FAR

Equity Securities
Equity Securities-
• Equity Securities can be preferred stock or common stock.
• Preferred stock, no significant influence.
• Common Stock, significant influence?
• If no significant influence, use the rules we are about to go over, known
as “trading security rules”.
• Also need to know if the stock is publicly traded so we can mark to
market at year end.
• All unrealized gains and losses on equity securities go on the income
statement, not OCI!

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Equity Securities
• Equity Securities can be common stock or preferred stock. Equity
securities are defined as securities that represent an ownership
interest in an enterprise.
• Equity securities definition also includes the right to acquire or
dispose of an ownership interest in an enterprise at fixed or
determinable prices.

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Represented by Shares
• Equity Securities may be represented by ownership shares, common,
preferred, and other forms of capital stock.
• Rights to acquire ownership shares, stock warrants, stock rights and
call options, and rights to dispose of ownership shares, put options.

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Equity Securities do NOT include
Redeemable preferred stock-Use debt security rules.
• Treasury stock is NOT an Equity Security.
• Treasury stock is the company’s own stock repurchased and held.
• Convertible bonds are not Equity Securities.

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Question***
• Which of the following are considered equity securities?
• I. Shares of Common Stock
• II. Shares of Preferred Stock
• III. Options and warrants to purchase shares of common stock
• A. I and II
• B. I and III
• C. II and III
• D. I II and III

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Answer is D
• Which of the following are considered equity securities?
• I. Shares of Common Stock
• II. Shares of Preferred Stock
• III. Options and warrants to purchase shares of common stock
• A. I and II B. I and III C. II and III D. I II and III

• Equity securities include not only common and preferred shares but
also options and warrants to purchase shares of common stock.

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Common Equity No Significant
Influence/Preferred Equity
Investment in investee $100,000
Cash $100,000

• Fair Value at Year end drops to $90,000

Unrealized loss on equity sec $10,000

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Dividends Received-No Significant Influence
• Dividends received are income (unless the dividend is liquidating)
• Cash $5,000 (BS)
• Dividend income $5,000 (IS)

• Liquidating Dividend: Distribution exceeds retained earnings by $5,000

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Question***
• In Year 5, Krin Corporation owns a 5% interest in Berger Corp. During the
current year Berger Corp paid a dividend of $8,000,000. Berger Corp had
retained earnings of $6,000,000 when the dividend was declared. How
much dividend will impact Krin Corp’s income statement in Year 5?
• A. $100,000
• B. $200,000
• C. $300,000
• D. $400,000

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Answer is C
• Krin Corp will receive a distribution of $400,000 ($8,000,000 X 5%)
and record dividend income of $300,000 for their 5% portion of
Berger Corp’s $6,000,000 of retained earnings. The difference of
$100,000 reduces Krin Corp’s investment in Berger Corp.
Cash $400,000
Dividend income $300,000
Investment in Berger $100,000 (liq div)

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Question***Same Facts
• In Year 5, Krin Corporation owns a 5% interest in Berger Corp. During the
current year Berger Corp paid a dividend of $8,000,000. Berger Corp had
retained earnings of $6,000,000 when the dividend was declared. How
much does total assets change for Krin Corp as a result of the distribution?
• A. $300,000 decrease
• B. $200,000 decrease
• C. $400,000 increase
• D. $300,000 increase

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Answer is D
• Total assets increase by $300,000, $400,000 increase in cash offset by
a $100,000 drop in the investment in berger, total increase of
$300,000 in total assets.
• Income is also up by $300,000 and retained earnings and equity
would increase as well.

