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. Correct Answer - B Reasoning: 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. ----- Shouldn’t the answer be option C? I understand that assets are reported at FV for both available for sale & trading securities, and since the transfer from available for sale to trading securities occurred, the unrealized gain/loss of $200,000 will be reflected in the Income Statement. So Income will rise by $200,000. Shouldn’t Equity also rise by $200,000 via retained earnings in equity? How’s the BS balanced if assets increased in value by $200,000 and nothing on the Liability side?
The way I understand this is: yes the $200,000 would flow into Equity through Retained Earnings But, Comprehensive Income would be lowered by $200,000 due to the reclassification So… Equity nets out even after the adjustment. can anyone confirm?
FinNinja Wrote: ------------------------------------------------------- > The way I understand this is: > > yes the $200,000 would flow into Equity through > Retained Earnings > But, > Comprehensive Income would be lowered by $200,000 > due to the reclassification > So… > Equity nets out even after the adjustment. > > can anyone confirm? That’s the way I thought of it: On December 31, the gain will be taken out of equity and put on the income statement. Will shareholders equity be the same? Not exactly, due to tax effects but it certainly wouldn’t rise.
So what you’re saying is that Equity is lowered by $200,000. This $200,000 is then moved to the income statement and then returned to equity via retained earnings. It won’t exactly be the same amount cuz of taxes. But that means, Equity was decreased when it was lowered and then increased by an approx. amount via retained earnings. No? bpdulog, option B (correct answer) says “stockholders’ equity will not change.” Meaning, it will be exactly the same pre & post asset reclassification.
Damil4real Wrote: ------------------------------------------------------- > So what you’re saying is that Equity is lowered by > $200,000. This $200,000 is then moved to the > income statement and then returned to equity via > retained earnings. It won’t exactly be the same > amount cuz of taxes. > > But that means, Equity was decreased when it was > lowered and then increased by an approx. amount > via retained earnings. No? > > bpdulog, option B (correct answer) says > “stockholders’ equity will not change.” Meaning, > it will be exactly the same pre & post asset > reclassification. Let’s say taxes are 25%. The gain represents $200,000 in additional taxable income, or $150,000 after taxes. So essentially, the full $200,000 won’t be recovered in equity. However, choice B is the best answer.
bpdulog, The 150 after taxes in your example was already present in equity because what goes to equity is after taxes. difference is that the 200 would go into Net Income because it is now an HFT security.
cpk123 Wrote: ------------------------------------------------------- > bpdulog, > > The 150 after taxes in your example was already > present in equity because what goes to equity is > after taxes. > > difference is that the 200 would go into Net > Income because it is now an HFT security. Oh, thanks for the correction. In any event, B still seems like the most logical answer.
yes, that is correct. B is the correct answer.