[Jahazield]

I don’t know if I’m in the right forum but…I need help.
Becker says it’s a 30,000 decrease. But the explanation doesn’t really say how it got there. As far as I was concerned the first year you write down from cost to fair value sure…but they did the same for the second year, and I thought you had to use you’re ending fair value in the first year to mark it up the second years fair value?

The following information pertains to Smoke, Inc.’s investment in marketable equity securities:
On December 31, Year 2, Smoke reclassified a security with a $70,000 cost and a $50,000 fair value from trading to available-for-sale.
An available-for-sale marketable equity security costing $75,000, written down to $30,000 in Year 1, had a $60,000 fair value on December 31, Year 2. Smoke believes the recovery is permanent.
What is the net effect of the above items on Smoke’s valuation allowance for available-for-sale marketable equity securities as of December 31, Year 2?
a.
$10,000 decrease.
b.
No effect.
c.
$30,000 decrease.
d.
$20,000 increase.

 

 

[samchuck]

I think this question is poorly worded, but it is looking for the change in the valuation allowance. The trick here is with the the valuation allowance moves in the opposite direction of the fair value of the security.

For presentation the AFS and valuation allowance accounts are netted together and presented on the balance sheet.

I'm understand things better with journal entries, so this shows how the effect on the valuation account will be the opposite of the effect on the security itself.

Year 1 – The security loses $45,000 and the Valuation Allowance increases $45,000

Unrealized Loss (OCI) $45,000

Valuation Account $45,000

In this year an increase in the valuation account, decreases the carrying value of the security to $30,00. In their respective accounts at the end of the year they have these balances:

AFS Security $75,000

Valuation Account $45,000 (Increase of $45,000)

But on the balance sheet they are netted and the presentation is merely:

AFS Securty $30,000

Year 2 – The security gains $30,000 and the Valuation Allowance decreases $30,000

Valuation Account $30,000

Unrealized Gain (OCI) $30,000

Here the debit to the valuation account decreases the valuation account, which causes the value of the asset to increase.

Ending account balances:

AFS Security $75,000

Valuation Acccount $15,000 (It has decreased $30,000 from the previous year)

Presentation on the Balance Sheet:

AFS Security $60,000 (It has increased $30,000 from the previous year)

Since the question is asking for the change in the valuation account, not the asset itself, it is the $30,000 decrease.

I hope that helps. I still think the wording is strange because AFS valuation accounts will debit and credit balances, so if Fair Value of the asset is higher than cost, both accounts will have a debit balance. I'm not sure how they would word that.

AUD- 99 (02/07/15)
REG- 05/16/15
FAR- 07/01/15
BEC- 04/24/15

[Jahazield]

Thank you so much! Your explanation gave perfect sense to the problem. You're right, their wording was throwing me off a bit.

[Author]

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