Meaning and definition of Unrealized Gains and Losses
An unrealized loss exists when the value of stock decreases after being purchased by an investor but he/she has not yet sold it. If a large amount of loss remains unrealized, the investor is probably expecting the stock’s future to turn around and the worth of the stock will increase to reach the price for which it was purchased. If the stock price reaches back the purchase price or even above it, the investor would then have an unrealized profit for the time he/she holds onto the stock.
The unrealized gains or losses are said to be realized on the sale of a stock. The unrealized gains and losses are also referred as “paper” profits and losses, which indicates that the profit/loss is only real “on paper.”
Let us assume that you buy shares in ABC Company at $10 per share, and then shortly afterwards, the stock’s price plummets to $3 per share, but you do not sell. At this point, you have experienced an unrealized loss of
$7 per share, for the value of your position is 7 dollars less than when you had entered into the position. Let us presume that the company’s fortunes again shift and the price of the share soars to $18. Since the shares have not yet been sold, you now would have an unrealized gain of $8 per share.
Recording unrealized gains and losses
The unrealized gains and losses are posted on the balance sheet under the section “Other Assets.” The line item can be referred as “Unrealized Gain (Loss)” on the stock portfolio. The unrealized gain is, however, reported on the balance sheet by:
1. increasing the asset available-for-sale securities, and
2. increasing the stockholders’ equity component accumulated other comprehensive income
Recording unrealized gains and losses is helpful in bringing the stock portfolio (or other investments) from cost basis, to market value, also known as “Mark to Market.” However, it is essentially important to be careful in distinguishing whether stock portfolio is “available for sale” or trading securities”, the treatment is different on income statement.