Wednesday, March 10, 2010

Revenue Recognition (contd.)

Dear Friends,

In my last post I addressed the conceptual framework on revenue recognition. Only when the revenue is both earned and recognizable (i.e. when the earning process is finished or nearly finished and delivery/exchange has taken place), it gets recognized in the financial statements.

I also referred to several exceptions to the afore-said rule, which have been laid out in various  pronouncements under GAAP. These alternative revenue recognition methods are being discussed underneath concisely.

1. Installment and Cost Recovery Methods – Only in restricted conditions, revenues and gains may be recognized using either of these methods.

• Collection of sales price is not reasonably assured;
• Receivables are collected over an extended period of time;
• No reasonable basis for estimating the degree of collectability.

Computation under Installment Method
Revenue is recognized as cash is collected and not at the point of sale.

• Gross profit is recognized in proportion to collection to receivables based on gross profit percentage and the remainder is deferred until collected (realized Gross profit = GP% * Collections for the accounting period).

• Installment receivables and deferred gross profit account are kept separately because gross profit rate may vary from year to year (selling and administrative expenses are excluded in computing the gross profit rate).

•If installments are receivable beyond one year, it should be recorded at the present value of the payments discounts at the market rate of interest.

Computation under Cost Recovery Method

It is similar to installment sales method except that no profit is recognized until cumulative collection of receivables exceed the cost of sales. In other words, profit is only recognized when all cost is recouped through collection of amount.

Note: This method is used when the uncertainty of collection is very high that even the use of installment sales method is precluded.

2. Revenue Recognition when right of return exists – When the buyer has the right to return the product, revenue should be recognized at the point of sale only if all of the following conditions are met:

• The seller’s price to the buyer is mainly set or established at the date of sale.

• The buyer has paid the seller or the buyer is required to pay the seller and the commitment to pay is not reliant on resale of product.

• As a consequence of pilfering, spoilage or mutilation of product, the buyer’s commitment to seller would be unaffected.

• The amount of future profits can be reasonably estimated.

• The seller does not have any impending requirement for future performance to result in resale of the product by the buyer.

If these conditions are not met , revenue must be recognized when the return privilige has substantially expired or the requirements are met. Also any costs/losses related to the sales must be accrued.

3. Long-term construction contracts – These are accounted for by two methods:

• Completed Contract Method and
• Percentage of Completion Method.

When estimates of costs to complete and extent of progress toward completion of long-term contracts are reasonably dependable, the percentage-of-completion method is preferable. When no dependable estimates can be made the completed-contract method is preferable.

Reporting Profit under percentage of completion

Income is recognized as the work on contract progresses.

• Recognized proportionately during contract as a percentage of completion.
(Actual cost to date/Estimated Total cost) * Total estimated contract income
Income previously recognized
Income to be recognized

• The amount of income recognized in the period is added to construction in progress.

Balance Sheet Amount

• Current Asset – excess of costs incurred and income recognized over billings.
• Current Liability – excess of billings over costs and income recognized.

Advantage of using percentage of completion method is that it renders periodic recognition of income and enhances inter-period comparability.

Under Completed Contract method, contract revenue and profit are recognized at completion of contract. All related costs are deferred until completion and then matched to revenues. Though, this method is based on results, it does not reflect the current performance and inter-period comparability is weighed down.

Under both the methods, losses are recognized in the earliest period estimable. Any profits recognized to date are reversed.

Let’s peep and put side by side both the methods through an example. Please follow the link below to view.

I shall resume with this topic in my next post and discuss recognition of revenue related to software, franchise fee and royalty income.

Farewell n be healthy and wealthy!!


Monday, March 1, 2010

Revenue Recognition

Holi Greetings to everyone!!

On this Festival of Colors "Holi" 

May God gift you all the colors of life,
colors of joy, colors of happiness,
colors of friendship,
colors of love and all other colors you want to paint in your life.

Happy Holi!!

It is a spring festival, celebrated at the end of the winter season on the last full moon day of the lunar month Phalguna (February/March), signifying dawn, light, life and a surge of energy. It begins at night by litting the bonfires a day before, suggesting destruction of evil and a hope for good.
I acquiesce with another delay on my part and admit my dereliction of duty and commitment. However, as Aprajita (undefeatedly) I will continue with my effort.

