Unrealised Gain - Definition and How does It Works?

An unrealised gain refers to the increase in the value of an asset or investment that an individual or entity holds but has not yet sold for cash. This gain remains "unrealised" because it exists only on paper and has not been converted into actual profit through a sale. For instance, if you own shares in a company and their market value rises, the profit you would make by selling them represents an unrealised gain until the sale occurs.

What is an unrealised gain

An unrealised gain occurs when the current market value of an asset exceeds its original purchase price, and the asset is still held by the owner. These gains are common in investments such as stocks, bonds, real estate, and other assets subject to market fluctuations. It's important to note that unrealised gains can fluctuate with market conditions; today's gain could diminish or turn into a loss if the asset's value decreases. In accounting terms, unrealised gains are often reported differently than realised gains, which are profits earned from the actual sale of an asset.

Recording unrealised gains

The accounting treatment of unrealised gains depends on the type of asset and the applicable accounting standards. For investments classified as "available-for-sale" securities, unrealised gains are typically recorded in a separate component of equity known as "Other Comprehensive Income" (OCI) rather than in the income statement. This approach reflects the potential gain without recognising it as actual income until the asset is sold. The journal entry for recording an unrealised gain on an available-for-sale security involves debiting the investment account to increase its value and crediting the OCI account to reflect the gain in equity. This method ensures that financial statements provide a comprehensive view of an entity's financial position, including potential gains that have not yet been realised.

How an unrealised gain works

Unrealised gains represent the potential profit on assets that have increased in value but have not yet been sold. For example, if an investor purchases shares at Rs. 1,000 and the market value rises to Rs. 1,500, the Rs. 500 increase is an unrealised gain as long as the shares are held. These gains can impact an investor's perceived wealth and influence financial decisions, such as portfolio rebalancing or assessing investment performance. However, since unrealised gains are not actualised, they do not immediately affect cash flow. It's also important to consider that tax implications on unrealised gains vary by jurisdiction; in many cases, taxes are not owed until the gain is realised through a sale.

Example of an unrealised gain

Consider an investor who purchases 100 shares of a company at Rs. 50 per share, totalling an initial investment of Rs. 5,000. Over time, the market price per share increases to Rs. 70. The total value of the investment is now Rs. 7,000 (100 shares x Rs. 70), resulting in an unrealised gain of Rs. 2,000 (Rs. 7,000 - Rs. 5,000). This gain remains unrealised as long as the investor holds the shares. If the investor decides to sell the shares at the current market price, the Rs. 2,000 gain becomes realised, and depending on the applicable tax laws, the investor may be required to pay taxes on the realised gain.

Conclusion

Unrealised gains reflect the increase in value of assets that have not yet been sold, representing potential profit on paper. Understanding how to account for and interpret unrealised gains is crucial for accurate financial reporting and informed investment decisions. While these gains can enhance the perceived value of an investment portfolio, it's important to remember that they are subject to market volatility and do not impact actual cash flow until realised through a sale.

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