 Hello, and welcome to the session in which we'll discuss the fair value option for financial assets and financial liabilities. What is fair value option? Well, we have to understand what fair value is and what option is. Let's start with the easy word option. What is an option? Option means you have the choice to do something or not to do it. So you don't have to report things at fair value if you choose not to. Now, what is fair value? Well, fair value means report something at how much it's worth today. What is it's fair value today? Fair value, I would say it's the other extreme of something we know about cost or historical cost. So if cost is on one extreme, fair value is on the other. Cost mean when you buy something, you buy it, you report it at cost initially and you keep it at cost. For example, in the US under US gap, property plant equipment are always reported at historical cost. Fair value means what? Means tell me how much those assets, specifically financial assets and financial liabilities are worth the day. So that's what fair value is. So if you choose to report them at fair value, well, that's the fair value option. This is what we are discussing here. Now, what is the problem with the fair value? The fair value, sometime you can get this information real easily, sometime you may not. So there are three levels of hierarchy when it comes to fair value and we will not be discussing those three levels of hierarchy in this session. Because if you go to Farhat lectures, I do have a separate recording for fair value, but this is not the topic about fair value. But you need to know a basic idea what is fair value. For example, if you own stocks in companies that are publicly traded like Amazon, Zoom, PepsiCo, Coca Cola. That's fine. Those prices are quoted in the Wall Street Journal and Finance Yahoo on CNBC. So it's very easy. So this is level one and this is the most reliable. Why? Because everyone knows what the price is. Everyone agrees on the price. Level two is observable prices. Here you don't have quoted prices. For example, you might have a bond or an investment in some company, but it's not publicly traded. What would they have to do? You might look at similar bonds to that company. That's observable prices. Same thing. For example, if you have a building and you want to value a building just for valuation purposes. Well, you don't have or let's assume you want to buy a home and you don't know the price of the home. So what you do is you see what is the home in that neighborhood that's similar to that home in terms of size, square footage, features and how much did it sell for? That's an observable price. So you're looking at some similar investment to what you are trying to value. This is called observable prices and this is level two. Obviously, you want level one. Level one is the most direct, most objective. Level two is less objective and level three, you are looking at unobservable prices. Here you are using maybe discounted cash flow to figure out the fair value of that asset or of that liability. So those are three level of hierarchy. Again, this is not the topic of our discussion, but students, you would need to know what is fair value. So fair value is how much something is worth the day. Sometimes it's easy to find out that information in the real world. Sometime it's not for our purposes, that information will be given to you. So the company have the option to report financial instruments at fair value. Bear in mind, once you chose this option, once you choose this option, once the company chooses this option, all changes in the fair value. What does that mean? Changes means the asset could go up in value, the asset could go down. So all gains and losses are reported in net income. So everything is reported in that income. Nothing goes on OCI. Once you choose the fair value option, because you choose to show this on your income statement. That's what you're saying. You want this to hit your income. The fair value option is used on an instrument by instrument basis. What does that mean? It means a company can buy three different stocks and choose to report, choose the fair value option for only one investment and not the two others. They do have this option, instrument by instrument basis. And the election takes place when you purchase the financial asset or you incur the financial liability. So you have to decide if you want to choose the fair value accounting for this asset or this liability, you have to do it at the beginning. Once you start and once you start, it's binding. You have to use, you have to keep using fair value till you sell or basically dispose of the investment. So once you use fair value, you have to keep using fair value until you sell the investment. Now the best way to illustrate this concept, which is an easy straightforward concept is to actually look at example. Before we look at examples illustrating the fair value option, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website farhatlectures.com. I don't replace your CPA review course, nor I replace your accounting course. I'm a useful addition, useful supplemental accounting addition. My motto is saving CPA candidate and accounting student one at a time by providing new resources, lectures, multiple choice, through false questions that's going to help you illustrate the concept and do better. This is a partial list of all the accounting courses that I cover. My CPA materials are aligned with your Becker, Wiley, Roger and Gleam. So it's very easy to go back and forth between my material and your CPA review course. If you're studying for your CPA, I'll give you access specifically to 1500 previously released AI CPA questions with detailed solution. Those questions appeared on previous exam. I kept them in their original format and I provide you detailed solution about these questions. If you have not connected with me only then, please do so. Take a look at my LinkedIn recommendation like this recording. It helps me tremendously. Share it with other connect with me on Instagram. I'm trying to grow my Instagram following Facebook, Twitter and Reddit. So let's take a look at an example to illustrate the concept of fair value. Adam Company purchases $100,000 of bonds in Fahad lectures during 20X5 and they classify it as available for sale. What do we know about available for sale investment? Well, what did we learn about available for sale investments? We learn that available for sale investments in bonds, which is when the longer have stocks, they are reported. Any changes in fair value is reported in OCI, other comprehensive income. Well, guess what? The fair value at December 31st is 112. So they went up in value, $12,000. Adam chooses the fair value option to account for this investment. So guess what? If we choose the fair value, forget about OCI. The gain will go into income. So what's going to happen? We're going to debit the investment itself. We no longer have a fair value adjustment. You remember when we did, when we, when we learned about marking the portfolio to market or marking the investment to market, we debited an account called fair value adjustment when we had an increase. That's not the case here. We debit the investment itself, $12,000 and we report the gain. We report the gain in income, unrealized holding gain loss income gets reported in net income. So it's no longer an OCI. Why? Because the company chooses to report this investment taken advantage of the fair value option. Let's take a look at another example. Economic integration holds 32 percent stake in Fahat lectures. Economic integration purchased the investment in 20x5 for 850,000. December 31st, the fair value of Fahat lectures is 800,000. Well, the fair value went down. Now, what I want you to be aware of is this. First of all, economic integration, maybe you notice this, maybe not, has a 32 percent stake. This means under what we learned is under those circumstances, they have to use the equity method. Okay, and what's the equity method? Well, we report net, we increase our investment in proportion of the net income reported and reduce our investment by the by the proportion of the dividend received of the dividend declared. Well, guess what, forget about all of this, because economic integration also chooses the fair value option. What does that mean? It means they're going to have to report a loss, a loss of 50,000. They will debit unrealized holding gain or loss. It's going to be a loss. That's an income statement account for 50,000. And they will simply credit the equity investment for 50,000. So clearly, as you see, actually, it's simple. It's for an accounting perspective. It's simpler to report things at using the fair value. It's simpler from an accounting perspective. But in the real world, what's difficult about the fair value is finding the fair value itself for certain assets and certain liabilities. Sometime that information is not available. If it's not available, you'll have to compute the fair value, estimate the fair value and disclose in your financial statements. How did I come up with this figure? You'd have to explain to the users, you know, did you just get this number out of the hat or did you? How did you come up with that? So you have to be very specific, actually, especially after recent fraud cases where companies were just throwing these fair value numbers out there and using them to book the to cook the financial statements. What should you do now? You should go to farhatlectures.com, work multiple choice questions, look at additional resources that's going to help you do better. I can help you do better. Whether you are a CPA candidate or an accounting student, give me a try. Study hard, invest in yourself. Accounting and the CPA will pay dividend for years. Don't shortchange yourself.