As mentioned in the introduction to this chapter, capital gains are the profits received from the
sale of an asset. This section will describe how to record capital gains in
The accounting methods for handling asset appreciation differs somewhat from depreciation because typically you are only concerned with the moment you sell the asset and realize the capital gains. This is opposed to the continuous nature of tracking depreciation. Capital gains are an important subject in the world of taxation, because governments tend to be quite interested in taxing capital gains in one manner or another.
As always, there are exceptions. If you hold a bond that pays all of its interest at maturity, tax authorities often require that you recognize interest each year, and refuse this to be treated as a capital gain. Consult the appropriate tax codes to determine the preferred treatment for each type of asset you have which may be affected by capital gains taxes.
Estimating the increasing value of assets is generally not simple, because often it is difficult to know its exact value until the moment it is sold.
Securities traded daily on open markets such as stock exchanges are possibly the easiest type of asset to predict the value of, and selling the asset at market prices may be as simple as calling a broker and issuing a Market Order. On the other hand, estimating the value of a house is more difficult. Homes are sold less often than stocks, and the sales tend to involve expending considerable effort and negotiations, which means that estimates are likely to be less precise. Similarly, selling a used automobile involves a negotiation process that makes pricing a bit less predictable.
Values of collectible objects such as jewelry, works of art, baseball cards, and “Beanie Babies” are even harder to estimate. The markets for such objects are much less open than the securities markets and less open than the housing market. Worse still are one-of-a-kind assets. Factories often contain presses and dies customized to build a very specific product that cost tens or hundreds of thousands of dollars; this equipment may be worthless outside of that very specific context. In such cases, several conflicting values might be attached to the asset, none of them unambiguously correct.
The general rule of thumb in accounting for estimating unrealized gains (or loses) is that you should only revalue assets such as stocks which are readily sellable and for which there are very good estimates of the value. For all other assets, it is better to simply wait until you sell them, at which time you can exactly determine the capital gains. Of course, there is no hard rule on this, and in fact different accountants may prefer to do this differently.