 Hello and welcome to the session. This is Professor Farhad in which we would look at a CPA simulation that deals with investments, fair value adjustments, reclassification adjustment. You might see something like this on the CPA exam or you might see something like this in your intermediate accounting course. So I'm going to go over these entries in details to show you how to solve a problem like this. Before we start, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have plenty of accounting, tax, finance, audit lectures that will help you with your courses as well as with your CPA exam. As always, I'm going to remind you to visit my website farhadlectures.com. If you are a CPA candidate or an accounting student, you will find additional resources that will complement and supplement your accounting and CPA preparation. So what is the difference between what I do and a typical CPA course? That might be your question because most likely you either have Becker, Roger, Wiley, Gleim or other courses. The way I explain things, I explain it as if this is the first time you are looking at it versus a review course where they assume certain knowledge. I don't assume anything. I eat you the material from scratch. Therefore, I can fill those gaps that you did not learn in college or you learned that you forgot about it, that your CPA review course don't cover more in depth. So let's go ahead and get started to look at this problem. We have Adam Company purchased 2 million shares worth of Maggie's 6% bond at par on July 1st, 2021. So we made an investment. Interest spate semi-annually. Adam determined that it should account for the bond as available for sale investment. So they want to treat it as available for sale on December 31st, 2021, which is the end of the year. The Maggie's bond had a fair value of 2.3 million. That's pretty good. Adam sold Maggie's bond on July 1st, 2022 for 1.8. Oops, it went down in value. Prepare the journal entries for the following transaction. The purchase of Maggie's bond, the interest revenue at the end of the year, any year end adjustment, interest revenue for the first half of the year, any adjusting entries upon the sale of Maggie's bond on July 1st, including updating fair value adjustments, recording any reclassification adjustment and recording the sale. Then complete the following table, basically how much net income we had for 2021, OCI, comprehensive income, same thing for 2022 and in total. So this could be a typical CPA question, typical simulation. Also, it could be a multiple choice questions, but this is a pretty comprehensive. Let's go ahead and get started. First, we're going to go ahead and purchase the bonds. When you purchase a bond, it's an investment. Therefore, you debit investment in bonds and you credit cash. This investment in bond is available for sale. Six months later, you would receive the revenue. You would receive the cash from the interest revenue. Now, here we are assuming that you receive the cash on December 31st. If you don't receive the cash, you will have, if you don't receive the cash, you will have interest receivable. Then you might receive the cash on January 1st. Here we're assuming you're going to receive the cash December 31st. That's fine. Debit cash, credit, interest revenue, nothing to it. See any year end adjustment. Now, now we are starting to get into the fair value adjustment, the year end adjustment. Remember, we purchased, the purchase was for $2 million. By December 31st, the value was $2.3 million. What happened is we have $300,000 of increase in value. What do we do? Well, you have to be very familiar with the fair value adjustment and where does the fair value adjustment go? Here's what you have to do. You're going to have to create an account called fair value adjustment, FVA. When you have a gain in the fair value adjustment account, I explain this in details in my lecture, but you have to know this very well. When you have a gain, you should have a debit balance. Now, you don't have any balance. You should have a debit balance. You should have a debit balance for the gain. The gain is $300,000. Therefore, I'm going to simply put, I'm going to debit fair value adjustment, $300,000. This is the adjustment and my balance is $300,000 and this is my balance. I did not have anything prior. The adjustment or I can say, let me not put $200,000,000. It might confuse people. My balance was zero and I needed $300,000 balance debit because it's a gain. Therefore, I debit fair value adjustment. Now, what do I credit? Well, I credit when I adjust my portfolio, it goes into OCI. Let me show you. I credit a gain account that goes into unrealized OCI. It's very important to understand. It goes into OCI, other comprehensive income. What I have on the credit, let me just put it again first. Not again, it's specifically, I'm going to call it unrealized gain OCI. So this is the credit. So I debit fair value and I credit OCI. Now, my balance and fair value is $300,000. My balance in OCI credit of $300,000. So this is what I did for year one adjustment. Now, let's move on. Six months later, I received the interest revenue again, very, very much the same as December 31st, debit, cash, credit, interest revenue. Now, we're going to get into July 1st. After I received the interest revenue in July 1st, I sold this investment for $1.8 million. So here's what happened to this investment. Let me show you what happened. We purchased this investment at $2 million. At the end of the year, the investment was worth $2.3 million. Therefore, it went to the right, $300,000, which we made the adjustment goes to the right, means you have a gain. It increased in value. Then by the time we sold it, it was $1.8 million. It went back to the left. So notice it went back to the left, $500,000, $500,000. So what do I have to do before I sell this asset? The first thing I have to do is I have to adjust it because I've been adjusting the company, Adam's company has been recording this investment at fair value over the life of the investment. Therefore, before we sell it, I have to bring it to fair value. So what is the fair value now? Really, I should have a loss. So notice after I make the adjustment, I have a loss. Let me change the color here. I have a loss. Now I have