The bonds are called for 101,000 and calculate the gain recognition if it is classified as available for sale.
According to the curriculum, available for sale securities are reported on the balance sheet at fair value. The fair value in this example is 98,500 and the amortized cost is 96,830 (beginning value + amortized discount).
The answer says the realized gain for this security if being classified as AFS is 101,000-96,830=4170.
I am wondering why it doesn’t use the fair value 98,500, i.e. 101,000-98,500=2,500?
In calculating the _ realized _ gain/loss for an available-for-sale security, the fair market value isn’t relevant. The calculation of the realized gain/loss is the sales price less the purchase price (adjusted for depreciation/amortization).
The only effect that the fair market value (as of the previous balance sheet date) has for available-for-sale securities is to create an unrealized gain/loss that goes direct to equity each year. Because _ that gets reversed _ when the security is sold, the entire (realized) gain/loss appears on the income statement when the security is sold.
For a trading security, you would have subtracted the fair market value because you had already recognized (through the income statement) the gain/loss that got you to that fair market value.
In the solution to example 1 of the reading on investments in financial assets, the unrealized gain on the debt security classified as AFS is $53,000. This unrealized gain is the difference between the fair value as at the end of the year of $350,000 and $297,000 amortized cost of the debt security. (The initial fair value of the security is $300,000)
My question is: why is the unrealized gain not $50,000 or similarly why is the initial fair value of $300,000 reduced by the amortization of $3,000 for the purposes of determining the unrealized gain??
The amortization of $3,000 is a _ realized _ loss (i.e., it goes through the income statement). Just as with depreciation, this lowers the basis for the asset. When computing the unrealized gain or loss, you compare the current market value to the basis.