 Hello and welcome to this session in which we would look at CPA exam questions that deals with accounting for investment. Accounting for investment is an important topic, whether you are studying for the CPA exam, or you are an accounting student taken intermediate or advanced accounting. Investment is a tough topic for many reasons. One is you have multiple levels of investments. So the investments could be trading, the investment could be considered available for sale, the investment could be held for securities, the investment could be reported under the equity method, and the investment could be a consolidated investment. So that's the first complication in investment. Then the second complication is when you are accounting for investments, you have to know how to account for the investment in subsequent years. So you have year one, year two, year three. Taking those two things together, it's going to create complications and difficulties for the students. So this is where FARHAT lectures come into place. On my website, whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my investment lectures. I do help you prepare for the exam. I don't replace your CPA review course. I explain the material differently. I explain it as this is the first time you are looking at the material rather than reviewing it with your real quick with acronyms with CPA review courses. Now after you learn the material, the CPA review course will make perfect sense. My material is organized to parallel your CPA review course. So I can add 10 to 15 points by helping you understand the material better. Now what is your risk? Your risk is one month of subscription. Give me a try. You don't like it, you cancel. You like it, you see improvement, you keep me. The potential gain is passed in the exam. And if not for anything, take a look at my website to find out how well or not well your university is doing on the CPA exam. I do have resources for other accounting, finance and CPA resources. Please connect with me on LinkedIn. And on LinkedIn you can see actual people recommendations who took my resources and used it and passed the exam. Like this recording, share it on YouTube. Connect with me on Instagram and Facebook. So let's take a look at the first question. And usually I start with the first question with what I considered easy. Because usually on the CPA exam they start with the easy to a medium to just kind of feel how well you know or don't know the material. So let's start with the first one. The investment category for which investors, positive intent and ability to hold is important is what? So when the company purchase an investment and their intent is to hold it. How do they classify under what category they classify the investment? Is it security reported under the equity method? Is it trading securities? Is it securities classified as health to maturity? Or is it securities available for sale? Now, if you don't know anything, hopefully you can connect ability to hold positive intent and ability to hold with health to maturity. If you did that, you are correct. There's one category that's called securities classify as health to maturity. When you buy an investment and you intend to hold it until it matures, you classify it under health to maturity. And the only securities that can take this classification is bonds, which is that securities bond or debt. Why bond or debt? Because you cannot, there's no maturity for equity securities like stocks. Now, what about the other classification? Trading means you intend to sell it in the near future, you will classify it under trading. And for now, the only investments you can have trading is that or it could be securities available for sale. Securities available for sale, it's not trading. It's not classified health to maturity. Then if it's not either of those, it will be held available for sale. And under available for sale, you could have debt, which is bonds, and you can have equity, which is stocks. And again, those topics I cover in details in my recording at foreheadlectures.com. What we are left with is the equity method. There's another question in this series of questions. We'll discuss the equity method. When do we use the equity method? In the statement of cash flows, inflows and outflows of cash from buying and selling trading securities typically are considered what? So if you are preparing a statement of cash flows, you are buying bonds and selling bonds and you are considered them trading securities. Well, generally speaking, when you think of bonds, buying and selling bonds, you would think, well, I'm making an investment. We would say, oh, it goes under investment activities. Hopefully you are familiar with the statement of cash flows. Otherwise, go to foreheadlectures. Well, guess what? If it's trading securities, it's not an investment. It's operating. So simply put, you are trying to generate cash flow from buying and selling securities to operate your business. So trading securities operating your business. Now, if this word trading, we said it's available for sale, AFS, available for sale or held to maturity, then guess what? Those will be considered investing. Same securities. If you intend to hold them to maturity or your intent is available for sale, then they will be considered investing activities for the cash flow statement. Gap regarding fair value accounting for investment in equity securities would generally apply to an investment when the percentage of ownership of another company is what? So here we're talking about fair value accounting for an investment. So when do we use the fair value accounting for an investment in equity securities? Simply put, we have three percentages, three categories or three points where we have to be aware of those percentages. First, zero to 20%, 20% to 50% and 50% plus. So you need to understand when do we use, what do we use for each method? Zero to 20%, we use the fair value. 