Trading Securities

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.read more, and available for sale securities.

We will understand more about the securities that are trading in detail.

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Source: Trading Securities (wallstreetmojo.com)

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.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.

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 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.

Journal Entries 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 dividend 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 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.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.

Conclusion

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 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 –

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