How to Classify Capital Gains on a General Ledger

Capital gains increase company profits.
Capital gains increase company profits. (Image: Jupiterimages/ Images)

A business may choose to invest in securities for several reasons. For example, a company might want to take a significant stake in another company by buying voting shares. A company might buy stocks, bonds and other securities simply because it seeks interest and dividend income or a trading profit. Capital gains affect a company’s general ledger, income statement and balance sheet.

Capital Gains

The excess of sale proceeds over book value is a capital gain if the item sold is a capital asset, such as securities, fixed assets, real estate and other valuable items. Inventory is not a capital asset, and gains from its sale are ordinary income, not capital gains. Until you sell capital assets, the profits are on paper only and are classified as unrealized capital gains. The general ledger entries for corporate investments depend on the intent of the investor and on whether a capital gain is realized or unrealized.

Classifying Investments

Investments are company assets. If the company intends to hold bonds until they mature, it classifies the bonds as a held-to-maturity investment. A company records the bond purchase at cost in its general ledger as a debit to the “held-to-maturity investment” asset account and a credit for cash. A “trading security” is a short term investment, and an “available for sale” security covers investments that don’t fit into the other two categories. The ledger entries for purchase of investments in these two categories mirror the entries for a held-to-maturity investment.

Unrealized Capital Gains

A company with unrealized gains at the end of a period on available-for-sale and trading securities must report these gains as income. The ledger entries for unrealized gains on trading securities are a debit to the trading securities asset account and a credit to an income account, “unrealized gains on trading securities.” This updates the book value of investments to match fair market value. A company records unrealized capital gains in the general ledger on available-for-sale securities as a debit to the “available-for-sale securities account” and a credit to the “other comprehensive income” account.

Other Comprehensive Income

Other comprehensive income is a separate section of the income statement. It reports unrealized gains and losses from investments, currency transactions and certain other sources, all of which reflect activity outside the company’s main area of business. After preparing the income statement, a company credits an equity account, “accumulated other comprehensive income,” and debits the other comprehensive income account to hold the income in a special section within the equity portion of the balance sheet. Unrealized gains from available-for-sale securities accumulate on the balance sheet until the company sells the securities.

Realized Capital Gains

When a company sells an investment for a capital gain, it must record the profit in an income account and remove the investment from the balance sheet. For example, if a company sells a held-to-maturity bond for a gain, it debits cash for the sale proceeds, credits the security for its book value and credits the difference to the income account “gain or loss from investments.” The procedure is similar for trading securities and available-for-sale investments, except that the latter requires an extra step -- debit the accumulated other comprehensive income account and credit the gain or loss from investments account to reclassify the accumulated income.

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