There’s a qn from Kaplan Prac Exam 2014:
Petrovich determines from the financial statement footnotes that Fisher reported an unrealized gain in its most recent income statement related to debt securities that are designated at fair value. Competitor firms following U.S. GAAP classify similar debt securities as available-for-sale. For comparison purposes, Petrovich decides to reclassify Fisher Global’s debt securities as available-for-sale. Ignoring any effect on income taxes, which of the following best describes the effects of the necessary adjustments? A. Net income is lower and asset turnover is higher. B. Return on assets is lower and debt-to-equity is lower. C. Return on equity is lower and debt-to-total capital is not affected. Answer: C U.S. GAAP requires that unrealized gains and losses on available-for-sale securities be reported in comprehensive income as parr of shareholders’ equity. The appropriate adjustment to Fisher’s statements is to decrease net income by the amount of the gain. Lower net income will result in lower ROA and ROE (lower numerators). Lower net income results in lower retained earnings. However. the gain increases other comprehensive income; thus, total equity does not change. In summary, assets, liabilities and total equity are not affected by the adjustment; thus, asset turnover. debt-to-equity and debt-to-toral capital are not impacted. /-------------------------------------------------------------/ May I know why the adjustment is to decrease NI and increase OCI? From CFA Book 2 P.117, “If a security initially classified as held for trading is reclassified as available-forsale, any unrealized gains and losses (arising from the difference between its carrying value and current fair value} are recognized in profit and loss.”