Available for Sale Securities – Unrealized Gains/Losses

Wait I’m totally confused. If the unrealized gain/loss isn’t calculated using the amortized cost basis, then why was an unrealized gain of $32,000 reported in equity??

According to here, http://financialexamhelp123.com/investments-in-financial-assets/,

“Unrealized gain/loss=Fair market value –carrying value

where carrying value is the purchase price (when reporting on the first balance sheet date after purchase) or the value reported on the previous balance sheet adjusted for any realized gain/loss (e.g., amortization) reported since the previous valuation. “

@Dr_Pain28 yeah, it took me a long while to wrap my head around it. i’m glad this was of some help.

🙂

Hi @yoshie ! Sorry for the late response but that looks right to me. When lay it out in terms of the accounting formula I see:

Step 1
+14K (Cash Account)
+14K (Interest Income that flows to Retained Earnings)

Assets and Equity go up by $14K, accounting equation balances (A = L + E).

Step 2
-2K (Decrease in book value of bond, which is an asset to you)
-2K (Decrease in interest income due to amortization of premium, reduces Retained Earnings)

Assets and Equity again decrease by the same amount, thus leaving the accounting equation in balance.

That seems to make sense to me, unless someone else chimes in and corrects us both.

@SpyAli @BeanCounter

Thanks you guys for responding. I really appreciate it.

I guess my breakdown came in at a more fundamental level, i.e. I didn’t realize that unrealized gains/losses were calculated using amortized cost basis. I think what confused me was the fact that AFS securities are reported at fair value, so I didn’t understand why amortized cost was even coming into play.

And yes, after revisiting older material, I was able to remind myself how to calculate amortized cost basis (thankfully hahah)

So I understand that the $2,000 is a realized loss for Alpha (as a result of having paid a premium for the debt). Is the unrealized gain $32,000 because if they were to realize the gain, it would effectively reverse that $2,000 realized loss, because they don’t fully eat the premium until maturity?

Ok I think I finally have it.
January 1, 2010
Balance Sheet
Reported at purchase price of $240,000

December 31, 2010
Balance Sheet
Reported at fair value of $270,000

Income Statement
Interest Income of $12,000 (5% x $240,000)
Realized loss of $2,000 via amortization of premium, which is equal to the difference between the coupon received ($14,000) and interest income ($12,000)

Shareholder’s Equity
Unrealized gain of $32,000, which is the fair value ($270,000) subtracted by the amortized cost ($238,000)

So as it stands, Alpha has suffered a realized loss of $2,000 due to the amortization of the premium (which is a built in loss spread out over the life of the bond to recognize the fact that Alpha will only be paid par at maturity, and also due to the matching principle).

Now, if they were to sell the bond on December 31st…

Balance Sheet
Bond is removed

Income Statement
Realized gain of $32,000, which is the unrealized gain reversed from equity and now recognized on the income statement as a “reclassification adjustment”

With the sale, Alpha has realized the gain of $32,000 sitting in equity. The previously realized loss of $2000 would be effectively reversed and Alpha would be $30,000 richer than when it bought the bond at $240,000.