GAAP Accounting Rules on Unrealized Capital Gains

by Angie Mohr

Generally accepted accounting principles (GAAP) in the U.S. require that how you account for your company's investments on its balance sheet is dependent upon the company's intentions to trade or hold the securities. These rules are in flux as of the date of publication. As the U.S. moves towards its committed adoption of international accounting standards, the possibility exists of companies being able to account for all investments at fair market value.

What Are Unrealized Gains?

Unrealized gains represent increases in the value of investments you hold on your balance sheet that have not been realized through a sale of the investment. For example, if you held two stocks in your portfolio, and you bought Stock A for $12 a share and Stock B for $19 a share, the stocks may have very different values three months from now. If you sell Stock A for $15 a share, you have made a realized gain of $3 a share. It's locked in and cannot change because you no longer own the stock. If you're still holding Stock B but it's now worth $23 a share, you have an unrealized gain of $4 a share. This gain will change as the stock changes in market value and could even turn into an unrealized loss.

Trading Securities

If your main intention is to hold investments for less than a year and plan to buy and sell frequently, they are considered trading securities. GAAP requires that these securities are revalued at every balance sheet period at their fair market value (FMV). FMV is determined by what you could get for them if you sold them today. Securities that are traded in public markets have an easily-established, published market value daily, and most trading securities fall into this category. The difference between the balance sheet value and the FMV is taken on the income statement as a gain.

Available-for-Sale Securities

This is the default category for most investment portfolios in companies. Available for sale means that the company likely will not hold the securities forever, but is not actively trading them. GAAP requires that these securities are also revalued at every balance sheet date, but the difference between the recorded value and the FMV goes to the equity section of the balance sheet. This ensures that these unrealized gains and losses -- which may never be realized -- do not affect the current year net profit of the company.

Held-to-Maturity Securities

Securities that the company plans to hold until their fixed maturity date are called held-to-maturity. The most common category of securities found here are bonds. Bonds mature on a certain date, at which time the company receives the face value of the bond and any accrued interest. The funds must then be reinvested. The value of a bond rises and falls based on current interest rates but, because none of these fluctuations will ever be realized, GAAP requires that this category of securities be recorded at amortized cost. Whatever premium or discount was paid for the bond is amortized into income over the life of the bond. This makes the recorded amount of the bond the same as its face value at maturity.

About the Author

Angie Mohr is a syndicated finance columnist who has been writing professionally since 1987. She is the author of the bestselling "Numbers 101 for Small Business" books and "Piggy Banks to Paychecks: Helping Kids Understand the Value of a Dollar." She is a chartered accountant, certified management accountant and certified public accountant with a Bachelor of Arts in economics from Wilfrid Laurier University.