 Hello and welcome to this session in which we would look at an exercise or a CPA simulation that deals with an investment that's considered available for sale investment. This topic is challenging for many reasons because when we are dealing with investments, we have to be aware whether we are dealing with a debt investment versus equity and the rules has recently changes between debt and equity. Therefore, if we are dealing with available for sale, it's only for debt. No longer available for sale investments can be considered an equity investment can be can be considered available for sale. And the other thing about available for sale that we need to be aware of available for sale investments, all the adjustments goes on the balance sheet into OCI other comprehensive income. And this creates some difficulties and confusion for students. So I hope this exercise will help you understand this topic in a sense that you can deal with it if you are faced with it on the CPA exam, or for understanding purposes for your intermediate accounting course. Now, if you are a CPA candidate or an accounting student, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. So if you're studying for your CPA, that's fine. That's great. What I provide is alternative explanation or a backup system or a supplemental information that's going to be useful addition to your CPA review course. I will help add 10 to 15 points to your CPA exam score by helping you understand the material differently. This way you can use your CPA review course better, increase your grade and pass your exam. Your risk is one month of subscription, your potential gain is passing the exam. And if not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. I do have resources for other accounting courses as well. Connect with me on LinkedIn if you haven't done so. Please like this recording. Connect with me on Instagram, Facebook, Twitter and Reddit. So let's take a look at this exercise where we have to prepare journal entries. And part of the CPA exam is you have to prepare journal entries or you could this exercise could be giving in a form of an exercise. So Aram company purchased 1.2 million of Abbey's ink bond, 8% bond at par on July 1st, 2021 with interest paid summary annually. Okay, let's start with this one. Let's record the purchase. Well, we purchase bond. It's an investment. Well, it's an investment in bond, credit cash 1.2 million. Simply put, you purchase something. When you purchase something, you purchase it at cost. You record it at cost and the cost is 1.2 million. Now, this investment pays interest semi annually. Well, six months later, we're going to have to pay interest. Well, when we receive the interest, we have to compute the amount of the interest. And simply put, you have to know how to do this, whether you are dealing with investments or whether you are dealing with bonds on the CPA exam. And that's the face value of the bond, 1.2 million times the stated value times the stated value times one half, because this bond pays interest semi annually. So every six months, this bond pays interest of 48,000. That's good enough. I'm going to receive cash of 48. I'm going to credit interest revenue 48. And that's the adjusted. That's the entry that I will make on December 31st. Now, I have to make an adjustment at the end of the year. Now, I need more information. I have to know, how is Adam accounting for this investment? Because it's a debt investment. That investment could be trading securities, could be available for sale, or could be held to maturity. So now, we are told that Adam accounts for this investment as available for sale. So they chose to account for it available for sale. Well, now I need to make the appropriate adjustment. Now, at December 31st, the AV bonds had a value of 1,420. That's good. So we stop right there. I need to make an adjustment. I need to adjust my investment to fair market. And guess what? This investment went up by 220,000. Well, how do I make my fair value adjustment? Now, if you're not familiar with this, you have to be very extremely 100% comfortable with fair value adjustment. If you're not, this is what I suggest you go farhatlectures.com, where I have this information in explain in detail for students. So we have a fair value adjustment account, and we have an account called the corresponding account, unrealized holding gain slash losses, you have to be very careful OCI, other comprehensive income. So the gain and the losses from this available for sale investment will stay on the balance sheet. So this is a balance sheet account. And this is a balance sheet account for that matter. It stays on the balance sheet. Now, I have a gain. Well, when I have a gain, it means I have to have a balance in my fair value of the gain. And the gain is 220,000. So I need to have a gain. I need to have a debit balance. I need to have a debit balance of 220. Well, I don't have any prior balance zero. Well, it means my entry has to be I debit fair value adjustment 220. And I credit a corresponding gain of 220. Therefore, by the end of 2021, this is my balance fair value adjustment 220 gain, unrealized, I call it unrealized, but it's really unrealized gain on investment unrealized right there. It's unrealized and it goes into OCI. It's important. This is the trick. The trick is to remember this is OCI. This is a balance sheet. This is not net income gain. This is not realized on the income statement. It means it's going to stay with you in future years. When you sell the investment, you have to account for this. Okay, so that's why it's extremely important that you understand OCI available for sale adjustments goes into OCI. OCI is a balance sheet account. Therefore, it doesn't get closed. It stays with you from year to year. So we practically finish for year 2021. We purchase the investment, we receive the, we receive the interest revenue, we prepare our adjustments. So far, so good. Now we sold this investments on July 1st. On July 1st. I'm sorry. We sold it on July. Yes, we sold it on July 1st for 1 million, 1 million and 80,000. Now before July 1st, we did receive some cash because this investment pays interest summa annually. So before we received it, we on July 30th, we received the cash, the same amount of cash. Therefore, July 30th, again, debit cash, credit interest revenue. Okay. And this obviously, this goes to the income statement. Interest revenue goes into net income. I didn't say this. Well, obviously it should be implied in the year. Good. Now we sold this investment on July 1st, which is we received the interest. We said, okay, we got two payment of interest. It's time to sell this investment. Actually what happened by that time, the bond is valued at 1 million and 80,000. What 1 million and 80,000. What do we have to do when we sell this investment? Well, before we sell it, we have to adjust our fair value account. We have to adjust our fair value account. Now we have a loss. So think of it this way. I usually use, when I explain this, I use a number line. Okay. This is zero. At the end of 2021, we were positive. We were positive. We were positive. We were positive. 