Question

we are aware of the types of investment securities a company can have, how does each type of security affect the financial statement when it comes time to record unrealized gains or losses? More specifically, what ARE unrealized gains and losses?

Answer 1

‎ Debt investments and equity investments recorded using the cost method are classified as trading securities, available‐for‐sale securities, or, in the case of debt investments, held‐to‐maturity securities. The classification is based on the intent of the company as to the length of time it will hold each investment. A debt investment classified as held‐to‐maturity means the business has the intent and ability to hold the bond until it matures. The balance sheet classification of these investments as short‐term (current) or long‐term is based on their maturity dates.

Debt and equity investments classified as trading securities are those which were bought for the purpose of selling them within a short time of their purchase. These investments are considered short‐term assets and are revalued at each balance sheet date to their current fair market value. Any gains or losses due to changes in fair market value during the period are reported as gains or losses on the income statement because, by definition, a trading security will be sold in the near future at its market value.

The treatment of unrealized gains or losses in the financial statements depends on whether the securities are classified as held to maturity, trading, or available for sale.

Unrealized gains or Losses on securities classified as held to maturity are not recognized in the financial Statements; they have no effect on the balance sheet, income statement, and statement of Cash flows. Even so, many companies choose to disclose the market value of the securities as part of the narrative description or in the footnotes that accompany the statements. Whether or not the market value is disclosed, held-to-maturity securities are reported on the balance sheet at amortized cost.

Investments classified as trading securities are reported in the financial statements at fair value. Unrealized gains or losses on trading securities are recognized in net income even though the securities have not been sold.

The gain increases net income, which in turn increases retained earnings.

Unrealized gains and losses have no effect on cash flows. Investments classified as available-for-sale securities are also reported in the financial statements at fair value.

However, an important distinction exists with respect to how the unrealized gains and losses affect the financial statements. Even though unrealized gains or losses on available-for-sale securities are included in the assets on the balance sheet, they are not recognized in determining net income. Increase is reported in a separate equity account called Unrealized Gain or Loss on Available-for-Sale Securities.

The statement of cash flows is not affected by recognizing unrealized gains and losses on available-for-sale securities

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