CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingEasy
A publicly traded company holds a portfolio of equity investments that are classified as available-for-sale (AFS). At the end of the current fiscal year, the fair value of these investments is $2,500,000, and their original cost was $2,300,000. During the year, the company had also sold some AFS securities, realizing a gain of $50,000. How should the unrealized gain on the remaining AFS investments be reported in the financial statements?
- AAs a direct adjustment to retained earnings on the balance sheet.
- BAs a component of other comprehensive income (OCI) and accumulated OCI on the balance sheet.
- CAs a component of net income on the income statement.
- DAs an extraordinary item on the income statement.
Show answer & explanationAnswer & explanation
Correct answer: B. As a component of other comprehensive income (OCI) and accumulated OCI on the balance sheet.
Unrealized gains and losses on available-for-sale (AFS) debt securities (and previously AFS equity securities before ASU 2016-01) are recognized in other comprehensive income (OCI). These amounts accumulate in accumulated other comprehensive income (AOCI) on the balance sheet until the securities are sold, at which point they are reclassified to net income.
Why the other options are wrong
- A. Direct adjustments to retained earnings are typically for prior period adjustments or certain accounting changes, not unrealized gains/losses.
- C. Unrealized gains/losses on available-for-sale securities are not recognized in net income until realized.
- D. Extraordinary items have been eliminated under U.S. GAAP, and this classification is incorrect for unrealized gains/losses.
AFS Unrealized Gains/Losses
Unrealized gains and losses on available-for-sale debt securities are recognized in other comprehensive income (OCI) and accumulated in accumulated other comprehensive income (AOCI).
- Not included in net income until realized.
- Part of comprehensive income.
- Impacts equity but not earnings until sale.
Memory trick: AFS gains hide in OCI's vault, awaiting the sale to complete the assault.