Unrealized Gain and Loss in Investments
What is the impact of unrealized gain and loss on net income?
When Lumber Company purchased 16% of Jack Company's common stock for $160,000 in 2019, the initial investment amount was fixed. However, the fair value of the investment changed over time. At the end of 2019, the fair value of the 16% investment in Jack was $144,000, resulting in an unrealized loss of $16,000. What is the impact of this unrealized loss on net income?
Impact of Unrealized Gain and Loss on Net Income
It is important to note that the unrealized loss of $16,000 is not included in Lumber's 2019 net income because it represents a change in the fair value of the investment and is considered a non-realized, or unrealized, gain or loss. Unrealized gains and losses are not recognized in the income statement until the investment is sold or otherwise disposed of.
When a company experiences an unrealized gain or loss on its investments, it does not immediately impact the net income. This is because unrealized gains or losses are considered to be fluctuations in the market value of the investment and are not realized until the investment is actually sold.
In the case of Lumber Company's investment in Jack Company, the unrealized loss of $16,000 in 2019 is not reflected in the net income for that year. This treatment aligns with the accounting principle of conservatism, which requires companies to recognize losses when they are certain, but gains only when realized.
Therefore, the unrealized loss of $16,000 is treated as a change in the fair value of the investment and is recorded in the balance sheet rather than the income statement. It is only when the investment is sold that the realized gain or loss will impact the net income.