Deciphering Investment Accounting for the U.S. FAR CPA Exam
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
Investments show up on the balance sheets of most companies, and accounting for them is a well-tested topic on the FAR section of the CPA exam.
What counts as an investment?
Investments are assets a company acquires with the intent of earning a return. They fall into two broad categories:
- Equity investments
- Debt investments
How do you account for equity investments?
The accounting method depends on how much of the investee the company owns:
- 0–20% ownership (cost or fair value method) — when a company owns less than 20% of another company, the investment is recorded at cost or fair value. Under the fair value method, changes in value are recognized in the income statement.
- 20–50% ownership (equity method) — this range generally indicates significant influence over the investee. The investment is initially recorded at cost, then adjusted for the investor's share of the investee's net income or loss.
- Over 50% ownership (consolidation method) — ownership above 50% generally means control, so the two companies' financial statements are consolidated.
How do you account for debt investments?
- Held-to-maturity — accounted for at amortized cost
- Available-for-sale (AFS) — accounted for at fair value, with unrealized gains or losses recognized in other comprehensive income (OCI)
- Trading securities — accounted for at fair value, with unrealized gains or losses recognized in income
What do the journal entries look like?
0–20% equity investment, at cost: A company invests $10,000 and owns 15% of the business.
- Debit Investment in XYZ $10,000
- Credit Cash $10,000
Equity method: The investee reports net income of $20,000, and the investor owns 30%. The investor's share is $20,000 × 30% = $6,000.
- Debit Investment in XYZ $6,000
- Credit Equity in Investee Income $6,000
Consolidation: No separate journal entry is typically made. Instead, all of the investee's assets, liabilities, revenues, and expenses are combined with the investor's own financial statements.
Held-to-maturity debt investment: A company invests $10,000 in a 10-year bond.
- Debit Investment in Bonds $10,000
- Credit Cash $10,000
Available-for-sale investment: An AFS security's fair value increases by $500.
- Debit Investment in AFS $500
- Credit Unrealized Holding Gain (OCI) $500
What gets disclosed?
Companies must disclose their accounting policies for investments, the nature and risks associated with them, and how fair values are determined.
Ownership percentage drives the accounting method for equity investments — cost or fair value below 20%, the equity method between 20% and 50%, and consolidation above 50%. Debt investments are classified by intent instead: held-to-maturity at amortized cost, and available-for-sale or trading securities at fair value, with the gain or loss landing in OCI or net income depending on which one it is.
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 95 on FAR. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.