Conceptual Question about changes in the fair value of investments

patbaker12

Suppose we are required to hold an investment at the minimum of fair value & amortized cost. If the fair value is greater than amortized cost obviously we hold the investment at amortized cost. In this case we don't record changes in the fair value as direct changes to surplus because the investment is currently being held at amortized cost right?

graham

I want to say yes, but let me stop and think through it first. Here's what we know:

• if an investment is held at fair value on the balance sheet then changes in its value would be unrealized capital gains and this is a direct charge to surplus
• if an investment is held at amortized value on the balance sheet then the annual amortization amount flows through the income statement as an expense and reduces the value of the asset on the balance sheet by that same amount (which I believe is what you alluded to in your question.) In this case, surplus is still affected but not as a direct charge.

The thing that's bothering me is that an asset may not be valued the same way over its lifetime. If one or the other of "fair value" and "amortized cost" is always lower, then we always use either "direct charges to surplus" or "charges to income". That seems straightforward. You have to pick one way to record changes otherwise you'd be double-counting.

But let's say initially, fair value is lower. We would record changes in the asset's value as direct charges to surplus. Then suppose after a few years, amortized cost is lower. I suppose we'd have to switch accounting methods and start recording changes in the asset's (amortized) value as charges to income (instead of changes in its fair value as direct charges to surplus.)

Without being an accountant, I guess that's reasonable. However, we'd have to make sure we always keep track of both values somewhere, the fair value and the amortized value, just in case they switch. We'd also have to remember to compare fair value and amortized value every time a quarterly or annual report is produced.

Sorry, that's probably a longer answer than you were looking for! But I always like to flesh out my answer to make sure my thinking is correct (and make it easier for someone else to follow and/or pinpoint any error in my reasoning.)

Conclusion: You are correct. (If an asset is held at amortized cost then we do not record changes in fair value as direct charges to surplus.)

Hope that helps.