The accounting for "available-for-sale" securities

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 big 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:   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 the income statement. In fact, a deeper study of accounting will reveal that the income statement structure can grow in complexity to capture various types of unique transactions and events (e.g., extraordinary gains and losses, etc.). 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 areas where accounting rules have evolved to provide for special circumstances. 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. The OCI gain/loss may be charged or credited directly to an equity account (Accumulated OCI), thereby bypassing the income statement. In the USA, there are actually a variety of reporting options for OCI. Some companies report OCI as part of a comprehensive income statement, while others prepare a separate schedule reconciling net income to total comprehensive income. Still other companies find it sufficient to include a reconciliation within a statement of stockholders' equity. International standards generally report the effects of changes in value of available sale securities as direct adjustments of equity. 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: 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: This charge against OCI will reduce stockholders' equity (the balance sheet remains in balance with both assets and equity being decreased). 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: 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. A VALUATION ADJUSTMENT ACCOUNT:   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. This coverage is best reserved for more advanced courses. DIVIDENDS AND INTEREST:   Dividend or interest income received on available-for-sale securities is reported in income:   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 aid the illustration, all accounts are held constant during the month of April, with the exception of those that change because of the fluctuation in value of Merriam's stock. In reviewing this illustration, 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.