20 to 50, we use something called the equity method and the equity method, I cover it in details on my website and you need to know it very well. And anytime we own more than 50% of the company, we consolidate, we use consolidation. And I have a whole course called advanced accounting when it comes to consolidation. And this is also covered on the CPA exam and I have a whole course called advanced accounting if you're taking advanced accounting. So simply put, when do we use the fair value? We use the fair value when you generally speak and when we own less than 20% of the company, therefore we report our investment at fair value, at fair value. Unrealized holding gain and losses on debt securities classified as available for sale. So we have what type of securities are we dealing with that? How are we characterizing them, categorizing them available for sale? So here we are dealing with debt securities, the type of the securities is that bonds, they are available for sale and available for sale, not trading, not held to maturity. So we'd have the following effect on accumulated other comprehensive income. So simply put, when we have unrealized holding gain on losses on these type of securities, how do they affect the comprehensive income? And you have to know a lot about comprehensive income, accumulated comprehensive income. Well, what do gains do? Well, what do gains do? Gains going to increase your comprehensive income. So immediately I would eliminate two choices. Would losses also increase? It cannot be as long as you know that gains increase your comprehensive income and losses decrease your, I'm sorry, let's be more specific, accumulated other comprehensive income. It means the answer is D. So simply put, if you have gains for a particular year, it's going to increase your accumulated other comprehensive income and specifically unrealized gain. And if you have unrealized loss, it's going to decrease. Therefore, the answer is option D, D as in David. Let's take a look at this question. Adam Corporation purchased debt securities during 2021 and classify them as available for sale. So we're dealing with debt securities available for sale. Remember, we could also have equity securities available for sale. But here we are dealing with that. We have the cost for each security and the fair value for each security. All declines. So notice this went up, this went down, and this investment went up. So we have three investments. All decline are considered to be temporary. Okay. How much gain will be reported by Adam Corporation in December 31 2021 income statement relative to this portfolio? So simply put, after you compute your portfolio gain or loss, the question is how much do you report in the income statement? And this question is really tricky, tricky. And basically, if you know the answer, you should know the answer. If you understand the material, you just, this is easy questions. Let's answer it 10 seconds. How much will go under the income statement? And the answer is nada, nothing, nothing. Why? Because if you have available for sale, gains or losses, unrealized gains or losses. Well, those goes to OCI. They don't go. They don't go to the income statement. The trick here is to make you compute the gain or the loss. Basically, you know, look at the gains, you have gains here, you have losses here, you have losses here, net them out and find the answer and say, well, the loss will be, you know, this much and it will go under the income statement. No, it doesn't. It will go in OCI. Available for sale, the question is income statement, nothing, zero. This is a typical questions on the CPA exam. You know the concept. All you have to do is know the concept. It will take you 10 seconds. Available for sale, income statement, don't go together, zero, come done, move on. Let's take a look at this question. Okay, let's take a look at this question. Adam Korp purchased 1000 bonds of good corporation in 2018 for $800 per bond and classify them as securities available for sale. The bonds available for sale were dealing with unrealized holding gain or loss on the balance sheet. The value of these holdings were 400 on December 31, 2019. A year later, they lost half of their value and 300 by December 31, 2020. They even lost more by the end of 2020. During 2021, they sold all the shares for 350. All right, let's see what the question is. If Adam record unrealized holding gain or losses up to the moment of sale. Okay, what would be the amount of the reclassification adjustment that Adam would record upon sale? Okay, I think for this question, I will need to snip it. There's going to be, there's a lot of work to do here because, because, you know, we bought them in 2018. We didn't sell them in 2021 and they're asking for, they're asking for the reclassification adjustment. So, okay. So, okay, let's do this or I'm going to do