220,000 on this bond gain. Now, six months later, we are negative. We are negative. The loss is 120,000. So we're going to be moving 340 units to the left. We're moving to the left. And every time we, to the left, it means it's worse than the prior era. Every time we move to the right, it's better than the prior period. We're moving to the left. And this is how I explain fair value adjustments. So if you want to go to Farhat Lectures to find it in the tails. What does that mean? It means we have to make an adjustment. In other words, I have to have in my fair value a balance of 120,000 as a balance because now I'm at a loss of 120. So what's my entry? What's my adjusting entry? I'm going to have to credit 340,000 debit loss, a debit unrealized holding gain loss, 340,000. What happened as a result? As a result now, my balance and fair value is 120. My balance and the unrealized loss is 120. And this is exactly what I have the minute before I sell this investment. So I have to do the fair value adjustment. Therefore, the entry is debit loss on investment, which is this one here, and credit fair value adjustment, this one here. And now my, I still have a balance 120 and 120 in each one of them, in each one of them. Okay, now I'm selling the investment. I'm selling the investment. Once I sell the investment, remember, once I sell the investment, the gain or the loss has to go on the balance, on the income statement, because the gain or the loss is realized. Obviously, I have a loss. Now, but I still have a loss in the balance sheet and 120,000 in fair value. What do I have to do now before I sell the investment and book my actual loss? I have to get this loss away, basically close this. So how do I close it? I debit fair value to make fair value go down to zero. Now fair value equal to zero. Okay, this is the debit. And I credit this to reclassification OCI, and make this goes, basically I close these accounts against each other in a sense. And this is, I don't know, it doesn't matter where you want to put the debit or the credit zero. This is zero. So basically, the fair value on the unrealized holding gain or loss, thank you very much. You performed your purpose, you kept us up to date about our account. But now thank you very much. We're selling the investment. Therefore, we have to take out anything that we put in you, which is the 220, which is the 120, now we just, we get rid of them. Okay, so we adjust the value of the investment, then since we're selling it, we get rid of both of these accounts, basically. Now we sell it. We sold it for $1,080,000. Start with cash. We debit cash $1,080,000. We're going to compare the $1,080,000 to the cost of $1.2 million because we did not recognize any of this loss on the income statement. What's the loss? The loss, the total loss is $120,000. Therefore, I debit cash $1,080,000. I debit my loss $120,000. And I remove my investment. My investment is gone. My investment is gone. $120,000, $1.2 million. I have to remove it. I have to remove it. Now let's take a look at what really happened over the years. If I ask you, if I ask you, what is, what is net income? What happened to net income or on the income statement in year 2021? So in year 2021, we had those three entries. The only thing that happened in year 2021 is we have interest revenue of $48,000. What happened to net income in year 2022? Well in year 2022, this area here, I had $48,000 of income of interest revenue on the income. This is a plus and I had this loss, 48 minus 20, 48,000 plus 20 minus, I'm sorry, not 20, 120 minus because let's see, fair value interest. And so those are the two income statement accounts. So we have to net them out. So if you were to ask what happened on the income statement, well 48 plus investment minus, what's the difference between them? Let's get the calculator. So if I take 48,000 plus minus 120, which is the loss, the difference is overall, I had a loss in year 2022, a loss of negative $72,000. Simply put, a loss on the income statement in a sense that the net amount is a loss of negative $72,000. Now let's see if I ask you, what is the effect on OCI in year 2021? Well OCI had a gain in year 2021 of $220,000. What is the effect on OCI? So let me just, yeah, let me just, just, just want to make sure. Yes. So, so yeah, what's the effect on OCI on 2021? This is 20, sorry, 2021, we did it. Let's assume what's the effect on 2022. 2022 OCI, we had $340,000, a loss, and we removed this, we removed 120 of it plus 120. The effect, the total loss is $220,000 on OCI. Simply put, this gain was removed. That's, that's exactly what happened. We had, we had a gain by 2022, the gain is gone, 220 and 220. Basically, the gain is gone. Okay. So in a sense, those two, they, and I showed you in the entry, they cancel each other out. Notice fair value and unrealized holding gain or loss, they cancel each other out. So this is the effect on, on OCI. Okay. So you have to understand the effect on OCI overall, and the effect on net income because you have to understand OCI is a balance sheet, balance sheet. You need to know which one has balance sheet and the only income is net income here. The reason I'm doing this is because the, the, on the CPA exam, they could ask you, what is the effect on the particular financial statement? You have to know the effect on a particular financial statement. Okay. The overall effect is a loss on this investment. What does that mean? Well, given everything, we experienced a loss for this asset, for this investment. Why? Well, think about it. What's the total loss? If you really want to know, what's the total loss? We bought this investment, 1.2 million. It gave us 48,000 in interest revenue. It gave us 48,000 in interest revenue. Then what's 48 plus 48. So we were happy with the, we were happy with the interest revenue, 48,000 plus 48,000. That's 96,000. Then here comes the loss when we sold it minus 120, 120. So overall, overall comprehensive income, overall it means overall comprehensive income. As a result, we had a loss of 24,000 after all said and done from this investment on comprehensive income. This is everything. Okay. Including interest revenue, selling the bond. So OCI really is gone. And what happened in comprehensive income, our comprehensive income went down. Again, there's a lot of moving parts. The key, I mean on the CPA exam, the questions are not designed to like really test your, test your deep knowledge or your advanced knowledge. The test, test your basic knowledge. So if you have a strong basic knowledge, and this is where I can help you have a strong basic knowledge plus your CPA review course, you will be ready to answer any questions on the CPA exam. It's worth the investment. Take a look at it, study hard, good luck, and stay safe.