 Hello and welcome to this session. This is Professor Farhad and this session would look at investment and equity securities. This topic is covered in financial accounting, intermediate accounting, much more in depth and 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 1,700 plus accounting, auditing, tax and finance lectures. This is a list of all the courses that I cover, including many CPA questions. If you like my lectures, please like them, share them, put them in playlists, subscribe to the channel. If they help you, it means they might help other people connect with me on Instagram. On my website, you will find additional resources such as practice questions, true, false, multiple choice notes, especially if you are studying for your CPA exam, CMA exam, EA or you're taking your accounting courses. I strongly check out my website. If you want to learn about the free requisite for this recording, please check in the description and I'll have the prerequisite. So what we need to talk about is classification and reporting of investments. We talked that for an investment to be classified, first we have to determine whether it's debt or equity and we already talked about debt and the section will focus on equity. That's the first thing, the type of the security. Two, is it short-term or is it long-term? Three, and this is important, three is important in the session is the percentage of ownership in another company's equity. How much, how much do you own? How much do you own 10%, 15%, 30% so forth, so on and so forth. So for the investment section, we already covered those health, maturity, straightening and available for sale. In this session, we would look at insignificant influence. We will look at significant influence and we will just don't look at the controlling influence at all. So let's take a look at the degree of percentage. So here we're discussing equity investments, you buy stocks. So when you buy stocks, how do you account for those investments? Well, it all depends. If you own between zero to 20%, you're gonna account for this investment at something called cost or market value. Well, we're gonna see what cost and market value means in a moment. If you own less than 20%, it means you lack significant influence. It means you have no saying in the company. Although in the real world, let me tell you something. Sometime you might only own 5% and you might have a major saying in the company. Why? Because all the other shareholders, they own smaller amount. But that's beside the point. From an accounting perspective, it's zero to 20%. If you own between 20 to 50, now you consider to have significant influence. Here what we say, here we say you have what we called significant influence. And what does that mean? It means you have enough power to vote yourself on the board of directors. You have enough power to vote your friends. So you have a saying in the company. Therefore, we're gonna be using the accounting method, which will work in the next session. If you own more than 50%, which is 50 to 100, we will consolidate your investments, which is we don't cover consolidation in this chapter. So the best way to illustrate this is just to start to look at the examples to see how we account for investments. So starting with very simple example. So the equity investments are initially recorded at cost, just like any other investments and assets when acquired, including any commission or brokerage fee. So if you pay the brokerage fee or commission, they get added to the cost. Let's assume ITI purchased 100 shares for $7,000. Simply put, you will debit. Stock investment $7,000, credit cash $7,000. So the initial investment is recorded at cost. On 11-1, the company received $10 in dividend. Well, we debit cash and we credit dividend revenue. Simply put, we receive cash because we hold the stocks. That's the cash is coming from the profit. It's technically it's called dividend revenue. Now let's assume the ITI portfolio has a cost of 7,000, which let's not assume that we have a cost of 7,000. Fair value at the end of the year is 9,000. What does that mean? It means when we purchase them, the cost equal to seven. Now the fair value of those investments equal to nine. Think about it this way. You bought a house for $7,000. Now your house is worth 9,000. What you have here is something called unrealized gain, unrealized gain. Unrealized means you did not sell it, so the gain is unrealized. You have it, but you did not cash it out. Now, when you have investments in securities and you own between zero to 20%, we said we have to use cost or fair market value. Well, what does that mean? It means you have to adjust your investment. It means you have to adjust your investment. Now we're gonna go back to what? We're gonna go back to the fair value adjustments. How do we prepare fair value adjustments? Okay, when we prepare fair value adjustments, we have an account called fair value adjustments and a corresponding account called unrealized holding gain slash loss and for equity, it's gonna go into income, okay? Now, just like with debt securities, okay? Maybe, let me