Question

Smith buys and sells securities, which it typically classifies as available for sale. On December 15, 2013, Smith purchased $500,000 of Jones shares and elected the fair value option to account for the Jones investment. As of December 31, 2013, the Jones shares had a fair value of $525,000. In the 2013 financial statements, Smith will show (ignore taxes):

Answer 1

Smith will report a capital gain of $25,000 in the 2013 financial statements, reflecting the increase in fair value of the Jones shares from the purchase price of $500,000 to $525,000, due to the election of the fair value option.

Step-by-step explanation:

When Smith purchased Jones shares for $500,000 and the fair value increased to $525,000, this results in an unrealized gain on the investment. Since Smith elected the fair value option for the Jones investment, this gain will be reported in the 2013 financial statements.

The fair value option requires that all changes in fair value be reported in the income statement for the period in which they occur. Therefore, in the 2013 financial statements, Smith will show a capital gain of $25,000 from the Jones investment as a result of the fair value measurement.