a loss of $200,000, $200,000 loss. So how do I make this adjustment? First, I have to go back $500,000 to the left. Therefore, in other words, if I have a loss, remember this was a gain, if I have a loss, I'm supposed to have a credit balance and fair value. And the loss should be, the balance should be $200,000. What entry do I need to make this balance $200,000? I'm going to have to credit fair value $500,000. So this is the adjustment and this is the balance. Now for every credit, I have to have a debit. I debit unrealized, now it's going to be unrealized gain slash loss, this account. Now I'm going to have to debit this account $500,000. Now I have a loss of $500,000. So this is what things look like right before I make the sale because I have to bring my account up to the adjustment, up to the adjustment. So this is right before I make the sale. So this is the balance here as well. Now once I sell this asset, once I sell this investment, I'm going to create a realized loss. Why it's a realized loss? Because I'm going to sell it for $1.8 million, my cost is $2 million. That's fine. I'm going to have to record a realized loss. But look what I have. I also have for this investment an unrealized loss of $200,000. So before I realized my loss, I need to back out the unrealized loss. So what do I need to do? I need to go back, reclassify this, remove the unrealized loss, credit this account, make it down to zero, and debit fair value $200,000 to make it go down to zero. So I have to back out the unrealized loss. Then I will record the loss. So let me show you the journal entries. So the first thing I did, I'm going to erase this. The first thing I did is I debited the unrealized loss. I like to call it unrealized. I like to call this account rather than loss on investment unrealized. I like to call it unrealized gain slash loss OCI. So this is what I call it up there. Okay. So I debited this account $500,000 because remember it went back to the left $500,000 and I credited fair value $500,000. So this is the entry that you see there. Then again, I don't need this $200,000 to be sitting in OCI anymore. I don't need this anymore. I have to get rid of this $200,000 that's sitting in OCI and sitting in fair value because I'm selling the investment. So what do I do? I close this account against each other. This one debit fair value, credit unrealized. This account went down to zero. Now I'm ready to sell the investment. I sold the investment for $1.8 million. I debit cash. I credit realized loss $200,000, $200,000, and I credit my investment for cost at $2 million. Therefore, I received cash $1.8 million. I debit cash. I debit the loss $200,000 and this loss is, let me write it again, is realized. Realized mean I got it in cash. I realize it, realized loss versus the unrealized. When I did not sell it, I had unrealized loss. Therefore, I had to get rid of the unrealized loss. I have to remove the unrealized loss to put the realized loss. If I don't remove the unrealized loss, then I have the losses. Guess what? I have my losses twice, one on the income statement and one on in the balance sheet under OCI. That's why I had to do my reclassification to get rid of this $200,000. So I debit cash, credit investment, credit investment for the $2 million, debit cash, and credit the loss. Now I need to fill out this table. You might see something like this on the CPA exam in a form of a simulation. So what do you have to know here? Well, they're asking you, the first thing they're asking you, how much is net income affected in 2021? Well, in 2021, what happened is I received a revenue of $60,000 right here. So interest revenue was $60,000. Therefore, I have $60,000 was affected in net income. Positive, it's a gain. What about OCI? In OCI, I had $300,000. Now comprehensive income, well, comprehensive income is net income plus OCI is $360,000. Let's look at 2022. What happened in 2022? In 2022, I received interest revenue again, $60,000. But what happened to in 2022, I sold my investment and I incurred a loss of $200,000. This loss right here, the last entry. Well, what's the net? Well, minus $200,000 plus $60,000. So the net on my net income, I'm going to put it in red to show you it's a loss. So it's negative $140,000. This is the effect on net income. What happened to my OCI? What happened to my OCI? In my OCI for 2021, it was OCI was, let's see, debited, then credited. So the net is $300,000. $300,000 debit. So it's basically a loss. So let me take you through OCI. What happened to OCI? Let me show you what happened to OCI first because it's easy to see plus $300,000 from 2021 minus $300,000 from 2022. What happened to OCI? Overall, OCI went down to zero. That's good. That's what you want. After you sell the investment, OCI has to be gone. So 2022, I have negative comprehensive income will have negative $400,000 and I'm sorry, $440,000, negative $440,000, which is the loss that you got from the income statement and the OCI loss. Now, overall total for net income, in one year you had $60,000 of gain, $140,000 of losses, overall you have $80,000 of losses and comprehensive income should be the same, $360,000 plus $440,000 minus, you have also a comprehensive income of negative $80,000, which it should match. It should match. So basically this is what, so you could be asked, you could be given this problem and only ask what is comprehensive income after two years and you have to go through this real quick without going through the journal entries or you might be given the whole thing, the whole problem to resolve in journal entries. So you have to be prepared for either or and to be prepared, this is why I tell you to visit my website, farhatlectures.com for additional resources where I explain this topic in details. CPA review courses, they assume, you know this, they just assume they're going to go through it real quick. When they spend 45 minutes, I spent four hours or three hours to really help you understand the topic. Once you learn that topic, you can go back to your becker, you can go back to Roger Wiley Glyme and ace what they're saying, take the most advantage of it. Anyhow, CPA is a very important investment in your career, take it seriously, don't don't shortchange yourself. Good luck, study hard and stay safe.