From Schweser:
Question asks about the impact of reclassifying debt securities that are at FV to AFS (FVOCI), assuming there are gains. Answer is that:
ROA is lower (I agree because you remove the gains from PL and the revalued amount of the asset will be higher, leading to a lower ROA
Debt to total capital is not affected: why is this? I thought if the associated gains go to OCI now, equity would be higher (as per the increase in OCI), hence D/C should be lower.
Thanks!
Equity contains different items, including OCI and retaining earnings. In both cases (at FVPL or FVOCI) you will end with after-tax gain which increase total capital.
Can someone please explain why net income and ROA are lower? Schwerser p 6 mentions that reclasiying from AFT to any category means that unrealised gains or losses are shown in the income statement. If there is a gain shouldn’t reclassifying from AFT to AFS mean no changes in NI and therefore ROA? thanks
It’s AFS to any category, rather than AFT to any category.
Self employed - i disagree it definitely says FVTPL (so AFT) to any=> unrealised gain or loss in IS. Im really confused,
Why do I remember you cannot reclassify from and into FVPL? (At least under IFRS)
Thats correct, but you can under GAAP.
I haven’t checked the text, but if you reclassify from HFT (held-for-trading) to AFS (available-for-sale), and you have a gain, the gain is removed from the Income statement and put into OCI which is a balance sheet equity account. Therefore, Net Income will decrease , Assets will remain unchanged , and ROA will decrease.
Debt-to-Capital will remain the same in this case. Why? Because although the gain is reclassified to OCI which increases equity, the removal of the gain from the NI means that it’s also removed from Retained Earnings which decreases equity. The net effect is a wash (and debt is unaffected).
If you reclassifying from HFT to AFS the unreliasd gains / losses are not transferred to OCI.
This is to stop firms from removing losses from the income statement. This is only applicable under Us GAAP by the way.
this is correct you can’t do that under IFRS.
Yes Frankliving and GAAPIFRS are correct, ignore my earlier comment - the gain stays in the income statement.
Not sure which problem states otherwise, but I believe that means ROA stays the same.
Assuming GAAP, TomRiddle is correct.
When transferring from FV to AFS, realized gain recognised in P&L becomes unrealized gains and are moved to OCI
As such, for:
Net income is reduced by the realized amount while equity remains the same (as the unrealized gain/losses would have previously been reflected in retained earnings and will not be recognised directly in equity)
No change as Equity remains the same. There would also be no impact to debt.
No reclassification from and in to FVPL under IFRS is correct.
I just wonder, under USGAAP, is there any corporate tax effect when realized gain recognized in P&L is transferred to OCI. If there is, the balance street structure may change?
This is wrong - check the curriculum…
Schweser Exam 2 Afternoon question 89 states that:
“Petrovich decides to reclassify the debt securities as AFS. Ignoring any effects on income taxes, which of the following describes the necessary ajdustments”? following US GAAP
Respone: C ROE is lower and debt/capital is not affected
So Mkipa1 does seem correct or Schweser is wrong.
Right, I believe that question was the basis of my (and probably Mkipa1’s) earlier comments. However, after checking the CFAI text, it mentions specifically that if a HFT security is re-classified to AFS, the unrealized G/L is kept in the income statement.
Based on that, I believe Schweser’s answer is incorrect.
wouldn’t be the first time Schweser gives wrong information…
Just read the cfai text too and it seems that i was mistaken on the treatment for HFT to AFS. Unrealized gains remain on the income statement.
Apologies for the misinformation