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Question***
• Bartell Inc purchases stock in Hooper Corp but cannot exercise
significant influence for a cost of $450,000 on October 5, year 1. At
12/31/1, the value drops to $400,000 and by the end of Year 2, the value
is $455,000. What amount is reported for Year 1?
• A. Income statement loss, $50,000
• B. Other comprehensive income loss $50,000
• C. Income statement gain $55,000
• D. Other comprehensive income gain $55,000

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Answer is A
• For Year 1, the mark to market would result in a loss on the income
statement in the amount of $50,000 due to the drop in market value
from $450,000 cost to $400,000 fair value.
Unrealized loss (income st) $50,000
• Valuation Account-Hooper $50,000

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Question***-Same Facts
Bartell Inc purchases stock in Hooper Corp for a cost of $450,000 on
October 5, year 1. At 12/31/1, the value drops to $400,000 and by the
end of Year 2, the value is $455,000 What amount is reported for Year
2?
A. Income statement loss, $50,000
B. Other comprehensive income loss $50,000
C. Income statement gain $55,000
D. Other comprehensive income gain $55,000

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Answer is C
• Choice “c" is correct, $55,000 unrealized holding gain on equity
securities reported in the Year 2 income statement:
• 12/31/Year 2 $ 455,000
• 12/31/Year 1 (400,000)
• Unrealized gain, reflected in income statement $ 55,000
Valuation Account, Hooper $55,000
• Unrealized gain on equity securities (Income St) $55,000

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Question***
• Derosa Corp purchased 1000 shares of Karl Corp’s marketable securities in Year 1
for $75 per share, no significant influence. At the end of Year 1, the market price
of Karl Corp was $60 although the average price of Karl Corp was $65 throughout
Year 1. At year end, Derosa Corp would report a debit to ?
• A. Unrealized loss on the income statement for $10,000
• B. Unrealized loss, other comprehensive income, $15,000
• C. Valuation allowance, Karl Corp $15,000.
• D. Unrealized loss on the income statement, $15,000.

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Answer is D
At the end of Year 1, a mark to market adjustment of $15,000 is needed
and the journal entry is as follows:
Unrealized loss Equity Securities (Inc St)$15,000
Valuation Account-Karl $15,000
Since the securities are equity, the loss hits the income statement.

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Question***-Similar Facts
• Derosa Corp purchased 1000 shares of Karl Corp’s marketable securities in Year 1
for $75 per share, no significant influence. At the end of Year 1, the market price
of Karl Corp was $60 but then increased to $70 at December 31, Year 2. What
amount is reported in December of Year 2?
• A. A debit to the Valuation account for $15,000.
• B. A gain of $10,000 on the income statement
• C. A gain of $10,000 in other comprehensive income
• D. No gain since the fair value of $70 is below cost of $75.

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Answer is B
• The market price increased from $60 at 12/31/1 to $70 at the end of
Year 2. The result is a gain of $10 X 1,000 shares or $10,000 on the
income statement since the securities are equity securities.
Valuation account, Karl $10,000
Unrealized gain on equity sec (inc st) $10,000
Note that even though the current market price of $70 is below cost of $75, a gain is still recorded
on the income statement in year 2 for the mark to market adjustment from Year 1.

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Non-Public Companies
• If the investee company is non-public, we carry the investment on our
books at cost minus any impairment loss. The impairment loss is a
realized loss on the income statement, and the asset is written down.

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Sale of an equity Security-
• The sale of an equity security does NOT give rise to a gain or loss IF all changes in the equity’s fair
value have been reported in earnings as unrealized gains or losses as they occurred up to the
moment of sale. If an equity security is sold right at the balance sheet date,
1/3 /1 Original cost
Investment in Equity Sec $80,000
Cash $80,000
12/31/1 Mark to Market
Investment in Equity $20,000
Unrealized gain (IS) $20,000
1/2/2 Cash $100,000
Investment in Equity Security $100,000
Total Assets do not change. No Income or loss, no change in retained earnings or equity.

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Sale of an equity security-
• Now let’s assume the sale of the equity security for $125,000 is in between
balance sheet dates and it was last marked to market several months ago at
$100,000
5/1/2 Cash $125,000
Investment in Equity Sec $100,000
Gain on Sale of Securities $25,000
Total assets increase by $25,000, earnings go up $25,000, retained earnings and
stockholders’ equity up by $25,000.
Any valuation account used would need to be removed upon sale.

