 Hello, and welcome to this session in which we would look at this exercise that deals with accounting for investment. This topic gives students a lot of headaches for several reasons. One, you might be dealing with equity, securities, versus debt, that's one complication. Then the law was recently changed. FASB was recently changed. We used to have various categories, trading available for sale, health to maturity. Now we only have one category for equity, and we still have three categories for that. Actually, for equity, we still have two categories because we have to account also using the equity method, so either the fair value, through income, or the equity method. And for that, we have three other categories. So it creates a lot of complication real quick. What I'm gonna do in this example is go over an investment and show you how do we treat this investment at cost when we purchase the investment at the end of the period and when we sell the investment. 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If you haven't done so, like this recording on YouTube, connect with me on Instagram, Facebook, Twitter, and Reddit. So let's take a look at this exercise to see how we would solve a problem like this. On March 31st, Adam Inc. bought 7% of the capital stock of Avi's company for 52.7 million. Now the first thing is they bought 7%. It means we cannot use the equity method. And remember, we're talking about capital stock, not debt. So here we are dealing with an equity. Okay, we are dealing with an equity investment. And is it an equity investment, equity security, equity investment? Are we gonna use fair value or are we gonna use the equity method? Do you know the rules? And we cannot use the equity method because we own less than 20%. The equity method between 20 and 50. Therefore, we're gonna be using the fair value. First, let's purchase. We bought the investment at 52.7 million. We debit investment in equity securities and we credit cash. This is one we purchased. Pretty straightforward, when we purchased inventory, investment, property, plant, and equipment, we record them at cost. And the cost is 52.7. We're done. Avi's net income for the year was 80.9 million. Really, that's irrelevant for us because we're not using the equity method. This is just to confuse you. The fair value of the shares held by Adam was 36.8 million on December 31st, 2021. That's relevant for us because we are using the fair value. Now, what do we have to do? We have to adjust the investment, the fair value. And guess what? We're gonna take a loss. We're gonna take a loss. How much is the loss? The difference between what we paid 52, the loss is 52.7 minus 36.8, which is the loss happens to be 15.9. So we debit a loss on investment and very please pay attention here. The loss is 15.9 and the loss goes into net income. N-I means net income. It doesn't go into O-C-I. It doesn't go into O-C-I. It's recognized. Listen to me carefully. It's recognized. It's recorded in the income statement. It's recorded in earnings. Then we create a fair value adjustment account of 15.9. So let's now create the fair value account, 15.9. So we have fair value adjustment and we have in there 15.9. Now, let's go. So we did all of this. Avi did not declare dividend. That's good. Even if they declare dividend, we debit cash, credit, dividend, revenue. If they declare dividend, whatever dividend we received. Okay, but they did not declare and make it easier for us. So prepare all the journal entries for 2021. We're already done. Now let's take a look at what happened in 2022. Assume that Adam sold the stock on January 20th, 2022 for 30.9 million. Okay. So the first thing I want you to see that the value of the stock kept on going down since December, December was 30.8. It went down to 30.9. The first thing we're gonna compute is the new loss. Basically, the experience more losses, 36.8 minus 30.9. So that's 5.9. So there's an additional loss of 5.9. Remember what we did earlier? We had a fair, let me go back and put down the fair value adjustment. We had in the fair value adjustment, 15.9. This is from year 2021. And also from year 2021, we had a loss that went to net income and we'll get done with this. We can have closed this account, but we recorded the loss. Now what we're gonna have to do, we're gonna have to record an additional 5.9 million in losses. Okay, so here we go. We're gonna debit a loss. And basically this loss, without even saying it's realized, it's gonna go into net income, 5.9 and credit fair value adjustment, 5.9. Credit fair value adjustment, 5.9. Now let's see how much do we have in fair value adjustment. 5.9 plus 15.9 equal to 21.8, 21.8. Now we solve the investment. When we sell the investment, what do we do when we sell the investment? We receive cash. So let's start with the easy part. We're gonna debit cash. We received cash 30.9, 30.9. Now what's gonna happen is this. We're gonna compare how much we received in cash versus what's our total loss for this investment? Well, we purchased this investment at 52.7. So let's do this real quick. So if we take 52.7 minus, we sold it for 30.9, we incur the loss of 21.8 million. Hold on a second. This looks like this number. Yes. Guess what? I already recorded all my losses. So all my losses has been recorded. Some of it in 2021, which is 15.9 in 2021, and some of it in 2022. But that's my total losses. So what I'm gonna do, when I book this transaction, I'm gonna debit cash, credit. I'm sorry, credit, not debit. I'm sorry, debit cash, debit fair value, not credit, debit fair value, debit fair value 21.8. So the fair value is gone, okay? Because I need to get rid of the fair value and get rid of the investment. The investment itself was 52.7. 52.7, 52.7. So what I did is notice what happened. Simply put, after all said and done, let's see what happened. The investment account is gone. The investment account is gone. The fair value adjustments are gone. They cancel each other. And all what I am left with basically is my losses. All what I'm left with is my actual losses. Is my actual losses. So I credited this account 52.7 for cash. So this is what's left after all said and done. So simply put, I bought something for 52.7. I sold it for 30.9 and I recorded the difference in losses. That's all what happened at the end of the day. Now, did we have to book this entry? Did we have to book this entry? Not necessary. You did not have to book this entry, this one here. So what would be the entry on January 20th? Obviously, you know, kind of you could figure it out because it's easy. I could have debit cash. I will debit cash 30.9. I would have debited fair value adjustment, fair value adjustment, only 15.9. I will debit a loss of 5.9. And I will credit the investment 52.7. Simply put, notice here, I credited fair value. I debited fair value. Okay, that's fine. I did not have to do that. All what I had to do is just remove the old fair value here. In other words, this entry wasn't really needed, but this entry will show you how to bring your investment up to date, make the fair value adjustment, which is good. But this is basically what it boils down to. So again, this should all add up. You know, 30 plus 15 plus five is, 30 plus 15 is 35 plus five plus five, plus 5.9, 20, it's 52.7. So this is 52.7 and this is 52.7. So we credit the investment. So rather than doing this entry, I can combine this with this and I will get this. The point here, the point that I'm trying to make is this. Your total losses cannot be more than 21.8 million. And here's the 21.8 million, 5.9 and 15.9. This is the 21.1 million. My fair value is gone. I debited fair value, credited fair value. This entry does not exist. Again, we're back to in the, you know, this is all gone, you know, back to what we're left with is cash. Cash, a loss, a loss in cash. Same thing, okay? I hope that I did not confuse you at the end. I just wanted to show you that there's more, you know, the last entry here, you did not have to update. You did not have to do that, but it's good to understand what you are doing. So basically we book the loss, then we remove the fair value adjustment. Okay, but the loss cannot be more than 21.8 million for everything from A to Z. And this is what actually happened. Understanding the context, understanding what we want to do in the entry is important because once you understand it, you can kind of manipulate those entries and nevertheless understand what's going on. And that's the point. At the end of this recording, I'm gonna remind you if you're an accounting student or CPA candidate to strongly check out farhatlectures.com. I don't replace your CPA review course. I can be a useful addition to your CPA review course. I can help you understand the material better. Good luck, study hard and stay safe.