charge against income is recorded in an account called Unrealized Loss on Investments: 3-3- X 6 Trading Securities 50,000 Cash 50,000 To record the purchase of 5,000 shares of Merriam stock at $10 per share
Download free eBooks at bookboon.com Current Assets 56 Cash and Highly-Liquid Investments *** Notice that the loss is characterized as “unrealized.” This term is used to describe an event that is being recorded (“recognized”) in the financial statements, even though the final cash consequence has not yet been determined. Hence, the term “unrealized.” April had the intended effect, and the stock of Merriam bounced up $3 per share to $12. Still Webster decided to hang on for more. At the end of April, another entry is needed if financial statements are again being prepared: *** Notice that the three journal entries now have the trading securities valued at $60,000 ($50,000 - $5,000 + $15,000). This is equal to their market value ($12 X 5,000 = $60,000). The income statement for March includes a loss of $5,000, but April shows a gain of $15,000. Cumulatively, the income statements show a total gain of $10,000 ($5,000 loss + $15,000 gain). This cumulative gain corresponds to the total increase in value of the original $50,000 investment. The preceding illustration assumed a single investment. However, the treatment would be the same even if the trading securities consisted of a portfolio of many investments. That is, each and every investment would be adjusted to fair value. 10.2 Rationale for Fair Value Accounting The fair value approach is in stark contrast to the historical cost approach used for other assets like land, buildings, and equipment. The rationale is that the market value for trading securities is readily determinable, and the periodic fluctuations have a definite economic impact that should be reported. Given the intent to dispose of the investments in the near future, the belief is that the changes in value likely have a corresponding effect on the ultimate cash flows of the company. As a result, the accounting rules recognize those changes as they happen. 10.3 Alternative: A Valuation Adjustments Account As an alternative to directly adjusting the Trading Securities account, some companies may maintain a separate Valuation Adjustments account that is added to or subtracted from the Trading 3-31- X 6 Unrealized Loss on Investments 5,000 Trading Securities 5,000 To record a $1 per share decrease in the value of 5,000 shares of Merriam stock 4-30- X 6 Trading Securities 15,000 Unrealized Gain on Investments 15,000 To record a $3 per share increase in the value of 5,000 shares of Merriam stock
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