A profit and loss account or income statement shows a company's revenues, expenses and profit or loss for an accounting period, which is usually a quarter or a year. Companies often hold investments in equity, debt or both, and have to show changes in the market value of certain types of investments as unrealized gains or losses. You must report gains or losses when you sell your equity, debt or other investment securities. An investment is in a loss position when the fair-market value drops below the acquisition cost.
Review your available-for-sale and trading securities at the end of an accounting period. Available-for-sale securities refer to long-term equity and debt holdings of companies in which you have a less than 20 percent interest. Trading securities are short-term investments that you plan to trade.
Compute the investment loss, which is equal to the current market value minus the acquisition cost. For example, if you bought shares representing less than a 20 percent equity interest in a publicly traded company for $1 million and the market value of these shares is currently $800,000, then your investment loss is $200,000 ($800,000 minus $1 million). Note that this loss is an unrealized investment loss or paper loss until you actually sell the shares.
Record the investment loss for available-for-sale securities in a "loss on available-for-sale securities" account, which is part of the "other comprehensive income" section of the income statement. Continuing with the example, the journal entries are to debit (increase) the loss on available-for-sale securities account and credit (decrease) the available-for-sale investments account, which is a balance sheet account. After adjusting for taxes, this reduces the comprehensive income section of the income statement but not the net income section.
If you sell the securities, the unrealized gain or loss becomes an actual gain or loss and moves from the other comprehensive income section to the net income section. In the example, if you sell the shares at current prices, debit (increase) cash and credit (decrease) the available-for-sale investments account by $800,000 each. Charge the $200,000 investment loss to net income, after adjusting for taxes.
Record the investment loss for trading securities in an "unrealized loss on trading securities" account. For trading securities, both unrealized and actual losses affect net income directly. Unlike available-for-sale securities, there is no entry to other comprehensive income for unrealized losses or gains. For example, a tax-adjusted $10,000 unrealized investment loss on trading securities affects the net income in the current period, whether or not you have actually sold the securities.