YouTube Transcript:
Fair Value Method for Equity Investments (less than 20% ownership stake)
Skip watching entire videos - get the full transcript, search for keywords, and copy with one click.
Share:
Video Transcript
View:
in this video we're going to talk about
how to use the fair value method to
account for an equity investment so
first of all if your company buy stock
in another company and your ownership
stake in that company is less than 20%
that's when you're going to use the fair
value method and what that means is that
the investment that firm that stake that
you bought in another firm is going to
be marked to Market on your firm's
balance sheet okay so that investment is
going to be Mark to Market when we say
Mark to Market what we mean is it's
going to be recorded at fair value so if
the fair value of that investment goes
up then you're going to Market to Market
you're going to increase the value of
your asset I'm I'm going to show you how
to do that but just one final point is
any of that unrealized gain or loss that
occurs that's going to go through net
income so that's going to affect your
income statement increase your net
income if it's a gain decrease your net
income if it's a loss okay so that's
basically the fair value method now
theoretically also so we're talking
about firms where you own less than 20%
St however if you own 20 to 50% there's
this thing called the equity method
which we'll talk about but you can make
an election to use the fair value method
right so it's not always this just firms
is less than 20% but this is the general
rule but let me show you an example to
kind of show you how the fair value
method would play out in in practice so
let's say that your company buys let's
say 4,000 shares of another company
called flying cars Incorporated and your
company pays $50 a share for those 4,000
shares and now flying cars Incorporated
they have 100,000 shares outstanding
total so you own 4% you have a 4% stake
in the firm so because you own Le
because you own less than 20% of flying
cars Incorporated you're automatically
going to use this Fair Value method so
let me show you the journal entries for
how it would work so when you buy your
investment or or when you buy flying
cars when you purchase this investment
you're going to debit the investment
account for
$200,000 because that's what you paid
right we just take the $4,000 and
multiply it by 50 that gives you
$200,000 okay now let's just assume you
paid cash so we credit cash for
$200,000 but let's pretend that the very
next day the share price jumps up to $63
a share right so you made a good
investment here because now we see that
it was originally at 50 but now it's at
63 so you've had a gain per share of $13
right and you own 4,000 shares so if we
multiply 4,000 * 13 we get
52,000 so you're $52,000 wealthier you
don't actually have the cash yet right
you haven't sold the investment but we
can tell that you've had a gain and so
we're going to credit unrealized gain on
investment right that's I just put a
little ni there so you know it goes to
net income we're going to credit that
for 52,000 now it seems weird you would
think you would would just debit
investment flying cars for 52,000 but
you don't you debit this thing called
fair value adjustment I see I made a
little M fair value adjustment so that's
what you debit now on the balance sheet
so let's say we've got our balance sheet
here we're going to have this investment
we're going to have that
200,000 and then if we let's just
pretend that right now at the end of
this day that we put together our
balance sheet right because remember
it's a snapshot of a point in time then
we would add in the 52,000 fair value
adjustment and so it' be
252 I know it's weird it just be easier
to just debit the investment account but
that's not how it works we add this and
this together and so effectively we have
marked this to Market and so it would be
on the balance sheet at
$252,000 so it's at its Fair values
that's all we're doing right the
alternative which we don't have an
option to do would be cost we just leave
it at 200,000 and say but that's not
what we do the fair value method says
hey we're wealthier it's it's gone up
right the share price has gone up so
we're going to Market to Market on the
balance sheet and then we're going to
have this unrealized gain of 52,000
would go to net income so if we were
putting together our net uh our income
statement at the end of the day today
this $52,000 gain would be included in
net income now all that being said let
me just show you what would happen if
you decided to sell the security so I'll
just show you the disposal so let's say
that the very next day so then this is
like okay we bought the shares then the
next day the share price went up and now
uh the share price goes down to $57 a
share the next day and you sell all
4,000 shares so this is a continuation
so like this was the first thing that
happened we bought it and then the share
price went up the next day and then now
here we are the day after that so I'm
not ignoring this this still happened
I'm just saying that now the next day
the stock price dropped okay so now what
are we going to do well we know here's
we know that we're going to have cash
we're going to debit cash for 228,000
where did I get that number so that is
the 4,000 shares that's how many shares
we own we multiply that by $57 a share
because the share price went down right
so we got cash of 228,000
now because we've sold the security we
have to get rid of the unrealized gain
and the fair value adjustment okay and
those we had the credited the unrealized
game for 52 Grand now we debit the
unrealized game for 52,000 just to zero
it out right so we get rid of that and
then we credit Our Fair Value adjustment
to zero that account out at least as far
as it pertains to this investment I'm
assuming we don't have other Investments
with unrealized gains and so forth
they'd be a little more complex now we
also need to make a credit to our
investment of
$200,000 where did that come from you
might be saying well remember when we
originally got the investment we debited
it for
$200,000 okay so now we credit the
investment for $200,000 and we've zeroed
that account out so now the plug to make this
this
balance is
$228,000 right now if you aren't
comfortable thinking about it as a plug
and by plug I mean like if we didn't
have this here we'd be like oh this side
doesn't balance with this side we need
to make an entry okay so that's kind of
the easy accounting way to do it but if
you want to think like well what is this
how why do we have this realized game
what's going on on here think about it
like this we got $828,000 for this stock
we originally bought it for
$200,000 okay so we have a
$28,000 realized gain and again the
difference between unrealized and realiz
is that the unrealized happened we
hadn't sold the stock yet but now we've
sold it and so that's all we mean when
we say that there's a realized gain and
so this realized gain is going to go to
net income this is going to affect the
income State and at the end of the year
assume this is all all of this stuff is
happening for one year actually the net
effect on the income statement would be
that it would be $228,000 higher net income
Click on any text or timestamp to jump to that moment in the video
Share:
Most transcripts ready in under 5 seconds
One-Click Copy125+ LanguagesSearch ContentJump to Timestamps
Paste YouTube URL
Enter any YouTube video link to get the full transcript
Transcript Extraction Form
Most transcripts ready in under 5 seconds
Get Our Chrome Extension
Get transcripts instantly without leaving YouTube. Install our Chrome extension for one-click access to any video's transcript directly on the watch page.
Works with YouTube, Coursera, Udemy and more educational platforms
Get Instant Transcripts: Just Edit the Domain in Your Address Bar!
YouTube
←
→
↻
https://www.youtube.com/watch?v=UF8uR6Z6KLc
YoutubeToText
←
→
↻
https://youtubetotext.net/watch?v=UF8uR6Z6KLc