Question

Assume CNA Financial Corporation provides the following footnote to its 2011 10-K report.

Valuation of investments:
CNA classifies its fixed maturity securities (bonds and redeemable preferred stocks) and its equity securities as either available-for-sale or trading, and as such, they are carried at fair value. Changes in fair value of trading securities are reported within net investment income. The amortized cost of fixed maturity securities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, which are included in net investment income. Changes in fair value related to available-for-sale securities are reported as a component of other comprehensive income. Investments are written down to fair value and losses are recognized in Realized investment gains (losses) on the Consolidated Statements of Operations when a decline in value is determined to be other-than-temporary.
The following table provides a summary of fixed maturity and equity securities.

Summary of Fixed Maturity and Equity Securities
December 31, Cost or Gross Gross Estimated
2011 Amortized Unrealized Unrealized Fair
(in millions) Cost Gains Losses Value
Fixed maturity securities available-for-sale
U.S. Treasury and obligations-
of government agencies $122 $16 $1 $137
Asset-backed:
Residential mortgage-backed 6,254 101 265 6,090
Commercial mortgage-backed 994 40 41 993
Other asset-backed 753 18 8 763
Total asset-backed 8,001 159 314 7,846
States, municipalities and-
political subdivisions 8,157 142 410 7,889
Foreign government 602 18 -- 620
Corporate and other bonds 19,492 1,603 70 21,025
Redeemable preferred stock 47 7 -- 54
Total fixed maturity securities-
available-for-sale 36,421 1,945 795 37,571
Total fixed maturity securities-
trading 6 -- -- 6
Equity securities available-for-sale:
Common stock 90 25 -- 115
Preferred stock 332 2 9 325
Total equity securities-
available-for-sale 422 27 9 440
Total $ 36,849 $ 1,972 $ 804 $38,017

Required:
(A) At what amount does CNA report its investment portfolio on its balance sheet? In your answer identify the portfolio’s fair value, cost, and any unrealized gains and losses.
(B) How do CNA’s balance sheet and income statement reflect any unrealized gains and/or losses on the investment portfolio?

a) Securities are reported at historical cost. Gains and losses are recognized upon sale of the securities.
b) Securities are reported at market value. Unrealized gains and losses on AFS (Trading) securities are recorded in accumulated other comprehensive income (net income).
c) Securities are reported at market value. Only unrealized losses are recognized in net income. Unrealized gains are deferred and recognized upon sale of the securities.
d) ecurities are reported at market value. Unrealized gains and losses are recognized currently in net income.

(C) How do CNA’s balance sheet and income statement reflect gains and losses realized from the sale of
available-for-sale securities?

a) Gains and losses realized from the sale of securities are recognized in current income. The company records an accounting (reclassification) adjustment in the AOCI account to reflect the elimination of previously recorded unrealized gains and losses.
b) Gains and losses realized from the sale of securities are recognized in current income. The company records an accounting (reclassification) adjustment in retained earnings to reflect the elimination of previously recorded unrealized gains and losses.
c) Gains and losses realized from the sale of securities are recognized in current income. The company records an accounting (reclassification) adjustment in cash and cash equivalents to reflect the elimination of previously recorded unrealized gains and losses.
d) No entry is required as the securities are currently reported at market value and all unrealized gains and losses are reflected in current income. The market value changes bypass the income statement.

Answer 1

CNA reports its investment portfolio on its balance sheet at fair value, which is $38,017 million. The balance sheet and income statement reflect any unrealized gains and losses on the portfolio as an adjustment to other comprehensive income. When CNA realizes gains and losses from the sale of available-for-sale securities, they are recognized in current income and an accounting adjustment is made in retained earnings.

Step-by-step explanation:

CNA reports its investment portfolio on its balance sheet at fair value, which is the estimated value of the securities at a particular point in time. The fair value of the portfolio is $38,017 million. The cost of the portfolio is $36,849 million, which represents the price originally paid to acquire the securities. The portfolio also has unrealized gains of $1,972 million and unrealized losses of $804 million. These unrealized gains and losses are not included in net income but are reported as a component of other comprehensive income.

CNA's balance sheet and income statement reflect any unrealized gains and losses on the investment portfolio as an adjustment to other comprehensive income. Unrealized gains and losses related to available-for-sale securities are reported as a component of other comprehensive income and are not included in net income. This means that option b) is the correct answer. The market value changes of the securities do not bypass the income statement.

When CNA realizes gains and losses from the sale of available-for-sale securities, they are recognized in current income. The company records an accounting (reclassification) adjustment in retained earnings to reflect the elimination of previously recorded unrealized gains and losses. This means that option b) is the correct answer for how CNA's balance sheet and income statement reflect gains and losses realized from the sale of available-for-sale securities.

Answer 2

(A) $37,571

(B) b) Securities are reported at market value. Unrealized gains and losses on AFS (Trading) securities are recorded in accumulated other comprehensive income (net income)

(C) a) Gains and losses realized from the sale of securities are recognized in current income. The company records an accounting (reclassification) adjustment in the AOCI account to reflect the elimination of previously recorded unrealized gains and losses.

Step-by-step explanation:

(A) Available for sale securities are the investments which a company intends to sell in the near future before the maturity date. These investments are reported at fair value.

(B) The unrealized gains and losses on Available for sale securities are recognized in the accumulated other comprehensive income. These investments are reported at fair value or market value.

(C) When the available for sale securities are sold out and the gains or losses are finally realized the amount is reported in the net income and a reclassification adjustment is made to the previously recorded unrealized gain or losses in the accumulated other comprehensive income.