Updated July 14, 2023
Definition of Trading Securities in Balance Sheet
Trading securities are either debt or equity securities that a company buys to make a short-term profit by selling them in the near future. As the company’s intent for buying trading securities is not to hold for the long term, the securities must show positive movement in a short span of time and should help companies realize returns quickly. In this topic, we are going to learn about Trading Securities in balance sheet.
The company must correctly identify trading securities. As the company wants to sell them quickly, it no longer has a horizon to hold and wait for positive movement. Companies trade on securities on which they have expertise. So the trading security will generally be from the industry similar to the company’s business line.
How to Report Trading Securities in Balance Sheet?
The company reports Trading Securities in the Balance Sheet at Fair Value, representing the market value. Since Trading Securities are actively traded, their prices fluctuate daily.
The company purchases Trading Securities for short-term gain, including them as part of Current Assets in the Balance Sheet. Another “Short-Term Investments” line item is added under Current Assets to record all the firm’s short-term investments. The Balance Sheet incorporates Trading Securities under the “Short-Term Investments” heading.
As the Fair value of trading securities recorded in the Balance Sheet changes daily, any gain or loss incurred from the security before its sale in the market is referred to as Unrealized Gain/Loss. The company adds a separate line item under the Equity portion of the Balance Sheet to record the Unrealized Gain/Loss of the “Trading Securities in Balance Sheet.” The head under which unrealized gain/loss is recorded in the Equity portion is called “Unrealised Profit/Loss from the sell of Short Term Investment”. The income statement records the realized gain/loss, including dividend income, interest income, and profit/loss from the sale of securities.
Examples of Trading Securities in Balance Sheet
Company XYZ is a steel manufacturing company. The company’s management plans to diversify the income source and decides to invest some money in the equity market. The management thinks “John Steel”, another steel company in the market, will perform well this year. If the performance of “John Steel” is good, then the share price of John Steel will increase. Considering this to be a short-term gaining stock. Company XYZ purchased the “John Steel” stock for trading purposes. “John Steel” also gives a dividend of $4 per share. Company XYZ buys 100 shares of John Steel at the rate of $ 50 per share. Show journal entries when the stock price of John Steel will drop to $40, but company XYZ will not sell it.
As Company XYZ will buy John Steel’s stock, cash will go out, and Current assets will increase. Company XYZ will be buying 100 shares of John Steel. The market price of John Steel is $50. So total investment will be (Share Price * Number of Shares) => 50 * 100 = 5,000
Investment in Trading Securities A/C …. Dr $5,000
To Cash A/C ……Cr $5,000
(Being Securities Purchased with Cash)
As Trading security is purchased with cash, the cash account will be reduced, and the Investment in trading securities accounts will increase. As a cash account carries a debit balance, crediting it will reduce the account’s balance. Similarly, investment in trading securities carries a debit balance, so debiting it further increases the account balance.
When the stock pays a dividend, this is a realized return. So Income Statement will be increased with the dividend amount. Company XYZ holds 100 shares of John Steel. As John Steel is giving $4 as a dividend per share, so total dividend received by company XYZ will be (100 * 4 = 400)
Cash A/c ….. Dr $400
To Dividend Revenue A/C ….. Cr $400
(Being Cash received as a dividend)
The Dividend Revenue will be shown as Income in the Income statement.
The Recorded value of the trading security in the balance sheet is $50, so when the price of John Steel’s share drops to $40, then the fair value of the trading securities will change in the balance sheet, and the unrealized loss will have to be recorded in Equity. As the price dropped from $50 to $40, there was an unrealized loss of $10 per share. Company XYZ is holding 100 shares, so the total unrealized loss is 100 * 10 = $1,000
Unrealized Loss in Trading Asset A/C ….. Dr $1,000
To Investment in Trading asset A/C …. Cr $1,000
(Being unrealized loss from trading asset recorded)
The adjustment will directly reflect in the income statement when the sale of the trading asset is eventually made.
Some of the advantages are as follows:
- Trading Securities help to realize short-term gains for the company. At times there are good short-term opportunities that arise in the market. Trading securities help companies to realize it.
- Recording trading securities at fair value enables the company to represent its investments accurately.
- Recording trading securities as current assets leads to an improvement in the current ratio.
- The liquidity of trading securities is high as they constantly trade in the market. The company can quickly liquidate the security if there is any financial crunch.
Trading Securities in the balance sheet are used as Current assets, so the liquidity problem is not there. Companies should be extremely careful while investing in trading securities, as trading securities are extremely volatile and can result in a loss. Companies can utilize excess cash for a short-term period to purchase trading securities actively.
This is a guide to Trading Securities in Balance Sheet. Here we also discuss the definition and how to report trading securities in a balance sheet. Along with advantages. You may also have a look at the following articles to learn more –