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Trading Securities

Accounting for companies' short-term investments

What are Trading Securities?

Trading securities are securities that have been purchased by a company for the purposes of realizing a short-term profit. Companies do not intend to hold such securities for a long period of time; thus, they will only invest if they believe they have a good chance of being compensated for the risk they are taking. A company may choose to speculate on various debt or equity securities if it identifies an undervalued security and wants to capitalize upon the opportunity.

 

Trading Securities

 

Trading securities purchased by companies are usually securities that are issued within the company’s industry since they are securities that industry-leading organizations make the most insight about. Any industry trends or impending news announcements can also influence companies to purchase trading securities.

 

How are trading securities shown on the balance sheet?

Trading securities are treated using the fair value method, whereby the value of the securities on the company’s balance sheet will be equivalent to their current market value. These securities will be recorded in the currents assets section under the “Short Term Investments” account and will be offset in the shareholder’s equity section under the “Unrealized Proceeds From Sale of Short Term Investments” account. The Short Term Investments account represent the current market value of the securities, and the “Unrealized Proceeds From Sale of Short Term Investments” account represents the cash proceeds that the company would receive if it were to sell the investments at the end of the specified accounting period. The example below assumes that the investments are purchased at the end of the 2017 accounting period:

 

Balance Sheet - Trading Securities
Taken from CFI’s Balance Sheet Template

 

Changes in the fair value of the trading securities are recorded through journal entries that reflect any increases or decreases in the values of the assets. For instance, in the above example, we see that there has been a loss of $2 billion, as the market value of the trading securities held by the company has declined over the course of the holding period. To account for this, a company would create journal entries where the loss would be debited from a “Trading Securities Market Value Adjustment” account, and credited to the “Unrealized Gain (Loss) On Short Term Investments”. Below is an example of how this may look:

 

Journal Entry - Trading Securities

 

In practice, such journal entries would be completed at the end of the current accounting period that the company is in. In the above example, we assumed that the company’s fiscal year was the same as the calendar year (i.e beginning on January 1 and ending on December 31). However, this may not always be the case since companies may opt to follow an accounting year different from the calendar year for a number of reasons, such as seasonality of the business or tax advantages.

 

How are trading securities shown on the income statement?

On an income statement, trading securities are recorded at the time of sale. Any gains or losses realized as a result of the securities in question are to be attributed to operating income as a new line item titles “Gain (Loss) on Sale of Trading Securities.” The gains or losses that are attributable to the trading securities are only recorded at the time of sale since this is when they will materialize. Prior to the sale, the securities can still fluctuate in value – changes that will be captured on the company’s balance sheet. Below is an example of how this would look:

 

Income Statement - Trading Securities
Taken from CFI’s Income Statement Template

 

Here, we can see how in 2017, the investment did not experience any change in value (recall our initial assumption that the investments were purchased at the end of the 2017 accounting period), and that the investments lost value over the course of the 2018 accounting period (as shown by our journal entry).

 

Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following resources:

  • Budgeting and Forecasting Course – CFI
  • Accounting Fundamentals Course – CFI
  • IFRS Standards
  • Cash Flow Statement

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