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How is an unrealized loss on an available-for-sale (AFS) security recorded in the financial statements?

For investments that are classified as available-for-sale (AFS), any unrealized gains or losses are recorded to other comprehensive income (OCI). When the company has an unrealized loss, the debit would be to other comprehensive income (reduces equity) and the credit is to the investment account on the asset section of the balance sheet. There is no income statement impact in this journal entry.

The credit to the investment account will reduce the carrying amount of the investment on the balance sheet. This reduction is sometimes referred to as a valuation allowance on the investment.

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  • How are changes in fair value for equity securities recorded on the income statement?

    Treatment varies depending on whether its classified as “trading” or “available-for-sale”. Additionally, you must determine whether the decline in fair value is temporary or other than temporary (i.e. permanent). Remember, to determine whether or not significant influence exists. For trading securities, unrealized and realized losses are recorded in the income statement. For available-for-sale securities, assuming change in fair value is temporary, then unrealized gains or losses recorded to OCI, which is part of stockholders’ equity on the balance sheet. Any realized gains or losses for AFS securities are recorded in the income statement.

  • What is an available-for-sale equity security?

    Assuming that the company owns less than 20% of outstanding shares and does not have significant influence, then a company can use the fair value option to value an investment. The equity investment can be classified as trading or available-for-sale. “Available-for-sale” (“AFS”) generally means that the company plans to hold the equity security for a period greater than 1 year. If less than 1 year, then the equity investment would be classified as “trading”. For an AFS equity security, unrealized gains and losses are recorded to OCI, which is part of stockholders’ equity in the balance sheet. The unrealized gains or losses are recorded to OCI because the change in fair value is considered “temporary”. Gains and losses can be realized on an AFS security if the equity security is sold or the company believes the change in fair value is “other than temporary”. The AFS security will be recorded as a current or non-current asset. Any cash inflows or outflows related to AFS securities will be recorded in the “investing section” of the cash flow statement.

  • What is the journal entry to reclass an unrealized loss from OCI to the income statement?

    If a company has an unrealized loss on an AFS security that is considered temporary, then the unrealized loss would be recorded to OCI. However, if the unrealized loss seems like it will be permanent (other than temporary), then the unrealized loss should be removed from OCI and recognized to the income statement. The journal entry below illustrates the Year 1 entry and the entry to reclass the loss to the income statement in Year 2.