Debt security classifications
| Category | Measurement | Unrealized gains/losses |
|---|---|---|
| Trading | Fair value | Net income |
| Available-for-sale (AFS) | Fair value | Other comprehensive income |
| Held-to-maturity (HTM) | Amortized cost | Not applicable (no fair value adjustment) |
HTM classification requires both the positive intent and ability to hold the security to maturity — equity securities can never be HTM (no maturity date).
Equity securities
Most equity securities (where the investor doesn't have significant influence) are measured at fair value through net income — the old AFS-equity option was eliminated by ASU 2016-01. A practicability exception exists for equity investments without a readily determinable fair value: measure at cost minus impairment, adjusted for observable price changes.
The equity method
Applies when the investor has significant influence — presumed at 20%–50% ownership (rebuttable). Key mechanics:
- Initial investment recorded at cost
- Investment increases by investor's share of investee's net income; decreases by investor's share of losses and dividends received
- Dividends received reduce the investment account — they are not income under the equity method
EXAMPLE: Investor owns 30% of Investee. Investee reports net income of $200,000 and pays $50,000 in dividends. Investor records: Investment income = 30% × $200,000 = $60,000 (increase to investment); dividends received = 30% × $50,000 = $15,000 (decrease to investment, not income). Net increase to the investment account = $45,000.
EXAM TIP: A frequent trap: candidates record equity-method dividends as investment income. Remember — under the equity method, only your share of the investee's net income is income; dividends are a return of investment.