Gains from accounting transactions can be divided into two main types as realized and unrealized. This involves the same transactions where the difference arises due to comparing its status at two different points of time. Realized gains refer to profits from completed transactions whereas unrealized gains refer to profits that have materialized, but the transactions have not been completed. That is the key difference between realized and unrealized gains.
CONTENTS
1. Overview and Key Difference
2. What are Unrealized Gains
3. What are Unrealized Gains
4. Side by Side Comparison – Realized vs Unrealized Gains
5. Summary
What are Realized Gains?
Realized gains are the profits earned from already completed transactions, thus they involve a receipt of cash. These are recorded in the income statement.
E.g. Company A disposes a vehicle for $14,000 which has a net book value (cost of $20,000 less accumulated depreciation of $7,800) of $12,200. Gain on disposal is calculated as below.
Figure 1: Realized Gains Calculation
$1,800 is transferred to the income statement in the section of ‘non-operating gains\\other incomes.
What are Unrealized Gains?
Unrealized gains refer to profits that have occurred on paper, but the respective transactions have not yet been completed. An unrealized gain is also called a paper profit because it is recorded on paper but has not actually been realized. Therefore, there is no cash receipt involved in unrealized gains. Unrealized gains are recorded in an account called accumulated other comprehensive income, which is found in the owners’ equity section of the balance sheet.
Considering the above example, until the vehicle is sold and cash is received any gains (or losses) are not recorded, thus the gain (or loss) is unrealized. The company may be confident that the vehicle can be sold for a profit; however, the actual proceedings will only be recorded following the sale.
Types of Unrealized Gains
Depreciation
Depreciation is a charge to account for the reduction in economic useful life of noncurrent assets. A yearly amount is reduced from the asset value and collected in a separate account named ‘Accumulated depreciation account’ which records the collective provisions for deprecation. If the asset can be sold for a value higher than the net book value at the end of the economic useful life, a gain is made.
Revaluation
Revaluation refers to the process of accounting for upward or downward movement in noncurrent assets. If the asset value appreciates, the increase in asset amount is transferred to a separate account called ‘revaluation reserve’. At the time of asset disposal, the revaluation gain becomes realized; the profit on disposal should be calculated for the revalued amount. Until the asset is sold off, this remains an unrealized gain.
Inventory
During a period of high inflation, the monetary value of inventories held may increase significantly while they are being processed. This change will only be accounted once the inventory is sold off.
Tax
Tax is the capital gains tax (tax charged on non- inventory items, e.g. for the appreciation of stocks, precious metals, commodities, and property). Prices of such assets are constantly affected by market conditions and capital gains tax will only be charged once the assets are sold off.
Figure 2: Commodity prices such as oil fluctuate frequently
What is the difference between Realized and Unrealized Gains?
Realized vs Unrealized Gains |
|
| Realized gains are profits made from completed transactions. | Unrealized gains are profits that have materialized, but the transactions have not been completed. |
| Case Involvement | |
| Cash is received upon conducting the sale. | No cash involvement until the gain is realized |
| Recording in financial statements | |
| This is recorded in the Income statement. | This is recorded in a separate reserve in the balance sheet |
| Accuracy | |
| This is less accurate since this method may not capture all the transactions conducted within the accounting period | This is more accurate since this method records all the transactions for a given accounting period. |
Summary – Realized vs Unrealized Gains
The main difference between realized and unrealized gains is the involvement of cash receipt where an unrealized gain becomes realized when the transaction is completed. There is no accurate way to establish the exact amount of a gain when it is at unrealized state; thus it cannot be reliably reported. The same is recorded at the completion of the transaction to ensure increased transparency of financial statements.
Reference:
1.”Realized and Unrealized Gains and Losses • The Strategic CFO.” ICal. N.p., 13 Feb. 2017. Web. 14 Feb. 2017.
2.”Disposal of Fixed Assets – What are the Journal Entries?” Double Entry Bookkeeping. N.p., 06 Nov. 2016. Web. 15 Feb. 2017.
3.”What are unrealized gains and losses?” What are unrealized gains and losses? | Investopedia. N.p., n.d. Web. 15 Feb. 2017.
4.”Recording Unrealized Gains and Losses of Investment Accounts.” The Accountant Beside You. N.p., n.d. Web. 15 Feb. 2017.
5.”Income Statement (Profit and Loss Statement) | Explanation | AccountingCoach.” AccountingCoach.com. N.p., n.d. Web. 15 Feb. 2017.
Image Courtesy:
1.”Price of oil (2003-2008)”By Equilibrium007 – Own work (Public Domain) via Commons Wikimedia