0:01 in this video we're going to talk about
0:03 how to use the fair value method to
0:06 account for an equity investment so
0:08 first of all if your company buy stock
0:11 in another company and your ownership
0:14 stake in that company is less than 20%
0:15 that's when you're going to use the fair
0:17 value method and what that means is that
0:20 the investment that firm that stake that
0:22 you bought in another firm is going to
0:24 be marked to Market on your firm's
0:26 balance sheet okay so that investment is
0:27 going to be Mark to Market when we say
0:29 Mark to Market what we mean is it's
0:31 going to be recorded at fair value so if
0:33 the fair value of that investment goes
0:36 up then you're going to Market to Market
0:38 you're going to increase the value of
0:39 your asset I'm I'm going to show you how
0:42 to do that but just one final point is
0:44 any of that unrealized gain or loss that
0:47 occurs that's going to go through net
0:48 income so that's going to affect your
0:50 income statement increase your net
0:52 income if it's a gain decrease your net
0:54 income if it's a loss okay so that's
0:56 basically the fair value method now
0:58 theoretically also so we're talking
1:00 about firms where you own less than 20%
1:03 St however if you own 20 to 50% there's
1:05 this thing called the equity method
1:07 which we'll talk about but you can make
1:10 an election to use the fair value method
1:12 right so it's not always this just firms
1:14 is less than 20% but this is the general
1:16 rule but let me show you an example to
1:17 kind of show you how the fair value
1:19 method would play out in in practice so
1:21 let's say that your company buys let's
1:24 say 4,000 shares of another company
1:27 called flying cars Incorporated and your
1:31 company pays $50 a share for those 4,000
1:34 shares and now flying cars Incorporated
1:36 they have 100,000 shares outstanding
1:40 total so you own 4% you have a 4% stake
1:42 in the firm so because you own Le
1:44 because you own less than 20% of flying
1:46 cars Incorporated you're automatically
1:50 going to use this Fair Value method so
1:51 let me show you the journal entries for
1:53 how it would work so when you buy your
1:55 investment or or when you buy flying
1:57 cars when you purchase this investment
1:59 you're going to debit the investment
2:01 account for
2:02 $200,000 because that's what you paid
2:05 right we just take the $4,000 and
2:08 multiply it by 50 that gives you
2:10 $200,000 okay now let's just assume you
2:13 paid cash so we credit cash for
2:16 $200,000 but let's pretend that the very
2:20 next day the share price jumps up to $63
2:22 a share right so you made a good
2:24 investment here because now we see that
2:27 it was originally at 50 but now it's at
2:31 63 so you've had a gain per share of $13
2:33 right and you own 4,000 shares so if we
2:38 multiply 4,000 * 13 we get
2:42 52,000 so you're $52,000 wealthier you
2:43 don't actually have the cash yet right
2:46 you haven't sold the investment but we
2:48 can tell that you've had a gain and so
2:51 we're going to credit unrealized gain on
2:52 investment right that's I just put a
2:54 little ni there so you know it goes to
2:56 net income we're going to credit that
2:59 for 52,000 now it seems weird you would
3:00 think you would would just debit
3:04 investment flying cars for 52,000 but
3:06 you don't you debit this thing called
3:08 fair value adjustment I see I made a
3:11 little M fair value adjustment so that's
3:14 what you debit now on the balance sheet
3:16 so let's say we've got our balance sheet
3:18 here we're going to have this investment
3:20 we're going to have that
3:23 200,000 and then if we let's just
3:24 pretend that right now at the end of
3:26 this day that we put together our
3:27 balance sheet right because remember
3:30 it's a snapshot of a point in time then
3:33 we would add in the 52,000 fair value
3:36 adjustment and so it' be
3:39 252 I know it's weird it just be easier
3:41 to just debit the investment account but
3:43 that's not how it works we add this and
3:46 this together and so effectively we have
3:48 marked this to Market and so it would be
3:50 on the balance sheet at
3:53 $252,000 so it's at its Fair values
3:54 that's all we're doing right the
3:56 alternative which we don't have an
3:58 option to do would be cost we just leave
4:00 it at 200,000 and say but that's not
4:02 what we do the fair value method says
4:04 hey we're wealthier it's it's gone up
4:06 right the share price has gone up so
4:08 we're going to Market to Market on the
4:09 balance sheet and then we're going to
4:12 have this unrealized gain of 52,000
4:14 would go to net income so if we were
4:15 putting together our net uh our income
4:17 statement at the end of the day today
4:19 this $52,000 gain would be included in
4:23 net income now all that being said let
4:25 me just show you what would happen if
4:28 you decided to sell the security so I'll
4:30 just show you the disposal so let's say
4:32 that the very next day so then this is
4:34 like okay we bought the shares then the
4:37 next day the share price went up and now
4:40 uh the share price goes down to $57 a
4:42 share the next day and you sell all
4:45 4,000 shares so this is a continuation
4:47 so like this was the first thing that
4:48 happened we bought it and then the share
4:51 price went up the next day and then now
4:53 here we are the day after that so I'm
4:55 not ignoring this this still happened
4:57 I'm just saying that now the next day
5:00 the stock price dropped okay so now what
5:03 are we going to do well we know here's
5:04 we know that we're going to have cash
5:07 we're going to debit cash for 228,000
5:09 where did I get that number so that is
5:11 the 4,000 shares that's how many shares
5:15 we own we multiply that by $57 a share
5:16 because the share price went down right
5:19 so we got cash of 228,000
5:23 now because we've sold the security we
5:25 have to get rid of the unrealized gain
5:27 and the fair value adjustment okay and
5:29 those we had the credited the unrealized
5:32 game for 52 Grand now we debit the
5:34 unrealized game for 52,000 just to zero
5:36 it out right so we get rid of that and
5:38 then we credit Our Fair Value adjustment
5:41 to zero that account out at least as far
5:43 as it pertains to this investment I'm
5:44 assuming we don't have other Investments
5:46 with unrealized gains and so forth
5:49 they'd be a little more complex now we
5:51 also need to make a credit to our
5:52 investment of
5:54 $200,000 where did that come from you
5:56 might be saying well remember when we
5:58 originally got the investment we debited
6:00 it for
6:02 $200,000 okay so now we credit the
6:05 investment for $200,000 and we've zeroed
6:08 that account out so now the plug to make this
6:09 this
6:12 balance is
6:15 $228,000 right now if you aren't
6:16 comfortable thinking about it as a plug
6:18 and by plug I mean like if we didn't
6:20 have this here we'd be like oh this side
6:21 doesn't balance with this side we need
6:23 to make an entry okay so that's kind of
6:25 the easy accounting way to do it but if
6:27 you want to think like well what is this
6:29 how why do we have this realized game
6:30 what's going on on here think about it
6:36 like this we got $828,000 for this stock
6:38 we originally bought it for
6:41 $200,000 okay so we have a
6:44 $28,000 realized gain and again the
6:46 difference between unrealized and realiz
6:48 is that the unrealized happened we
6:51 hadn't sold the stock yet but now we've
6:53 sold it and so that's all we mean when
6:55 we say that there's a realized gain and
6:58 so this realized gain is going to go to
6:59 net income this is going to affect the
7:01 income State and at the end of the year
7:04 assume this is all all of this stuff is
7:06 happening for one year actually the net
7:08 effect on the income statement would be
7:11 that it would be $228,000 higher net income
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