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I am Larry Walther, this is principlesofaccounting.com Chapter 9.
In this module we are going to look at the available for
sale security category of investments and how to account for those.
First of all, Available for
Sale Securities are reported on the balance sheet at their fair value.
The accounting is very similar to trading securities that we looked at in Chapter 6.
There's an important difference, however.
And that is that changes in value in these investments,
rather than going to operating income each period,
go to a unique category of income called Unrealized Gain/Loss.
Other comprehensive income.
So, other Other Comprehensive Income is now a new term.
It is a unique classification or category of comprehensive income that's not
part of operating income, it's a separate category or a unique classification.
Recognized that for trading securities, the gain or lost or
change in value Went to operating income.
Now we're going to this other comprehensive income
to reflect the changes in available for sale securities.
Recognize that most transactions and
events make their way to the income statement.
Therefore the income statement is deemed to be all-inclusive.
Historically, once upon a time many years ago,
accounts dispute income is only related to current operating concept.
Transactions and
events that were not directly related to operation might have been charged or
credited directly to stock or is equity and bypass the income statement entirely.
Companies have a variety of reporting options related to
other comprehensive income.
It can be reported in an comprehensive income statement.
This goes beyond just the operating income that's seen and
what you might consider to be the normal income statement.
Or other comprehensive income can be measured and
reported in a separate schedule.
That reconciles the company's reported operating net income
to the total comprehensive income of the business.
Let's look at an example now.
This will help clarify, perhaps.
Webster Company acquired an investment in Merriam Company.
The intent was not for trading, control or to exert significant influence.
It's classified as available for sale.
It was purchased for $50,000.
We debit the investment account available for sale securities and
credit cash on the date of acquisition.
Financial statements were prepared at the end of the month.
Value of the investments declined from its $10 purchase price to $9 a share and
here's how we're going to do this.
We're going to debit unrealized gain or loss dash other comprehensive income.
That's that other comprehensive income component charge that's going to be
offset against our stockholder's equity.
And we'll credit the investment account available for sale of securities.
The rationale here is that net income is not affected by these temporary
fluctuations on investments that we're holding for
more than just trading purposes.
And so we're going to carve them out into other comprehensive income
rather than floating them through our normal operating income.
During the next month the stock jumps up $3 in value so
we have a $15,000 recovery in value.
We're going to debit or increase the investment account $15,000 and we're going
to credit this other comprehensive income unrealized gain or loss account.
After the three journal entries,
the investment account has been changed to be reflecting $60,000 in value,
they give the initial 50,000 minus the 5000 write down plus the 15,000 write-up.
That equals its market value at the balance sheet date.
And the other comprehensive income has an adjusted total of 10,000 in credits.
The 5,000 debit from month one and the 15,000 credit from month two.
Now, the treatment would be the same even if the available for
sale securities consist of a portfolio of many investments.
An alternative to directly adjusting the available for sale securities account
might be to carry a valuation adjustment account like the allowance for
uncollectable accounts or something like that that would offset or
increase the investment category.
In my journal entries I just debited and credited the investment account directly.
That separate valuation account could be added or subtracted to the Available for
Sale Securities at cost to bring them the fair value.
It provides the same net results but it gives additional information on what
the relative differences are between cost and
market value and it certainly is useful for tracking tax basis information.
The tax law does not adjust investments to fair value at each financial state of date
as do the financial accounting.
Now if we had dividend income on this.
Debit, cash, and credit, dividend income here.
This is in addition to the recording of the gains and losses that flow into OCI.
The dividend income is considered to be operating income in this case.
It might be helpful to look at our example on a balance sheet.
Here we have the available for sale securities at the end of March,
valued at 45,000.
That was a a $50,000 minus the $5,000 write down.
And our offsetting debit is shown as a reduction from stockholders' equity
as accumulated other comprehensive income or loss.
If we go to the next month we've got our available for
sale securities at $60,000 and our other comprehensive income account accumulated
is now carrying a $10,000 net credit balance.
Which increases stockholders equity.
So we're reflecting the change in value but
we're not impacting the operating income through the normal income statement.
It's only considered to be an other comprehensive income account that's
generally regarded as a It's a direct adjustment
to the equity accounts.
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