Available-for-sale (AFS) securities Investments in debt and equity securities that are not classified as trading securities or held-to-maturity securities. are debt and equity securities not classified as trading or held-to-maturity securities. AFS securities are purchased to yield interest, dividends, or increases in fair value. They are not actively managed like trading securities. If the intent is to sell AFS securities within the longer of one year or operating cycle, they are classified as short-term investments. Otherwise, they are classified as long-term.
Valuing and reporting available-for-sale securities. As with trading securities, companies adjust the cost of the portfolio of AFS securities to reflect changes in fair value. This is done with a fair value adjustment to its total portfolio cost. However, any unrealized gain or loss for the portfolio of AFS securities is not reported on the income statement. Instead, it is reported in the equity section of the balance sheet (and is part of comprehensive income, explained later). To illustrate, assume that Music City had no prior period investments in available-for-sale securities other than those purchased in the current period. Exhibit 15.4 shows both the cost and fair value of those investments on December 31, 2010, the end of its reporting period.
Example: If fair value in Exhibit 15.4 is $70,000 (instead of $74,550), what entry is made? Answer:
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The year-end adjusting entry to record the fair value of these investments follows.
Point: Unrealized Loss—Equity’ and Unrealized Gain—Equity’ are permanent (balance sheet) equity accounts.
Exhibit 15.5 shows the December 31, 2010, balance sheet presentation — it assumes these investments are long term, but they can also be short term. It is also common to combine the cost of investments with the balance in the Fair Value Adjustment account and report the net as a single amount.
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Let’s extend this illustration and assume that at the end of its next calendar year (December 31, 2011), Music City’s portfolio of long-term AFS securities has an $81,000 cost and an $82,000 fair value. It records the adjustment to fair value as follows.
Point: Income can be window-dressed upward by selling AFS securities with unrealized gains; income is reduced by selling those with unrealized losses.
Example: If cost is $83,000 and fair value is $82,000 at Dec. 31, 2011, it records the following adjustment:
Selling available-for-sale securities. Accounting for the sale of individual AFS securities is identical to that described for the sale of trading securities. When individual AFS securities are sold, the difference between the cost of the individual securities sold and the net proceeds (sale price less fees) is recognized as a gain or loss.
Point: ‘Fair Value Adjustment— Available-for-Sale’ is a permanent account, shown as a deduction or addition to the Investment account.
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