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CPA FAR – STUDY UNIT 5

Cash and Investments
Core Concepts

1. Cash
a. Cash is the most liquid asset and the customary medium of exchange. Thus, it provides the
standard of value (the unit of measurement) of reported transactions.
b. Cash is ordinarily a current asset. To be classified as cash, an asset must be readily
available for use by the business.
1) Restricted cash is not actually set aside in special accounts. It is designated for
special uses and should be separately presented and disclosed.
c. Cash equivalents are short-term, highly liquid investments.
d. Noncash items include (1) nonsufficient funds checks, (2) overdrafts, and (3) noncash
short-term investments.
e. Cash is recorded in a general ledger control account, with corresponding subsidiary ledgers,
and appears as one account on the balance sheet.
f. The most common bank reconciliation adjusts the book balance and the bank balance.
Each result should be the true balance.
2. Fair Value Option (FVO)
a. An entity may elect the FVO for most recognized financial assets and liabilities. An item is
then measured at fair value.
b. The decision whether to elect the FVO is made irrevocably at an election date (unless a
new election date occurs).
3. Investments in Equity Securities
a. An equity security is an ownership interest in an entity or a right to acquire or dispose of
such an interest.
b. Investments in equity securities are measured at fair value at each balance sheet date.
Unrealized holding gains and losses on remeasurement to fair value are reported on the
income statement at each subsequent reporting date.
c. At each reporting date, a qualitative assessment of whether an investment is impaired must
be performed. It is impaired if its fair value is lower than the carrying amount.
4. Equity Method
a. If the FVO is not elected, the equity method is applied when an investor has significant
influence over the investee. An investment of 20% or more of the voting stock of an
investee is presumed to enable the investor to exercise significant influence.
b. Under the equity method, the investor recognizes in income its share of the investee’s net
income or loss for the period.
1) The investor’s share of the net income (loss) of the investee increases (decreases) the
equity method investment.
2) Dividends received from the investee decrease the equity method investment but do
not affect the investor’s income.
c. Any difference between the cost and the underlying equity in the investee’s net assets at
the acquisition date also affects the carrying amount of the investment and equity method
income when this difference is amortized in subsequent periods.

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2 CPA FAR – Study Unit 5

5. Investments in Debt Securities

a. A debt security represents a creditor relationship with an issuer. Debt securities are
classified as (1) held-to-maturity, (2) trading, and (3) available-for-sale.
b. Held-to-maturity securities are reported at amortized cost. The holder of the security must
have the (1) positive intent and (2) ability to hold the security until its maturity date.
c. Trading securities are purchased and sold frequently. They are initially recorded at cost
but are remeasured at fair value at each balance sheet date. Unrealized holding gains and
losses are reported in net income.
d. Available-for-sale securities are those not classified as held-to-maturity or trading. At each
balance sheet date, they are remeasured at fair value. Unrealized holding gains and losses
are reported in other comprehensive income.
6. Investments in Bonds
a. A bond is a formal contract by an issuer to pay an amount of money (face amount) at the
maturity date plus interest at the stated rate at specific intervals.
b. An investment in a bond is recorded on the purchaser’s books at the present value of the
bond’s cash flows (interest and principal), discounted at the prevailing market interest
rate at the time of the purchase.
1) If the bond’s stated rate is greater than the current market rate, the purchase price is
higher than the face amount, and the bond is purchased at a premium.
2) If the bond’s stated rate is less than the current market rate, the purchase price is
lower than the face amount, and the bond is purchased at a discount.
3) An investor in bonds rarely uses a separate premium or discount account, instead
recording the investment at historical cost.
c. Any premium or discount is amortized over the life of the bond using the effective interest
method. The essence of the effective rate method is application of a constant interest rate.
The total amount of interest revenue recognized changes every period.
d. When debt securities with detachable stock warrants are purchased, the price should be
allocated between the warrants and the securities based upon their relative fair values.

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