Final answer:
Realized gains or losses occur only when an asset is sold or disposed of, not when it is merely adjusted to fair value on the company's books. Any such adjustment represents an unrealized gain or loss. Therefore, the correct answer to the student's question is false (b. false).
Step-by-step explanation:
Realized gains or losses occur when a company actually sells the asset, not just when an asset is adjusted to its fair value on paper.
Gains and losses become realized when a transaction occurs and the asset is actually disposed of. Therefore, if a company adjusts the value of an asset on its books to reflect fair value, but does not actually sell the asset, any gain or loss is considered unrealized. Unrealized gains and losses can affect the balance sheet and the income statement, but they do not result in actual cash flow changes until the asset is sold and the gains or losses become realized.
Example of Unrealized Gain
For instance, if a company owns stock in another company and the stock's market value increases, the company holding the stock may adjust the value on its books. This adjustment reflects the stock's increased fair value, resulting in an unrealized gain. It is only when the company actually sells the stock at the increased value that the gain becomes realized.
Example of Unrealized Loss
Conversely, if the fair value of the asset declines below its book value, this constitutes an unrealized loss. This loss will only become realized if the company decides to sell the asset at its reduced fair value.