In this posting, I am going to talk about Revenue Recognition. Revenue is one of the most important indicators of a successful business. Since revenue reporting directly impacts an entity's results of operations and financial position, it is essential to have a thorough knowledge of the underlying concepts and practices.  However, revenue accounting literature has emanated in various diverse pronouncements that at times it is often challenging to relate and identify the appropriate pronouncement. I get down to it by discussing the following two important Statements of Financial Accounting Concepts(SFAC):
  • SFAC 5, Recognition and Measurement in Financial Statements of Business Enterprises giving recognition guidance and
  • SFAC 6, Elements of Financial Statements giving presentation guidance.
The terms REALIZED and REALIZABLE focuses on conversion or convertibility of noncash assets into cash or claims to cash (SFAC 6). They identify revenues or gains or losses on assets sold and unsold, respectively. RECOGNITION is the process of formally recording an item in the financial statements of an entity.

Per SFAC 5, revenues and gains are recognized when they are both realized/realizable and earned. Revenues are considered to have been EARNED when the entity has significantly completed its key activities (purchasing, manufacturing, selling, rendering service, delivering goods, allowing other entities to use enterprise assets etc.) thereby, entitling it to the benefits represented by the revenues.
Since gains generally involve no EARNING process, it is more significant for them being realized or realizable.

It is important to understand the timing of revenue recognition as it can have a significant impact on an entity's results of operations. Consider the following situations where (i) revenue is realized and earned at the same time (ii) revenue is realized before it is earned  and (iii) revenue is earned before it becomes unrealizable:
  • The customer pays for the merchandise at the cash register to retail store owner or when a manufacturer processes COD orders.
  • Payment for magazine subscription or rent in advance.
  • Manufacturer delivers and sells the products on credit.
Several transactions have been guided by other pronouncements on revenue recognition and are considered exception to SFAC 5. To mention a few:
  1. ASC 605-10-25-3, Installment and Cost Recovery Methods of Revenue Recognition (APB 10)
  2. ASC 605-15-25, Revenue Recognition When Right of Return Exists (FAS 48)
  3. ASC 605-35, Long-Term Construction-Type Contracts (ARB 45) 
  4. ASC 605-35, Accounting for Certain Production-Type Contracts (SOP 81-1)
  5. ASC 985-605, Software Revenue Recognition (SOP 97-2)
  6. ASC 952-605, Franchise Fee Income, Royalty (FAS 45)
Keeping in mind the various pronouncements on revenue recognition, generally speaking, following four conditions must be met in order for revenue to be both earned and realizable:

1. Persuasive evidence of an arrangement exists.
2. The arrangement fee is fixed or determinable.
3. Delivery or performance has occurred.
4. Collectibility is reasonably assured.

If any of the afore-said conditions is not satisfied in an accounting period, revenue recognition must be deferred until the period in which the final condition is met.

This was a brief introduction to the conceptual framework on revenue recognition. I will dig deeper into this topic in my next post.

Until then......Goodbye, Au revoir and Sayonara.



Tuesday, February 16, 2010

Accounting for Treasury Stock

Hello Dear Reader,
Having addressed on "Earnings per Share", I would like to move on to another essential aspect of stockholder's equity, Accounting for Treasury Stock.

Recalling the definition of Treasury Stock, it is the stock reacquired or repurchased by the issuing entity,  reducing the quantity of outstanding stock on the open market. To explain differently, when an entity reacquires its own common or preferred stock in an open-market transaction, such stock is termed Treasury stock. Bear in mind, it is the stock which is authorized and issued but not outstanding. Also be acquainted that:-
  1. It is reported as a reduction (debit) in stockholder's equity;
  2. No gain or loss is recognized on a treasury stock transaction and
  3. Retained earnings may be decreased abut never increased by the treasury stock transaction.
There are two ways to account for treasury stock transactions:
  • Cost method
  • Par-value method
Either of the methods adopted will not affect the stockholder's equity. What sets them apart is their stance and use of different equity accounts.

Cost Method
It is a less complicated method than the par-value method where an entity considers purchase of treasury stock as a temporary reduction in stockholders equity and not as retirement of shares. Distinguishing features include:
  1. Debit the treasury stock account for the cost to acquire the shares.
  2. At the time of reissuance/sale of treasury stock, credit the treasury stock account for the cost of shares.
  3. The gain/loss on acquistion is recognized at the time reissuance/sale.
    • Gains are credited to paid-in-capital from treasury stock transactions.
    • Losses are first charged to paid-in-capital  from treasury stock transactions and the remainder, if any is charged to retained earnings.
  4. Retirement of treasury stock will require additional journal entries.

