 Hello and welcome to the session. This is Professor Farhad and this session we would look at the statement of comprehensive income and reclassification adjustment. This topic is covered in intermediate accounting and generally speaking this topic gives students some issues because the statements of comprehensive income is fairly new to the students and reclassification adjustments require a prior knowledge. So basically two topics that are fairly new and they give students some headaches. Obviously these two topics are covered on the CPA exam, the FAR section. As always 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 1600 plus accounting, auditing, finance, and tax lectures. This lecture will go under my intermediate accounting and I have hundreds of intermediate accounting lectures. Please, if you like my lectures, please like them. It doesn't cost you anything. Share them. Put them in playlists. If they help you, it means they might help other people as well. Please connect with me on Instagram as well. On my website you will find additional resources such as PowerPoint sites, true, false, multiple choice, exercises. If you're studying for your CPA exam, 2000 plus CPA questions plus many exercises that are considered quasi CPA simulation. So let's start to talk about the component of other comprehensive income. In other comprehensive income we learn in a prior chapter that we have one and two step approach. The one step approach and the two step approach, basically the presentation, we can show comprehensive income in a combined statement of income and comprehensive income. So this is one statement or we can show comprehensive incomes in a separate statement starting with net income. Simply put, let's take a look, visually let's take a look at them and this is we're combining the two. This is the income statement. Then we have the other comprehensive income than comprehensive income or we can have two separate statements. This is the income statement separately. Then we have the comprehensive income statement starting with net income, which is two. This is one. This is two. And this is only one. Okay. So those are the two approaches. Now the best way to approach this because this is a complete comprehensive income statement. The best way to approach this is to start from scratch. So what I'm going to do, I'm going to start from scratch, building a balance sheet to get to the comprehensive income statement section. Then we'll look at the reclassification adjustments because it does deal with comprehensive income. So understanding comprehensive income statement before you get to the reclassification makes your life much much easier. So to illustrate the concept, let's take a look at an example. Assume that on January 1st, Hinge Company had cash and common stock only at their balance sheet. At that date, we had no assets, no other assets, liabilities or equity. So simply put, we are looking at a simple balance sheet. We have cash of 50,000 and we have common stock. That's it. Now what we did is we took the cash. We took the $50,000 cash and we bought investments. So after with the purchase, we no longer have cash. Now we have debt investments of 50,000 and nothing else. Practically a simple balance sheet. This is on January 2nd, the following day. That's what we did. Now we have a debt investment on the books with a cost of $50,000. Around mid-year, June 30th, we sold $20,000 of the available for sale securities for $22,000. So of the $50,000, you remember we bought $50,000 worth of securities. We sold $20,000 of them and we sold them for $22,000. What does that mean? It means we had a gain of $2,000. This is a realized gain. Remember, realized gain goes on the income statement, $2,000. So make a note of it. Also because we have those debt securities, we received $3,000 in interest. Well, that's good. If we receive $3,000 of interest, that's interest income that also goes on the income statement. So at the end of the year, if we sold $20,000, we must have $30,000 of that investment. And this is what our portfolio would look like at the end of 2020. The cost is $30,000 of the securities. Now they have a value of $34,000. What does that mean? It means we have an unrealized gain of $4,000. That's unrealized versus, so let me highlight and you should know what realized versus unrealized. Unrealized means it's a gain that's on the books that we have not sold it yet. Okay, $4,000. Now we need to make an adjustment to reflect that net unrealized gain of $4,000. Now we need to make an adjustment to reflect this $4,000 gain. We're going to debit fair value adjustment, $4,000, credit unrealized holding gain or loss equity $4,000. If you are lost, stop. If you don't know what this is, we are adjusting our portfolio to market, please, in the description, look at that prior video to learn how to do this because if you don't know how to adjust your portfolio from period to period, this is period one, okay? And you're going to be lost in this lecture. So go ahead and look in the description and I will have a video explaining how to do so. Okay, so let's take a look at what our financial statements would look like. Well, we have an income statement and what goes on the income statement, two things, the interest revenue of $3,000 and the realized gain of $2,000. So our total income is $5,000 for the period. Now we have statement of comprehensive income. What goes on the statement of comprehensive income? We're starting with net income, $5,000. Then we're going to add the $4,000 of unrealized gain. Now you saw how this this whole income statement is put together and this whole statement of comprehensive income put together. So we're going with the two-step approach. This is one and this is two. Also, if we want to be a little bit more technical, let's take a look at the statements of stockholders equity and we're starting with the balances, common stock, nothing for retained earnings, nothing for accumulated and equity was $50,000 at the beginning. We had net income of $5,000 which will increase retained earnings. Then we had the gain from the portfolio, other comprehensive income and the ending balances will be $50,000 stock, $5,000 retained earnings, $4,000 accumulated other comprehensive income in total of $59,000. Now let's take a look at the balance sheet when we started, which was clearly very simple. We