(Financial Statement Effect of Securities) Presented below are three unrelated situations involving equity securities.

Situation 1: A debt security, whose fair value is currently less than cost, is classified as available-for-sale but is to be reclassifiedas trading.

Situation 2: A noncurrent held-to-maturity portfolio with an aggregate fair value in excess of cost includes one particular debtsecurity whose fair value has declined to less than one-half of the original cost. The decline in value is considered to be permanent.

Situation 3: The portfolio of trading debt securities has a cost in excess of fair value of \(13,500. The available-for-sale debt portfoliohas a fair value in excess of cost of \)28,600.

Instructions

What is the effect upon carrying value and earnings for each of the situations above?

Step by step solution

01

Step 1:Reclassification of securities

Situation 1 does not affect the company’s carrying value and earnings because these are already recognised in available-for-securities.

02

Effect of held-to-maturity securities

Situation 2 does not affect the company’s carrying value and earnings because the given security is held-to-maturity security. In these types of securities, the amount is considered only at the time of the security’s maturity.

03

Adjustment of unrealized holding gain or loss

Situation 3 affect the carrying value and the earnings. Trading securities’ fair value is less than the cost value representing the unrealised loss that decreases the company's net income. Available-for-securities fair value is more than the cost representing unrealised gain that increases the company’s net income.

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