Par Value Method
This method holds the view point that a treasury stock transaction is "retirement" of shares and its reissuance/sale is a "new" issue. It is slightly more complex than cost method but when it comes to retirement of treasury stock the journal entries are fairly simple. 

Note: Under par value method we start with the assumption of retiring such shares, therefore, when the treasury shares are actually retired, the treatment is fairly simple. This does not hold true for cost method.

Key features of par value method:-
  1. On repurchase of own shares, debit the treasury stock account for the par value and not the cost of reacquisition.
  2. Treasury shares acquired for a price more than they were originally issuedDebit additional paid-in-capital (APIC - common stock) for the premium received when the shares were first issued to public. The excess, if any, goes to retained-earnings.
  3. Treasury stock acquired at a cost equal to or less than the original issue cost - Debit APIC - common stock for premium at the time of issuance and paid-in-capital from treasury stock is credited for the difference between the original issue price and the cost to acquire treasury stock.
  4. When treasury shares are resold, credit the treasury stock account at par value and credit or debit APIC - Treasury Stock for the remainder.
I have exemplified both the methods through simple transactions in powerpoint slides. Please use the link beneath to view the file.

This brings me to a finale of Treasury Stock Accounting. I trust you benefit from it.

Remain with me...more will come....


Friday, February 5, 2010

Earnings Per Share

Hello Friends!

It's been some time since I last wrote on "Pension Accounting". I apologize for not being able to keep up with the desired pace and will endeavour not to lose track of it. Laying my thoughts aside on how I feel about neglecting the job I volunteered for, I shift to an interesting topic “Earnings Per Share(EPS)” .

Simply put, EPS is the piece of an entity's income allocated to each outstanding share of common stock. It is the key indicator of a company's profitability and a major component of price-to-earnings ratio. FASB Statement 128 (Codification Topic 260) requires the computation, presentation and disclosure of EPS for publicly traded entities.

All entities with publicly held common stock start off by computing Basic EPS while ignoring any potentially dilutive securities. In addition to Basic EPS, Diluted EPS is determined where the capital structure of an entity includes potentially dilutive securities. The objective of Basic EPS is to assess performance of an entity over its reporting period and that of Diluted EPS is to provide similar results while giving effect to all dilutive potential common shares that were outstanding during that period.

Note: A security is considered potentially dilutive if any other contract/security allows its owner to acquire common stock during the reporting period or after the end of the reporting period. For example, stock options/warrants,  and convertible bonds/preferred stock.

Both Basic and Diluted EPS  must be presented for two elements:-

a) Income from Continuing Operations - It is the income (or loss) available to common stock holders after adjusting the preferred stock dividend.
Dividend on cumulative preferred stock is always backed out whether declared or not from the net income. However, in case of non-cumulative preferred stock, a deduction is made for the dividend that has been declared.

b) Net Income - Not only an adjustment is made for preferred stock dividend as discussed above but also for income from discontinued operations, extraordinary items and cumulative effect of a change in accounting principle.

Presentation - EPS is reported on the face of Income statement for both the elements mentioned above. Where an entity reports a discontinued operation, an extraordinary item or the cumulative effects of accounting changes, the EPS must either be presented on the face of income statement or in the notes to financial statements.
Computation of Basic EPS

Basic EPS = Income from Continuing operations or Net Income   
                 Weigheted-average no. of common shares outstanding

Weighted-average number of shares outstanding during the period include shares outstanding the entire period, shares issued during the period and shares where all of the conditions of the issuance have been met. 

In computing the weighted-average no. of shares following adjustments are required:-

1. Treasury shares are excluded as of the date of repurchase. Example - if on Jan 1, year 1 shares issued and outstanding were 20,000 and on Jul 1, year 1 the company reacquired its 4000 shares and held in treasury, the weighted average shares outstanding for year 1 would be 18,000 (20,000 * 6/12 + 16,000 * 6/12).

2. Stock Dividends and Stock Splits - If stock dividends and stock splits are given effect to during the year,  they are reflected in EPS retroactively for all periods presented i.e they should be considered outstanding for the entire period in which they were issued. Example - if 10,000 shares were outstanding on Jan 1 and on Jul 1stock dividend of 10% is issued, the no. shares outstanding on Jan 1 will be 11,000 (10,000 + 10% of 10,000).

