Getting Started Trading Securities

Trading securities Investments in debt and equity securities that the company intends to actively trade for profit. are debt and equity securities that the company intends to actively manage and trade for profit. Frequent purchases and sales are expected and are made to earn profits on short-term price changes. Trading securities are always reported as current assets.

Valuing and reporting trading securities. The entire portfolio of trading securities is reported at its fair value; this requires a “fair value adjustment” from the cost of the portfolio. The term portfolio refers to a group of securities. Any unrealized gain (or loss) from a change in the fair value of the portfolio of trading securities is reported on the income statement. Most users believe accounting reports are more useful when changes in fair value for trading securities are reported in income.

Point: Unrealized gain (or loss)’ refers to a change in fair value that is not yet realized through actual sale.

To illustrate, TechCom’s portfolio of trading securities had a total cost of $11,500 and a fair value of $13,000 on December 31, 2010, the first year it held trading securities. The difference between the $11,500 cost and the $13,000 fair value reflects a $1,500 gain. It is an unrealized gain because it is not yet confirmed by actual sales. The fair value adjustment for trading securities is recorded with an adjusting entry at the end of each period to equal the difference between the portfolio’s cost and its fair value. TechCom records this gain as follows.

 



Point: ‘Fair Value Adjustment—Trading’ is a permanent account, shown as a deduction or addition to ‘Short-Term Investments—Trading.’

The Unrealized Gain (or Loss) Gain (loss) not yet realized by an actual transaction or event such as a sale. is reported in the Other Revenues and Gains (or Expenses and Losses) section on the income statement. Unrealized Gain (or Loss)—Income is a temporary account that is closed to Income Summary at the end of each period. Fair Value Adjustment—Trading is a permanent account, which adjusts the reported value of the trading securities portfolio from its prior period fair value to the current period fair value. The total cost of the trading securities portfolio is maintained in one account, and the fair value adjustment is recorded in a separate account. For example, TechCom’s investment in trading securities is reported in the current assets section of its balance sheet as follows.

 
Example: If TechCom’s trading securities have a cost of $14,800 and a fair value of $16,100 at Dec. 31, 2011, its adjusting entry is



Selling trading securities. When individual trading securities are sold, the difference between the net proceeds (sale price less fees) and the cost of the individual trading securities that are sold is recognized as a gain or a loss. Any prior period fair value adjustment to the portfolio is not used to compute the gain or loss from sale of individual trading securities. For example, if TechCom sold some of its trading securities that had cost $1,000 for $1,200 cash on January 9, 2011, it would record the following.

Point: Reporting securities at fair value is referred to as mark-to-market accounting.
 
 



A gain is reported in the Other Revenues and Gains section on the income statement, whereas a loss is shown in Other Expenses and Losses. When the period-end fair value adjustment for the portfolio of trading securities is computed, it excludes the cost and fair value of any securities sold.