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FVNI-Dividends received by investor
• Dividends are distributions of earnings paid to the shareholders.
• A big benefit of equity investing is the participation of dividends, or
corporate earnings.
• There are 2 types of dividends, cash dividends and stock dividends.

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Cash Dividends received
• Under the FVNI method, cash dividends received are income. If
investor receives a $5,000 cash dividend from investee, and assuming
investor cannot exercise significant influence,
• Cash $5,000 (BS)
Dividend Income $5,000 (IS)

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Do Not Recognize Stock Dividends
• Stock dividends are not cash dividends. While cash dividends are
considered income to the investor, stock dividends are NOT. Stock
dividends are additional shares of stock being distributed to the
investor which will serve to lower the cost basis per share when its
time to sell. For now, no entry for the investor, in connection with a
stock dividend.

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Question*
• Woodley Inc became a 4 % owner of Jenssen Inc by purchasing 5,000 shares of
Jenssen Inc on March 1 Year 13. Jenssen Inc paid a cash dividend of $3 per share
on November 1 Year 13. In its Year 13 Income Statement what amount would
Woodley Inc report as dividend income?
• A. $15,000
• B. $18,000
• C. $25,000
• D. $0

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Answer is A
• Woodley Inc became a 4 % owner of Jenssen Inc by purchasing 5,000 shares of Jenssen
Inc on March 1 Year 13. Jenssen Inc paid a cash dividend of $3 per share on November
1 Year 13. In its Year 13 Income Statement what amount would Woodley Inc report as
dividend income?
• A. $15,000
• B. $18,000
• C. $25,000
• D. $0
• As a 4% owner, Woodley would use the FVNI method to account for its investment in Jennsen.
Under the FVNI method dividend income is equal to the
• Number of shares times the cash dividend per share. At the time the cash dividend is paid,
Woodley has 5,000 shares times $3 per share =$15,000
• DR Cash $15,000
• CR Dividend Income $15,000

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Question-Similar Facts
• Woodley Inc became a 4 % owner of Jenssen Inc by purchasing 5,000 shares of
Jenssen Inc on March 1 Year 13. Woodley Inc received a stock dividend of 1,000
shares on September 1 Year 13 when the market value of Jenssen Inc was $20
per share. Jenssen Inc paid a cash dividend of $3 per share on November 1 Year
13. In its Year 13 Income Statement what amount would Woodley Inc report as
dividend income?
• A. $15,000
• B. $18,000
• C. $25,000
• D. $0

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Answer is B
• Woodley Inc became a 4 % owner of Jenssen Inc by purchasing 5,000 shares of Jenssen
Inc on March 1 Year 13. Woodley Inc received a stock dividend of 1,000 shares on
September 1 Year 13 when the market value of Jenssen Inc was $20 per share. Jenssen
Inc paid a cash dividend of $3 per share on November 1 Year 13. In its Year 13 Income
Statement what amount would Woodley Inc report as dividend income?
• A. $15,000
• B. $18,000
• C. $25,000
• D. $0
• As a 4% owner, Woodley would use the FVNI method to account for its investment in Jenssen.
Under the FVNI method dividend income is equal to the
• Number of shares times the cash dividend per share. At the time the cash dividend is paid,
Woodley has 6,000 shares times $3 per share =$18,000
• Cash $18,000
• Dividend Income $18,000

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Return of Capital Distribution
Reduce investment in investee for return of capital distribution. If the
investee gives the investor more money than the investee has in its
retained earnings there is a return of capital.
Journal entry to record a return of capital distribution or liquidating
dividend ( dividend in excess of investor’s share of retained earnings).
Cash 10
Investment in investee 3
Dividend Income 7

