On January 9, 2006, Company X paid $2,000,000 for 100,000 shares of stock in Company S. Originally the company intended on holding the securities for the foreseeable future. As of December 31, the stocks were valued at $2,200,000. In 2006, Company S had earnings per share of $0.90 and paid dividends per share of $0.20. In late December 2006, the company decided to place the securities in their active marketable securities portfolio. What is the impact of this change in status on the income and the stockholders’ equity of Company X? A) Stockholders’ equity will rise by $200,000, but income will not change. B) Income will rise by $200,000, but stockholders’ equity will not change. C) Income and stockholder’s equity will rise by $200,000. D) Income and stockholder’s equity will not change. Your answer: B was correct. Income will rise by $200,000, but stockholders’ equity will not change. The stocks were classified as debt and equity securities available for sale, but now they will be classified as debt and equity trading securities. The gain would have been reported in the securities valuation account in the equity section and not on the income statement, but now will be reported as income. My question is, would the more correct answer be stock holders equity will decrease and income will increase by $200,000 being that the increase in income will eventually flow to retained earnings?
Income will rise because Unrlzd gains will now move to income from the Comprehensive Income. This would also mean that equity should decrease which is not an option here. Unless the equity is left unchanged and amortized in the future. I know this is done when some thing is transferred from available for sale to held to maturity
Looking at it again, the net change is zero to equity (decrease equity, increase ni, flows to equity). I need more coffee.
hmm… but would all of it flow back … as there were dividends paid out
I guess the valuation occured December 31st and since they had already moved the securities to trading by then(“late December”), equity was never updated in this case. If the valuation occured before moving the stocks to trading, then equity would have been affected.
My guess is that the amount of equity gained by going through comprehensive income is now reversed when it goes though the IS. It would be double counting otherwise.
Ok, I think I got it now after reading the example in the CFAI book 2. Both available for sale and trading portfolios are carried at market value on the balance sheet. So transferring between them affects only the income statement since the difference between the carrying values is reflected in the income statement for the trading portfolio only.
That makes perfect sense, thanks for clarifying this 
cfaDecember Wrote: Both available for sale and > trading portfolios are carried at market value on > the balance sheet. So transferring between them > affects only the income statement since the > difference between the carrying values is > reflected in the income statement for the trading > portfolio only. exactly!