year later your home is worth 350 what happened to your home your home went up in value of 60,000 Okay, that went up in value what you have is unrealized gain It means it went up, but you did not sell it just went up in value So if you are reporting your assets your personal asset you have the option to report it at 350 and Record an unrealized game because the value of your home went up So this is the idea or you could have your home We could have went from 290 down to 260 then you have a $30,000 loss So this is the idea of unrealized holding gain or loss, but for notes receivable Those unrealized holding gain or losses are reported in the income statement and this is extremely important Here's what you need to know about fair value every time you hear the word fair value It means you have an unrealized holding gain or losses So your assets or your liabilities either went up or other went down to record that increase or decrease you have to Understand certain assets and certain liabilities are reported on the income statement In terms of gains and losses and others are reported on the balance sheet So the next thing you ask yourself is where is it reported now? I'm gonna tell you notes receivable is reported on the income statement It does not mean that all unrealized holding gain and losses are reported on the income statement Others are reported in the equity section of the balance sheet So we have to be very careful about this, but I just told you where notes receivable is reported now Why can we report notes receivable at fair value? Well, if you think about it, it's a form of an investment How so well think about it when you lend money you expect to receive Interest in return while you are investing your money It's a form of an investment and the good thing about the note It's a negotiable notes receivable is a negotiable instrument negotiable means you can sell it You can trade it. You can buy a note. You can sell a note. So it's negotiable So the best way to illustrate this is to just to tell you why do they change in value? So you understand why you would have unrealized holding gain or loss Let's assume you have a note with a stated rate of 10% you lend someone money $100,000 and they're paying you 10% in other words, they pay you $10,000 a year in interest revenue Now you have that note $100,000 now let's assume the overall interest rate went down in value to 7% So simply put if somebody wants to borrow money They can now borrow money at 7% because interest rate went down now You have that note in your hand and that note is paying you 10,000 Well, if somebody else wants to lend money, okay, if they want to lend money now They can only get if $100,000 they own they can only earn per year $7,000 guess what because the other option the market rate is lower You the value of your note will go up now. You can sell this note Anyone will be willing to buy it from you for more than 100,000 Why because your note is earning 10% now? How much will they pay you'll have to do the discounted cash flow and you will find the value which should be more than 100,000 so you will have an unrealized unrealized gain the opposite is true If interest rate went up to 12% and you your note is temp paying 10% Well, guess what if somebody wants to buy your note, they will never pay you the full amount They'll pay you a discount amount. They'll pay you less It means you the value of your note went down the point And I'm trying to make is notes are affected mainly by the changes of interest rate Okay, and we'll see this later on when we talk about bonds how how interest rate determine the price of a bond But simply put think about it from a logical perspective You have a piece of paper that paying you 10% if someone wants to lend money they can only lend it at 7 So if you want to sell yours, you're gonna sell it for more Because you're compensating the other party more. So this is why it goes up and down So when the election takes place when the fair value election takes place when you initially Recognize the note. So when you initially get the note, you will need to say I would like to have this note reported at fair value or if there's a new basis of accounting That could trigger the recognition. Don't worry about this new basis. Simply put when the company initially gets the note They would say we chose to report this note at fair value. What does that mean? It means in their notes when they have the notes They will say for example this and this and this notes. They are reported at fair value We chose to report them. You don't have to report all of your notes You can select specific instrument and once you make that election once you say I would like to Report my notes receivable, then you must and this is a strong word and accounting. We don't use it much You must use the fair value till disposition of the note. So simply put You will keep reporting this note up and down Reporting gains and losses in the income statement until you get rid of it So once you select it you have to stick with it If it's not elected at the date of the recognition usually you cannot use it because we're gonna assume that you only Selected at the date of recognition So you must select it at the date of the recognition and you must use it for the whole life of the note The best way to illustrate this is just to work a simple example It's a basically straightforward concept assuming you understand the concept of fair value So Adam company receives a notes receivable from its customers for five hundred and thirty thousand So simply put the customer promise to pay them five hundred and thirty thousand that was on December 31st 20x5 at that date the fair value and the carrying value were the same. There's nothing for Adam to make Adam chooses the fair value option for these receivable Excellent on December 31st 20x6 a year later. The note has a fair value of five hundred and seventy. So the note went up $40,000 in in value. What does that mean? We're gonna write up the note if the note went up. There's an increase in the note We're gonna debit the notes receivable an additional 40,000 To to bring it up the fair value and we're gonna book on unrealized holding in or loss an income of 40,000 on the income statement. Therefore we reported $40,000 of income on the income statement and this is how we would report this now the opposite would have been true If the fair value of this note was let's assume was went down to went down to five hundred thousand If that happens rather than five seventy then we would have an unrealized holding gain or loss a debit So we'd have an unrealized Holding gain slash loss a debit of thirty thousand and we would have write down the note of 30,000 write down the note and this is how we would report the note at fair value and remember this note is Specific to a customer. Okay, those are we're writing the specific note at the end of this recording I'm gonna remind you whether you are an accounting student or a CPA candidate to take a look at my website farhat lectures calm I don't replace your CPA review course. I'm a useful addition to your CPA review course I explained the material differently than your CPA review course as you can tell I go a little bit more in depth I'll give you more examples if that helps you well Invest invest in yourself invest in your career. The CPA is worth it. Good luck study hard and of course stay