Question

On January 1, Bargain Company's valuation allowance for trading investments account had a debit balance of $18,500. On December 31, the cost of the trading securities portfolio is $80,000. The fair value is $100,000. Which of the following would Bargain Company report?

Answer 1

Answer: An unrealized gain, $1,500

Explanation: An unrealized gain is a gain that would result from an uncompleted trade, should it be closed. In this question, the value of the securities have gone up to $100,000 but the securities have not been sold yet. The unrealized gain, due to increase in value is $20,000 ($100,000 - $80,000).

However, there is a debit balance of $18,500 in the valuation allowance account. This account is used to offset any asset on which a deferred tax is to be paid, in this case our incomplete trade. The amount therefore has to be subtracted from the unrealized gain, leaving Bargain Company with $1,500 gain ($20,000 - $18,500).

An unrealized loss stems from a decline in value on a transaction that has not been completed yet. The entity or investor would not incur the loss unless they chose to close the deal or transaction while it is still in this state. For instance, while the shares in the above example remain unsold, the loss has not taken effect. It is only after the assets are transferred does that loss become substantiated. Waiting for the investment to recoup those declines could result in the unrealized loss being erased, or becoming a profit.