Chartered Financial Analyst (CFA) Practice Exam Level 2

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What is the treatment of changes in fair value for investments classified under cost or FVPL?

Realized as a gain or loss on the balance sheet
Recognized as a gain or loss on the income statement
Ignored until sold
Automatically reinvested into the investment

The correct answer is: Recognized as a gain or loss on the income statement

For investments classified under Fair Value Through Profit or Loss (FVPL), changes in fair value are recognized as gains or losses on the income statement in the period they occur. This aligns with the principle of fair value accounting, which aims to provide a realistic update of an investment's value and its impact on financial performance. When an asset is revalued, the increase or decrease in value is reported directly in the income statement. This treatment reflects the current market conditions and the actual economic performance of the investment during that reporting period, thereby ensuring that stakeholders are informed about the latest financial results. In contrast, investments classified under the cost method generally do not reflect changes in market value unless they are sold; therefore, their gains or losses are recognized only upon disposal. Other choices, such as ignoring the changes until sold or automatically reinvesting them, do not follow the principles of accounting used for fair value treatments. Recognizing these changes on the income statement provides transparency and a timely reflection of the investment's performance.