What is the accounting treatment for securities available for sale?

Answer 1

Firms initially record investments in securities available for sale at acquisition cost, including transaction costs. If a firm classifies debt securities as available for sale, it must amortize any difference between the purchase price and the maturity value of the debt over the remaining term to maturity, the same as if the firm classified the debt as held to maturity. This amortization makes interest revenue on these debt securities differ from the cash receipts for debt service payments. On the date of each balance sheet, firms measure securities classified as available for sale at fair value. The difference between amortized cost for debt securities or the carrying value for equity securities and the fair value of these securities is an unrealized holding gain or loss. The unrealized holding gain or holding loss increases or decreases Other Comprehensive Income (a shareholders' equity account), which firms close to Accumulated Other Comprehensive Income (another shareholders' equity account) at the end of the period. Accumulated Other Comprehensive Income includes the sum of all increases and decreases in fair value of securities available for sale that have not yet appeared in net income. Holding gains and losses on securities available for sale affect net income only when the firm sells these securities; that is, when the firm realizes the gain or loss.

Firms must test securities classified as available for sale for impairment. If the securities are impaired, the firm treats the unrealized loss in Accumulated Other Comprehensive Income as if it were realized.

The required accounting for trading securities and for securities classified as available for sale differs with respect to the income statement but not with respect to the balance sheet. The unrealized gain or loss on trading securities appears in net income in the period when fair value changes occur. The unrealized holding gain or loss on securities available for sale appears in other comprehensive income period by period, and its cumulative amount resides in the Accumulated Other Comprehensive Income account on the balance sheet. Management can sell securities with unrealized holding gains (or losses) and transfer through net income to Retained Earnings the entire unrealized holding gain (or loss)—that is, management can affect the timing of gain or loss recognition in net income for securities available for sale but not for trading securities. This timing ability is, however, asymmetric in that impairment rules preclude indefinite deferrals of the recognition in income of unrealized losses, but not unrealized gains. Users of the financial statements should be alert to this accounting effect in evaluating the profitability of firms with both types of securities.