A company holds a debt security classified as Available-for-Sale (AFS). Cost = $100,000. Fair Value at Year 1 end = $90,000. The decline is not due to credit factors (no credit loss). In Year 2, the Fair Value rises to $95,000. What is the accounting impact in Year 2?

Answer options:

Recognize $5,000 gain in Net Income.

Recognize $5,000 gain in Other Comprehensive Income (OCI).

Recognize $5,000 gain in Net Income only if it reverses a previous credit loss.

No entry until sold.

How to approach this question

AFS Rules: Unrealized G/L -> OCI. Credit Losses -> Net Income (Allowance). If loss was OCI, recovery is OCI.

Full Answer

B.Recognize $5,000 gain in Other Comprehensive Income (OCI).✓ Correct

For AFS debt securities, changes in fair value not related to credit losses are reported in OCI. The Year 1 loss of $10,000 went to OCI. The Year 2 recovery of $5,000 also goes to OCI.

Common mistakes

Putting AFS unrealized gains in Net Income (that's for Trading securities).

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