the journal entries because that's the best way to understand the counting. First, we bought the bonds. When we bought the bonds, we bought them at, we bought them at 800,000. So, we're going to have, we're going to debit investment held to maturity, 800,000, credit cash, 800,000. Fair enough. Now, a year later, those bonds lost half of their value. Well, lost half of their value, it means we're going to have to have a fair value adjustment account and unrealized holding gain slash losses equity. So, this is the balance sheet account. Okay. So, the first year we lost half of the value. Well, let's do this. Okay. This is zero. So, the first year we have 400 negative, negative $400,000 of losses. We lost negative 400K. So, if you listen, if you go to Farhad Lectures, you understand you're moving to the left. The left means you are experiencing losses. So, you have to book losses of $400,000. If you are moving to the left, you're going to credit fair value adjustment because the previous balance is zero, because this is no investment. We're going to credit fair value adjustment, $400,000, and debit, the balance was zero, debit, unrealized holding gain losses, $400,000. Therefore, the balance at the end of the first year, $400,000. So, this is the adjustment for the year 2019. Now, a year later, 2020, we lost an additional $100,000. It means we moved to the left further, $100,000, and this is year two. Year two, what we're going to do, we're going to move to the left, it means we're going to credit. It means in total, now in total, in year two, in total, this is year two, we have negative $400,000. We're going to credit. We moved $100,000 to the left. We're going to credit fair value adjustment, $100,000, unrealized holding gain or loss, another $100,000. So, by year 2020, we have half a million in losses by the end of the year. Now, they're saying we kept track of our unrealized holding gain or loss up to the moment of sale. Well, up to the moment of sale, it means by that time, we moved back up. You remember the price recovered $50. The price recovered $50. Therefore, we're going to move to the right, $50,000. Why? Because we have $1,000 shares, $50,000, $50,000. So, what we do is, first, we have to make, we have to adjust the portfolio because we're adjusting it up to the time of the sale. So, we're going to debit because we're moving to the right, $50,000. The balance, the minute, the second before we sold was $450,000 and available for sale and $450,000 credit and $450,000 debit and unrealized holding gain or loss. Now, what do we need to do? The first thing we need to do is we need to close fair value and unrealized, reclassify and close the reclassification adjustment. Therefore, we have to close this, close this. How do we do so? Well, what we're going to do is, we're going to obviously debit. We're going to, well, let's do it on a T account. Let's use a different color. Let's go back to see if I can find a different color real quick here. Let's do red here. Let's do black. Okay? So, we're going to debit this account $450,000 to make it go down to zero. And we're going to credit, move this to the reclassification adjustment, basically also make this account zero. Now, we sold the investment. Now, we sold the investment. So, we haven't even answered the question yet. Well, let's see if we did. A debit of $500,000, a credit of $500,000, a debit of $450,000 and a credit of $450,000. So, the reclassification is a credit of $450,000. But let's go ahead and journalize the entry of the sale, although they're not asking us, but they could ask you about this. So, the cash that you received from this transaction, $350,000, you have to credit investment held to maturity, $800,000. And now, you actually debit a loss, a credit, debit a loss for on the investment for $450,000, for the entry to balance in this way. You took it out of the unrealized holding gain or loss, and this became realized. This became realized. They're not asking us about this. They're asking us about what's the reclassification adjustment. It will take a credit. It's a credit of $450,000, a credit of $450,000, the reclassification adjustment. And the answer will be, will be D, D as in David. Again, at the end of this recording, I would like to remind you that if you are a CPA candidate, to take a look at my website, foreheadlectures.com, these are not easy topics. Especially the last questions you notice, you have several years of fair value adjustments. You have to be very comfortable with these topics. Now, on the exam, it's not difficult. On the exam, they usually ask you about the basics. I will be shocked if they'll give you a multiple choice like this. And if they do, it means you are doing very well on the exam because this one, this multiple choice, as you notice, we went through one, two, three, four. You didn't have to go through the four. We really went through actually four, four, because year one, year two, the third, the reclassification, well, yeah, three, three. So we went through three transactions to find the answers, three adjusting entries. I doubt that they will give you on the CPA exam questions like this, but hey, if you know this, you'll be ready to answer their questions. Again, my resources are aligned with your CPA review course. I don't replace your CPA review course. I can only help you increase your score. Good luck, study hard, and of course, stay safe.