only had cash and common stock, asset and common stock. Now at the end of the year, we have $25,000 in cash. We still have that investment of $34,000, common stock, $50,000 retained earnings, $5,000 and accumulated retained earnings. Now we all know where all these numbers are coming from. This is from the sale of stock plus the interest. Remember, we sold them for $22,000 and the interest was $3,000. This is $50,000 original cost. We sold the $20,000. The remaining was $30,000 and the remainder we added $4,000 of increase in value. We have $34,000 retained earnings, $5,000 from the net income and the $4,000 from the adjustment of the portfolio. So this is the accumulated other comprehensive income of $4,000. So hopefully now after going through this simple but I believe powerful illustration, we do understand where accumulated other comprehensive income, where does it come from? So this is a simple example. Now the next example I'm going to work is multi-year. So I was going to show you from year to year what's going to happen. Now we're going to start this example. Here's what's going to happen. When the company sells securities during a year, double counting of the realized loss or gain and comprehensive income may occur. What does that mean? Sometime, not sometime, at the end of the year you might have an unrealized gain on a security that sits on the balance sheet. Then you're going to sell that security and when you sell that security, let's assume you sold it at a gain. Now you have an unrealized gain on the balance sheet and again on the income statement. What we have now is double counting. So double counting result when a company report unrealized gain or loss in other comprehensive income in a prior period and report those gains and losses at part of income in the current period. So it gets reported twice. So what do we have to do? We're going to see what we have to do. We have this reclassification adjustment. I'll show you how it works and this is basically what this whole thing is about. So starting with a portfolio at the end of 2020, so this is a different example, we have two securities, Lehman bonds, 6% bond and Woods company bond. The reason I put a star here because I'm going to be selling Lehman bonds. I just want you to make a note of it. Lehman, we paid 50,000 for them. The fair value is 105. We have an unrealized holding gain of 25. Woods, we bought them at 120. Fair value is 135. We had an unrealized gain of 15. Total portfolio, we have an unrealized gain of 40,000. This is year one. There is no prior balance in the fair value adjustment balance. Let's book this entry. We debit fair value adjustment, 40,000. Credit, unrealized holding gain or loss, 40,000. Again, I'm going to ask you to stop if you don't understand where this is coming from. I'm not going to explain it. See in the description, you need to learn how to adjust your portfolio to market. So this is the year one adjustment for the portfolio. So let's take a look at the statement of comprehensive income. Let's assume this company, open company, we're going to call it, report net income of 350,000. Let's build the statement of comprehensive income, three headings, the period. We're going to start with net income, 350, which is given to us, plus other comprehensive income of 40,000. Now, you have to understand that on the balance sheet, we're going to have open company report on the balance sheet. It's investment of 240,000, which is the 200 plus the fair value adjustment of 40. So on the balance sheet, let's take a look at this. We're going to have 200 plus the 40, which is 240 on the balance sheet, the investment. That's on the balance sheet. Now, what needs to be done too, we need to transfer unrealized holding gain equity to accumulated OCI. We need to accumulate OCI. So OCI goes to accumulated OCI. So OCI here is we have it was a credit. So notice we credited, notice here unrealized holding gain or loss equity was a credit. Now we need to debit it and transfer it to OCI. So simply put it went from OCI, which is unrealized holding gain or loss as an OCI account to accumulate it to A OCI. So we transfer the 40,000 to accumulated other comprehensive income. Simply put, if you want to see on a T account, first we debited fair value adjustment 40 credited unrealized holding gain or loss 40 to adjust the portfolio. Then what we did, we took this 40,000 to OCI. So we debited OCI in credited accumulated A OCI. So we transfer it to 40. Now this is, let's make the balance zero on the credit side. So this is basically what we did. We transfer it to 40,000. This is at the end of year one. Now, year two, August 10th, year two, which is 2021, year 2021, open company sells at Sleeming. Remember I told you I'm going to sell Leeming. That's why I made the note of it. For 105, realizing a gain of 25,000, which is 105 minus 80 of the cost. So we debit cash 105, credit that investment 80,000, credit the gain, which goes on the income statement of 25,000. Now remember this gain two is sitting on A OCI. So technically kind of we're counting in a sense the gain twice. It's on two different places. You're going to see what's going to happen. Okay, now let's look at the portfolio at the end of 2021. At the end of 2021, we only had woods left. We did not buy any new securities. The cost of the wood is 120. The fair value is 155. We have an unrealized holding gain or loss of 35. Now again, we have to make the appropriate adjustment. The prior balance was a gain of 40. Now the gain is 35. So we need to make an adjustment for 5,000. Again, if you don't know what you're doing here, this is when I say stop. So I need to reduce my unrealized holding gain or loss equity by 5, credit fair value adjustment by 5. Okay, so this is my 2021 adjustment. So this is the statement of comprehensive income assuming the company made 720,000 in net income. Then we're going to add, now we're going to subtract unrealized holding gain or loss because we had 40,000 in gains. Now the gains went down to 35. So we have losses of 5,000, which is reflected here, minus 5,000 of other comprehensive income of 5,000. Now remember, this other comprehensive income will have to be transferred to accumulated other comprehensive income. So this is OCI. We'll have to be transferred into AOCI. So let's do that. So year two, what we did is we we credited fair value adjustment. We