Fiduciary had an investment in Portfolio A that had a market value of $7 million accounted for as available for sale. It had originally charged $3 million when Portfolio A was marked-to-market in the equity account on Fiduciary’s balance sheet. Now, it has been determined that $1 million of the $3 million charge has been permanently impaired. Fiduciary should: A) charge an additional $1 million against the income statement while recognizing an additional charge (debit) to the equity section of the balance sheet. B) reclassify $1 million by charging it against the income statement while recognizing an increase (credit) to the equity section of the balance sheet. C) reclassify $1 million by charging it against the income statement while recognizing a decrease (debit) to the equity section of the balance sheet. D) charge an additional $1 million against the equity section of the balance sheet.
B You are moving that $1 million of impairment through the income statement. Increase equity, and eventually the impairment will flow to RE.
you guys are good. Your answer: C was incorrect. The correct answer was B) reclassify $1 million by charging it against the income statement while recognizing an increase (credit) to the equity section of the balance sheet. When there is an impairment of a previously realized charge that only affected the equity section of the balance sheet, a reclassification charge must be made to transfer the permanent impairment charge to the income statement. This accounting entry is a charge against the income statement with a corresponding credit or increase to the equity section. Why are we increasing equity? What would be the offsetting entry?
I think of the decreased retained earnings due to running a 1MM loss through the IS. The only way to make it balance is to offset it with a credit to equity. At the end of the day, you should end up with the same equity as before, but now you took a hit to NI. Don’t know if that’s the right way to explain it, but that’s the way I think of it.
shouldn’t there be another BS adjustment?
no other b/s adj needed… the debit is to NI and the credit is to equity, therefore this is a balanced entry
k im lost on this can someone paraphrase it in laimens terms? or even use another example or generic rules for impairment 1luv free tibet brapp
dark, hate to break it but NI isn’t on the BS
you’re right… it’s not. but the entry comes back in to equity through retained earnings. also, not all transactions hit the b/s only… e.g. sale of $100 would show up as a debit to cash, and a credit to inventory (v simplistic example) and if this were it, it would ultimately result in an unbalanced b/s (assuming you sell for more than you buy), but Sales, COGS are on the I/S, not the B/S and NI flows back in to equity at the end of the year to make the b/s balance.
so there’s a temporary imbalance that’s resolved @ next BS date?
ng30, I think you are right although its not really an “imbalance” though since the B/S is a static snapshot of your firm. its not like they are activly running an imbalance. When they run the Balance Sheet it will show the $7m mark up under Comprehensive Income but Retained earnings would be $1m less due to the hit it took on the I/S. This all makes since but what about taxes? Is the $1m hit below NI? otherwise the decrease in NI would be less then $1m due to the tax shield.