Unrealized Loss (Securities) - Explained
What is an Unrealized Loss ?
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Table of ContentsWhat is an Unrealized Loss?How Do Unrealized Losses Work?Unrealized Losses in AccountingExample of an Unrealized LossAcademic Research on Unrealized Loss
What is an Unrealized Loss?
An unrealized loss is a loss that exists on paper which often results from an investor retaining an asset or security whose price or value has depreciated. A paper loss that results from an investor holding onto an asset that has declined in price or lost value is an unrealized loss. Investors hold onto assets or securities of this nature with the belief that they might recover its lost value. An asset that has declined in value but is yet to be sold has an unrealized loss, the loss turns to a realized loss after the security has been sold.
Back to: ACCOUNTING, TAX, & REPORTING
How Do Unrealized Losses Work?
The loss related to a security or asset that has declined in value remains unrealized once the asset is yet to be sold. In the case of a transaction, a losing transaction that is yet to be completed still has an unrealized loss. One such deal is closed or the asset sold, it becomes a realized loss which can then be used by an investor to offset capital gains during taxation. In certain cases, an investor can hold onto a losing asset or a security with an unrealized loss with the hope that it would regain its value. Also, an investor can decide to sell a losing asset in order to transform an unrealized loss to a realized loss especially when the investors portfolio is at stake if such asset is not sold. Here are the important facts to note about an unrealized loss;
- An unrealized loss is a paper loss of a security that has declined in value or an asset that has dropped in price.
- A transaction has has decreased in value but is yet to be sealed is an unrealized loss.
- When a losing asset is sold or a losing transaction closed, an unrealized loss is converted to a realized loss.
- Investors hold onto losing assets or securities hoping that the asset will regain its value or price.
- When a losing asset is sold, the investor has noticed that the stock will not regain its value.
Unrealized Losses in Accounting
The type and size of a losing security determines whether the account or finance of a firm will be affected by an unrealized loss. Also, unrealized loss apply to different securities differently, for instance, if a losing security is a security that has a maturity time and must be held to maturity, it has no impact on the finances of the firm. Not all unrealized losses are recorded in the financial statement of a firm, depending on the nature of the security in question. For securities that have maturity period, a firm can mention their unrealized losses in footnotes below the financial statement.
Example of an Unrealized Loss
The example below is helpful for a better understanding of an unrealized loss; Mr Brandy is an investor and purchases 50 shares of XYZ company at $20 each. After purchasing the shares, the value of the shares drop to $16 but the investor still holds onto the shares, this is an instance of an unrealized loss. Mr Brandy has an unrealized loss of $4 on each share. If after holding onto the shares with the hope that they would regain their value, if the value of the stock increased to $18 per share and Mr Brandy sells the shares, this is realized loss.
Academic Research on Unrealized Loss
- SOMA's Unrealized Loss: What does it mean?, Bonis, B., Noonan, J., & Fiesthumel, L. (2018). SOMA's Unrealized Loss: What does it mean?.
- Unrealized Gain and Loss and Dividend Law, FLB, Jr. (1942). Unrealized Gain and Loss and Dividend Law. University of Pennsylvania Law Review and American Law Register, 338-346.
- Impact of the unrealized gain or loss on stock returns: theory and tests in an alternative utility framework, Li, S. (2016). Impact of the unrealized gain or loss on stock returns: theory and tests in an alternative utility framework(Doctoral dissertation, Universit Grenoble Alpes).
- Are investors reluctant to realize their losses?, Odean, T. (1998). Are investors reluctant to realize their losses?. The Journal of finance, 53(5), 1775-1798.
- Are Taiwanese individual investors reluctant to realize their losses?, Shu, P. G., Yeh, Y. H., Chiu, S. B., & Chen, H. C. (2005). Are Taiwanese individual investors reluctant to realize their losses?. Pacific-Basin Finance Journal, 13(2), 201-223.
- Value relevance of unrealized foreign currency translation gains and losses, Bazaz, M. S., & Senteney, D. L. (2001). Value relevance of unrealized foreign currency translation gains and losses. American Journal of Business, 16(2), 55-62.
- Risk, Diversification and the Design of Loss Limitations Under a Realization-Based Income Tax, Scarborough, R. H. (1992). Risk, Diversification and the Design of Loss Limitations Under a Realization-Based Income Tax. Tax L. Rev., 48, 677.