If the events take place after the close of the period but before the completion of financial report, the per share contribution should be based on the new number of shares.
The retroactive treatment is given to stock dividends and stock splits for the reason that they change the total number of shares but not the proportionate shares outstanding.

Computation of Diluted EPS

a) If-converted method - It is identical to Basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding during the period, if dilutive common shares would have been issued from conversion of debt or preferred stock. The numerator  is adjusted to add back i) any dividends on convertible preferred stock and ii) the after tax amount of interest recognized in the period associated with any convertible debt.

Dilutive Effect: Convertible preferred stock is dilutive if Basic EPS is greater than preferred dividend per share of common stock obtainable. Similarly, convertible bonds are dilutive if Basic EPS is greater than interest net of tax per share of Common stock obtainable. Only when the dilutive effect is established, both numerator and denominator are adjusted for the items mentioned above.

In other words, the conversion, exercise or contingent issuance of securities should not have an anti-dilutive effect. Anti-dilutive ssecurities are excluded from diluted EPS. Thus, it is important to calculate the per share effect of each potentially dilutive security and include only those which have a dilutive effect.

Where a loss from continuing operations already exists, including potential shares in the denominator of a Diluted EPS will result in an anti-dilutive per-share amount. Thus, potential common shares are excluded in computation of diluted EPS when a loss from continuing operations exist, even if the entity reports net income.

b) Treasury Stock method applies to options and warrants. Under this method exercise of warrants is assumed at the beginning of the period or at the time of issuance, whichever, is later and proceeds from exercise are assumed to be used to purchase common stock at the average market price during the period.

This method is applied indivdually to each option and warrant to asssess if they are dilutive. If the average market price is less than the exercise price, the options and warrants are anti-dilutive.

The effect of options and warrants is only on the denominator i.e weighted average number of shares, for the net additional shares that are issued.

The difference between i) additional number of shares issuable under the warrant/option and ii) number of shares assumed to be purchased at the average market price is included in the denominator.

Example: Entity X has 1,000 warrants outstanding exercisable at $54 per share. The average market price of the share is $60. Assuming that the warrants are exercised, the incremental shares includible in the denominator would be 100 (1,000 - (1000*54/60)). Since options/warrants have only a denominator effect, its per share effect is $0.00. 

Remember, Diluted EPS should reflect the maximum dilution of all potentially dilutive securities. Thus, always begin with the security with the smallest individual per share effect or the most dilutive security and include all with a dilutive effect. Because options and warrants have $ 0.00 per share effect, they are always the most dilutive securities.

With this, I wrap up the topic on Earnings Per Share. Once again, before I close...a confession...somewhere in my thoughts I felt culpable and lost by not joining in any dialogue with you in the last two weeks but at this point in time I feel less remorseful.

Have a Nice Weekend!

Thursday, January 21, 2010

Pension Accounting

Bonjour! Dear Friend

Prior to initiating the discussion on the subject matter for the day, I want to make some confessions. Pension Accounting was a thorny topic for me and it took me some time to imbibe it. Whilst I am going to write about it, makes me feel perturbed, yet I want to share my learning with you. At work, a project director taught me a mantra once “keep things simple, keep things stupid” and they are easy to manage. I tried applying the same mantra here and it least I was able to answer the multiple choice questions expected on the exam. Knowing that this was not a very heavily tested area, I took some risk and kept my fingers crossed of not running over a simulation on the D-day! I was glad, I could sail through a few multiple choices slickly on the test.

Lets begin with looking at the applicable authoritative pronouncements. The new Codification Topic 715 covers all of the following FASB statements under its various subtopics:-

1)FAS 87 and FAS 88, Employer's Accounting for Pensions,

2)FAS 132R, Employers Disclosures about Pensions and Other Post  Retirement Benefits,

3)FAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans amending  FAS 87 and FAS 88 and

4)FAS 106, Employers' Accounting for Post Retirement Benefits other than Pension.

Defined Benefit Pension Plan (FAS 87) is crucial from the exam perspective. It is a plan that defines an amount an employer commits to pay to its employee, called pension benefit, for life beginning at retirement. It is a function of age, number of years of service and compensation. The objective is:-
a) to provide a measure of pension expense reflecting the terms of underlying plan and
b) recognize the pension expense of an employee over his/her approximate service period.

Knowing the Pension Expense components or Net Periodic Pension Cost 
Net Periodic Pension Cost is the amount recognized in employer's financial statement as the cost of pension plan for the period. Please ensure to take a look at the key terms laid out in FAS 87 for a better understanding.

