GAAP Accounting Rules on Unrealized Capital Gains

The US GAAP accounting treatment of unrealized gains depends on the type of investment a company holds. Keep in mind that not all investments will have unrealized gains and losses. Held-to-maturity investments like bonds don't usually elicit unexpected gains. Along with a fixed maturity date, bonds have a fixed payment schedule and a predetermined final payout. Accountants can record interest income from bond payments at whatever interval payments arrive -- usually on a monthly basis.

Trading securites can be debt or equity investments that management plans to resell or trade in the near future. These securities are valued at fair value and any unrealized gains and losses are recorded in operating income. For example, say Company X owns one share of trading stock that increased $5 in value. The company doesn't sell the stock, so the gain is unrealized. The accountant should record a journal entry that debits Trading Securities for $5 and credits the Unrealized Gains subaccount of Operating Income for $5.

Available-for-sale securities are almost identical to trading securities. The only reason the security is considered available for sale is because management asserts they are carrying the security for a reason other than trading. Instead of affecting operating income, unrealized gains and losses are recorded in the other comprehensive income account. For example, if Company X determines that its stock is available for sale, the accountant would debit Available-For-Sale Securities and credit Other Comprehensive Income.

The accounting treatment is a bit different for companies that have significant influence in their investment. If a company owns between 20% and 50% of another company's stock, it has a significant influence in it. Any unrealized stock gains should be accounted for using the equity method. In equity accounting, the stock is considered part of the company's assets and the gain can be recognized immediately. For example, say that Company X had significant influence in the stock that increased $5 in value. The accountant would debit Equity Investment for $5 and credit Investment Income for $5.

If a company owns more than 50% of another company's stock, it exercises majority control over the company. Even if the other company continues to operate as usual and maintains its legal existence, accounting requires companies to use the consolidation method if they exercise control over another company. Under the consolidation method, the "controlled" company's financial information must be incorporated into the financial statements of the controlling company. For example, say that Company X exercises control over the company with the $5 stock gain. In this situation, no additional journal entry would be required because Company X consolidates 100% of the company's income statement and balance sheet into their financial statements.