B is corrent. Since the securities were available-for-sale, unrealized gains and losses are reported as a component of other comprehensive income (loss) for year 1. The decline in market value from $62,000 to $55,000 should be reported as a $7,000 reduction in other comprehensive income for year 1. In year 2, the further reduction in the market value from $55,000 to $50,000 should be reported as a $5,000 reduction in other comprehensive income for year 2. Since the securities were sold in year 2 for $50,000, a realized loss of $12,000 would be reported in net income for year 2. The realized loss is computed by subtracting the selling price of $50,000 from the cost of $62,000. To avoid double counting the loss in comprehensive income, $12,000 should be reported as a reclassification adjustment in other comprehensive income for year 2. The reclassification adjustment of $12,000, when netted with the $5,000 unrealized loss recognized in year 2, causes a net positive effect of $7,000 in comprehensive income for year 2. This results in answer “B” being the correct answer. The schedule below shows how the effects described above would be reported in net income and other comprehensive income for year 1 and year 2.| | Year 1 | Year 2 | | Loss from sale of securities (reported in net income) | $ 0 | $(12,000) | | Net income | $ xxxx | $ xxxx | | Other comprehensive income: | | | | Unrealized loss on available-for-sale securities | $(7,000) | $ (5,000) | | Reclassification adjustment | $ 0 | 12,000 | | Net effect on other comprehensive income | $(7,000) | $ 7,000 |
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