Trading Securities

Updated on January 11, 2024

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.

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If 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. Trading securities include equity mutual funds and exchange-traded funds.

Key Takeaways

  1. Trading securities are debt or equity assets that a company’s management actively seeks to buy and sells to profit in the near term on securities they anticipate will gain in price. These securities can be found on the balance sheet at the fair value as of the balance sheet date.
  2. The fact that these securities are exchanged frequently—sometimes even daily—on the open market makes them the fastest-moving securities. The company’s management is directly in charge of these securities, managing them to determine whether they will increase earnings for the present period.
  3. These investments are regarded as the company’s current assets for the time being because the company will presumably sell them. Securities’ market values fluctuate every day. Because of this, the securities must be displayed at fair value.

Trading Securities Explained

The trading securities are those financial instruments that the company purchases and holds for short term and then sell off with the intention of earning profits. In this way the companies take advantange of the fluctuations in prices of those securities in the financial market and makes profit for short term, thus, capitalizing on market opportunities. Investment in trading securities are reported in the balance sheets of the company in the form of assets.

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.read more, and available for sale securitiesAvailable For Sale SecuritiesAvailable for sale Securities are the company's debt or equity securities investments that are expected to be sold in the short run and will are not be held to maturity. These are reported on the balance sheet at fair value, and any unrealized gains or losses on these securities are reported in other comprehensive income as a part of shareholders' equity rather than in the income statement.read more.

We will understand more about the securities that are trading 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.

They are reported at the fair market value in the balance sheet of the companies. But any change in the value of investment in trading securities is to be accounted for in the income statement. However, the accounting treatment of these securities can change depending on the rules and accounting standards followed in different countries.

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Trading Securities In Balance Sheet Explained in Video

 

Types

Let us study the various types of securities that are traded by entities. Some commonly traded securities are bonds, stocks, exchange traded funds or derivatives.

  • Stocks – The stocks are the shares of companies that are bought and sold in the stock exchange. The companies listed in the stock exchange, issue the shares to the general public who invest in such stocks, thus getting a part of the company ownership. This type of trading securities on balance sheet is a way in which companies raise capital for meeting their operational expenses. The management is not under the obligation to pay back the raised amount but in return, the investors are entitled to certain rights in the management decisions. Investors use these stocks to take advantage of price fluctuations and earn profits or make long term investments in them.
  • Bonds – Bonds are the debt instruments issued by companies or the government and municipalities. It is a form of borrowing made by the bond issuers from the investors. Due to this, the issuer is obliged to pay back the amount to the investor within a period of time, known as maturity date, along with interest which are known as coupon payment. There are different kinds of bonds available in the market which the investors purchase as per their risk appetite, investment horizon and objective. It is important to check the credit rating of the issuer before investment.
  • Derivatives – They are financial instruments whose value depends on another underlying asset. Derivatives are of various types like forwards, futures, options or swaps and are widely used for hedging, speculation or getting the exposure to a particular market or asset without directly having their ownership. Thading in them offer some benefits like capitalizing on market fluctuation, risk management or increase in market liquidity. However, there is the element of counterparty risk and possibility of large losses, ddue to which there are some strict rules and regulations in the contracts.
  • Exchange traded funds – They are the funds are those that include a portfolio of assets, which may include stocks, bonds or commodities. This type of trading securities on balance sheet is traded like individual stocks in the stock exchange. The advantage is that thy have low broker commissions and low expense ratio than individually buying stocks. They are commonly used to track some particular investment strategies.

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Accounting

As per the accounting system of trading securities accounting, 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.read more 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.read more of a company during that period.

After that, at the end of each accounting period, which may be each quarter or every year a comparison is made between the fair market value of the security and their original price. If there is any change, then the change in valuation is recorded in the profit and loss statement. If the difference gives a positive amount, that is the market value is more than the original cost, there is an unrealized gain. Else, it is known as unrealized loss. They remain urealized till they are sold of by the entity.

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.read more 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 of trading securities accounting 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.read more. 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.read more the temporary account and transfer the amount to the income statement.

Example

Let us understand the concept with the help of a suitable example.

ParticularsDebitCredit
Investment in Trading Securities$100,000
To Cash$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.read more “Cash” to invest in the securities.

The next transaction would be related to the cash dividend. Since Grow & Lead Corporation has declared a cash dividendDeclared A Cash DividendDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities.read more of $0.50 per share, here’s the journal entry for that particular transaction –

ParticularsDebitCredit
Cash$100,000
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. read more because United Co. has been receiving cash in the form of the dividend. If the asset increases, we debitDebitDebit represents either an increase in a company’s expenses or a decline in its revenue. read more 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.read more 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. –

ParticularsDebitCredit
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 –

ParticularsDebitCredit
Cash$20,000
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 –

Trading Securities Vs Available For Sale Securities

The above are two different types of financial assets that entities hold in their investment portfolio. However, there some differences in both of them, as given below:

  • The intention of the former is to trade to earn profits for short term but the aim of the latter is not necessarily for short term
  • The former takes advantage of price fluctuation for short term for trading purpose, but the latter may be held for a long term with the intention to earn interest or dividend.
  • The former is reported in the balance sheet at the fair market value and any subsequent change in it is, which may be a gain or loss, are reported in the profit and loss statement. But for the latter, even though the fair value is recorded in balance sheet, any chages are not recorded in income statement. The unrealized changes are recorded in the statement of changes in equity.
  • The former which may be done physically or through online trading securities is frequently bought and sold, and they require constant monitoring and management. However, the latter is held for longer periods and their purchase or sale depends on market conditions and investment strategy.

Thus, we see that the main distinction is in the accounting treatment trading intention. It is necessary to understand both the concepts clearly so that companies can profitable invest in both and maximize investment value.

Frequently Asked Questions (FAQs)

Is trading securities a kind of wealth?

Trading securities are recorded on the asset side of a company’s balance sheet as current assets. However, these assets are temporary since the corporation plans to buy and sell them as soon as possible to make a profit.

Is cash a part of trading securities?

Marketable securities are easily and affordably convertible into cash. Therefore, they are highly liquid financial products. In addition, marketable securities are liquid since they typically have maturities of less than one year and little impact on prices from the rates at which they can be bought or sold.

Where is trading in securities done?

Securities are created on the primary market, and investors trade those securities on the secondary market. In addition, companies sell fresh stocks and bonds to the public for the first time on the primary market, such as through an initial public offering.

This article has been a guide to what is Trading Securities. We explain it with example, differences with available for sale securities, accounting and types. You may learn more about accounting from the following articles –

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