just kind of fix this. The first account is called fair value adjustment and it's basically a fair value adjustment account and the other account is unrealized holding gain slash loss. It's either a gain or a loss. So when you have a gain, when you have a gain of, so the first thing you say, okay, I have a gain of 10,000. A gain of 10,000 means I should have a debit balance in fair value adjustment of 2000. It means you have to have a debit balance of 2000. Excellent. If you have to have a debit balance of 2000, what do you need to do? You need to debit this account 2000. If you debit this account 2000, the corresponding credit is 2000 here for unrealized gain or loss and this is your adjustment. Therefore, you debit fair value adjustment 2000, credit unrealized gain, here it's unrealized gain because this account could be a loss again as a credit loss as a debit and therefore you just prepared your first adjustment, your first fair market value adjustment. Now, this is 2019. So I'm going to take this example and we're going to assume 1231, 2020 because you need to understand how do you adjust your portfolio from year to year. So let's do this. So this is 1231, 19. Let's assume in 1231, 2020. You looked at your portfolio again, you look at your portfolio and here's what you see. You see that your portfolio has a cost of one million, fair value of one million and 3,000. So you would say, okay, I have unrealized gain of 3,000. This is a gain of 3,000. What do you say when you said you have unrealized gain of 3,000? Well, it means if I have unrealized gain of 3,000, it means I should have a debit balance of 3,000. The balance should be 3,000 debit and fair value. Now, if the debit balance is 3,000, what do I need to do? Well, the entry will be, I need to debit fair value adjustment for 1,000. Hold on a second. Didn't you say 3,000? Yes, I said 3,000, I already have 2,000. All what I need is 1,000. Now I am at 3,000 and I credit the unrealized holding gain slash loss in other 1,000. And I credit this 1,000. Now I'm up to 3,000. Simply put, I'm gonna show you this on a timeline. On a timeline, this is what it looks like. The first year, 2019, we had, in 2019, we had $2,000 of gains. In 2020, we had $3,000 of gains. So what we did is we moved to the right 1,000 unit and this is your adjustment. And this is your adjustment, 2020. Now, let's go to 2021. 2021. In 2021, you had a portfolio with the cost of $10,000. You sold everything that you had those million shares and fair market value of, let's make it 6,000, okay? Now what happened is you have a loss of $4,000. What does that mean? It means now, if this is zero, you are at 1,000, 2,000, 3,000, 4,000. You're supposed to be here. So you are here now, you are here now and you have to move from 3,000 gain to 7,000 loss. It means in the fair value account, you have to have a balance of, your balance has to be accredited because it's a loss. Your balance has to be accredited of 7,000. Your balance, this is your balance. You should end up with a 7,000. Well, if I need to end up with a 7,000, it means I need to credit this, I'm sorry, if I need to end up with 4,000, I need to credit this account 7,000. So the 7,000 to make this zero and keep me with 4,000. So if I credit fair value adjustment 7,000, I have to debit this account 7,000. 7,000 debit, 3,000 credit will keep me 4,000 a loss, which is, this is what I have, 4,000 loss. And notice here, I moved 7,000 to the left. So every time I moved to the left, I debit. Every time I move to the left, I debit unrealized gain slash loss. Here it's a loss of 7,000 and I credit fair value adjustment 7,000. So here's the trick. Every time you move to the left, this is your entry. Every time you move to the right, so next, so in 2022, you could have more losses than 4,000 or you could start to recoup your losses and go into gain and move to the right. Every time you move to the right, this is your journal entry. Okay, and make sure you know how many units you are moving back and forth. I hopefully, this will clarify the fair value adjustment. Many students have issues with it. So let's go back here. So let's go back to the word we report things. Unrealized gain and loss is reported and other revenue and expenses, obviously on the income statement. Fair value adjustment, it's a permanent asset which report adjustment to the portfolio. It goes on the balance sheet and this is what it looks like. So the fair value is listed under the asset. It's added to the asset because it's a gain and the net amount is 9,000 or in some companies what they do, they show you 9,000 and they will show you the cost and the gain is 2,000. Now, sometimes what you do is you sell your investments. So let's take a look at an example when you sell them. When the investments are sold, what you do is you would look at the difference between how much you receive, the net proceeds and the cost. And the difference is either a gain or a loss. Okay, let's take a look at an example. So the prior period fair value adjustment not used in compute gain or loss from the sale of stocks. So let's take a look at this. Let's assume March 