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5.2. Valuation Adjustments
#cfa-level-1 #reading-23-financial-reporting-mechanics

In contrast to accrual entries that allocate revenue and expenses into the appropriate accounting periods, valuation adjustments are made to a company’s assets or liabilities—only where required by accounting standards—so that the accounting records reflect the current market value rather than the historical cost. In this discussion, we focus on valuation adjustments to assets. For example, in the IAL illustration, Transaction 13 adjusted the value of the company’s investment portfolio to its current market value. The income statement reflects the $2,100 increase (including interest), and the ending balance sheets report the investment portfolio at its current market value of $102,100. In contrast, the equipment in the IAL illustration was not reported at its current market value and no valuation adjustment was required.

As this illustration demonstrates, accounting regulations do not require all types of assets to be reported at their current market value. Some assets (e.g., trading securities) are shown on the balance sheet at their current market value, and changes in that market value are reported in the income statement. Some assets are shown at their historical cost (e.g., specific classes of investment securities being held to maturity). Other assets (e.g., a particular class of investment securities) are shown on the balance sheet at their current market value, but changes in market value bypass the income statement and are recorded directly into shareholders’ equity under a component referred to as “other comprehensive income.” This topic will be discussed in more detail in later readings.

In summary, where valuation adjustment entries are required for assets, the basic pattern is the following for increases in assets: An asset is increased with the other side of the equation being a gain on the income statement or an increase to other comprehensive income. Conversely for decreases: An asset is decreased with the other side of the equation being a loss on the income statement or a decrease to other comprehensive income.

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(See the boxes showing the accounting treatment of Transaction 3, which refers to the originating entry, and Transaction 3a, which refers to the adjusting entry.) In other words, prepaid expenses are assets that will be subsequently expensed. <span>In practice, particularly in a valuation, one consideration is that prepaid assets typically have future value only as future operations transpire, unless they are refundable.<span><body><html>

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ved and the corresponding liability to deliver newsletters) and, subsequently, 12 future adjusting entries, the first one of which was illustrated as Transaction 12. Each adjusting entry reduces the liability and records revenue. <span>In practice, a large amount of unearned revenue may cause some concern about a company’s ability to deliver on this future commitment. Conversely, a positive aspect is that increases in unearned revenue are an indicator of future revenues. For example, a large liability on the balance sheet of an airline relates to cash received for future airline travel. Revenue will be recognized as the travel occurs, so an increase in this liability is an indicator of future increases in revenue. <span><body><html>


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