1)Service Cost (cost - addition to pension expense) - It is the discounted PV of benefits earned by an employee during the current period.

2)Interest Cost (cost - an addition to pension expense) - Causes an increase in Projected Benefit Obligation (PBO) due to passage of time. It is calculated as interest rate * beginning PBO, where interest rate is the assumed discount rate at which the pension benefit could be effectively settled.

3)Actual Return on Plan Assets (return - decreases the pension expense) - It is calculated as FV of plan assets at the end less FV of plan assets in the beginning plus Benefits paid during the year less contributions made during the year.

4)Prior Service Cost amortization - It is the cost of retroactive benefits granted in a plan amendment. Retroactively increasing benefits increases the PBO and prior service cost at the date of amendment and vice-versa. The increased or decreased cost is amortized as a component of net periodic pension cost. Amortization can be done on Straight Line basis that amortizes cost over the average remaining service life of the active employee.

5)Actuarial gains/losses - It occurs due to changes in actuarial assumptions. Gains decrease and losses increase the penion cost. There are 2 components of gains/losses - a) Current period difference being the difference between actual and expected return (expected rate of return on plan assets * market related value of plan assets) and b) Amortization of the unrecognized gain/loss for previous periods.

6)Amortization of Transition Asset (decrease) or Liability (increase) to penion expense, a FAS 87 adjustment. This indicates the funded status of the plan when FAS 87 was adopted. The employer records the amortization over average remaining service of plan employees or over 15 year year period, if the service period is below 15 years.
Note - Under FAS 106, the amortization period is 20 years instead of 15 years.

I have tried to exemplify the expense elements in the file linked below.

Post Retirement Benefits other than pension (FAS 106) is very much similar to FAS 87 except that it talks about plan for fringe benefits to retired employees. They both allocate benefit costs based on years-of-service. Since the expense elements are same as explained above, I would now like to talk about FAS 158.

Recognition of Liability or asset - FAS 158 amended FAS 87 and FAS 106 requiring companies to report their plans’ funded status as either an asset or a liability on their balance sheets. This has been well explained in an article below by Kenneth W. Shaw.

There is another article on FAS 158 explaining how FAS 87 and 106 have been amended and gives a bird's eye view in a tabular form on the pension expense elements and the related journal entries. I highly suggest you to go through Figure 1 and 2 in it.

With this, I conclude the topic on Pension Accounting. Speaking candidly, this topic was hard for me to write on and is still giving me butterflies.  I sincerely hope that I was able to justify the topic. Would love to see your comments on this one for sure!


Monday, January 11, 2010

Accounting for Investments - Equity and Cost Method

Hello and Welcome Dear Reader

Before I begin with my topic of the day, I wanted to share an interesting article on Investing in Gold. With sudden rise in price of Gold, it seems, everyone's getting more passionate about buying yellow metal. Then I landed on this article in Money magazine " Coming down with Gold fever" and I had to ask myself...Is it another bull run? The truth is Gold prices may rise further but this is not the right time to invest in it. The article stated that it is a myth to consider precious metal offering better protection than stock or bonds against inflation. So, what is an investor's best bet? Invest prudently at different points in time for better returns as timing to buy can never be perfect and definitely investing in Gold is a good way to diversify one's portfolio.

Now coming back to today’s subject for dialogue “Accounting for Investments-Equity Method” laid out in Codification Topic 323 (APB Opinion No 18). This method is applicable if an investment enables the investor/parent to influence the operating or financial decisions of the investee/subsidiary. In other words, the parent company exercises significant influence over the subsidiary and holds 20% or more of the voting stock in it. Furthermore, the equity method of accounting meets the objectives of accrual accounting than does the cost method. The cost method is generally followed for investments in noncontrolled corporations and unconsolidated subsidiaries.

It is important to understand the meaning of "significant influence".  It is indicated by many factors, some of them being:-
- Level of Parent Co's representation in the Board of Directors;
- Parent's ability to make policy decisions for the subsidiary; or
- Parent being the single largest shareholder of the subsidiary.

Upon acquisition, the initial investment is recorded at cost and subsequent to acquisition, the Investment and Investment Income account are adjusted periodically by recognizing the share of investee's earnings. I have explained this in more detail by charting a T account of  "Investment Account". Refer to the link below to view the file.

