Trading Securities
“Trading securities” is a financial term that refers to a category of financial instruments, typically stocks and bonds, that a company or an investment entity buys and holds primarily for the purpose of selling them in the short term to capitalize on short-term price fluctuations. These securities are essentially the opposite of “held-to-maturity” securities, which companies plan to hold until they mature.
Here are some key points about trading securities:
- Short-Term Intent: Trading securities are purchased with the intent of selling them in a relatively short period, often within a few days or months. Their main goal is to profit from short-term price movements.
- Marked to Market: These securities are marked to market at the end of each accounting period. This means that their value on the balance sheet is adjusted to reflect their current market value. Any unrealized gains or losses (i.e., gains or losses that occur on paper but haven’t been realized through an actual sale) due to this revaluation are recorded in the income statement.
- Liquidity: Given their short-term nature, trading securities are considered current assets on a company’s balance sheet.
- Income Statement Impact: As mentioned, unrealized gains or losses from revaluation are recorded in the income statement. Additionally, when the security is actually sold, any realized gain or loss (the difference between the selling price and the cost) is also recorded in the income statement.
- Not for Long-Term: They differ from “available-for-sale” securities and “held-to-maturity” securities. The former is intended to be held for an undefined period and can be sold before maturity, while the latter is intended to be held until maturity.
- Trading Activities: Entities that primarily deal with trading securities are often active traders, looking at market trends, company news, and other indicators to make frequent buy and sell decisions.
For example, if a company buys shares of another publicly-traded company with the intent of selling them after a favorable quarterly earnings report, those shares would be classified as trading securities. If the share price goes up before the sale, the company would record an unrealized gain on its income statement, and the new market value of the shares would be reflected on the balance sheet. When the company eventually sells the shares, it would record a realized gain or loss based on the selling price compared to the cost of acquisition.
It’s worth noting that the accounting treatment for trading securities ensures that stakeholders have a clear view of the impact of such securities on a company’s financial position and performance.
Example of Trading Securities
Let’s use a fictional example to understand the concept of trading securities in a practical context.
ABC Investment Corp.
ABC Investment Corp. is a financial entity that deals with purchasing and selling securities with the aim to capitalize on short-term market fluctuations.
January 1, 2023:
- ABC Investment Corp. purchases 10,000 shares of XYZ Company at $10 per share, totaling a $100,000 investment.
- ABC classifies these shares as trading securities because they plan to sell them soon, expecting that XYZ’s upcoming product launch will boost its share price.
March 31, 2023:
- By the end of the first quarter, XYZ Company’s shares have appreciated in value and are now trading at $12 per share due to positive market sentiment regarding their new product.
- Although ABC hasn’t sold the shares yet, they need to mark these trading securities to market.
Here’s how the accounting would look:
- Marking to Market:
- The total market value of the shares by March 31 = 10,000 shares x $12/share = $120,000
- Unrealized gain = $120,000 (current value) – $100,000 (purchase value) = $20,000
- ABC would adjust the value of the trading securities on its balance sheet to $120,000.
- ABC would also record an unrealized gain of $20,000 in its income statement for the first quarter.
April 15, 2023:
- Encouraged by the share price rise, ABC decides to sell the entire position of XYZ Company’s shares.
- The market price on the sale date is $13 per share.
- Recording the Sale:
- Realized gain from the sale = (Sale value) – (Original purchase value)
- Sale value = 10,000 shares x $13/share = $130,000
- Realized gain = $130,000 – $100,000 = $30,000
- ABC would record a realized gain of $30,000 in its income statement when the shares are sold.
In this example, ABC Investment Corp. realized a gain of $30,000 by selling the trading securities (XYZ Company shares) and also reported an unrealized gain of $20,000 earlier in the year, based on the appreciation in the share price at quarter-end. The distinction between unrealized and realized gains helps stakeholders understand how much of the gains are due to market fluctuations versus actual sale events.
