Available for Sale Securities

What are Available for Sale Securities?

Definition: Available for sale securities, often abbreviated AFS, are debt and equity investments that are not classified as trading or held-to-maturity securities. In other words, they are all the investments that don’t fit into the trading or held-to-maturity categories.

An available for sale security is a debt or equity instrument that is not classified as one of the following:

  • Trading securities. This classification is assigned to investments where the intent is to sell them in the short term to earn a profit.
  • Held-to-maturity securities. This classification is assigned to investments where the intent is to hold them until the maturity date.

These classifications are mandated by Generally Accepted Accounting Principles for recording investments in the accounting records of a business. The classification is made when a security is purchased.

What Does Available for Sale Securities Mean?

Available-for-sale (AFS) is an accounting term used to describe and classify financial assets. It is a debt or equity security not classified as a held-for-trading or held-to-maturity security—the two other kinds of financial assets. AFS securities are nonstrategic and can usually have a ready market price available.

The gains and losses derived from an AFS security are not reflected in net income (unlike those from trading investments), but show up in the other comprehensive income (OCI) classification until they are sold. Net income is reported on the income statement. Therefore, unrealized gains and losses on AFS securities are not reflected on the income statement.

Net income is accumulated over multiple accounting periods into retained earnings on the balance sheet. In contrast, OCI, which includes unrealized gains and losses from AFS securities, is rolled into “accumulated other comprehensive income” on the balance sheet at the end of the accounting period. Accumulated other comprehensive income is reported just below retained earnings in the equity section of the balance sheet.

Example

Available for sale securities are accounting for and valued much like trading securities because they are sold quite often. AFS balances are reported on the balance sheet at their fair market value. This means that at the end of each period, the AFS account must be evaluated and adjusted for the changes in the market price of the investment. For instance, if the stock price when down, the company would record an unrealized loss of the period and adjust the investment account down. These unrealized gains and losses are not reported on the income statement because they haven’t actually occurred yet. Instead, the unrealized activity is reported on the balance sheet as part of the comprehensive income section.

The presentation on the balance sheet depends largely on management’s intent. For example, management can intend to sell the investments in the current period. These securities would be reported as short-term investments. Likewise, securities that management intends to sell in future periods would be reported as long-term investments on the balance sheet.

Accounting for Available for Sale Securities

If a business has investments in debt and equity securities that are classified as available-for-sale securities, and also if the equity securities have readily determinable fair values, then subsequently record their fair values in the balance sheet. Exclude any unrealized holding gains and losses from earnings, and instead report them in other comprehensive income until they have been realized (i.e., by selling the securities to a third party).

If an available-for-sale security is being hedged in a fair value hedge, then recognize the related holding gain or loss in earnings during the period of the hedge.

Available for sale securities may be classified as current assets on the balance sheet if they are to be liquidated within one year, or as long-term assets if they are to be held for a longer period of time.

Types of Available for Sale Securities

Available for sale securities can broadly be categorized into the following two categories:

Financing Instruments

Financing instruments refer to securities that are issued by a company in the form of bonds and new equity for the purposes of financing the business’ operations. The securities are recorded as liabilities on the company’s balance sheet since the company is expected to provide a certain return to investors that purchase the securities.

For bondholders, the company is legally obligated to make coupon payments and repay the bondholders the face value of the bond at maturity. For stockholders, the company is expected to make operating decisions that will result in an appreciating stock price, which will compensate the stockholders.

Investment Securities

Investment securities are securities purchased by a company for the purpose of making an eventual capital gain or to diversify away some of the risks of the company’s existing investment portfolio.

Companies that operate in a given industry may possess a knowledge advantage over external investors regarding factors that may affect stock prices, which is another reason why companies may choose to invest.

Available for Sale Securities in Banks and Financial Institutions

They are broadly classified by Bank and Financial Institutions under the Banking Book or the Trading book.

Banking Book refers to assets on a Bank’s balance sheet that is expected to be held to maturity. Banks and Financial Institution are not required to mark these assets on a mark to market (MTM) basis and such assets are usually held at historical cost in the books of accounts of the company. The popular category includes assets under Held to Maturity (HTM) category.

Trading Book refers to assets held by a Bank which are available for sale and are traded regularly. These assets are acquired with the intent not to be held till maturity but to profit with them over the near term. Banks and Financial Institution are required to mark these assets on a mark to market (MTM) on a daily basis and such assets are recorded at fair value which is also known as Mark to market accounting. The popular category includes assets held under the Held for Trading (HFT) category and Available for Sale (AFS) category.

Available-for-Sale vs. Held-for-Trading vs. Held-to-Maturity Securities

As mentioned above, there are three classifications of securities—available-for-sale, held-for-trading, and held-to-maturity securities. Held-for-trading securities are purchased and held primarily for sale in the short term. The purpose is to make a profit from the quick trade rather than the long-term investment. On the other end of the spectrum are held-to-maturity securities. These are debt instruments or equities that a firm plans on holding until its maturity date. An example would be a certificate of deposit (CD) with a set maturity date. Available for sale, or AFS, is the catch-all category that falls in the middle. It is inclusive of securities, both debt and equity, that the company plans on holding for a while but could also be sold.

From an accounting perspective, each of these categories is treated differently and affects whether gains or losses appear on the balance sheet or income statement. The accounting for AFS securities is similar to the accounting for trading securities. Due to the short-term nature of the investments, they are recorded at fair value. However, for trading securities, the unrealized gains or losses to the fair market value are recorded in operating income and appear on the income statement.

Changes in the value of available-for-sale securities are recorded as an unrealized gain or loss in other comprehensive income (OCI). Some companies include OCI information below the income statement, while others provide a separate schedule detailing what is included in total comprehensive income.

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