Accounting for Investments - Cost Method ( Codification 325 formerly referred as APB 18) - This method is applicable when the investor is not able to exercise significant influence over the investee and generally is evidenced by lack of ability to take policy decisions, temporary investment, holds non-voting preferred stock or ownership in voting stock is less than 20%.

Upon acquisition, the investment is recorded at Cost. Unlike Equity Method, the investment account under this method is not adjusted for investor's share of investee's income. Dividend is recorded as income and an adjustment is made for liquidating dividends (i.e dividends distributed by the investee exceed the investor's share of earnings since acquisition are treated as return of capital and recorded as reduction of the investment account).

Example: P Co acquired 20% stock of S Co on Jan 1, Year 1 and S Co's net income for year 1 was $10,000. During the year P Co received dividend of $2,300.
Liquidating dividends = $2,300 - (20% of 10,000) = $300
Journal entry: Dr Cash $2,300
                     Cr Dividend Income $2,000
                     Cr Investment in S Co $300

Now, keeping the facts of the case same, try out the entries under the equity method and compare the end result. You will notice that under both the methods Investment in S Co is reduced by the amount of liquidating dividend.

To summarize Investments are accounted for by one of three methods — the cost method (Codification Topic 325/APB 18), the fair value method (Codification Topic 320/FAS 115) of which I talked in my last blog post , and the equity method (addressed in Topic 323/APB 18).

Focus on how investment account and investment income account get affected by various transactions under Equity method. Remember, investment and investment Income accounts are always reciprocal to each other except for when the dividend is received by the Investor.

With this, I wind up the topic related to Investments. I have tried to wrap the significant areas related thereto and and earnestly wish that you find it useful.

Warm Regards.......


Monday, January 4, 2010


"Every year gives us another chance, chance to change, to hope and wish for the better. That betterment will surely come. Wishing You all a Very Energetic, Healthy n Fulfilling New Year!

Since, I have fairly talked about Bonds, I would like to shift to "Investments" which is a closely related topic. It is a pretty interesting area, frequently used and easy to absorb.

The Authoritative Pronouncement on Investments, Codification 320 (formerly known as FASB Statement 115) discusses accounting treatment for following Investment types:-

a. Held-to-Maturity Securities (HTM) comprising only Debt securities with the management's ability and intent to hold until maturity. These are carried at amortized cost i.e acquisition cost is adjusted for amortization of premium or discount. Unrealized holding loss is not reported unless the decline in FV  is permanent.

b. Trading Securities comprising of both debt and equity securities held with the purpose of selling in the short run. These are carried at Fair Value and unrealized holding gain/loss is reported on the income statement.

c. Available-for-Sale Securities (AFS) also includes both debt and equity securities which are not actively traded but not necessarily held to maturity. These are also carried at fair value and unless the decline in FV is permanent the unrealized holding gain/loss is reported under other comprehensive income (OCI).

Note:-In case of equity securities this codification is applicable only if significant influence does not exist (i.e. investment in equity securties is less than 20%).

On the Statement of Cash Flows both HTM and AFS securities are classified as cash flow from investing activity. Trading securities are, however, classified as cash flow from operating actitvity.

In the Balance SheetHTM and AFS securities may be classified as current or non-current where as Trading securities are short-term investments.

Decline in FV
If there is a permanent decline in Fair Value of HTM and AFS securities, investment is written down to fair value, thus, becoming a new cost basis and unrealized loss is taken to earnings.

Sale of securities
Premature sale of HTM securities is considered as a sale at maturity in either of two cases:-
1. The sale occurs so close to maturity that interest rate risk is virtually eliminated; or
2. Sale occurs after 85% of principal is recovered.

Realized gain/loss on sale of HTM securities is recognized in accordance with its amortized cost method (either staright line or effective interest).

When AFS securities are sold, the proportionate amount of unrealized gain/loss in OCI is reclassified and becomes part of realized gain/loss. The realized gain/loss on sale is then the difference between original cost and the selling price.

Since unrealized gain/loss on Trading securities is included in earnings in the period they occur, the realized gain/loss on sale of such securities is the amount not already recognized as unrealized.

Transfer of Securities between Categories
When the securities are transferred between the categories i.e from HTM to AFS or Trading or vice versa, such transfers are recorded at FV with adjustment to unrealized gain/loss and recognized gain/loss. This is summarized in the chart which can be viewed by following the link below.

In the next post I will continue with this topic and talk about investment in equity securities when siginificant influence does exist.

Thank you and Good bye