Reclassification of Investments: Rules, Accounting Treatment, and Financial Reporting

Companies sometimes change their intentions regarding the investments they hold.

When this happens, accounting standards allow (or require) a reclassification of investments between categories like Held-to-Maturity (HTM), Available-for-Sale (AFS), and Trading Securities.

This article explains the reclassification rules, accounting treatment, examples, and disclosure requirements under U.S. GAAP (ASC 320) and IFRS (IFRS 9).

1. When Can Investments Be Reclassified?

Under both U.S. GAAP and IFRS, investment reclassification is restricted and only allowed under specific conditions, including:

✦ A change in intent by management

✦ A change in circumstances that was not anticipated at initial classification

✦ Regulatory or legal changes forcing a different classification

Companies must have credible and documented reasons to justify reclassification, and frequent or inappropriate reclassifications can undermine financial reporting integrity.

2. Permissible Reclassifications and Their Accounting

Here’s how reclassifications are handled depending on the source and destination investment category:

(A) From Trading to AFS or HTM:

✦ Not generally permitted.

✦ Trading securities must be sold or maintained as trading until maturity (if debt).

(B) From AFS to Trading:

✦ At the reclassification date: Recognize any unrealized gains or losses immediately in net income. Adjust carrying value to fair value.

(C) From HTM to AFS:

✦ At the reclassification date: Measure investment at fair value. Recognize any difference between amortized cost and fair value in OCI (not in net income).

(D) From AFS to HTM:

✦ At the reclassification date: Fair value becomes the new amortized cost. Any unrealized gains or losses already in OCI are amortized over the remaining life of the security (not recognized immediately in earnings).

(E) From HTM to Trading:

✦ At the reclassification date: Measure investment at fair value. Recognize the difference between amortized cost and fair value immediately in net income.

3. Practical Examples of Reclassification

Example 1 – AFS to Trading:

• Carrying value (fair value) = $105,000

• Original cost = $100,000

• Unrealized gain in OCI = $5,000

Reclassification journal entry:

Debit: Unrealized Gain – OCI – $5,000

Credit: Unrealized Gain – Income – $5,000

Effect: Unrealized gain moves from OCI into net income immediately.

Example 2 – HTM to AFS:

• Amortized cost = $95,000

• Fair value = $90,000

• Unrealized loss = $5,000

Reclassification journal entry:

Debit: Unrealized Loss – OCI – $5,000

Credit: Held-to-Maturity Securities – $5,000

The security is now carried at fair value as an AFS security, and the loss affects OCI, not net income.

4. Impact of Reclassification on Financial Statements

✦ Balance Sheet: New classification determines whether securities are carried at fair value (AFS, Trading) or amortized cost (HTM).

✦ Income Statement: Reclassifications may trigger immediate recognition of unrealized gains or losses into earnings.

✦ Other Comprehensive Income (OCI): AFS securities' previous unrealized gains or losses stay in OCI unless moved to trading.

5. Special Note on "Tainting" the HTM Portfolio

Under U.S. GAAP (ASC 320):

✦ Selling or reclassifying a significant amount of HTM securities (for reasons other than allowed exceptions) "taints" the portfolio.

✦ Result: All remaining HTM securities must be reclassified as AFS, and future use of HTM classification may be prohibited for a period of time.

Allowed exceptions include:

✦ Significant deterioration in the issuer’s creditworthiness

✦ Regulatory changes requiring sale

✦ Major business combination or corporate restructuring

✦ Unanticipated external events (e.g., natural disasters)

6. IFRS Approach to Reclassification (IFRS 9)

Under IFRS 9, reclassifications are only allowed when there is a change in the business model for managing financial assets.

Key points:

✦ Reclassification is applied prospectively from the reclassification date

✦ Reclassification between amortized cost, FVOCI (fair value through OCI), and FVTPL (fair value through profit or loss) is allowed based on business model change

✦ Gains/losses are treated based on movement between categories: FVOCI to FVTPL: reclassify cumulative OCI into income FVTPL to FVOCI: fair value becomes new carrying amount; no adjustment to profit/loss Amortized Cost to FVTPL: recognize fair value difference immediately in profit/loss

7. Disclosure Requirements

When investments are reclassified, companies must disclose:

✦ The reason for the reclassification

✦ The amount reclassified

✦ The impact on the financial statements (e.g., net income, OCI)

✦ Details of any tainting of HTM securities (if applicable)

Clear disclosure provides transparency into management’s investment strategies and market responsiveness.

8. Summary of Reclassification Rules

From → To	Accounting Treatment
AFS → Trading	Recognize unrealized gains/losses in net income
HTM → AFS	Recognize unrealized gains/losses in OCI
AFS → HTM	Fair value becomes new amortized cost; amortize OCI balance
HTM → Trading	Recognize fair value difference in net income
Trading → Other	Generally not permitted