Accounting rules require companies to record certain investments at fair value to reflect the true economic value of the investment portfolio. The accounting for the gain or loss resulting from a fair market value adjustment depends on the type of securities. For trading securities, which are short-term investments you buy with the intention of reselling in the near future, the gain or loss is part of the net income for the current period. For available-for-sale securities, which are longer-term investments, the gain or loss is part of other comprehensive income, which is below the net income line.
Calculate the gain or loss from a fair value adjustment. For publicly traded securities, the gain or loss is the difference between the current market price and the book value of the securities. If you have multiple securities in your portfolio, calculate the fair value gain or loss for each security. For example, if your company is holding shares in other companies worth $10 a share and the share price increases to $12 a share, the fair value gain is $2 a share. However, if the share price then drops to $8 a share, the fair value loss is $4 a share.
Record a fair value gain or loss for trading securities, which is a current asset account, on the balance sheet. For a gain, the journal entries are a debit to trading securities and a credit to unrealized gain or loss on investments. For a loss, the journal entries are to credit trading securities and debit unrealized gain or loss on investments. The "unrealized gain or loss on investments" account is part of the net income calculation of the current period.
Record a fair value gain or loss for available-for-sale securities, which is also a balance sheet asset account. For a gain, the journal entries are to debit available-for-sale securities and credit unrealized gain or loss on securities, which is part of the "other comprehensive income" section of the income statement. This section appears below the net income line. The sum total of net income and other comprehensive income is total comprehensive income.
Transfer balances from unrealized gain or loss accounts to gain or loss on sale of securities accounts when you actually sell the securities. Realized gains and losses are part of the net income calculation in the current period.
Companies usually transfer the other comprehensive income balances to "accumulated other comprehensive income" in the stockholders' equity section of the balance sheet at the end of an accounting period.
Fair value adjustments also apply to derivative instruments. Companies use derivatives to hedge exposures to interest rate volatility, foreign exchange fluctuations and changes in fixed asset market values. The treatment of gains and losses on these derivatives depends on the intended use of the hedging. Consult a qualified tax accountant for more details on how to record fair value adjustments for derivative hedges.