When they switched from the cost method to the equity method (crossing over the 50% barrier), they have to re-calculate their ownership to equity method during the time they only had 15% (what WOULD have been, should they have been using equity.)
In doing so, it's looked at as an available for sale security, since it is neither trading or held to maturity. As such, they would have to mark to market the decrease in market value at the end of the year when they still had only 15%. They bought it for 20,000, and the FMV at 12-31-Year 1 was 17,000. So they would have to debit loss on AVS security in OCI, and credit the investment.
Since they are now adjusting the value of the investment of what “would have been”, it is now in equity method, and not considered an AFS security. In this problem, the total value of their investment “had it been equity the entire time” would have been 24,450. In doing the calculation switching it to equity, they made the adjustment 3,000 OCI loss and 3,000 reduction of investment, thus, the investment account “would have been” 17,000 had the equity method been used. So to get the 17,000 investment account up to the actual new equity method value of 24,450, you have to make an adjustment of 7,450. HOWEVER, if you strictly make that adjustment to RE (credit) and Investment (debit), the 3,000 of loss is still hanging around in OCI … you need to make it whole, and adjust it back to zero at that time. Therefore, you would debit the Investment account by 7,450, adjusting to the actual value of 24,450, then credit OCI loss for the 3,000, making it zero, and the difference of 4,450 is the adjustment/plug to RE.
Hopefully that helps.
Licensed Florida CPA:
B: 71, 73, 79
A: 83
R: 78 (expired), 77
F: 74, 74, 80
It's finally freaking over.
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