CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsMedium
A company holds equity securities classified as available-for-sale (AFS). At the end of the year, the fair value of these securities is $150,000, while their cost was $130,000. There were no sales of AFS securities during the year. How should the $20,000 unrealized gain be reported in the financial statements?
- AAs an increase in Accumulated Other Comprehensive Income (AOCI) in equity.
- BAs a component of net income.
- CAs a deferred gain liability.
- DAs a direct increase to Retained Earnings.
Show answer & explanationAnswer & explanation
Correct answer: A. As an increase in Accumulated Other Comprehensive Income (AOCI) in equity.
Unrealized gains and losses on available-for-sale (AFS) debt securities are reported as a component of Other Comprehensive Income (OCI) and accumulate in Accumulated Other Comprehensive Income (AOCI) in the equity section of the balance sheet, not in net income.
Why the other options are wrong
- B. Unrealized gains/losses on AFS debt securities do not affect net income until realized.
- C. Unrealized gains are not liabilities; they are equity adjustments.
- D. Retained Earnings are affected by net income and dividends, not unrealized AFS gains.
Available-for-Sale (AFS) Debt Securities
Debt securities not classified as held-to-maturity or trading, reported at fair value with unrealized gains/losses in OCI.
- Reported at fair value on the balance sheet.
- Unrealized gains/losses are recognized in Other Comprehensive Income (OCI).
- Realized gains/losses (from sale) are recognized in net income.
Memory trick: AFS: OCI's Fair Value Friend.