You have been hired as a consultant for ABC Investment Group. ABC incorporated i

Question

You have been hired as a consultant for ABC Investment Group. ABC incorporated in 1999 and manages investment portfolios for small to medium size companies. The Director of the company is not up to speed on how unrealized gains and losses as well as realized gains and losses on bonds should be accounted for. The Director has been told that under certain conditions unrealized gains and losses can be accounted for in the income statement and accounted for as part of other comprehensive income under other conditions. The Director is also unclear as to how to determine whether a security is impaired and how to determine the amount that is required to be written down. You have been asked to look into these issues and determine the proper accounting treatment for bonds.

In a minimum of 10 to 15 sentences, identify the key terms in your case and state why you believe each is relevant to your case , and make sure to document your sources

Explanation / Answer

Treatement of Unrealized Gain/Loss

Increase or decrease in the value of a security result in unrealized gain or loss. The treatment of such a gain or loss depends on the classification of investments (FASB 115) which can be held-to- maturity, available-for-sale securities or trading securities. The treatment of gain/loss for each type of security is discussed below:

1) Any security to be held-to-maturity will get reported at an "Amortized Cost". In other words, no unrealized gain or loss is recognized with respect to such an investment.

2) Trading securities are reported at fair value and any unrealized gain or loss occurring with respect to such securities will form part of income statement for the relevant period.

3) Available-for-sale securities should be reported at fair value. However, any unrealized gain or loss occurring with respect to such securities wil not be reported in the income statement. The gain or loss will be reported as a part of comprehensive income. Further, it will be reported separately under the stockholder's equity section of the balance sheet.

Once the gain/loss has been realized, they form part of the income statement irrespective of the type of investment.

_______

Impairment of Security

The impairment can occur only with respect to available-for-sale and held-to-maturity securities. The steps to be followed for impairment are provided below:

a) Determine whether the fair value of the security is less than the amortized cost (book value) of investment as reported in the balance sheet.

b) Determine whether the decline in fair value is other than temporary.

c) If the impairment is other than temporary, the impairment loss will be equal to the value by which the fair value of the security falls below the amortized cost. In such a case, the fair value of the security will be treated as the new cost basis and will be reported accordingly in the books of accounts.

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