How Unrealized Gains and Losses Are Recorded in the Income Statement

Graziano Stefanelli
Sep 30
3 min read

Unrealized gains and losses represent changes in the fair value of financial instruments or other assets that have not yet been sold or settled. Their treatment in the income statement depends on the type of asset, the business model for managing it, and the applicable accounting framework. Under both IFRS and US GAAP, some unrealized gains and losses are recognized immediately in profit or loss, while others bypass the income statement and are reported in other comprehensive income (OCI).

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When unrealized gains and losses flow through profit or loss

Unrealized gains and losses appear in the income statement when financial assets are classified as:

IFRS 9: Fair value through profit or loss (FVTPL).
US GAAP (ASC 320): Trading securities or derivatives not designated as hedges.

For example, if an equity investment carried at FVTPL increases in value from 100,000 to 120,000, the 20,000 unrealized gain is recorded in the income statement as part of investment income.

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When unrealized gains and losses bypass profit or loss

Certain assets and transactions direct unrealized changes to OCI instead of the income statement:

Debt instruments at FVOCI (IFRS 9).
Available-for-sale securities (US GAAP prior to ASC 326).
Cash flow hedge effective portions.
Foreign currency translation adjustments.

These amounts accumulate in equity under “Accumulated Other Comprehensive Income” until reclassified to profit or loss upon realization.

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Journal entries to recognize unrealized gains and losses

If an investment increases in fair value by 5,000 at FVTPL:

Debit: Investment in Securities 5,000
Credit: Unrealized Gain (Income Statement) 5,000

If the same instrument is classified as FVOCI:

Debit: Investment in Securities 5,000
Credit: OCI – Unrealized Gain 5,000

This demonstrates how classification determines whether the change impacts net income or equity directly.

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Standards governing unrealized gains and losses

IFRS 9: Requires classification based on business model (trading, collecting cash flows, or both) and contractual cash flow characteristics. Unrealized gains/losses flow through profit or loss for FVTPL assets and through OCI for FVOCI assets.
US GAAP: Trading securities record unrealized gains and losses in income. Available-for-sale securities record them in OCI. Held-to-maturity securities are carried at amortized cost and are not adjusted for fair value changes unless impaired.

These standards ensure consistent treatment across different categories of financial assets.

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Impact on income statement and performance metrics

Unrealized gains and losses recognized in profit or loss directly affect net income and earnings per share. Those recorded in OCI bypass earnings but reduce or increase equity. For analysts, the distinction is critical: unrealized income in profit or loss may create volatility in earnings, while amounts in OCI affect book value but not current-period profitability.

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Disclosures required in financial statements

Companies must disclose:

Methods used to measure fair value.
Amounts of unrealized gains and losses recognized in income and OCI.
Reclassification adjustments from OCI to profit or loss.
Risk exposures affecting fair value changes.

This disclosure helps investors assess the extent to which earnings are driven by realized operations versus market-driven revaluations.

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Operational considerations

The recognition of unrealized gains and losses affects not only reported income but also risk perception. Heavy volatility in fair value reporting may obscure underlying operating performance. Analysts must distinguish between realized and unrealized results to evaluate sustainable profitability. Companies should provide clear disclosures and explanations to help stakeholders understand the impact of fair value changes on financial performance.

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DATA STUDIOS

.....[datastudios.org]