Unrealized Gains and Losses on Available for Sale Debt Investments

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“This video. I m going to show you how to account for unrealized gains or or losses on available for sale debt investments. So available for sale debt. Investments are a market on the balance sheet.

So that means they re going to be presented at fair value so we have to make changes at the end of each period to make sure that they re at fair value. And any unrealized gains or losses are going to go through other comprehensive income. They re not going to go through net income. They re not going to show up in the income statement.

No changes no realized gains or losses are going to hit the income statement. Unless. We were to actually sell the available for sale debt. Investments.

So let me walk you through an example and kind of show you how this works so let s say that we have this babu chocolate factory. They issued these bonds in the bonds..


The issue price was ninety two thousand two hundred and twenty one dollars. And so from the investor s point of view they re going to debit debt investment and they probably call it debt investment afs available for sale debt investment for ninety two to twenty. One you re going to credit cash for ninety two twenty one and then i ve got a little effective interest table that i put together here now at the end of the dirt at the end of the first year. They re going to need to make an adjusting journal entry because they ve received interest right.

So. The investor has been paid interest by babu right so you re going to debit cash you re going to debit debt investment you re basically amortize encountered in to all that we have in our video on it. What i want to introduce here is that what if at the end of year one then a year one here we say that okay we look and we see that the fair value the fair value of the bond is now ninety five thousand dollars. So the fair value of the bond is ninety five thousand dollars.

So you might be thinking. Why why would the fair value be different than the carrying value because we can see at the end of at the end of year one we can see the carrying value of the bond set ninety three 521. So why would the fair value be different. Well.

It could be the case that maybe between between when we issued the bonds and the end of the first year. Maybe interest rate have gone down interest rates have gone down so now our bonds are more valuable relative to other other bonds so for whatever reason we look we see the fair value is now ninety five thousand and we see that the carrying value is lower than the fair value right so the fair value the end of year..


One is greater than the carrying value so we re going to meet. We re going to need to make an adjusting journal entry. And so it seems kind of counterintuitive you would think you would just debit debt investment directly and then just increase the asset account directly and then credit oci but it doesn t work like that we could create this philly account called fair value adjustment. I know it just adds complexity.

I apologize. But fair value adjustment. Available for sale securities. Okay so what we re going to do we debit.

This and this is going to be added if we were to think about our balance sheet. If we were to look at our balance sheet. So let me say here so here s our balance sheet. And then we ve got our assets.

Okay. So we would see available for sale security..


Okay and we would have it if we just have the carrying value it would be a 95 or 93 five to one. But then we re going to add the fair value adjustment. We re going to add that 1479 okay and if you add them together the net amount is ninety five thousand which is the fair value okay so we have marked this to market that s what we re doing when we re debiting this fair value adjustment account. We are marking this to market now we ve got a debit we need a credit so what do we credit we credit unrealized gain right if it d have been a loss you know obviously we d be debiting putting a lot and then we d be crediting the fair value adjustment.

But we have a gain here so we re going to credit the unrealized gain. But again this is going to go ci other comprehensive income. If you don t know what that is i ve got another video on other comprehensive income basically. Other comprehensive income is and accounted.

So ultimately going to get closed out to accumulated other comprehensive of income on the balance sheet. But basically it increases equity oci increases equity. But if by passes net income. I pass is net income if we ott if this was encounter for as a trading investment.

Okay then it would direct you d be unrealized gain. But it would go is b and i because it would go to net income instead of oc..


I but this isn t available for sale security. So it bypasses the income statement. Okay so equity increases net income is not affected okay. So our journal entry balances here now if in when we go.

And actually sell the available for sale security. Then we could recognize a realize gain that would go in effect net income right so with available for sale securities. It s not that you will never ever affect net income. It s just that the unrealized gains and losses bypass.

The income statement. Go to this o ci account. But then when you actually sell the available for sale security. Then you re going to have a charge to net income again or a loss and so that s why managers like available for sale securities.

Because you can time when you sell the available for sale security to get a little boost to to your net income or so forth right so that s called earnings management and we ll talk about ” ..

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