The accounting for available-for-sale securities will look quite similar to the accounting for trading securities from Chapter 6. In both cases, the investment asset account will be reflected at fair value. But, there is one significant difference pertaining to the recognition of the changes in value. For trading securities, the changes in value are recorded in operating income. However, for available-for-sale securities, the changes in value go into a special account called Unrealized Gain/Loss – Other Comprehensive Income. It may be helpful to review the Chapter 6 coverage of trading securities.

 

OCI

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Other comprehensive income (OCI) is somewhat unique. Begin by recognizing that the accounting profession embraces the all-inclusive approach to measuring income. This essentially means that all transactions and events make their way through net income. This has not always been the case; once only operational items were included in the income statement (a current operating concept of income).

Despite the all-inclusive approach, there are a few circumstances where accounting rules provide for special treatment. Such is the case with Unrealized Gain/Loss – OCI. The changes in value on available-for-sale securities are recognized, not in operating income as with trading securities, but instead in this unique account. There are two reporting options for OCI. Some companies report OCI within a broader statement of comprehensive income, while others prepare a separate schedule reconciling net income to
total comprehensive income.

 

Example

Assume that Webster acquired an investment in Merriam Corporation. The intent was not for trading purposes, control, or to exert significant influence. Thus, the investment was classified as available-for-sale. The following entry was needed on March 3, 20X6, the day Webster bought stock of Merriam:

 

Purchase of Stock Journal entry

 

Next, assume that financial statements were being prepared on March 31. By that date, Merriam’s stock declined to $9 per share. Accounting rules require that the investment “be written down” to current value, with a corresponding charge against OCI. The charge is recorded as follows:

 

Decline in Value Journal entry

 

This charge reduces other comprehensive income. But, net income is not reduced, as there is no charge to a “normal” income statement account. The rationale is that the net income is not affected by temporary fluctuations in market value, given the intent to hold the investment for a longer term. During April, the stock of Merriam bounced up $3 per share to $12. Webster’s adjustment is:

 

Stock Value Journal entry

 

Notice that the three journal entries now have the available-for-sale securities valued at $60,000 ($50,000 – $5,000 + $15,000). This is equal to their market value ($12 X 5,000 = $60,000). The OCI has been adjusted for a total of $10,000 in credits ($5,000 debit and $15,000 credit). This cumulative credit corresponds to the total increase in value of the original $50,000 investment. As an alternative to directly adjusting the Available-for-Sale Securities account, some companies may maintain a separate Valuation Adjustments account that is added to or subtracted from the Available-for-Sale Securities account. The results are the same; the reasons for using the alternative approach are to provide additional information that may be needed for more complex accounting and tax purposes.

 

Dividends and Interest

Dividend or interest income received on available-for-sale securities is included in net income:

 

Dividends/Interest Income Journal entry

 

On the Income Statement

Assume that Webster’s operations produced a $10,000 net income for April. The lower portion of the resulting statement of comprehensive income would appear as follows:

 

Webster Income Statement

 

On the Balance Sheet

The preceding events would result in the following balance sheet presentations of available-for-sale securities at March 31 and April 30. To simplify the illustration, the only accounts that are assumed to change during April relate to the fluctuation in value of Merriam’s stock and an assumed increase in cash and retained earnings because of the $10,000 net income. In reviewing the following illustrations, note that available-for-sale securities are customarily classified in the Long-term Investments section of the balance sheet. And, take note that the accumulated OCI is appended to stockholders’ equity.

 

Webster Balance Sheet

 

Webster Balance Sheet

 

Did you learn?
Recall the accounting for trading securities from an earlier chapter.
Understand the nature of Other Comprehensive Income.
Have a broad concept of income reporting principles, as comprehended by the “all inclusive” approach.
Describe the method of accounting for available-for-sale securities, and be able to provide a comprehensive illustration.
Be able to describe how available-for-sale securities impact the financial statements, especially with changes in value.