Fair Value Method
Often companies use excess cash to purchase stocks and bonds from other companies. If a company purchases stocks or bonds with the intent to sell these items at a future date when they need cash, these are referred to as "Available-for-sale securities".
A company initially records the "available for sale securities" at cost. While holding onto the securities the company must calculate the fair market value for these securities at the end of each subsequent accounting period.
Debt
A company initially records the "available for sale securities" at cost. While holding onto the securities the company must calculate the fair market value for these securities at the end of each subsequent accounting period.
The difference between the purchase price and the current fair market value results in an unrealized gain or loss. The unrealized gain or loss affects the company's accumulated other comprehensive income, a component of stockholders' equity.
Realized gains and losses are included in income; unrealized amounts are included in income (trading investments) or in other comprehensive income (available-for-sale investments).
Unrealized holding gains (unrealized because asset is not sold yet)-increase in fair value of an asset while held.
Realized holding gain (realized through sale) increase in fair value of an asset while held.
Using the fair value method, available for sale investment with unrealized gains and losses included in other comprehensive income should have:
- The original investment is recorded at its investment cost.
- Transaction costs, such as brokerage fees, included in acquisition cost and capitalized, or immediately expensed.
- Interest or dividends declared are recorded as investment income.
- Interest income includes amortization of any premium or discount inherent in the initial purchase price
- At the end of each reporting period, the investments are revalued to fair value (market
- value), whether this is higher or lower than the existing balance in the investment account.
- Unrealized holding gains, defined as the difference between the existing balance in the
- investment account (the new fair value) and the old fair value, are recorded in other comprehensive income.
- The investment is reported at fair value on the balance sheet.
Using the fair value method, available for sale investment with unrealized gains and losses recognized in net income should have:
- The original investment is recorded at its investment cost. This is fair value on the purchase date.
- Transaction costs, such as brokerage fees, may be included in acquisition cost and capitalized, or immediately expensed.
- Interest or dividends declared are recorded as investment income.
- At the end of each reporting period, the investments are revalued to fair value, whether
- this is higher or lower than the existing balance in the investment account.
- Holding gains, defined as the difference between the existing balance in the investment
- account (the new fair value) and the old fair value, are recorded in net income.
- The investment is reported at fair value on the balance sheet.