What is an available-for-sale (AFS) security?
– Definition: An available-for-sale security is a debt or equity investment that a company does not intend to trade actively in the short term and does not plan to hold to maturity. It sits between two other common accounting categories: held-for-trading (HFT) and held-to-maturity (HTM).
– Key idea: AFS investments are carried at fair value on the balance sheet, but unrealized gains and losses are reported outside net income — in other comprehensive income (OCI) — until the investment is sold.
Core terms (short definitions)
– Fair value: the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.
– Unrealized gain/loss: the increase or decrease in an investment’s fair value that has not been realized by selling the investment.
– Other comprehensive income (OCI): a component of shareholders’ equity that accumulates certain gains and losses excluded from net income, including unrealized gains/losses on AFS securities.
– Held-for-trading (HFT): securities purchased with the intention of short-term resale; unrealized gains/losses flow through net income.
– Held-to-maturity (HTM): debt securities a firm intends and has the ability to hold until maturity; measured at amortized cost (unless impaired).
How the accounting works — step-by-step
1. Classification at purchase
– When a company acquires an investment, it must classify it as HFT, HTM, or AFS based on intent and ability to hold.
2. Initial measurement
– Record the investment at cost (cash paid or fair value of consideration).
3. Subsequent measurement
– AFS securities are remeasured to fair value each reporting date.
– The change between cost (or last carrying amount) and fair value is an unrealized gain or loss.
4. Where the unrealized amount is reported
– For AFS: record unrealized gains/losses in OCI (accumulated other comprehensive income on the balance sheet). They do not affect net income until realized.
– For HFT: unrealized gains/losses go into net income immediately.
– For HTM: measured at amortized cost; not remeasured to fair value unless impairment occurs.
5. On sale or realization
– When an AFS security is sold, the accumulated OCI amount related to that security is reclassified from OCI into net income (i.e., realized gain or loss recognized on the income statement).
6. Bank regulatory capital
– For banks, changes in AFS fair value can affect regulatory capital calculations; firms should monitor regulatory guidance.
Balance sheet placement and current vs. long-term
– AFS securities are reported at fair value under assets.
– Classification as current (short-term) or noncurrent (long-term) depends on intent/expected holding period: if management expects to sell within 12 months, list as a current asset; otherwise as a long-term asset.
Short checklist for accountants and analysts
– [ ] Decide the intended holding purpose at acquisition: HFT, AFS, or HTM.
– [ ] Record initial purchase at cost (debit investment; credit cash).
– [ ] Each reporting date, determine fair value.
– [ ] Record unrealized gains/losses: for AFS post to OCI; for HFT post to net income.
– [ ] If sold, reclassify accumulated OCI into net income and record cash proceeds vs. carrying amount.
– [ ] For HTM, test for impairment instead of fair-value remeasurement.
– [ ] For banks, evaluate the regulatory capital effect of any OCI movement.
Worked numeric example (simple)
Assumptions:
– Company buys an AFS bond portfolio for $100,000 cash on Jan 1.
– At the next reporting date the portfolio’s fair value is $50,000.
Journal entries:
1) Purchase (Jan 1)
– Debit: AFS investments (asset) $100,000
– Credit: Cash $100,000
2) Adjustment to fair value (reporting date)
– The carrying value must be reduced by $50,000 to match fair value.
– Debit: OCI — unrealized loss $50,000
– Credit: AFS investments $50,000
(Balance sheet: AFS investments now $50,000; accumulated OCI shows a $50,000 loss.)
3) If fair value later increases by $10,000 (to $60,000)
– Debit: AFS investments $10,000
– Credit: OCI — unrealized gain $10,000
(Accumulated OCI loss is now $40,000 net.)
4) On sale at $60,000
– Debit: Cash $60,000
– Debit/Credit: Remove AFS investments ($60,000 carrying)
– Reclassify the $40,000 net loss from accumulated OCI into current period net income as a realized loss (amounts depend on prior OCI balance). Net income is then affected on sale.
Notes and assumptions for the example
– This example simplifies accrued interest,
This example simplifies accrued interest, taxes and transaction costs. Real-world accounting for available-for-sale (AFS) securities typically involves additional entries for accrued interest, broker fees, and deferred taxes; those items affect both timing and amounts in the balance sheet and income statement. Below are practical notes,