When examining Available for Sale (AFS) securities, it's essential to recognize their similarities to trading securities, with the primary distinction being the treatment of unrealized gains and losses. For AFS securities, changes in fair value are recorded in Other Comprehensive Income (OCI) rather than directly impacting net income. This means that while AFS securities can generate income through dividends and experience changes in fair value, the unrealized gains or losses are not reflected in the income statement until the securities are sold.
AFS securities can be classified as either current or long-term assets, depending on the intent to sell within a year or hold for a longer period. The classification will be specified in the problem statement. The initial measurement of these securities is at cost, which is the amount paid for the investment. Subsequently, they are measured at fair value, similar to trading securities, but with the crucial difference that unrealized gains or losses are recorded in OCI.
For example, consider a transaction where ABC Company purchases 500 shares of XYZ Company common stock for a total of $40,000, indicating the intent to classify these shares as available for sale. This can be presented in two ways: either as a total cost of $40,000 or as a per-share price of $80 ($40,000 divided by 500 shares). Regardless of how the information is presented, the total amount is what matters for the journal entry.
The journal entry for this transaction would involve debiting the investment in AFS securities for $40,000, reflecting the increase in assets, and crediting cash for the same amount, indicating the outflow of cash. This entry maintains the overall asset balance, as the increase in the investment is offset by the decrease in cash.
In summary, understanding the treatment of AFS securities, including their classification, measurement, and the impact of unrealized gains and losses on financial statements, is crucial for accurate financial reporting. The key takeaway is that while AFS securities share characteristics with trading securities, their unique treatment in OCI is a fundamental aspect of their accounting.