Available-for-Sale Security

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Available-for-sale security (AFS) is a term used in accounting to classify financial assets that are neither held for trading nor held to maturity. AFS securities are debt or equity instruments that are bought with the goal of either selling them before they mature or, if they don't have a maturity date, keeping them for a long time. 

Any changes in the value of AFS securities between accounting periods are recorded in other comprehensive income (OCI), a component of shareholders' equity unless they are sold or become impaired. AFS securities are represented at fair value on the balance sheet.

Definition of AFS Securities

Financial assets must be categorized when they are purchased into one of the following groups in accordance with the US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS):

• Held-for-trading securities: These financial assets are primarily purchased and sold in order to make quick money. On the balance sheet, they are stated at fair value, and the income statement includes any gains or losses resulting from changes in their value or from their sale.
• Held-to-maturity securities: These are debt instruments with a set maturity date that the entity intends to hold till maturity and has the financial wherewithal to do so. On the balance sheet, they are recorded at amortized cost, and the income statement includes any gains or losses from their sale or impairment as part of net income.
• Available-for-sale securities: These are financial resources that don't fit into the categories mentioned above. Until they are sold or become impaired, at which point they are reclassified to net income on the income statement, they are recorded at fair value on the balance sheet and any profits or losses resulting from changes in their value are recorded in OCI on the statement of comprehensive income.

The business model of the firm and the characteristics of the assets' cash flows determine how financial assets should be categorized. The assets' classification impacts how they are measured and how gains or losses are recorded in the financial accounts.

Types of AFS Securities

AFS securities come in both debt and equity forms. Debt instruments, which include bonds, notes, debentures, loans, and certificates of deposit, are agreements that grant the holder the right to receive fixed or predictable payments from the issuer. Equity instruments, such as ordinary stock, preferred stock, warrants, and options, are ownership rights that grant the holder a portion of the issuer's remaining interest.

The maturity date of AFS securities can also be used to classify them. Securities having a one-year or shorter maturity date are regarded as current assets, whereas securities with a longer maturity date or without a maturity date at all are regarded as non-current assets.

Examples of AFS Securities

The following are some examples of AFS securities:

• A business purchases corporate bonds with a five-year maturity date that were issued by another business. If the market is favorable, the corporation plans to sell the bonds before they mature; otherwise, it will keep them until they mature.
• A business makes an investment in common stock that has no set expiration date and was issued by another business. The corporation does not hold the issuer in high regard and does not have any plans to keep the stock for a protracted period of time. When the stock hits a specific price point or when the corporation needs money, it plans to sell the shares.
• A business invests in foreign government treasury bills with a six-month maturity period. The corporation wants to diversify its portfolio rather than frequently trade the bills in order to generate some interest income.

Accounting Treatment of AFS Securities

The accounting treatment of AFS securities involves three steps:

• Initial recognition: Any transaction costs that are directly attributable to the acquisition are added to the fair value of the AFS security when an entity acquires it. Fair value is the sum that, at the measurement date, would be received for the sale of an asset or paid for the transfer of a liability in an orderly transaction between market players.
• Subsequent measurement: An AFS security is measured at its fair value at each reporting date by an entity after initial recognition. Observable or unobservable inputs can be used in models that use valuation methodologies, quoted market prices, or other methods to estimate fair value. AFS securities are assessed at costless impairment losses if fair value cannot be determined with sufficient accuracy.
• Gains or losses recognition: Until the AFS security is sold or becomes impaired, an entity records any gains or losses resulting from variations in the fair value of this component of shareholders' equity in OCI. Unrecognized profits and losses on derivatives, foreign exchange translation adjustments, and excess from revaluing property, plant, and equipment are just a few examples of sources of income and expense that are included in the area of the statement of comprehensive income called OCI that does not appear in net income. When an AFS security is sold or becomes impaired, an entity changes the accrued gains or losses from OCI to net income on the income statement.
  

The following journal entries illustrate the accounting treatment of AFS securities:

1. On January 1, 2020, Company A purchased 1,000 shares of Company B's common stock for $10 per share, plus $100 in transaction costs. Company A classifies the investment as an AFS security. The journal entry to record the purchase is:

Debit
Investment in AFS securities 10,100


     Credit

     Cash 10,100


2. On December 31, 2020, the fair value of Company B's common stock was $12 per share. Company A adjusts the carrying value of the investment to its fair value and records the unrealized gain in OCI. The journal entry is:


Debit
Investment in AFS securities 2,000

     Credit
     Unrealized gain on AFS securities (OCI) 2,000


3. On June 30, 2021, Company A sold the investment for $13 per share. Company A recognizes the realized gain in net income and reclassifies the unrealized gain from OCI to net income. The journal entry is:


Debit
Cash 13,000

Unrealized gain on AFS securities (OCI) 2,000

     Credit
     Investment in AFS securities 12,100
     Realized gain on sale of AFS securities (net income) 2,900

Advantages and Disadvantages of AFS Securities

Investing in AFS securities can have some advantages and disadvantages for an entity. Some of the advantages are:

• Liquidity: An entity can benefit from the liquidity that AFS securities can offer by being able to sell them when it needs money or when the market is in a good place.
• Diversification: AFS securities can assist a company in diversifying its holdings and lowering its exposure to particular risks or market swings.
• Flexibility: A company may be able to adapt its investment strategy in accordance with its goals and expectations with the help of AFS securities.
  

Some of the disadvantages are:

• Volatility: Due to market fluctuations or other circumstances, the fair value of AFS securities is liable to change, which may have an impact on an entity's financial position and performance.
• Impairment: If an entity experiences losses as a result of an AFS security's fair value falling significantly or permanently below its cost, the security may be considered impaired.
• Taxation: Depending on the country and the type of security, AFS securities may have various tax implications. For instance, while other jurisdictions may only tax realized gains or losses on AFS securities, some may also tax unrealized profits or losses on AFS securities.

Data on AFS Securities

The total market value of AFS securities held by US nonfinancial corporate businesses was $1.6 trillion as reported in the Federal Reserve Board's Financial Accounts of the United States report for the fourth quarter of 2020. This represents an increase of 8.3% from the previous quarter and 15.4% from the same quarter of 2019. The breakdown of AFS securities by type was as follows:

• Corporate and foreign bonds: $1.1 trillion (69%)
• US government agency securities: $0.2 trillion (13%)
• Municipal securities and loans: $0.1 trillion (8%)
• Corporate equities: $0.1 trillion (6%)
• Mutual fund shares: $0.04 trillion (3%)
• Other: $0.02 trillion (1%)

Conclusion

Financial assets that are not held to maturity or for trading fall under the category of available-for-sale securities. On the balance sheet, AFS securities are reported at fair value, and any changes to that value are recorded in other comprehensive income (OCI) until they are sold or become impaired. AFS securities can give entity flexibility, diversity, and liquidity, but they also come with volatility, impairment, and taxation issues. Interest rates, currency exchange rates, credit ratings, prevailing economic conditions, and investor preferences are only a few of the variables that affect the market value and performance of AFS securities.