9th, we sold a stock with $500 cost for $800. Well, the net proceeds is, stop it daddy. The net proceeds is 800 and the cost is 500. So 800 minus 500 equal to 300, we have a gain. So now how do we book the transaction? We received cash of 800. So we're gonna debit cash, 800 credit the investment which is a stock investment for 500 and the difference is a gain. The gain is 300. So it looks something like this. Debit cash, credit stock investment, credit the gain on the investment. So let's take a look at few examples to illustrate the concepts of selling or maintaining the portfolio of equity securities. The most challenging aspect in this chapter is to adjust your portfolio from period to period, from year to year. And hopefully I was able to explain this. So make sure you know this. Otherwise the journal entries for basic purchases, sale and dividend, it's not a problem. It's when you have to adjust your portfolio, especially starting year two because you have to take into account what's in year one. So let's take a look at these journal entries. This company purchase investments in trading securities at a cost of 130 on December 15. This is the first and only purchase of such securities. On December 28, they received $15 in cash from the purchase and the stock at the end of the year was trading at 140. So we have to record the purchase, the dividend and the fair value adjustments, three things. First, record the purchase. Well, we purchased a stock. Debit short-term investments, credit cash. And now we have short-term investments of $130. Transaction two, we receive $15 of dividend, debit cash, credit dividend revenue, that's pretty straightforward. Transaction three, which is this is the fair value adjustment, which is the fair value adjustment given at 140. What they're telling us here is our balance should be, this should be 140. That's what they're saying. It should be 140. We have a gain of $10. So what does that mean? Well, we don't add the $10 to the investments. We add the $10 to the fair value adjustment. If it's a gain of $10, it means we have to have a debit of $10. Well, if we need to have a debit of $10 and we don't have any prior balance, it means the entry is $10 fair value adjustment. Remember, from the line perspective, we're going from zero, we didn't have anything, and we're moving to the right. Remember, if we're moving to the right, we debit fair value adjustments, we credit unrealized holding gain slash loss. So we credit this account $10. Okay, so that's the entry. So first, what should be the balance be? It should be 10. So I made the 10. So I made the adjustments. I debit fair value adjustments, and obviously I credit, I debit fair value adjustments, and I credit unrealized holding gain or loss. So first, determine what's the current balance account is equal to, the current balance account equal to zero on fair value adjustment. Determine what the account should be. It should be 10 and find the difference, which is 10. Now remember, year two, so now it's zero, and now this is year one, you're at a 10. You're at a $10 gain. Year two, you could be moving further to the right, or you could go further to the left, or you could go to the left. You could go to the left and stay positive, and you could go to the left and become negative. It doesn't matter. The entry would reverse. Okay, if you're going to the left, and if you're going to the right, you're going from $10 gain to $22 gain, then it's the same entry, but you will add 12 units. Hopefully, this makes sense, because again, this issue gives problem, this issue gives students a lot of problem. So this is the adjustments. We already looked at this, and this is how things are presented, because they're asking us how things are presented. Short-term investments would be recorded at cost. The cost is 130, fair value adjustment is positive. Now if you had a loss, it will be a negative, and it would reduce the 130, but it's a gain, therefore it's a plus, and this is your portfolio on the balance sheet. On the income statement, you are going to have a dividend under other revenue and gain of $15, and unrealized holding gain of $10. This is what you will have. Now let's assume you sold one of those investments, okay, and you sold some of them. You sold $33 of the 130, and you sold them for 36. Well, if you sold them for 36, you sold them for more than when you purchased them for. Therefore you have a gain, you have $3 gain. Therefore you debit your cash. This is the net proceeds, $36. You remove the investments. You credit short-term investments, which is you're gonna credit this account, and you have a gain, a new gain, which is a realized gain. Now your short-term investments is $97. If you like this recording, please like it, share it, subscribe, put it in playlist. In the next session, I would look at the equity method. As always, I would like to remind you to look at my website for additional resources, especially if you are studying for your CPA exam. If you need those seven to 10 points, I am here to help you get there. Good luck, study hard, and stay safe, especially during those corona.