credited fair value adjustment right here and we debited unrealized holding gain or loss. What do we do next? We're going to transfer this 5,000. We're going to credit unrealized holding gain or loss and we're going to debit accumulated OCI. So this transfer to OCI. Now in AOCI, AOCI, we have 35,000. In fair value adjustment we have 35,000 and we have a gain of 35,000. So this is the adjustment that I just did. I debited accumulated other comprehensive income and I credited unrealized holding gain or loss. So I showed you this on the prior site. Let's go back and see it. I'm going to highlight it in yellow because I showed you on the T account before. So I transferred the 5,000 to AOCI from OCI to AOCI. Now at December 31st, let's take a look at what we have. At December 31st, here's what's happening. At December 31st, open company report on its balance sheet that investment of 155 because that's the one that's left the cost of 120 plus fair value adjustment of 35 and accumulated other comprehensive income of 35 which is I showed you. So and this is the entry to transfer. Now what we need to do, we need to explain, we need to explain that 25,000 of the gain was removed from AOCI. So let me show you what really happened behind the scene. Although the journal entries did not show you but I'm going to show you. So on the notes of the financial statements companies are required to take out the prior gain. The gain that was counted twice and the gain that was counted twice is this gain 25,000. So let's see what's going to happen now. So the gain on the income statement we don't touch because it's closed and we moved on. So this is the balance at the beginning AOCI. The beginning was 40 and the ending was 35. Let's take a look at it one more time. Please make a note of this account. The beginning was 40 when we transfer year one then transfer year two. The ending was 35. But what really happened is this. So this is I'm going to show you exactly what really happened. What really happened is we added $20,000 of the current period other comprehensive income. So we added OCI, 20,000 then we had to remove, we had to deduct. Notice it's a minus 25 for the realized gain. So all in all is we reduced it by five. But this 5,000 took into account, kind of took out the 25. So let me show you from a T account what happened really. Okay, so you have to go back and follow with me. Okay, we started with debited fair value adjustment 40, credited unrealized holding gain or loss 40. This is for year 2020. We had $40,000 in gains. Then the second thing we did is we transferred it. We debited unrealized holding gain or loss and we took this amount to AOCI. Therefore the balance was zero. The balance was zero. Then in year 2021, we booked the gain of 25,000 when we sold Lehman bond. When we sold Lehman bond, what should have happened is this. When we sold Lehman bond, we needed to go back to this 40,000 right here, accumulated other comprehensive income and back out of it 25,000 of the gain because this gain, this 25,000 is counted here. And now it's counted here. It's counted in two places. So what we needed to do, we needed to remove this 25,000. Therefore, what we do is we debit accumulated other comprehensive income. We reduced accumulated other comprehensive income. The balance became 15 and we credit fair value adjustment. We credit fair value adjustment. Now the balance and fair value adjustment is 15. So the balance 15, the balance is 15. Then what we need to do is we need to ask ourselves when we get to the 2021 portfolio, 21 portfolio, it says we should have a gains of 35,000. Well, there we go. If we have, in the fair value adjustment, a current balance of 15, and we need the balance to be 20, what does that mean? It means we need to increase fair value adjustment by 25. So for every debit in the fair value adjustment, the corresponding credit is unrealized holding gain or loss. Now, if you are lost at this point, again, you have to see how we adjust the fair value, adjust the fair value from the prior session. Therefore, we debited fair value adjustment. We credited unrealized holding gain or loss. Now, the balance is 35. This is what we needed to do. We need to have 35,000 of gain reflective in the portfolio, which we do. If it's a debit balance and fair value, remember, fair value, if we have a debit balance, it means we have a gain and the gain is 35,000. So the fair value adjustment is correct. Now, we only have an AOCI 15,000. Once we close this 20,000, once we close it to OCI, we debit unrealized holding gain or loss and credit OCI, we are back to 35,000 to OCI, which it should match fair value. So those two should match. 35 of gain, 35 of gain. So simply put, what we did is we removed the gain indirectly. So let me show you basically what happened. If you look at it, notice, if we take, here's the, let me show you the $5,000 adjustment, what we did here. If you really think of it, this negative 25, credit 25, debit 25, net is credit five. You see that those two, I'm going to highlight them in yellow, those two entries, credit 25, debit 20, the net is five. The net is 5,000. Credit 20, debit 20, the net is five. Therefore, we credited this account five. We debited this account five. So this is the net. This is the net of every, this is everything, the net. But what we did earlier in this entry, I showed you the 5,000, but I showed it to you clearly. So the 5,000, you remember the net, notice that this is the net, and this has end up to be the net. But I wanted to show you the last, the last entry to show you how the 25,000 was taken out. Okay, so this, so this page here is just going to show you that the 25,000 was taken out. It was taken out out of AOCI, so it's not double counted. So I just wanted to show you how it works technically, technically. Okay. In the next session, we would look at transfer between categories, between available for sale versus trading versus health or maturity. As always, I would like to remind you to like my lectures if you like them. I strongly suggest you visit my website for additional resources, PowerPoint slides through false multiple choice. If you're studying for your CPA, you are investing, making a lifetime investment. Make it properly. It's worth it. Study hard. The counting is not easy. But if you spend the time, if you spend the effort, you will do fine. Good luck.