Study Smarter.....Study The Answers!


1) Key Things To Know 5) Medium Test
2) Self Test 6) Hard Test
3) Practice as You Learn 7) Quick Study Sheet
4) Easy Test  

Key Things to Know

Investors make investments in bonds (debt) and equities (stocks) for three primary reasons:

1) appreciation in market value
2) interest and dividend income
3) significant influence and control

The journal entry to record the purchase of all types of investments is:

Investment $ cost
Cash $ cost

Record the investment at cost plus commission (no commission expense)

Accounting methods:

1) Fair Market Value (FMV) Method
2) Equity Method
3) Cost Method (used when there is no reliable FMV)

The accounting method used depends on the investor's purpose for making the investment.

Fair Market Value (FMV) Method

Use for investments made for appreciation and income:

1) No significant influence or control (usually owning < 20% indicates)
2) Fair market value is reliable - bid ask quote on an exchange or reliable cash flows

3 categories of investments under the FMV method:

1) Held to Maturity : Intend to hold to maturity (bonds only)
2) Trading Securities: Intend to hold for one year or less (stocks and bonds)
3) Available for Sale: Intend to hold for more than one year (bonds only)

Bonds Held to maturity:

Do not adjust to fair market value. FMV is not relevant when not selling Adjust the cost of the bond investment based on the amortization schedule

Trading Securities (Investments held < than or equal to 1 Year with a reliable FMV):

Adjust the investment to fair market value at the end of each period Report the change in fair market value on the income statement using the account - Unrealized Holding Gain/Loss-IS Report dividend income

Available for Sale (Bonds only held Long-term with a reliable FMV):

Adjust the investment to fair market value at the end of the period Report the change in fair market value in owners' equity as other comprehensive income until the investment is sold Use the account: "Unrealized Holding Gain/Loss - OE" Report interest income

FMV Method Journal entries: Record 2 things each period

1) Adjust to fair market value - make the investment equal to fair market value

Equity securities: report change in FMV on the income statement "Unrealized Holding Gain/Loss - IS"

Trading - intend to hold 1 year or less, report on income statements "Unrealized Holding Gain/Loss - IS"

AFS - intend to hold > 1 year, report change in owner's equity, "Unrealized Holding G/L - OE"

2) record dividends received

The entries follow:

  1) Adjust to FMV 2) Receive Dividends
Trading: Fair Value Adjustment * Cash
(Stocks/Bonds) Unrealized Holding G/L - IS       Dividend Income
    (Income Statement)  
AFS: Fair Value Adjustment * Cash
Bonds Unrealized Holding G/L - OE       Dividend Income
    (Owner's Equity)  

* Debit Fair Value Adjustment if FMV increases and
credit Fair Value Adjustment If FMV decreases

Important to notice: The only difference in trading and available for sale is how the change in fair market value is reported. Trading is reported on the income statement. Available for Sale is reported on the balance sheet in owner's equity.

Bonds: classification (trading or available for sale) is based on management's intent to hold the security at the end of the period.

Management may change their intent from one period to the next. Record a change for the current period as follows:

Trading to Available for Sale:

Use "Unrealized Holding Gain/Loss - IS account to record the change in FMV

The unrealized holding gain loss -IS account reported on the income statement in the prior period was closed to retained earnings.

Available for Sale to Trading:

  • Unrealized Holding G/L - OE is only reported only for a LT investment The account must be = 0 if the investment is held ST
    • Unrealized Holding G/L - OE
    • Realized Gain/Loss

The Unrealized Holding G/L - OE account is adjusted to 0.

  • For the current period - the change in FMV is recorded to Unrealized Holding Gain/Loss - IS

The Equity Method:

Use for equity investments with significant influence (typically > 20% ownership) Significant Influence assumed to occur:

- Access to financial information others do not have
- Seat(s) on the board of directors
- Influence company policies and procedures

The objective of the equity method is to report the investment at the owned share of the investee's owner's equity.

The investment should increase when the investee's owner's equity increases (earn income) and decrease when the investee's owner's equity decreases (losses and dividends paid).

Record 3 Journal entries: (Do not adjust to fair market value)

  "Profit" "Losses"
1) Profit/Loss Investment Investment Expense
Investment Revenue
2) Dividends Cash  
Investment in "X"
3) Depreciation Book Value > FMV FMV > Book Value
(Eliminate difference
in BV & FMV)
Investment Investment Expense
Investment Expense

Eliminates the difference between book value and fair market value of all depreciable assets at the time of purchase

Note: Some books do not discuss the depreciation journal entry.

The 3rd entry is only made when the book value of an asset is not equal to fair market value at the time of purchase

Sell an investment

1) Adjust the investment to FMV on the date of the sale
2) Record the cash received with a debit
3) Remove the investment and fair value adjustment accounts Debit or credit the total amount in the account to get it to 0 When selling part of the shares, only remove the % sold.
4) Remove the "Unrealized Holding G/L - OE" account balance when the investment is AFS, held LT. Debit or credit the total amount in the account to get it to 0 When selling part of the shares, only remove the % sold.
5) Plug to realized gain (credit) or realized loss (debit) to balance the entry (if the investment is AFS or the equity method)

1st: Adjust to current FMV before selling the investment)

FMV adjustment $
Unrealized Holding Gain/Loss $

2nd Remove the investment sold

Cash (db)

Realized Gain/Loss (AFS and equity method only)
Unrealized Holding G/L (debit or credit)
Fair Value Adjustment (debit or credit
      Investment (cr)

Accounts Reported on the Income Statement (current year only):

Unrealized Holding Gain/Loss - IS
Realized Gain/Loss
Dividend Income (stocks)
lnterest Income (bonds)
Investment Revenue
Investment Expense

Accounts Reported on the Balance Sheet (cumulative balance):

+ - Fair Value Adjustment
= Investment reported balance

Unrealized Holding Gain/Loss - OE
(part of other comprehensive income in equity)

Cost Method:

Used when no significant influence and no reliable fair market value

  • Report at cost - Do not adjust to an unreliable fair market value
  • Report dividends and interest as income




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