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.
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What does “other than temporary” mean for an available-for-sale investment?
When the investment is classified as available-for-sale, then any unrealized losses are recorded to OCI because management believes the fair value will increase in the long term. Therefore, the loss is considered temporary. However, if management decides that the loss is “other than temporary”, that means that the decline in fair value is permanent, and […]
Where does a company record the purchase of an available-for-sale security in the cash flow statement?
When a company purchases an available-for-sale security, the purchase cost represents a cash outflow and would be recorded in the investing section of the cash flow statement. This is captured in #3 in the visual below.
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 […]