What is Trading Securities?
Trading securities are investments in the form of debt or equity that the management of the company wants to actively purchase and sell to make profit in the short term with securities they believe are going to increase in price, these securities can be found on the balance sheet at the fair value on the balance sheet date.
For example, let’s say that the management of a company invests a certain amount of money in debt or equity (meaning in a particular bond or a stock) for a short period. The purpose of doing this is to buy and sell that particular bond or the stock within a short while to make money.
As we note from Starbucks SEC Filings, Trading securities include equity mutual funds and exchange-traded funds.
There are three classifications of securities as per accounting – trading securities, held to maturity securitiesHeld To Maturity SecuritiesHeld to maturity securities are the debt securities acquired with the intent to keep them until maturity. This type of security is recorded as an amortized cost in the company's financial statements, treated as debt security with a particular maturity date., and available for sale securities.
We will understand more about the securities that are trading in detail.
Understand Trading Securities in Detail
Trading securities in the balance sheet are the fastest moving securities among all three.
The reason these securities are the fastest moving is that these securities are traded regularly (even daily) in the open market. And these securities are managed directly by the management of the company to see whether these securities can bring in more profits for the current period or not.
As per the accounting system, such securities are placed in the balance sheet of a companyBalance Sheet Of A CompanyA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. at a fair value. It is done so that the economic benefit (or loss) can be shown on the financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. of a company during that period.
Since the company will most probably sell off the investments, these investments are considered as the current assets of the companyCurrent Assets Of The CompanyCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. for the period.
The market value of securities changes every day. That’s why the securities must be shown at the fair value.
But the question remains what would we do till the time the investments are not sold? The treatment for this is to create a temporary account to which we can transfer the unrealized gain or lossUnrealized Gain Or LossUnrealized Gains or Losses refer to the increase or decrease respectively in the paper value of the company's different assets, even when these assets are not yet sold. Once the assets are sold, the company realizes the gains or losses resulting from such disposal.. And whenever the selling is done, we can write offWrite OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets. the temporary account and transfer the amount to the income statement.
Journal Entries Example
- United Co. has kept aside $100,000 for short-term investment purposes. This amount won’t be used for any operational purpose or working capital. This money would purely be used for making a quick gain on the short-term investment.
- The management of United Co. has seen that Grow & Lead Corporation has been doing extremely well for the last couple of years. And United Co. decided to invest the entire amount into the stocks of the Grow & Lead Corporation. The market priceMarket PriceMarket price refers to the current price prevailing in the market at which goods, services, or assets are purchased or sold. The price point at which the supply of a commodity matches its demand in the market becomes its market price. of each stock of Grow & Lead Corporation was $5 per stock.
- In the first year of investment, Grow & Lead Corporation has paid out a cash dividendCash DividendCash dividend is that portion of profit which is declared by the board of directors to be paid as dividends to the shareholders of the company in return to their investments done in the company. Such a dividend payment liability is then discharged by paying cash or through bank transfer. of $0.50 per share. At the end of the year, the value of shared purchased by United Co. reached $125,000.
- Later in the next year, when the shares were sold, the amount received was $120,000.
- How would we report these transactions assuming that the management of United Co. had invested $100,000 for trading securities?
- First of all, we will treat each one transaction separately and would see how each transaction would get reflected in the books of United Co.
- The first transaction was to invest $100,000 in trading securities of Grow & Lead Corporation. At $5 per share, United Co. had bought 20,000 shares. And the following would be the entry in the books of accounts of United Co. –
|Investment in Trading Securities||$100,000|
This journal entry was passed so that we can create a current asset called “Investments in Trading Securities” and record it in the balance sheet of United Co. And cash is credited since United Co. has to let go of the other current assetCurrent AssetOther current assets refer to the category of assets which record all the uncommon and insignificant assets readily convertible into cash and doesn't fit in any common current assets categories like cash & cash equivalents, inventory, trade receivables, etc. “Cash” to invest in the securities.
The next transaction would be related to the cash dividend. Since Grow & Lead Corporation has declared a cash dividend of $0.50 per share, here’s the journal entry for that particular transaction –
|To Dividend Revenue||$100,000|
We passed this entry to reflect the income received in the income statement. We have debited cash accountCash AccountCash Accounting is an accounting methodology that registers revenues when they are received & expenditures when they are paid in the given period, thereby aiming at cash inflows & outflows. because United Co. has been receiving cash in the form of the dividend. If the asset increases, we debitDebitDebit is an entry in the books of accounts, which either increases the assets or decreases the liabilities. According to the double-entry system, the total debits should always be equal to the total credits. the asset. At the same time, we have credited divided revenue because when income increases, we credit the account. And the same dividend revenue can be reflected in the income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements. of the books of accounts of United Co.
Finally, the major transaction of the above example of trading securities is the fair value at which the value of shares was recorded at the end of the year.
According to that, United Co. had gained $(125,000 – $100,000) = $25,000 as unrealized gain. Since the money is not received, we will record the following journal entry in the books of United Co. –
|Investments in Trading Securities||$25,000|
|To Unrealized Gain on Trading Securities||$25,000|
The next year, United Co. was able to sell the shares and gained $120,000 from the sale. Meaning the actual profit was $(120,000 – 100,000) = $20,000.
But in the previous year’s balance sheet, United Co. had shown $25,000 as the unrealized gain. So, here’s the final entry we need to pass for making things right –
|Loss on Sale of Trading Securities||$5,000|
|To Investment in Trading Securities||$25,000|
By doing this, United Co. has made things right. The real gain was $20,000, and by passing the last entry, the investment in trading securities got closed, and United Co. had got a profit of $20,000.
From the above discussion, it’s clear that how a company can use a certain amount of money for short-term investments and can gain a lump sum amount at the end of the period.
Two things are most important here –
- First, at the end of the year, the balance sheet should reflect the fair value of the stocks or the bonds in which the amount is being invested.
- Second, the [wsm-tooltip header="Reverse Entry" description="Reversing entries refer to those journal entries passed in the current accounting period to offset the entries for outstanding expenses and accrued income recorded in the immediately preceding accounting period." url="https://www.wallstreetmojo.com/reversing-entries/"]reverse entryReverse EntryReversing entries refer to those journal entries passed in the current accounting period to offset the entries for outstanding expenses and accrued income recorded in the immediately preceding accounting period.[/wsm-tooltip] to effect the unrealized gain or loss.
Trading Securities in Balance Sheet Video
This article has been a guide to what is Trading Securities? Here we discuss why trading securities are reported at fair value on the balance sheet along with examples and journal entries. You may learn more about accounting from the following articles –