Definition
An available-for-sale security refers to a financial asset that a company purchases with the intent of selling it in the future. They are not bought for daily business operations nor held until maturity. The value of these securities is reported at fair market value on a company’s balance sheet.
Phonetic
The phonetics for the keyword “Available-for-Sale Security” are: ə-ˈvā-lə-bəl-fər-sāl sə-ˈkyu̇r-ə-tē
Key Takeaways
- Classification: Available-for-sale (AFS) securities are one of three types of securities that businesses purchase. Unlike trading securities (which are bought with the intention of reselling for a profit) or held-to-maturity securities (which a company intends to keep until it matures), organizations buy AFS securities with the intention of possibly selling them before maturity due to price changes or other beneficial opportunities.
- Accounting Treatment: AFS securities are recorded on a company’s balance sheet at fair value, and any unrealized gain or loss is included in the comprehensive income part of the shareholders’ equity, not in the income statement. However, when an AFS security is sold, all previous unrealized gains or losses are reclassified into the income statement as a realized gain or loss.
- Risks and Advantages: A key advantage of AFS securities is that they provide businesses with the flexibility to sell and profit from short-term price fluctuations. However, the downside is that they expose companies to a higher amount of risk than held-to-maturity securities due to their sensitivity to market price fluctuations.
Importance
Available-for-Sale Security is important as it represents an important investment category in the world of finance. These are debt or equity securities purchased with the intention of selling them when they’ve appreciated in value, but they’re not held to any specified maturity date. They could be sold in response to changes in interest rates, from business needs, or for liquidity purposes. Their significance lies in their impact on a company’s financial statements – they must be reported at fair market value on balance sheets, and any unrealized gains or losses must be reported in other comprehensive income, contributing to the shareholders’ equity. Hence, they can significantly impact a company’s reported financials and are of interest to investors, creditors, and industry analysts.
Explanation
Available-for-Sale (AFS) securities are part of a company’s broader investment portfolio, and they serve a crucial financial purpose. Essentially, they represent an investment strategy that offers the right balance of risk and return, providing the company with financial flexibility, additional income, and liquidity management. Companies purchase these securities not for the purpose of trading them in the short term nor for holding till maturity. Instead, they plan to sell them if the need arises for cash, business expansion, or favorable changes in interest rates.The use of AFS securities does play a substantial part in a company’s financial management strategy. When assets are classified as AFS, it means they can be sold in response to changing market conditions to realize gains or to limit losses, depending on the company’s financial goals. Consequently, this classification allows a company to leverage market volatility to its advantage. The profit or loss from these sales can be used to invest in other areas of the business, potentially increasing its overall profitability. Therefore, the effective use of AFS securities allows a firm to maximize the potential returns of its investment portfolio.
Examples
1. Corporate Bonds: A company purchases bonds from another company with the intention of reselling them later at a more attractive price for gain. These bonds are considered as available-for-sale (AFS) securities which can be sold at any time based on market conditions. This gain or loss from the sale is then reported in the company’s comprehensive income until it’s actually sold.2. Mutual Funds: An investment firm can classify its investment in mutual funds as available-for-sale securities. The firm buys shares with no intent of trading them in the immediate future but they are open for potential sale based on market conditions or changes in their investment strategies. The changes in fair value is accounted for in other comprehensive income.3. Equity Investments: A company can acquire shares of another company and categorize them as available-for-sale securities, when it doesn’t have significant influence or control over the investee and does not intend to sell the shares in the short term. Any unrealized holding gains or losses are reported as a separate component of shareholders’ equity until the investment is eventually sold.
Frequently Asked Questions(FAQ)
What is an Available-for-Sale Security?
An Available-for-Sale (AFS) Security refers to a type of investment security a company may buy and hold for potential sale in the future. These aren’t bought with the intent to sell in the short-term nor held to maturity. Instead, they lie somewhere in the middle.
How is an Available-for-Sale Security classified?
AFS Securities are classified as a financial asset, and they can be found on the balance sheet as a non-current asset, unless the envisioned sale date is within 12 months of the balance sheet date.
How are Available-for-Sale Securities valued on the balance sheet?
They are valued at fair market value on a balance sheet. Any unrealized gains or losses are recorded on the balance sheet under accumulated other comprehensive income, a part of the equity section.
Can you give examples of Available-for-Sale Securities?
Examples of AFS Securities include bonds, stocks, or notes which are not classified as either held-for-trading or held-to-maturity securities.
How are gains and losses from Available-for-sale securities reported?
Unrealized gains or losses are reported in a separate account (Accumulated Other Comprehensive Income) in the equity section of the balance sheet. When these securities are sold, the realized gains or losses are reported within the income statement.
What’s the difference between Held-to-Maturity, Held-for-Trading, and Available-for-Sale Securities?
Held-to-Maturity securities are bought for long-term investment and are kept until maturity, and they are accounted for at amortized cost, not current market value. On the other hand, Held-for-Trading securities are intended for short-term profit, and they are reported at fair value, with gains or losses recognized in earnings. AFS Securities sit in the middle, not scheduled for a set sale date for profit nor held until maturity, and unrealized gains or losses move through Other Comprehensive Income.
Why might a business invest in Available-for-Sale Securities?
Businesses might invest in AFS securities as they provide an opportunity for earnings through potential price appreciation. They’re also a productive way for a company to manage its cash and diversify its holdings.
Related Finance Terms
- Marketable Securities
- Fair Value Accounting
- Unrealized Gain/Loss
- Liquidity Management
- Balance Sheet Classification
Sources for More Information