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FVNI Method-when to reduce investment account
• Other than for fair value adjustment at year end, under the FVNI
method, the investment account is reduced only if:
• Shares of stock are sold, or
• Cumulative distributions exceed cumulative earnings (a return of
capital), or
• Investee incurs losses that substantially reduced net worth.
(impairment)

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Question*
• Which of the following is correct regarding the (fair value net income)
method?
• I. The investment in investee account is adjusted for investee
earnings.
• II. The investment in investee is adjusted to fair value at the end of
the reporting period.
• A. I only
• B. II only
• C. Both
• D. Neither
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Answer is B
• Which of the following is correct regarding the (fair value net income) method?
• I. The investment in investee account is adjusted for investee earnings.
• II. The investment in investee is adjusted to fair value at the end of the reporting
period.
• A. I only
• B. II only
• C. Both
• D. Neither
• I is wrong, Under the FVNI method, the investment in investee ( asset account) is
NOT adjusted for investee earnings.
• II. The investment in investee is adjusted to fair value.
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Question*
• Under the FVNI method which of the following is correct?
• I. Cash dividends paid by the investee are reported as income by the investor if
paid out of investee earnings.
• II. Unrealized losses at year end are reported in other comprehensive income.
• A. I only
• B II only
• C. Both
• D. neither

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Answer is A
• Under the FVNI method which of the following is correct?
• I. Cash dividends paid by the investee are reported as income by the investor if
paid out of investee earnings.
• II. Unrealized losses at year end are reported in other comprehensive income.
• A. I only
• B II only
• C. Both
• D. neither
• I is correct, Cash dividends paid by the investee are reported as income by the
investor if paid out of investee earnings
• II is wrong, Unrealized losses at year end are reported in earnings for all
investment in equity securities.

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Question*
• Under the FVNI method of reporting for investments in equity securities
• I. The investor should hold less than fifty percent but more than twenty percent
of the investee shares.
• II. Dividends received by the investor in excess of investee earnings should be a
reduction in the Investment account.
• A. I only
• B. II only
• C. Both
• D. Neither

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Answer is B
• Under the FVNI method of reporting for investments in equity securities
• I. The investor should hold less than fifty percent but more than twenty percent of the
investee shares.
• II. Dividends received by the investor in excess of investee earnings should be a reduction
in the Investment account.
• A. I only
• B. II only
• C. Both
• D. Neither
• I is wrong, FVNI method used when less than 20% owned, no significant influence.
• II is correct Cash dividends received in excess of investee earnings are recorded as a
reduction in investment account.

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Question*
• Under the FVNI method, cash dividends received by the investor are
reported as
• I. Income to the investor if the dividends are NOT in excess of investee
earnings.
• II. An increase in the Investment in Investee account.
• A. I only
• B. II only
• C. Both
• D. Neither
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Answer is A
• Under the FVNI method, cash dividends received by the investor are reported as
• I. Income to the investor if the dividends are NOT in excess of investee earnings.
• II. An increase in the Investment in Investee account.
• A. I only
• B. II only
• C. Both
• D. Neither
• I is correct, Under the FVNI method, cash dividends received by the investor are
reported as income to the investor if the dividends are NOT in excess of investee
earnings.
• II is wrong, An increase in the Investment in Investee account is not recorded for
dividends received under the FVNI method.

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Question*
• Under the FVNI method, the investment in investee account is
reduced for
• I. Stock dividends received.
• II. Ordinary Losses incurred by the investee.
• A. I only
• B. II Only
• C. Both
• D. Neither

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Answer is D
• Under the FVNI method, the investment in investee account is reduced for
• I. Stock dividends received.
• II. Ordinary Losses incurred by the investee.
• A. I only
• B. II Only
• C. Both
• D. Neither
• Under the cost method or FVNI, the investment account is reduced only if:
• Shares of stock are sold, or
• Cumulative dividends exceed cumulative earnings (a return of capital), or
• Subsidiary incurs losses that substantially reduced net worth.

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